20-F 1 a06-6447_120f.htm ANNUAL AND TRANSITION REPORT OF FOREIGN PRIVATE ISSUERS

 

As filed with the Securities and Exchange Commission

 

 

SECURITIES AND EXCHANGE COMMISSION

 

Washington, D.C. 20549

 


 

FORM 20-F

 

o

 

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

 

 

THE SECURITIES EXCHANGE ACT OF 1934

 

 

OR

ý

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

 

 

THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the fiscal year ended December 31, 2005

 

 

OR

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number: 1-13980

 

Koninklijke KPN N.V.

(Exact name of registrant as specified in its charter)

 

Royal KPN N.V.

(Translation of Registrant’s Name into English)

 

The Netherlands

(Jurisdiction of incorporation or organization)

 

Maanplein 55

2516 CK The Hague

The Netherlands

(Address of principal executive offices)

 

Securities registered or to be registered pursuant to Section 12(b) of the Securities Exchange Act of 1934:

 

Title of each class

 

Name of each exchange
on which registered

 

 

 

Ordinary Shares

 

New York Stock Exchange*

American Depositary Shares

 

New York Stock Exchange

 


*                                         The Registrant’s Ordinary Shares are not listed for trading, but only in connection with the registration of American Depositary Shares (“ADSs”) which are evidenced by American Depositary Receipts (“ADRs”).

 

Securities registered or to be registered pursuant to Section 12(g) of the Securities Exchange Act of 1934:

 

None

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Securities Exchange Act of 1934:

 

None

 

Number of outstanding shares of each of the Registrant’s classes of capital or common stock as of December 31, 2005, the close of the period covered by the annual report:

 

                                        2,151,360,368 Ordinary Shares; and

                                        1 Special Share

 

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

 

 

Yes ý

No o

 

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 o

No ý

 

Note—checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those sections.

 

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 ý

No o

 

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 ý

Accelerated filer o

Non-accelerated filer o

 

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

 

 

Item 17 o

Item 18 ý

 

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 o

No ý

 

 



ANNUAL REPORT AND FORM 20-F

This publication is prepared in both Dutch and English comprising the full Annual Report and Form 20-F for 2005 of Koninklijke KPN N.V. This document complies with the applicable Dutch regulations. For Dutch statutory purposes, the official English language version of the Annual Report and Form 20-F prevails. It also forms the 2005 Annual Report on Form 20-F for filing with the Securities and Exchange Commission (SEC) in the United States. Cross-references to Form 20-F are set out at the end of this document.

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CONTENTS

Profile 5

Foreword by the Chairman and CEO 6

KEY INFORMATION 8

Risk factors 12

Information about the Company 17

History and developments 17

Organizational structure 18

Fixed division 19

Mobile division 28

Other activities 32

Property, plant and equipment 33

Research and development 37

Intellectual property 37

Regulatory developments 38

Operating results 44

Consolidated Results of Operations 44

Segmental Results of Operations 47

Liquidity and capital resources 59

Critical Accounting Policies and Estimates 63

Corporate Social responsibility 68

Corporate Governance 70

Remuneration Report 80

Report by the Supervisory Board 88

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Financial statements 93

Report of Independent Registered Public Accounting Firm 96

Consolidated Income Statement 97

Consolidated Balance Sheet 98

Consolidated Cash Flow Statement 100

Consolidated Statement of Changes in Group Equity 101

General notes to the Consolidated Financial Statements 102

Notes to the Consolidated Income Statement 112

Notes to the Consolidated Balance Sheet 119

Other disclosures 136

Commitments, contingencies and legal proceedings 137

Related party transactions 140

Subsequent events 141

Notes to the Consolidated Cash Flow Statement 142

Segment Reporting 143

Information on US GAAP 146

Corporate Income Statement 154

Corporate Balance Sheet 155

General Notes to the Corporate Financial Statements 156

Notes to the Corporate Balance Sheet 157

Other Information 160

Information per quarter 161

Information about the KPN share 162

Additional information for shareholders 166

Glossary of terms 174

Cross-reference to Form 20-F 178

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PROFILE

KPN provides telephone, Internet and television services to personal customers through its fixed network in The Netherlands. For business customers, we provide a range of services, from voice, Internet and data services to fully-managed outsourced ICT solutions, in The Netherlands and internationally. For both private and business customers, we offer mobile services in The Netherlands, Germany, Belgium and Western Europe.

As of December 31, 2005, we served 6.9 million fixed-line subscribers and 2.2 million Internet customers in The Netherlands as well as 20.8 million mobile customers in Germany, The Netherlands and Belgium, while we employed 29,286 individuals (26,598 FTEs).

KPN was incorporated in 1989. Its shares are listed on Euronext Amsterdam and the stock exchanges of New York, London and Frankfurt. Our credit ratings on February 28, 2006 were BBB+ with negative outlook (Standard & Poor's) and Baa2 with stable outlook (Moody's).

Mission statement

Our customers trust us to provide them with high-quality, reliable services to help them achieve their business and personal goals, and to enrich their work and leisure time. We offer them a range of innovative products which enable them to access information and entertainment, anytime, anywhere, and let them choose how to do that, from, for example, a phone, a computer, a PDA or a television screen. We also let them choose from a wide range of brands which we have designed to suit different needs (and pockets) - from the reliable high-quality KPN brand, to youth brands such as Hi, or no-frills brands such as Het Net and Simyo.

We believe that the society of satisfied customers this approach creates, forms the basis for profitable growth and, as a result, creates value for our shareholders. Equally, we believe that our commitment to quality and customer satisfaction can be realized only if our employees are motivated to provide the best possible services.

We are equally conscious of our responsibilities to the wider community: it is our policy to use our knowledge and technology to contribute to the well being of all our stakeholders, and take steps to account to them for our environmental performance.

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FOREWORD BY THE CHAIRMAN AND CEO

At KPN, we are developing our business to meet the demands of today’s information - and entertainment - hungry world. As new services emerge at a rapid pace, our customers’ expectations increase; to meet them, we have been transforming our company and our business - and that transformation continues.

The year 2005 was one of major developments. External market pressures compelled us to focus on dealing with the decline in revenues from our traditional voice business, to make provision for the convergence of services and for ‘bundling’ (providing more than one service at a single price), to introduce more flexible pricing, to introduce next-generation services, to respond to opportunities and industry consolidation, and to deal with increasing regulation. Combined with sweeping technological changes and greater competition in our traditional core businesses, it is no surprise that continual change has become the norm.

STRATEGY

To confront these challenges, we defined what we call our ‘Attack, Defend and Exploit’ strategy, which we announced on March 1, 2005.

We are

  • attacking the market for new communications, information and entertainment services aimed at establishing leading positions that deliver attractive long-term financial returns; we are migrating our entire network to Internet protocol (IP) to enable us to deliver these new services;

  • defending traditional services to maintain and, where possible, increase our leading share of declining markets, this includes introducing wholesale offers which use the advantage our scale gives us; and

  • exploiting our leadership in traditional and new services markets to achieve a cost structure which is better than that of our competitors and which gives us a sustainable competitive advantage.

In addition, we set ourselves the goal of being better than our competitors at satisfying our customers’ needs; we want to create a point of difference in customers’ minds by changing their experience through being more responsive and flexible.

RESULTS

The strategy which we set out at the beginning of the year is already delivering visible results: in a single year our share of the consumer broadband market in The Netherlands increased by more than 6 percentage points to 36.1%; we launched our new generation of voice services - Voice over Internet Protocol (VoIP) - and are now rolling that out at full speed; we expanded our digital TV offer; and we increased our share of what is a contracting traditional consumer voice market . We also achieved a significant market share in next-generation IP-based network services for the business market. We strengthened the profile of our mobile business with the acquisition of Telfort. Combined with the profitable growth that our mobile strategy is delivering, this has increased our confidence that our strategy is successfully ensuring that our business evolves to meet today’s, and future, challenges.

We achieved all the targets we had set ourselves for the year at: EUR 11.9 billion reported revenues and other income were up 1%. The improved visibility in our cash flow translates into more confidence in our ability to deliver relatively attractive returns, both short- and longer-term, to shareholders. For 2005, we are proposing a dividend of 45 cents (up 29%) and have also allocated EUR 1 billion - after pre-funding of scheduled debt redemptions - for the planned repurchases of shares in 2006. Our increased confidence also enabled us to commit to at least maintain the absolute amount of ordinary dividends we intend to pay in 2006 and 2007 at 2005’s level of EUR 950 million, even if the number of outstanding shares is reduced as a result of further repurchases. Our declared intention not to hold unused surplus cash balances is evidenced by the fact that we are already planning to return our expected 2006 free cash flow to our shareholders.

The group as a whole made considerable progress during 2005. The Fixed division is now well positioned to deal with stronger competition and for the expected battle over VoIP. The Mobile division made equally good progress with the successful launch of a multi-brand strategy across the three countries in which we operate - The Netherlands, Belgium and Germany - the launch of a new strategy in Germany, the turnaround of performance in The Netherlands and a 21% increase in the number of customers of the division as a whole.

Meanwhile, we are more convinced than a year ago of the need for greater financial flexibility. On February 7, 2006, we announced that we have redefined our financing framework. The ever-increasing rate of change in our industry - combined with our continued commitment to deliver attractive returns to shareholders - requires the flexibility for us to be able to seize opportunities that will further advance the execution of our strategy.

MARKET DEVELOPMENTS

The competitive landscape is changing as the IT, telecommunications, consumer electronics, and media and entertainment markets converge rapidly. The next telecoms revolution is already underway, but it is a revolution, which is more about new services, applications and content, than about technology or infrastructure. Telecoms are clearly no longer the sole preserve of the telecommunications industry. We see this not as a threat, however, but as an opportunity: competition drives us to be more creative and innovative. While fixed-line services will continue to be relevant for the foreseeable future, we are moving in the long term towards IP-based multi-media services which run on next generation All-IP networks. We see our future as a Multi-play (multi-media) company.

2005 was the year in which we translated our vision of becoming an all-IP service and network operator into an operational plan. In 2006 we will begin a limited roll-out of an All-IP network with the objective to develop and test migration processes.

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We believe that our key differentiators - innovation and reliability, combined with our branding, distribution and execution capabilities - will enable us to find and drive new growth. We are changing our business from one that has been product-centric to one that is customer-centric. The telecommunications industry has historically measured success by volume and, as a result, has been focused on price; now the measure of success is value, and the key to that value is service and differentiation. Our marketing strategy is based on the premise that it is not enough simply to have the right technology: it has to be branded to appeal to a specific customer, in the right package, at the right price and in the right place.

We expect that during 2006 we will take our first steps in converging our fixed and mobile businesses. Creating a single customer interface for all the services we offer will enable us to increase revenues and value from existing customers, and to generate stronger customer loyalty in highly competitive markets.

Our industry, we believe, is critical to the EU’s growth. There is predicted to be a massive take up of Information Communications Technology (ICT). To make ICT universally available, however, we need to build next-generation All-IP-based networks (NGNs) - multiple, competing open platforms, which use cable, satellite, broadband and mobile. NGNs, which stimulate more content and better services, create a virtuous circle of growth and e-services, but we can make the necessary investments in infrastructure only if the economics make sense. We operate in Europe’s most advanced telecommunications environment but, paradoxically, it is one of the most heavily regulated. As a ‘telecom’ company, therefore, we are constrained by regulatory measures, but are competing with IT and other companies which are not. What is needed to realize this growth is a deregulatory approach.

REGULATION

However, regulation is a key element in shaping the nature and characteristics of the telecommunications sector and in harnessing the vast socio-economic benefits it can bring. Encouraging competitive markets to promote an efficient supply of telecom services, while preventing abuse of market power, will expand the telecommunications as a sector and will also bring added benefits to other areas of the economy.

Regulatory intervention, if any, should keep pace with developments in relevant markets, and should include all competitors in them, whether traditional or new. If regulatory intervention is based on historic market models, it will distort competition rather than creating a level playing field, which should be its principal objective.

CORPORATE SOCIAL RESPONSIBILITY

We are very conscious of the responsibilities our position in the wider society brings, particularly in working in a sustainable way and in reducing the environmental impact of our operations. During 2005, we began to implement our three-year environmental policy, which aims to reduce energy consumption and carbon dioxide emissions, create less waste and achieve a higher degree of waste separation. Progress will be reported in our 2005 Sustainability Report, due to be published in April 2006.

Our future success rests on our ability to keep pace with changes in the market, our cost-effectiveness and on the quality and motivation of our personnel. In an increasingly competitive and innovative market, however, we have to ensure that we retain and motivate those people who are necessary to our future competitiveness while, at the same time, ensuring that the business is lean and efficient. In 2005, we embarked on discussions with employees about their career prospects and agreed guidelines with the works council for doing so. We value what we feel is an open and constructive relationship with our central works council and have great respect for their understanding of the need for transformation and their considerable contribution to facilitating this in the past year while considering the needs of all concerned.

We demonstrate our commitment to society in many ways, particularly in healthcare and education, with a focus on the elderly and children. During the year, we made a number of contributions to the community, from an offer of three years’ free broadband Internet access (which began in 2004) for schools in The Netherlands, to helping deaf and hard-of-hearing people through a pilot project with a mobile text telephone that makes it easier for them to communicate. In response to teachers’, parents’, special interest organizations’ and authorities’ pleas for advice and support from their ISPs in overseeing children’s safe use of the Internet, we launched two websites and published a book, providing valuable advice. We will devote even more attention in 2006 to the responsible use, particularly by children, of new media, and have created a charitable foundation for this purpose 'My child online'.

LOOKING AHEAD

It is our intention to make any technology which becomes available easily accessible to our customers, but innovation has no value in itself - it is relevant only if it makes a difference to our customers’ daily lives. It is our goal to respect them as individuals and, in return, to be trusted to give them the best deal; to continue to create value for them and for us through a multi-brand strategy; and to provide services which meet their needs.

We see our future as one in which we ‘dare to be different’. We place immense value on the trust our customers have in us and aim to build on it by driving for innovative solutions, by maintaining our competitive edge, and by constantly developing our business.

The transformation of the Company will continue, not only in response to, but also in anticipation of, ever-more-rapidly evolving technologies and the commercial opportunities these present. The year 2005, although a year of major transformation, was indeed, only the beginning.

Ad Scheepbouwer

Chairman and CEO

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KEY INFORMATION

Presentation of financial and other information

In this Annual Report and Form 20-F (referred to hereinafter as 'Annual Report'):

  1. ‘KPN’ refers to Koninklijke KPN N.V.;

  2. ‘We’, ‘us’, ‘our’, the 'Company', the ‘Group’ and similar terms refer to KPN and any or all of its subsidiaries, associates and joint ventures as the context requires;

  3. ‘E-Plus’ refers to E-Plus Mobilfunk GmbH & Co. KG - a limited liability partnership - and any or all of its subsidiaries, as the context requires;

  4. ‘KPN Mobile’ refers to KPN Mobile Holding B.V. or KPN Mobile N.V. and any or all of its subsidiaries, as the context requires;

  5. ‘BASE’ refers to BASE N.V./S.A.;

  6. 'SNT' means SNT Group N.V. and any or all of its subsidiaries as the context requires;

  7. ‘NTT DoCoMo’ refers to NTT DoCoMo, Inc. and any or all of its subsidiaries, as the context requires;

  8. 'KPN Mobile The Netherlands' means KPN Mobile The Netherlands B.V. and any or all of its subsidiaries, as the context requires; and

  9. 'Telfort' refers to Telfort B.V. and any or all of its subsidiaries, as the context requires.

In compiling the information in this Annual Report, we have used data and projections obtained from industry surveys, market research and other publicly available information. Such data and other publications generally state that the information they contain has been obtained from sources believed to be reliable but that the accuracy and completeness of such information is not guaranteed and that the projections they contain are based on a number of significant assumptions. We have not verified this information independently or determined the reasonableness of such assumptions. As a result, this information may not be accurate, complete, adequate, up-to-date or comprehensive.

Our market share in traditional voice is defined as our share in the total traffic volumes. These figures are based on externally available market data, which may not be completely accurate.

Our market share in Internet is defined as the total number of our KPN ISPs' active narrowband and broadband Internet users as percentage of the total number of active Internet users (including cable). These figures are based on externally available market data, which we cannot verify for accuracy.

Our market share in consumer broadband is defined as the total number of our ADSL broadband connections as percentage of total consumer broadband connections, which consist of ADSL competitors and broadband via cable. These figures are based on externally available market data, which we cannot verify for accuracy.

The customer figures of our mobile network operators consist of the number of registered SIM cards - excluding dual cards but including data-only PC connections and machine-based SIM cards - at the end of each reporting period. The customer base also comprises inactive prepaid users, who have had neither incoming nor outgoing traffic during a three-month period, but have not yet met the disconnection criteria (mostly 12 months of inactivity). We define mobile market revenue share as our mobile network operators' share in the total revenues of the respective countries' mobile telephony markets. In 2004, we reported market shares based on customer base market share. However, we are of the opinion that revenue market share is a better indicator of our market position. Accordingly, we report revenue market share and adjusted historical comparative information.

Other mobile network operators may calculate their number of customers differently than we do, which may affect the comparability and accuracy of data.

Service revenues are defined as the aggregate of connection fees, monthly fixed subscription fees and traffic revenues. ARPU is the quotient of service revenues during a month and the average number of customers during that month.

Details of key exchange rates used in the preparation of this Annual Report are given elsewhere in this document together with Noon Buying Rates in New York for the equivalent periods.

For descriptions of abbreviations please refer to the glossary.

Forward-looking statements

We have made forward looking statements in this Annual Report. These statements are based on our beliefs and assumptions and on information currently available to us. They include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, potential growth opportunities, potential operating performance or expense improvements and the effects of future legislation or regulation.

Forward-looking statements include all statements that are not historical facts and can be identified by the use of forward-looking terminology such as the words ‘believe,’ ‘expect,’ ‘plan,’ ‘intend,’ ‘anticipate,’ ‘estimate,’ ‘predict,’ ‘potential,’ ‘continue,’ ‘may,’ ‘will,’ ‘should,’ ‘could’, ‘shall’, or the negative of these terms or similar expressions. Examples of forward-looking statements include but are not limited to:

  1. telecommunication usage levels and market conditions, including the number of telephone access lines, traffic patterns (including Internet usage) and development in customer numbers;

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  2. competitive forces in liberalized markets, including pricing pressures, technological developments, alternative routing developments and our ability to retain market share in the face of competition from existing and new market participants;

  3. regulatory developments and changes, including with respect to the levels of tariffs, the terms of interconnection, electromagnetic field strengths of mobile transmission equipment, customer access and international settlement arrangements, and legal and regulatory proceedings and investigations;

  4. the success and market acceptance of business, strategic, operating and financial initiatives (many of which are untested), the level and timing of the growth and profitability of new products, startup costs associated with entering new markets, the successful deployment of new systems and applications to support new initiatives, efforts at improving customer satisfaction, and local conditions and obstacles;

  5. the amounts of future capital expenditure;

  6. our dependence on and relationship with suppliers;

  7. the timing of the rollout of Universal Mobile Telecommunication System (UMTS) networks, the All-IP fixed network and other new, enhanced or upgraded networks, systems, products and services, and their performance and impact on our financial position;

  8. any acquisitions, dispositions or mergers we or our subsidiaries may enter into;

  9. the availability, terms and deployment of capital;

  10. the impact of tax rulings, the timing for settlement of tax losses carried forward and uncertainties regarding future tax liabilities;

  11. the amount and timing of any potential future impairment charges for our licenses, goodwill or other assets;

  12. the impact of regulatory competitive developments on capital outlays and our ability to achieve cost savings and realize productivity improvements;

  13. uncertainties associated with developments related to the International Financial Reporting Standards (IFRS), as well as with developments related to United States Generally Accepted Accounting Principles (US GAAP);

  14. general economic conditions, government and regulatory policies, and business conditions in the markets we and our affiliates serve; and

  15. risks related to information and communication technology systems generally.

Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. No undue reliance should be put on any forward-looking statements. Unless required by applicable law or applicable rules of any stock exchange on which our securities are listed, we have neither the intention nor an obligation to update forward-looking statements after distribution of this Annual Report.

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Key financial figures

The following tables show our selected historical financial data for the years ended December 31, 2001 through 2005.

Our Consolidated Financial Statements for the years 2005 and 2004 have been prepared in accordance with International Financial reporting Standards (IFRS). The SEC adopted on April 12, 2005 amendments to Form 20-F for foreign private issuers related to the first-time adoption of IFRS. This amendment allows KPN to provide only one year of comparative IFRS figures in the Consolidated Financial Statements over the year 2005. As a result we have not adjusted our 2003, 2002 and 2001 Consolidated Financial Statements for IFRS. Therefore comparative amounts for these years are not available.

Our Consolidated Financial Statements for the years 2003, 2002 and 2001 were prepared in accordance with Dutch Generally Accepted Accounting Principles (Dutch GAAP).

Our US GAAP figures differ in certain significant respects from IFRS. For information on the differences between IFRS and US GAAP as they relate to us, please refer to the Notes to our Consolidated Financial Statements.

You should read this table together with 'Operating results' and our Consolidated Financial Statements and the Notes thereto, which are included elsewhere in this Annual Report.

Income Statement Data

Amounts in millions of euro, except for shares and per share data

As at and for the year ended December 31,

2005

2004

2003

2002

2001

In accordance with IFRS:

Revenues

11,811

11,746

Other income

125

73

Operating profit

2,348

2,645

Profit/(loss) before taxes

1,814

2,057

Profit attributable to shareholders

1,437

1,707

Earnings per ordinary share and per ADS (non diluted) (1)

0.66

0.72

Earnings per ordinary share and per ADS on a fully diluted basis (1)

0.65

0.71

In accordance with US GAAP:

Total revenues from continuing operations

11,656

11,624

11,984

11,750

11,065

Operating profit from continuing operations

2,071

2,457

-4,185

621

-527

Profit/(loss) before taxes from continuing operations

1,714

2,439

-4,262

263

739

Effect of discontinued operations, net of taxes

22

18

319

48

-117

Profit/(loss) after taxes

1,357

2,079

-3,670

-15,094

-230

Earnings per ordinary share and per ADS from continuing operations, (non-diluted) (1)

0.61

0.86

-1.62

-0.40

-0.04

Earnings per ordinary share and per ADS from continuing operations on a fully diluted basis (1)

0.61

0.86

-1.62

-0.40

-0.04

Earnings per ordinary share and per ADS from discontinued operations (non-diluted) (1)

0.01

0.01

0.13

0.02

-0.09

Earnings per ordinary share and per ADS from discontinued operations on a fully diluted basis (1)

0.01

0.01

0.13

0.02

-0.09

Total earnings per ordinary share and per ADS (non-diluted)

0.62

0.87

-1.49

-6.23

-0.18

Total earnings per ordinary share and per ADS on a fully diluted basis

0.62

0.86

-1.49

-6.23

-0.18

Weighted average number of outstanding ordinary shares

2,192,232,156

2,385,418,773

2,468,678,426

2,423,921,066

1,274,495,172

Weighted average number of outstanding ordinary shares on a fully diluted basis

2,197,620,705

2,404,343,845

2,468,678,426

2,423,921,066

1,274,495,172

  1. Please refer to Note [8] of the Consolidated Financial Statements for a discussion on the method used to calculate profit or loss per share.

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Balance Sheet Data

Amounts in millions of euro, except for shares and per share data

December 31, 2005

January 1, 2005(1)

December 31, 2003

December 31, 2002

December 31, 2001

In accordance with IFRS:

Total assets

22,702

24,230

 

 

 

Non-current liabilities

12,204

12,297

 

 

 

Provisions

3,958

4,076

Shareholders' equity

5,076

6,266

Group Equity

5,104

6,411

Capital stock (including additional paid-in capital)

14,634

15,866

Number of subscribed shares

2,151,360,369

2,329,399,969

2,490,996,877

2,490,996,877

2,254,147,806

In accordance with US GAAP:

 

 

Total assets

23,402

24,383

25,224

33,049

56,178

Long-term liabilities

12,380

8,056

9,364

12,769

17,185

Provisions

4,246

3,598

3,760

1,958

1,844

Exchange right

-

-

-

-

659

Shareholders' equity

5,632

7,178

7,137

11,227

26,665

  1. KPN applies IAS 32 Financial Instruments: Disclosures and Presentation, IAS 39 Financial Instruments: Recognition and Measurement and IFRS 5 Non-current Assets Held for Sale and Discontinued Operations as from January 1, 2005. As a result, we report figures as of January 1, 2005. For US GAAP there is no difference between the closing balance as at December 31, 2004 and the opening balance as at January 1, 2005.

PER-SHARE INFORMATION

Amounts in euro

2005

2004

 

 

 

Dividend per ordinary share

0.45

0.35

The proposed dividend for 2005 consists of a cash dividend of EUR 0.45 per share of which EUR 0.13 was paid as an interim dividend. For further information about our dividend policy refer to our section "Information about the KPN Share".

WORKFORCE

 

2005

2004

 

 

 

Average number of FTEs in The Netherlands

20,590

21,797

Average number of FTEs outside The Netherlands

6,737

7,114

Average number of FTEs

27,327

28,911

Number of FTEs as of December 31

26,598

28,056

Number of employees as of December 31

29,286

31,116

ANNUAL HIGH AND LOW CLOSING PRICES OF OUR ORDINARY SHARES ON EURONEXT AMSTERDAM AND OUR ADSS ON THE NEW YORK STOCK EXCHANGE

 

Euronext Amsterdam

NYSE

High

Low

High

Low

EUR

EUR

USD

USD

 

 

 

 

 

2001

18.01

2.21

16.88

2.09

2002

6.85

3.99

6.79

3.70

2003

7.13

5.37

8.02

5.92

2004

7.07

5.80

9.65

7.03

2005

8.56

6.39

10.17

7.89

For further information about closing prices of our ordinary shares refer to the section "Information about the KPN Share".

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Risk factors

Our business is subject to various risks relating to changing competitive, economic, political, regulatory, legal, social, industrial, business and financial conditions. These conditions are described below and discussed in greater detail elsewhere in this Annual Report. The following risk factors could harm our business, financial condition and operating results, adversely affect our revenues and profitability, and possibly lead to a drop in the trading price of our shares.

The markets in which we operate are increasingly competitive and our principal businesses face significant competition. If we are unable to compete effectively, this could lead to loss of revenue, reduced margins, loss of market share and adversely affect our financial position.

The competitive landscape for our Fixed division is changing rapidly and is one of the most dynamic and competitive in Europe. The traditional voice market continues to contract, while the VoIP penetration starts to accelerate and Cable and ADSL operators penetrate this (new) voice market, already offering Multi-play solutions (Television, Internet and Telephony combined). Meanwhile, mobile operators are pushing for fixed-to-mobile substitution and non-Telco service providers (like MSN, Google, IBM) start offering voice as an integral service. Combined with the fact that the Dutch broadband acceleration is unrivalled and the penetration of broadband in the households in The Netherlands is the highest in Europe, this changing competitive landscape for our Fixed division may result in acceleration of the decrease of fixed-line subscriptions and traditional traffic volumes and price declines of broadband and VoIP, which would adversely affect our margins and financial position.

In addition, in our business market, ICT becomes increasingly vital for businesses. Furthermore, there is an increased demand for managed services and a continuing shift in focus from network technology towards functionality of applications. New communication services are IP-based and data-access becomes independent of hardware devices. Because of these developments, IT and system integrators (e.g. Cap Gemini, Accenture, IBM, etc.) are moving down the value chain and could gain market share at our expense. In addition, global telecommunication solution providers are penetrating more and more our national corporate markets, because customers are increasingly in search for global network solutions. Meanwhile, Global Internet players (e.g. Skype, MSN, Googletalk) offer on-net VoIP for free. KPN's strategy in the business market is aimed at grasping the opportunity to shift from decreasing traditional communication services towards services in the larger and growing market for end-to-end ICT Services. But goals will be hard to achieve due to the fact that we will attempt to enter new markets and we will face new and more (global) competitors. In addition, many of our competitors are able to charge lower prices than us. Our regulatory tariffs limit our flexibility in terms of pricing and sales incentives. If we are not able to cope with the continuing pressure for lower prices, this could lead to deterioration of our financial results.

In general, our Fixed division may not be successful in both offering resistance to the increasing competition and the need to move from our traditional services to an All-IP network operator and service provider, as a result of which our revenues within the fixed business could decline more than we currently anticipate.

Because of the aforementioned developments in our competitive landscape, the Fixed business increasingly shows similarities with the Mobile business, as subscriber acquisition and retention cost and marketing expenses increase. In addition, the introduction of new products and services (e.g. TV, VoIP and ICT-solutions) causes new costs and an upward trend in existing operational cost. The upcoming migration to an All-IP network will reduce the cost in the long term, but requires additional capital expenditures in the short and mid-term. In order to cope with the anticipated pressure on our revenues and consequently, the risk of deterioration in our profitability, our Fixed division has set up an ambitious restructuring and cost saving program. While our aim is to reduce around 8000 FTEs in the period 2005 - 2010, we may not be successful in these efforts, as a consequence of which our financial position could deteriorate.

Our Mobile division business faces intense competitive pressure from existing and new market participants in all our markets. In our core markets, we compete with the largest international groups and alliances of mobile operators. Competition based on price, subscription options offered, coverage and service quality remains intense, and we expect pressure on calling rates to remain high as we compete with other operators for market share. Our traditional mobile markets for voice have become increasingly saturated. The market for mobile data is picking up more slowly than expected. As a result, the focus of competition is shifting towards brand and distribution power and also from customer acquisition to customer retention and satisfaction efforts. Substantial expenses are required for customer retention and satisfaction efforts, and significant customer defections would have an adverse effect on our financial position.

We face competition from a variety of competitors, including, but not limited to, existing fixed and mobile network operators, operators offering new mobile network services such as wireless fidelity services (WiFi) and/or WiMAX, providers of higher speed xDSL and glass fiber services, and others. Some of these competitors are smaller and may be more flexible and responsive than we. Other competitors may operate on a broader scale and have more financial resources and capital at their disposal, enabling them to compete more effectively than we. For instance, in terms of more aggressive pricing, time-to-market with new products and services, network quality and network rollout, and customer care and satisfaction. For example, our mobile subsidiaries E-Plus in Germany and BASE in Belgium both compete with top two operators in their respective market that have a significantly higher market share and thus an ability to exert significant influence over the market. As a result, our subsidiaries may be at a competitive disadvantage and could rapidly lose market share, which could harm our financial results.

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Our public image is important to our sales, marketing and customer relations' efforts. Any damage to our image, whether as a result of corporate actions, developments of particular business units or otherwise, could adversely affect our market position and ultimately harm our financial results.

Regulatory decisions and changes in the regulatory environment could adversely affect our business.

In our Fixed division, most of our network activities in The Netherlands are overseen by regulatory bodies. These authorities regulate, among other things, the prices we may charge for many of our services and the extent to which we have to provide services to our competitors. In recent years, these authorities have compelled us to reduce some of our prices. Regulatory authorities may increase the severity of pricing controls, extend the range of services to which regulations apply (including any new services that we may offer in the future), and extend the services that we have to provide to our competitors. For instance, the Dutch telecommunication regulator, OPTA, has in a recent decision subjected our wholesale line rental business to regulation and forced us to withdraw our tariffs for transit services. These and other regulations may impact our financial position, the severity of competition and our future profitability.

In our Mobile division, we have to comply with an extensive range of requirements regarding the licensing, construction and operation of our mobile networks and services. Decisions by regulators regarding the granting, amendment or renewal of licenses, to us or to third parties, could adversely affect our future operations. Governments in the countries in which we operate may issue telecommunications licenses to new operators whose services will compete with ours. In addition, other changes in the regulatory environment concerning the use of mobile phones may lead to a reduction in the usage of mobile phones or otherwise adversely affect us. Additionally, decisions by regulators could further adversely affect the pricing for services we offer. In all countries in which we operate, mobile terminating tariffs are expected to be regulated, even if it is not yet fully clear which measures will be taken. Tariffs for mobile roaming services have also attracted the attention of regulators and politicians. In the coming years, we expect further obligations to be imposed on all mobile operators in Europe to reduce MTA-tariffs. Regulatory intervention will likely increase the pressure on our pricing and could negatively affect our financial position.

The markets in which we operate undergo rapid technological changes. As a consequence, we have to make substantial investments in our business on an ongoing basis to remain competitive. New communication services are more and more IP-based and, especially in our Fixed business, data access becomes independent of hardware devices. As a consequence, new (global) competitors are entering the market and competition is increasing in all areas of our business. This may be disadvantageous for us and may lead to a decline in our operating results.

Since our markets are undergoing rapid technological change, our future success depends, in part, on our ability to anticipate and adapt in a timely and effective manner to those technological changes. To remain competitive, we must continually improve the speed and features of our existing products and services and develop attractive new products and services for our customers.

In the mobile arena, this mainly refers to EDGE, UMTS technologies and new data services (such as i-mode, content downloads, location based services). New licensed and unlicensed spectrum will become available in the future, which poses a constant threat to our mobile business based on GSM, UMTS and WiFi, as it allows new entrants to the market of wireless and mobile communications services.

Within our Fixed division our strategy to migrate to an All-IP network operator and service provider is the basis for our new service portfolio and our planned cost reductions. The technical roll out of our All-IP network (yet in a piloting phase) is expected to take a number of years (2007 - 2009). We may not be successful in the timely roll out of such a network as a consequence of which our main competitors, including global branch entering what used to be a domain of telecommunication companies, may successfully compete with us and gain market share at our expense. In addition, the strategy we pursue in migrating our customers towards IP-based solutions could be less effective and efficient than we anticipate. Furthermore, our investments in new IP-based services and solutions could prove to be more time consuming and more expensive than we had estimated, all of which could adversely affect our financial position.

In general, we may not succeed in developing, introducing or improving these items in an economical or timely manner, or at all. Our competitors may be able to improve existing products and services or develop and introduce new products and services faster than we are able to. The changes require substantial ongoing investments in both our Mobile and our Fixed business if we are to achieve organic growth and remain competitive. We must also correctly estimate customer demand, and there is the risk that the new products and services introduced by competitors will be preferred over our new products and services. This could adversely affect our financial position.

In the future, we may be confronted with very significant costs related to asset retirement obligations (i.e. removal of KPN cable networks) following an amendment of the Telecommunications Act, which may become effective in 2006. This could negatively affect our financial position.

Lastly, since in the long term, we are drastically changing our technical infrastructure, we may not be able to succeed in meeting the high quality standards we delivered in the past with our traditional product portfolio. This may have a negative effect on the value of our brands in the various markets in which we operate, thus negatively affecting our financial position.

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We have made substantial investments in UMTS licenses in our core markets. We may not generate a sufficient return on these investments.

We have made substantial investments in UMTS licenses in our core markets. There may be significant delays in receiving the requisite number and type of handsets and equipment needed for UMTS products and services. The size of the market for these products and services is as yet unknown and may fall short of expectations as UMTS technology may prove not to be superior to existing or other future technologies. We cannot be certain that the demand for UMTS services will justify the related costs. In some locations, the investments, although required under the licenses may not be commercially desirable or may lack a matching customer demand. In addition, we have a number of significant competitors in each of our geographic markets. Our competitors may be able to build out their UMTS networks more economically or quickly than we can. This could place us at a competitive disadvantage in providing UMTS services in the relevant market. In Germany, we could also be at a disadvantage if regulatory action were taken that would allow for the use of 900 MHz frequencies for UMTS, which would, as a matter of technology, already be possible. While network sharing could provide a possibility to reduce costs, we cannot give any assurance that this will be the case or that we will be able to make such network sharing work commercially or technically. If our strategy is not successful, our financial position as well as our business strategy may be adversely affected.

Based on regulatory requirements, we expect continuing substantial capital expenditures on the rollout of our UMTS networks. In addition, we expect to incur significant marketing costs and other costs in relation to the launch of our UMTS services. As a result, our net income can be expected to decrease, except to the extent enhanced earnings from UMTS networks offset such charges.

In Belgium, a further roll out of our UMTS network started in 2004 in order to comply with the license requirement of a minimum 30% population coverage by the end of 2005. The Belgian regulator BiPT may carry out measurements during 2006 in order to verify this compliance. Non-compliance with the license obligations may lead to the incurrence of an administrative fine and may ultimately result in the loss or suspension of the UMTS license of BASE.

If we fail to introduce new or enhanced products and services successfully, our revenues and margins could be lower than expected.

Part of our business strategy is based on the introduction of new or enhanced products and services, including VoIP and WLR, Interactive IP-TV formats, integrated communication and messaging clients, content and entertainment services, new mobile data services, machine-to-machine services. Any of the new or enhanced products or services we introduce may encounter technical difficulties or fail to achieve market acceptance or new or enhanced products or services introduced by our competitors may be more appealing to customers. If our new or enhanced products or services are not successful or delayed, our customers may decide to discontinue using our services and choose other telecommunication providers. In addition, newly introduced products and services may not be profitable in the short term. As a result, we may not recover the investments, such as the costs of network upgrades and marketing expenses, we plan to make new products and to launch services.

Changes in markets, our business plans and network infrastructure and the valuation methodologies applied have resulted, and may in the future result in substantial write-downs of the carrying value of our assets.

Our regular review of the carrying value of our assets (including goodwill, intangible, tangible and financial fixed assets) has resulted in significant impairments in the past, and we may in the future be required to recognize additional impairment charges. Events in the technology and telecommunications markets, including significantly reduced stock prices, market capitalization and credit ratings of other participants, as well as the ongoing review and refinement of our business plans and network infrastructure and changes in the valuation methodologies applied and the underlying assumptions, have resulted, and may in the future result, in substantial impairments of our intangible or other assets, including licenses and network equipment. In addition, we have been recognizing, and may be required in the future to recognize, increased depreciation and amortization charges if we deem the useful lives of our fixed assets to be shorter than originally expected.

We depend on our relationship with various partners and suppliers and any disruption in these relationships may adversely affect our business.

Our businesses depend upon our ability to obtain adequate supplies of telecommunications equipment and related software, our contractors’ ability to build and roll out telecommunications networks on schedule, and our suppliers’ ability to deliver dependable technical support. Due to downturns in economic conditions, some of our suppliers may cease to do business. We cannot be certain that we will be able to obtain quality telecommunications equipment and support from alternative suppliers, particularly in relation to new technologies, on a timely basis if our existing suppliers are unable to satisfy our requirements. This could lead to an interruption in the operation and build-out of our networks, which may affect our financial position and results of operations. In addition, as part of our cost reduction program we have sold a substantial part of what we considered to be our non-core assets. A significant part of the services previously rendered to us by these non-core assets are now provided to us by new owners of the assets, or other external suppliers. We depend on our relationship with these suppliers, especially Atos Origin, for the continuation of these services, some of which are vital to our business.

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Network interruptions or service slowdowns caused by local or global system failures, misuse of our network and related applications as a result of inadequate security, may result in reduced user traffic, reduced revenue and harm to our reputation and business operations.

Our ability to operate our businesses depends significantly upon the performance of our technical infrastructure. Failures in power supply by power companies are increasing in The Netherlands and may harm our technical infrastructure. Although our critical infrastructure equipment has power interruption backup facilities, these facilities may prove not to be adequate during a prolonged interruption. Our technical infrastructure is also vulnerable to damage or interruption by floods, fires, telecommunication failures and similar events. It also may be subject to break-ins, sabotage, terrorism, vandalism and similar misconduct. Furthermore, the security of our network and related applications may be inadequate, which may result in access and misuse by hackers and other unauthorized users and may adversely affect our operations. The occurrence of a natural disaster, other unanticipated problems at our facilities or any other damage to, or misuse of or failure of our systems could result in interruptions in our service. System failures, including failure of our network and the networks used by our suppliers, and hardware or software failures or computer viruses, could also affect the quality of our services and cause temporary service interruptions, resulting in customer dissatisfaction, penalties and reduced traffic volumes and revenue. Any of these factors could affect our business and financial position.

Our Mobile and Fixed division's business may be hampered because of more stringent regulation of the exposure of the public to electromagnetic fields of base stations.

Our businesses may increasingly be subject to more stringent regulation of exposure to electromagnetic fields of mobile transmission equipment. Health risks perceived by public opinion may cause national and local governments to further impose restrictions on the construction of base station towers, the upgrade of networks and the replacement of existing antennae and other related infrastructure. As a result, we are experiencing difficulties and delays in obtaining building permits for our mobile transmission equipment. This may prevent us from completing the further build-out of our mobile networks, providing new services and fulfilling UMTS license terms. In addition, it may become more difficult to renew leases for existing base stations and other equipment, with the cost of such leases increasing. Any of these factors could affect our business and financial position.

Although various scientific reports have denied that certain radio frequency emissions from wireless handsets and mobile base stations pose health risks, local and national governments have begun to regulate the emission of electromagnetic fields as an environmental threat. We cannot rule out that exposure to electromagnetic fields from mobile base stations will be identified as an environmental issue and potential health risk in the future. Any perceived health risks associated with mobile communication equipment may lead to a more restrictive approach towards building permissions for base stations and could result in a radio network of insufficient quality. A reduction in network quality may result in a lower number of customers and a reduced usage per customer.

We have liabilities with respect to our pension plans and the actual cost of our pension plan obligations could exceed current estimate. Any pension funding obligations may impact our financial position.

As of December 31, 2005, we recognized pension provisions of EUR 1.0 billion as a result of defined benefit plans. The recognition of the pension provision is subject to actuarial and financial assumptions, which are management estimates of in particularly future salary increases, discount rates, expected indexation of the benefits and return on assets. These determine the costs and cash flows of providing the post-employment benefits. Changes in assumptions can result in changes of the pension obligation and the related pension costs as well as the contributions to the pension funds. In that event, the adjustments required to be made to our recorded provision for these benefits may have an adverse effect on our results of operations and financial condition, and cash payments to fund these plans could have an adverse effect on our cash flows.

Our share price has been, and may continue to be, volatile.

World stock markets have always experienced volatility that has affected the market prices of equity securities including those of telecommunications companies and our company. This has led to large swings in trading prices in short periods of time and has not always been related to the operating performance of the companies concerned.

The factors that have caused, and may cause in the future, fluctuations in our share price, many of which are beyond our control, include the following:

  • the emergence of new and powerful competitors using VoIP technology;

  • the general state of the securities markets, with particular emphasis on the European telecommunications sector;

  • competition, regulatory conditions and the status of telecommunications liberalization in Europe;

  • the build-out of UMTS networks, the development of compatible handsets, delays in the rollout of UMTS services and networks and costs relating thereto;

  • competitors’ positions in the market and ongoing concentration of the telecommunications industry;

  • changes in the financial estimates by securities analysts;

  • our earnings releases and the earnings releases of our competitors;

  • the outcome of legal proceedings;

  • fluctuations in foreign exchange rates and interest rates; and

  • international political and economic conditions.

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We are involved in several legal proceedings. Such proceedings could eventually lead to payments of claims and damages or otherwise harm us.

We are a party to several legal proceedings of a regulatory and other nature. The proceedings themselves could divert management attention and capacity from our core business and could harm our public image. If we lose our cases, we could be forced to reduce our tariffs, make payments of claims and damages and suffer other disadvantages.

For a discussion of current legal proceedings, please refer to the section titled 'Commitments, contingencies and legal proceedings' in our Consolidated Financial Statements and to 'Regulatory Developments'.

We may be subject to additional tax liabilities in the future, including as a result of audits of our tax returns.

The tax authorities may audit our tax returns and may disagree with the positions taken in those returns.

An adverse outcome resulting from any settlement or future examination of our tax returns may subject us to additional tax liabilities and may adversely affect our liquidity and annual effective income tax rate. In addition, any examination by the tax authorities could cause us to incur significant legal expenses and divert our management's attention from the operation of our business.

We may need to incur additional debt or issue new equity to finance strategic and technological investments, such as the rollout of our All-IP network, and to refinance debt.

Financing and refinancing conditions will largely depend on future market conditions, our credit ratings, the telecommunication industry ratings, and our results of operations and future prospects, and we cannot be certain that financing will be available to us on favorable terms, or at all. Our credit rating may be impacted by the rapid technological and industry developments, our operational performance and our competitive and financial position going forward. If we cannot raise new funding, we may be unable to pursue growth opportunities or to refinance our existing indebtedness.

If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our securities.

Effective internal controls are necessary for us to provide reliable financial reports and prevent fraud. If we cannot provide reliable financial reports or prevent fraud, our financial results could be harmed.

We devote significant attention to establishing and maintaining effective internal controls. We are in the process of documenting, reviewing and, where appropriate, improving our internal controls and procedures in connection with Section 404 of the Sarbanes Oxley Act of 2002, which requires annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments as from the financial year 2006. We are in the process of testing our internal controls in connection with the Section 404 requirements. We already have, as part of this documentation and testing process, identified several areas for further attention and improvement. The analysis and evaluation is currently underway, but we are not yet in a position to determine the magnitude of the deficiencies identified. Implementing any appropriate changes to our internal controls may require specific compliance training of our directors, officers and employees, entail substantial costs in order to modify our existing accounting systems, and take a significant period of time to complete.

We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial reporting processes and related Section 404 reporting requirements. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our financial results or cause us to fail to meet our reporting obligations. Any such failure could also adversely affect our assessment of the effectiveness of our 'internal control over financial reporting' that will be required when the Section 404 requirements become applicable to us. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the market price of our securities.

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INFORMATION ABOUT THE COMPANY

 

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History and developments

Koninklijke KPN N.V. was incorporated under the laws of The Netherlands on January 1, 1989. On June 28, 1998 our name was changed from Koninklijke PTT Nederland N.V. to Koninklijke KPN N.V. We have our corporate seat in The Hague, The Netherlands. We are registered under number 02045200 at the Commercial Register of the Chamber of Commerce for Haaglanden, The Hague, The Netherlands, and our executive offices are located at Maanplein 55, 2516 CK The Hague, The Netherlands. Our telephone number is (+31) 70 4460986. Our agent for service of process in the United States is KPN INS, Inc., 494 8th Avenue, 23rd floor, New York NY 10001.

Our main objectives, as described in article 4 of our Articles of Association are to participate in and to manage other enterprises and companies, among such, companies that operate in the field of the transmitting, storing and converting of information, as well as to manage and dispose of information and to let our subsidiaries carry out the concessions or licenses that are granted by the government in the field mentioned above. Our Articles of Association are accessible at the Chamber of Commerce and filed with the SEC as an exhibit to this Annual Report on Form 20-F.

KPN provides telephone, Internet, television services to personal customers through its fixed network in The Netherlands. For business customers, we provide a range of services, from voice, Internet and data services to fully-managed outsourced ICT solutions, in The Netherlands and internationally. For both retail and business customers, we offer mobile services in The Netherlands, Germany, Belgium and Western Europe.

KPN was incorporated with two main subsidiaries: PTT Telecom B.V., offering telecommunication services, and PTT Post B.V., serving as the primary postal company in The Netherlands. In the period from incorporation until the listing of our shares on Euronext Amsterdam in June 1994, the State of The Netherlands was our sole shareholder. At the end of 2005, the State held 7.76% (2004: 20.69%) of our outstanding shares.

The demerger of our mail, express and logistics business operations to TNT Post Group (TPG) was completed in 1998.

In November 1999, we transferred our mobile business to a separately incorporated subsidiary, KPN Mobile N.V. KPN Mobile issued new shares to NTT DoCoMo in August 2000, as a result of which NTT DoCoMo held a 15% interest in KPN Mobile. In connection with a financial restructuring of KPN Mobile in December 2002, NTT DoCoMo elected not to exercise its anti-dilution rights, resulting in a decrease of its interest to 2.16%. In October 2005, we purchased NTT DoCoMo's remaining interest in KPN Mobile N.V.

In the period from 2000 to 2002, we acquired E-Plus and BASE, mobile network operators in Germany and Belgium respectively. Following these acquisitions and the purchase of UMTS licenses, KPN initiated a refinancing program. The refinancing included share offerings in 2000 and 2001 and the sale of non-core assets.

On October 4, 2005 we acquired Telfort, a Dutch mobile network operator.

For the financial impact of our recent major asset disposals, please refer to the section titled 'Sale of activities and assets', under ‘Other consolidated results of operations'.

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Organizational structure

On April 1, 2005 we completed our process of changing our organizational structure. All historical figures are aligned to reflect this new structure.

The major change was a split between a Wholesale and Operations unit and two retail units within our Fixed division. The new structure of our Fixed division is designed to ensure greater focus on revenue generation in the market and tighter cost management. In the new structure, Network Operations and Wholesale focuses on operational assets, costs and operational excellence. Segment Consumer and segment Business, our retail units, are responsible for our retail market and portfolio management in the business as well as consumer market segments and are focusing on customers, customer acquisition, revenues and margin.

We have split our former business unit Fixed Telephony into Voice Consumer and Voice Business. In our segment Consumer we introduced new business lines Internet and KPN TV to align with our Multi-play strategy. With respect to SNT we fully integrated our teleconferencing, Teleconnect, call factory and 0800/0900 services in the new business line Customer Interaction Services within segment Business. The call center activities of SNT for core customers are allocated to Wholesale and Operations. In our segment Wholesale and Operations we introduced IT Operations to achieve our IT rationalization ambition.

In addition, KPN has embarked on a comprehensive program to achieve a structurally lower cost base by - amongst others - simplification of the group structure.

The overview below reflects our organizational structure as of December 31, 2005.

Our main joint ventures include Zeus Telecom, Schiphol Telematics, Tetraned and Mobirail.

For more information, please refer to the section titled 'Legal Structure', under 'Additional information for shareholders', elsewhere in this Annual Report.

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Fixed division

We offer voice and data services through our fixed network in The Netherlands and data services in Western Europe. We are the leader in the traditional Dutch market segments, such as switched voice communication and leased data lines, and are actively growing our market share in the new IP and DSL markets.

Growth of revenues is a key challenge for the industry, in particular for KPN as an incumbent operator in a very competitive market. In today's dynamic market, various competitors are trying to create new positions for themselves in areas such as VoIP and Multi-play (voice, Internet, VoIP and television). These new services are generally rendered at lower tariffs and the revenues of these new growth areas do not entirely compensate for the decline in the traditional services.

In order to counter these developments, our strategy in the Dutch fixed-line market is threefold:

  • attacking the market for new communications, information and entertainment services (and migrating our network to complete IP to enable us to deliver them), aimed at establishing leading positions that deliver attractive long-term financial returns;

  • defending traditional services to maintain our leading share of declining markets, including leveraging our scale advantage through wholesale offer; and

  • exploiting our leadership of both traditional and new services markets in order to achieve a cost structure that is unrivaled by our competitors and which will represent a significant sustainable competitive advantage.

To fulfill our ambitions, the Fixed division is improving its position in the broadband market through intensive subscriber acquisition programs and by developing new, attractive, customer-focused broadband communication services (like ADSL, Voice over IP, IP-VPN, and KPN TV), as well as by offering improved bundled packages and services.

As of April 1, 2005 we simplified the structure within our Fixed division. As from this date the Fixed division structure is based on 3 segments for services and products. These segments are: Consumer, Business and Wholesale and Operations.

Throughout this report we will describe our business and financial analysis consistent with our new segment structure, and all comparable figures are aligned with this new group structure.

Segment Consumer

IMPLEMENTING OUR STRATEGY

Within the competitive Dutch telecom market many mobile, cable and other fixed operators are active. The traditional voice market continues to contract while VoIP starts to accelerate, offering new entrants like Cable and ADSL-operators more opportunities to penetrate this (new) voice market as they already offer Multi-play solutions (Television, Internet and Telephony combined). During 2005 Internet companies such as Google, eBay and Microsoft made moves towards the communications portfolio of operators. In addition mobile operators are pushing for mobile-only solutions. We are very much aware that their offers should not be solely viewed in terms of business as it is today but also as an option on what it may become in a completely new environment.

We experience major shifts in our customers’ buying patterns as they discover the possibilities of the new services and technologies. We see a gradually increasing need for more personalized solutions. As a result, “old” markets started to shrink while “new” markets with new business models are developing.

Against this background, we refocused our strategy during 2005.

Attacking the market for new communications, information and entertainment services, aimed at establishing leading positions that deliver attractive long-term financial returns

Major 2005 initiatives that rely upon this strategy were:

  • acquiring ISP market share;

  • extending the service portfolio for KPN ISPs;

  • launching VoIP;

  • launching a “naked” ADSL package without fixed-line telephony subscription;

  • extending KPN TV offerings; and

  • launching a test environment for KPN IP-TV.

As part of our acquisition policy 136,000 broadband customers were acquired during 2005 from several smaller ISPs (such as Freeler, Hcc!net, Tiscali and CistroN). As a result of these acquisitions and autonomous growth, our ISPs’ market share increased from 29.7% as of December 31, 2004 to 36.1% as of December 31, 2005.

We have extended the range of options on offer to Internet customers. We have begun to include home installation and repair packages as part of our portfolio. KPN Planet has positioned itself as a full service provider, marketing an expansive package comprising a DSL line, Internet access, hardware components and personalized content offerings. With new products such as Music Stream, Movie Stream and Game Stream, we aim to offer our customers an attractive online entertainment experience. These additions contributed to KPN Planet's healthy growth, which has seen it become the largest ISP in The Netherlands. Our brands - KPN Planet, XS4ALL, Het Net - also received numerous commendations from consumer media for their consistent high quality of service.

In the second quarter of 2005, we started initial trials of our consumer VoIP product “Internetplusbellen“. Having achieved the service quality and reliability we demand, we began the further rollout of voIP in December 2005, both in terms of consumer reach and portfolio depth. Starting with flat fee calling, voice and e-mail services, we intend to expand our portfolio in the near

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future with featers such as video calls, security services and support of WiFi video phones.

In the light of a rising number of mobile-only users, we introduced “naked” ADSL (ADSL-only) and a package, combining a KPN "naked" ADSL connection and a competitively priced KPN Mobile subscription.

The introduction of KPN TV services in October 2004 forms part of our Multi-play strategy to offer our customers a combination of TV, Internet and telephony services. In 2005 we intensified marketing and sales promotions for KPN TV, and introduced Car TV, a television service available in cars for front and rear seats. In the third quarter we introduced the Personal Video Recorder ("PVR"), a new Digital TV proposition that enhances the consumer 's experience of watching TV. The easy to use PVR provides the opportunity to simultaneously watch and record different channels, or to watch programs on delay. At the end of 2005, 'Digital TV by KPN' (based on DVB-T technology) could be received in the main metropolitan areas of The Netherlands (covering about 45% of all Dutch households). As of December 31, 2005, we had about 184,000 KPN TV subscribers (including Digitenne), of which the majority chose packages in combination with our voice and ADSL offerings. We positioned KPN TV as an inexpensive alternative to cable TV. If the KPN customer has at least one of KPN's products, including voice or ADSL, KPN TV can be purchased for only EUR 7.95 per month. We believe this offer will improve customer loyalty for KPN.

At the end of 2005 we started a trial with KPN IP-TV. Instead of broadcasting every channel continuously, IP-TV transmits only what subscribers request. Entertainment on demand, delay TV, pay-per-view options and Personal Video Recorders ("PVR") are cornerstones of our future portfolio. The difference between DVB-T and IP-TV is transmission (via terrestrial signal or via DSL-network) and a broader portfolio of services that is expected to become available on IP-TV. So far, this launch is restricted to a maximum of several hundreds of users but the full commercial launch of KPN IP-TV is planned for the first half of 2006. We have already contracted more than 60 channels for IP-TV.

KPN and the State of the Netherlands have, in principle, reached an agreement in 2005, under which KPN will acquire all shares of Nozema Services for EUR 75 million. The takeover still requires approval from The Netherlands Competition Authority (NMa). Nozema Services delivers terrestrial broadcast services for both TV and Radio. With these services we can facilitate the national roll out of digital terrestrial TV (DVB-T). KPN intends to achieve national coverage of its DVB-T product before the end of 2006, subject to the approval by the NMa.

Defending traditional services to maintain our leading share in declining markets

Despite the arrival of new means of communication, the market for fixed telephony remains fundamental to our business. We consequently continued to compete aggressively by offering new services to improve customer value.

In 2005, we made a number of enhancements in our fixed telephony portfolio such as:

  • BelPlus and BelVrij minute packages; and

  • new line of DECT handsets.

We extended the benefits of our BelPlus flat fee packages. Beginning with the third quarter of 2005, all minutes purchased (up to a maximum of 1,800 minutes per account) have unlimited validity. BelPlus has proven to be very effective as a win-back vehicle. 28% of our telephony customers have subscribed to one of these packages. In the fourth quarter of 2005 we introduced BelVrij Avond & Weekend, our first flat fee package offering unlimited local and national evening and weekend calls.

We have launched an innovative mobile-like handset program. With modern designs and equipped with functions and navigation menus familiar from mobile handsets, this new line of DECT handsets converts the old fixed-line telephone into a terminal with a color display, icon-based menus, a wide range of ring tones and SMS messaging. In addition, we combined the benefits of our BelPlus portfolio with the advanced capabilities of the new DECT handsets by packaging both in a three-year rental contract.

PRODUCTS, TARIFFS, COMPETITION AND DISTRIBUTION

The Consumer segment primarily generates revenues from our Voice business line (including VoIP), our Internet business line and from our KPN TV business line. Our products and services can be grouped in products and services relating to access, traffic, equipment, supplementary services and digital TV.

Voice and VoIP

Access

KPN offers fixed-line telephony access services through analogue (PSTN) and digital lines (ISDN). Each PSTN line provides a single telecommunication channel, whereas ISDN access lines offer a choice of one or two channels. Using ISDN, a single line can be used for a number of purposes at the same time, including voice, data, Internet and fax transmission.

The revenues from these access services consist principally of subscription fees charged bi-monthly to customers and one-time connection fees. Total net sales from connections depend on the number of new connections and customer lines, the mix of the customer base (fees for digital lines are higher than for analogue lines) and fees charged for our services.

We are the largest provider in the traditional voice access market, but experience continued competitive pressure. In the consumer market there is heavy competition from mobile-only solutions and increasingly from VoIP solutions. As of December 31, 2005, about 16% of Dutch households have only mobile phones (compared to 12% as of December 31, 2004). Broadband penetration (the number of households with a broadband connection) increased significantly. This key number showed an increase from 45% in 2004 to approximately 58% in 2005. These

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high broadband penetration rates make it attractive for cable operators and alternative DSL providers to introduce a low-priced VoIP service to compete with us. Cable operators such as UPC, Casema, Multikabel and Essent and the telecommunications operator Versatel provide most of the VoIP lines. Most of these VoIP lines have replaced a PSTN or ISDN connection from KPN.

Under the name “Internetplusbellen“ we started a trial of our own VoIP product in the second quarter of 2005. After an initial period to reach the quality standard we set as a prerequisite we began the further rollout of VoIP, both in terms of consumer reach and portfolio depth, in the fourth quarter of 2005. XS4ALL has also started selling VoIP products to its customers. We now support more services (e.g. Video Calling) and have intensified marketing and distribution.

In all, the number of PSTN and ISDN lines continued to decline during 2005. As of December 31, 2005, we supplied approximately 5.0 million PSTN and ISDN connections to residential customers (compared to 5.4 million as of December 31, 2004).

We believe that our home market is one of the most competitive telecommunication markets in Europe, primarily due to the early liberalization of the telecommunication sector in The Netherlands. Carrier Pre Select (CPS) operators have a significant presence in The Netherlands. Our major competitors in this field are Tele2 and Pretium. Thanks to our more aggressive approach, employing for example outbound calls from our contact center, we are now successfully competing with these CPS operators. This was reflected in an increase of our traditional voice market share from approximately 60% as per December 31, 2004 to approximately 64% per December 31, 2005.

With the rise of broadband, infrastructure ownership becomes more important to be able to offer the customer a complete range of products (voice, Internet, TV). The acquisition of Versatel (a Dutch company with an own backbone network in The Netherlands mainly focused on business clients and consumer broadband) by Tele2 (a large Swedish Carrier Pre Select company) is an example of this shift in market approach. The Tele2/Versatel combination already acts as a strong force - next to KPN - in aggressively promoting DSL broadband-based triple play in The Netherlands, relying on its exclusive right to the live broadcasts of Dutch soccer competition since the third quarter of 2005.

Cable operators - positioning themselves as an alternative to KPN - increased their efforts to cash in on their broadband-enabled networks in 2005. During the year they focused their activities on rolling out digital voice (VoIP) as a cornerstone of their strategy to increase their market share.

Voice traffic

We offer:

  1. local telephony traffic: call minutes from calls within a call area or to an adjacent area;

  2. national long-distance traffic: call minutes from calls between customers in different local call areas in The Netherlands;

  3. fixed-to-mobile traffic: call minutes from one of our fixed lines to a mobile telephone; and

  4. outbound international traffic: call minutes from international calls by direct dialing.

As a result of the liberalization of the telecommunication market, telephone users are free to choose a provider that handles their calls by either Carrier Pre Select or by Carrier Select. New services are generally rendered at lower tariffs.

In order to maintain our market share, we increasingly focus on providing more value to our voice customers through voice bundle discount packages, branded as BelPlus packages. In addition, we combined the benefits of our BelPLus portfolio of flat fee offerings (e.g. a new flat fee package for weekend and eveningcalls which has already been introduced and a 24 hours flat fee we intend to introduce in 2006) with the advanced capabilities of the new DECT handsets.

Since its introduction in the second quarter of 2003, approximately 1,421,000 consumers have opted for BelPlus packages, representing a penetration rate of approximately 28% of our total residential customer base. Since their introduction in 2005 almost 100,000 combined BelPlus- handset packages have been sold.

Through these activities in the traditional voice market, we have been able to increase our market share in traditional voice calls contrasting with market share losses in previous years. At the end of 2005, our market shares were: between 65% - 70% (for local calls), approximately 60% (national), approximately 65% (fixed-to-mobile) and between 40% - 45% (international - excluding international traffic from telephone cards).

Tariffs Voice

Our tariffs for fixed-line voice telephony services are subject to regulatory approval, except for international voice services. Under the regulatory framework applicable to the Dutch telecommunication sector, these tariffs will continue to be subject to regulation for as long as the Dutch regulator designates us as having significant market power. During 2005 our traffic tariffs remained unchanged.

On January 1, 2004, and December 1, 2004, MTA tariffs were reduced following regulatory intervention. As of December 1, 2005, the fixed-to-mobile tariffs were reduced again by approximately 12%, which resulted in lower revenues for our Fixed division. The reduced Mobile Terminating Access (MTA) tariffs had no impact on the operating result of our Fixed division.

The level of monthly subscription fees is higher for ISDN access lines than for standard PSTN access lines. During 2005 our subscription fees for PSTN and ISDN lines remained unchanged.

Internet

As part of our strategy to increase our market share in the broadband Internet market, we continued to extend our range of DSL access variants and supplementary services, and continued

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to migrate dial-up customers to broadband solutions. During 2005, broadband penetration continued to grow. About 58% of Dutch households have a broadband connection. To increase our retail broadband market share we put more emphasis on the acquisition of new customers. We also acquired a number of smaller ISPs that already used KPN's ADSL including Freeler, Tiscali, and Hcc!Net. This strategy is important to us, because broadband lines are increasingly used to offer a combination of Internet, voice and TV-services.

We offer customers broadband access through our KPN Internet organization. 'Direct ADSL' (which offers a direct ADSL connection without using an ISP), KPN Planet, Het Net and XS4ALL are the brands under which we sell our range of broadband products.

The total number of KPN ADSL connections increased by 26.0% from 1,381,000 at the end of 2004 to 1,740,000at the end of 2005, representing 42.3% of the total consumer broadband market in The Netherlands (including broadband offered by cable operators).

Our three ISPs plus Direct ADSL increased their number of broadband subscribers from 936,000 as of December 31, 2004 to 1,485,000 as of December 31, 2005.

Subscribers using ADSL by KPN receive additional savings on premium services and have access to specific broadband services. Subscriptions at (introductory) discounts are offered in order to gain market share. During 2005, we increased the ADSL transmission rate several times, whilst keeping prices stable in order to attract new customers. Competition in the ISP market remains strong. Our main competitors in the ISP market are @home, Chello, Tiscali and Wanadoo.

We are building on our existing customer base and on the strength of our brand names in The Netherlands. We charge our ADSL Internet customers monthly subscription fees that comprise of two parts: the ISP charges the customer the fee for Internet use, while the use of the infrastructure is charged directly to the customer. Additional services are charged per service through the ISP. All customers of our ISPs pay a monthly subscription fee.

Apart from broadband ADSL services, we offer narrowband Internet dial-up services: Internet dial-up both to customers of our own ISPs as well as to customers of third party ISPs (via so-called 0676 numbers). As a result of the migration of dial-up customers to broadband offerings, our Internet dial-up access minutes are rapidly decreasing. As of December 31, 2005, we had in total 564,000 dial-up subscribers in The Netherlands (2004: 700,000).

Internet traffic

We offer Internet dial-up minutes to our own and other ISPs. Due to the increasing penetration of broadband and the migration of dial-up customers to broadband, our Internet dial-up customers and minutes continued to decrease rapidly during 2005.

Tariffs internet

Given technological developments and competition, which results in pressure on ADSL subscription fees, we are offering higher transmission speeds while maintaining our ADSL tariffs. The highly competitive environment, however, forced us to give discounts on modem prices and to offer free installation costs.

Tariffs for dial-up subscriptions and connection fees remained unchanged in 2005.

Digital TV

We offer wireless digital broadcast TV and radio (based on DVB-T) as from October 18, 2004, as part of our Multi-play strategy to become an all-round provider of voice, broadband Internet and TV services. We are one of the first telecom operators to venture into the TV market. At the end of 2005, 'Digital TV by KPN' could be received in the main metropolitan areas in which about 3 million (or approximately 45%) of the Dutch households reside. KPN intends to achieve national coverage of its DVB-T product before the end of 2006, subject to approval by the NMa.

The offering is comparable to standard cable, but at lower subscription prices (EUR 7.95 per month (Multi-play price)) and lower set-top box prices.

During 2005, we experienced a slower market growth for digital TV than expected.

As of December 31, 2005, we had approximately 184,000 KPN TV subscribers (including Digitenne), of which the majority chose packages in combination with Voice and ADSL.

Our Brands and Marketing

Our products and services are sold under various brands. The KPN brand is our primary brand used for our Voice activities in the consumer market. Internet and broadband services are marketed under our Planet Internet, Het Net, XS4ALL (three ISPs), and Primafoon (retail chain) brands.

In 2005, marketing was refocused from a product to a target group orientation. For the consumer market the main objectives are the aligning of products, market concepts and brands to a number of homogeneous market groups. For each of these groups we have put tailored Multi-play packages aimed at increasing overall customer satisfaction. Enhanced CLM (Customer Lifecycle Management) tools support this approach. As a consequence, we put less emphasis on nationwide promotion campaigns on TV and concentrated more on regional and personal marketing.

Our mainstream and premium brands - KPN, Planet Internet and XS4ALL- are targeted at the mainstream and higher end segments of the consumer market. Our economy brand - Het Net - is used for the budget segments of our market. All these brands are broadly considered as reliable competitive priced brands. XS4ALL has repeatedly been named in independent tests as the preferred brand regarding its reliability and high-service quality. Our other

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brands are scoring in the top range of these polls as well.

With this policy, we anticipated the more individual approach the market is increasingly demanding from us. This has contributed to the developments reported above: turnaround of market share in the voice market, continued strong growth of ADSL sales and the successful extension of KPN TV.

Segment Business

IMPLEMENTING OUR STRATEGY

Competition in the Dutch business market remains fierce. ICT is becoming increasingly vital for businesses. Furthermore there is an increased demand for managed services and a continuing shift in focus from network technology towards applications functionality. New communication services are IP-based and data-access becomes independent of hardware devices. As a consequence of these developments, IT and system integrators (e.g. Capgemini, Accenture, IBM, etc) are moving down the value chain. Corporate customers increasingly demand for International solutions for their national and international business. Meanwhile, Global Internet players (e.g. Skype, MSN, Googletalk) offer on-net VoIP for free. KPN's strategy in the business market is aimed at grasping the opportunity to shift from decreasing traditional communication services towards services in the larger and growing market for end-to-end ICT Services.

Attacking the market for new communications, information and entertainment services, aimed at establishing leading positions that deliver attractive long-term financial returns

We believe we are the preferred supplier for IP-VPN services in The Netherlands, providing us with an excellent basis to sell services and applications that are based on IP-VPN to our customers.

KPN has made substantial progress in implementing an advanced IP and Ethernet/MPLS-based infrastructure and has begun to offer various VoIP and other IP-based services including managed firewalls and application on demand services (examples of such applications are various business applications, such as Exact, e-HRM tools, and e-Procurement tools). With these developments we have made a start in transforming our business from a communication service provider towards an end-to-end ICT-provider.

We launched a new campaign 'ZekerWeten®', emphasizing the service quality of KPN. As part of this initiative, KPN introduced several innovative advisory tools, for example the TelecomScan; an online advisory tool for small and medium sized enterprises to discover their optimum communications mix, taking into account the Company's mobile and fixed telephony usage. We also introduced the Business Continuity Quick Scan, which helps large enterprises to analyze their contingency planning to ensure the continuity of their business processes in case of emergency.

In December we launched a trial for Zakelijk InternetPlusBellen in our Business segment, which is our VoIP offering for the small business market. Our offer is based on a xDSL-connection and provides our customers with one solution, comprising both telephony and Internet services.

A national product portfolio is not sufficient to be successful in the top end of the business market. Corporate customers increasingly require international solutions for their international and national business. To meet those shifting requirements, KPN has developed an international proposition based on a smart combination of its own European data network and various partner networks. With this low cost infrastructure KPN is able to deliver advanced seamless data and voice services to global customers under one contract, one helpdesk and one invoice.

KPN implemented a new approach to innovation based upon entrepreneurship and an increased focus on sector specific ICT opportunities (e.g. Education, Health care). We expect to introduce the first services in early 2006.

Defending traditional services to maintain our leading share in declining markets

Discussions with our customers are leading to the creation of tailor-made packages as part of which customers and KPN agree upon optimal migration timing. This approach has led to significant decreases of migration and churn of the traditional services.

We further reduce churn by building customer-focused program teams for our largest accounts. This results in improved responsiveness to customer demands, of both new and existing customers. Where relevant we advise and help our customers to migrate from traditional to new technologies to better support their business processes and reduce the total cost of ownership.

BelZakelijk is a prepaid voice package offering a range of 10 different call bundles varying from EUR 5 to EUR 5,000 per month.

We have further enhanced the benefits of the pre-paid BelZakelijk minute packages offering a 1% extra discount for multi-site customers as well as DECT-handset rentals for the BelZakelijk package. In addition, the BelZakelijk Jaarbundel was introduced, which allows customers to pay their telephone bill one year in advance and gives customers a higher discount when doing so. By the end of 2005, approximately 253,000 customers had opted opted for BelZakelijk, providing 38% market penetration in the primary target group of small and mid-sized companies.

In February 2005, we introduced ISDN1 as a cost effective and efficient solution for ISDN2 customers migrating to ADSL. In July we also introduced "*21 online", which is an online switching service for large customers. With "*21 online" large enterprises can easily route their incoming voice traffic via a web-tool. In August we introduced 088 company numbers, which are national telephone numbers not bound to a geographic location for business customers. Customers pay a one-off fee dependent on the amount of numbers required.

For small and medium sized companies we introduced our 'flexible' concept for telephony equipment. This allows the customer to pay a monthly fee for the telecom functionality without major capital expenditures thus increasing flexibility and ensuring a high quality communication solution.

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We were faced with deregulation of the 0800/0900 market prices. KPN's packaging strategy on CRM solutions in this declining service number market together with the new portfolio on micro-payments and CCOD (call center on demand) functionalities creates a full suite of CRM services that we believe will enable us to maintain our positions in these declining markets.

PRODUCTS, TARIFFS, COMPETITION AND DISTRIBUTION

The Business segment primarily generates revenues from our Voice business line, our Data business line, (international) Managed Services, our Equipment (solutions) business line and Customer Interaction Solutions.

Voice Services

Products

KPN offers fixed-line telephony access services through analog (PSTN) and digital lines (ISDN). The revenues from these access services consist principally of subscription fees charged bi-monthly to our customers. Total net sales from connections, for which we charge a one-off connection fee and subscriptions, depend on the number of new connections and customer lines, the mix of the customer base (fees for digital lines are higher than for analogue lines) and fees charged for our services.

KPN offers national and international calls. The revenues from these traffic services consist of minute-based fees charged bi-monthly. The minute-based fees range from our standard BelBasis offering (in the small office/home office market segment) to different BelZakelijk packages (in the small and medium sized enterprises segment) to Worldline XL (a volume based discount arrangement for our large enterprise customers).

Tariffs

Our tariffs for fixed-line voice telephony services are subject to regulatory approval. Under the regulatory framework that applies to the Dutch telecommunication sector, these tariffs will continue to be subject to regulation for as long as the Dutch regulator designates us as having significant market power. The level of monthly subscription fees for ISDN access lines is higher than for standard PSTN access lines. During 2005 our subscription fees for PSTN and ISDN lines remained unchanged.

Competition

We face aggressive competition in a declining traditional voice market due to the high pace substitution from fixed to mobile and data (VoIP) together with a high penetration of broadband connections.

In the corporate market traditional voice telephony is increasingly being replaced by broadband and IP-VPN solutions. This trend is also increasing now that IP-VPNs are being equipped to provide intercompany voice traffic (for free).

In the small business market we experience heavy access competition from cable operators, which are now offering Voice over IP solutions bundled with broadband Internet. Increasing broadband penetration in the business market enables competitors to offer more business services at lower costs, e.g. electronic payments, and poses a high risk for our traditional voice access services.

In the traditional voice access market we are the largest provider, but experience continuing competitive pressure from direct access and Carrier Select and Carrier Pre Select competition. Our main direct access competitors are Versatel, BT Ignite, MCI Worldcom, TTG, Colt and Enertel. The main Carrier Select and pre select competitors are Tele2 and Pretium.

Data and Internet access services

Products

We offer a range of data communication services for business customers. We are the leading provider of these services in the Dutch business market both in terms of revenues and in terms of number of connections. In addition, we offer data services in Europe through our KPN EuroRings network and worldwide with our partners. The telecommunication solutions based on data/IP services we offer include:

-National data services

KPN offers an extensive portfolio of data services ranging from Traditional Transmission Services such as Leased lines and broadband services to Network Services such as IP-VPN, Ethernet VPN services and Internet Access Services. KPN is the leading provider of Internet Access Services in The Netherlands. Both xDSL (e.g. ADSL, SDSL) access technology and optical fiber access technology is supported. These services are targeted at business costumers and at Internet Service Providers.

-International data services

Through our KPN EuroRings network we provide international connectivity services in Europe. The international services also vary from Transmission Services such as international leased lines to Network Services such as IP-VPN and Ethernet VPN Services. Furthermore, for worldwide solutions we work with partners like SingTel, Telefónica and Sprint. This is complemented with substantial participations in various sea cables.

-Integrated & Managed Solutions

KPN provides Managed Network Services, Managed IT Services and Mobile Data Solutions to customers who are outsourcing parts of their ICT-infrastructure and management to KPN. KPN aims to provide one seamless, end-to-end solution tailored to each customer’s specific ICT requirements.

Tariffs

The pricing of KPN's data services, Internet Access Services and integrated & managed solutions is largely based on recurring monthly subscription fees. The pricing depends on the bandwidth, the quality level and the functionality provided. The pricing of leased lines also depends on the geographical distance. Some services have an additional volume-based pricing component. Customers are typically billed on a monthly basis.

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Data services are partly regulated. The service fees of regulated services are therefore based on prescribed cost-based calculations as stipulated by the Dutch telecommunication regulator, OPTA.

The price level of data and Internet Access Services is declining. This is the result of a combination of intense competition, overcapacity of bandwidth and the migration from traditional services with higher prices to next generation services with lower prices.

Competition

We have many competitors in the data communications services market, such as BT Global Services, MCI, IBM, Colt, Essent, Enertel, Versatel and BBNed. Our competitors invest in the construction of backbone infrastructures in The Netherlands and in local networks in large Dutch cities, comparable to our CityRings network. Local government fiber initiatives also increased the competitive pressure within The Netherlands and introduced new competitors.

Equipment, voice and data solutions (EnterCom)

Products

KPN designs, delivers, integrates and services voice and data communication solutions (such as PBX installations and Local Area Networks) and offers communication solutions for special events, call centers and dealing and trading. Anticipating IP and Mobile convergence, we offer combined solutions to meet customer demand in new areas like video surveillance, security, Dynamic Instore Marketing (narrow casting) and healthcare. We use high-quality partners to enable us to acquire specialist knowledge in new areas. Increasingly customers require managed solutions.

KPN provides outsourcing solutions for all or part of the telecom operations and infrastructure of companies, increasingly focusing on the integration of fixed, mobile and data communication. We offer the know-how of our consultants, project and implementation managers and specialists in management and technology.

Tariffs

We believe we are able to offer competitive prices for our products, service contracts and other services due to our excellent supplier relations, extensive knowledge of communication solutions and the use of technology (such as service on line) for servicing the products. By offering ongoing support and other services, revenues from equipment and voice and data solutions move increasingly from one-off revenues to recurring revenues (for example Managed Solutions 'tariff per minute' in a managed call center environment and Managed IPT solutions).

Competition

Our competitors are numerous and vary in size, depending on the product/service we sell in the ICT market space. Our main competitors are Imtech, Getronics and Dimension Data.

We maintained our leading position with high success rates and high customer satisfaction. Clients have chosen KPN increasingly for our end-to-end full service provisioning and Fixed and Mobile convergence as well as our innovative solutions.

Customer Interaction Services (CIS)

Products

The Business to Business ('B2B') portfolio of SNT combined with KPN's already existing 'interaction portfolio' created the new Customer Interaction Services unit which is fully equipped for a new growing market of 'interaction services' between businesses and their customers. Through this business unit, KPN provides a wide range of corporate-voice-inbound and interaction services varying from conferencing services and 0800/0900 service numbers to new services like CRM software applications.

Tariffs

The 0800/0900 service numbers market prices are subject to regulatory approval. Under the new Telecommunications Act these prices will be deregulated in 2006. We expect that this development will improve our competitive position.

Competition

The competition for interaction services varies from operators (0800/0900) to software companies (CRM software). We believe the ability to offer a combination of traditional routing facilities and CRM applications will give KPN a competitive advantage. To exploit this competitive advantage, KPN has established a number of select partnerships with companies like RightNow Technologies and Epiphany.

Distribution

Business Market Fixed offers telecommunication solutions for the large, small and-medium markets through a variety of sales and distribution channels. The small and medium market is serviced by KPN Personal Sales, KPN Sales stores (KPN Business Centers), Value Added Resellers, callcenters (in- and outbound) and online sales via KPN.com.

In 2005 we expanded our distribution power in the small and medium market through dedicated projects within these channels. To improve our local presence we introduced our portfolio in the Business Centers and selected Value Added Resellers with data-expertise. We are redesigning our online sales platform to make it easier for our customer to choose and order the right product. Significant steps were made when we introduced CRM-solutions in our call centers, which make it easier for the agents to target the customer with the right proposition.

Large corporate customers are serviced by dedicated (strategic) account management, supported by consultants offering integrated all-inclusive solutions. We improved our distribution power for this market by differentiating our sales approach and implementing multi-channel initiatives in alignment with the customer profile and value.

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Our Brands and Marketing

For business customers in The Netherlands, KPN is the primary brand for both fixed telephony, Internet/broadband and data network services. KPN also owns Infonet Netherlands, which offers data networking services, as an exclusive distributor of Infonet Inc. in the Dutch Market. In 2005, KPN's marketing further refocused from a product to a market orientation for both consumer and business customers. For Small and Medium Enterprises as well as Large Enterprises, our major goal in 2005 was to offer our customers a range of services and easy-to-use solutions based on their business needs. To meet this goal we often successfully played the role of ICT-advisor. Advising the customer was also a part of the continuous improvement of our customer service to finally reach higher customer satisfaction. Examples of advising the customer are the 'ZekerWeten'-campaign, a fixed-mobile campaign emphasizing our advisory capabilities based on innovative advisory tools; the "Telecomscan", an online advisory tool for SMEs to identify the best possible communications mix, taking into account a company’s mobile and fixed telephony usage; and the Business Continuity Quick Scan which helps large enterprises to gain insight in the continuity of their business processes in case of a crisis.

We were successful in increasing our sales of broadband (Office DSL), IP-VPN and Ethernet VPN network solutions, nationally as well as internationally. During 2005 we continued offering managed services. These services optimize business processes and contribute to business continuity and ultimately cost savings. In the SME market KPN has strengthened its position with intensified marketing campaigns for KPN's DSL offering and KPN's new product line up.

Segment Wholesale and Operations

Within this segment our main external activities are:

  1. national wholesale and local-loop services;

  2. international wholesale voice and wholesale data services; and

  3. customer relations management activities.

IMPLEMENTING OUR STRATEGY

In the wholesale market there is a growing demand for higher bandwidth and new broadband services, while revenues from traditional voice and internet services are decreasing. As a consequence of this shift we see increases in (external) wholesale volumes as Cable and ADSL operators are entering the retail voice market via VoIP. The transit volumes we handle for other operators are tending to decrease given that direct-interconnection initiatives are surfaceing more and more. Internationally, there is a trend towards international consolidation and strategic alliances, as a consequence of which the downward pressure on tariffs increases, only partly offset by increasing volumes.

Attacking the market for new communications, information and entertainment services, aimed at establishing leading positions that deliver attractive long-term financial returns

In our wholesale market we continue to search for new opportunities. In the first quarter of 2005 we introduced wholesale ADSL. This service is an added value service on top of local loop unbundling, which enables ISPs and other operators to add ISP-specific value, e.g. e-mail services, spam- or virus-filters and firewalls, without the need to invest in the construction of their own DSL network.

Defending traditional services to maintain our leading share in declining markets

We continue to search for possibilities to maintain or increase our (traditional) revenues by leveraging our scale advantages and responding to consumer desire for choice through wholesale offerings in addition to KPN-branded retail offers.

Exploit to achieve a structurally lower cost base and improved customer satisfaction

In March 2005 we announced our Exploit initiative to achieve a structurally lower cost base. We launched several cost savings programs, mainly concentrated in the categories of personnel, traditional IT systems and infrastructure.

The IT Transformation Program announced is now fully operational and has delivered its first benefits in 2005. Agreements were made with KPN’s main IT suppliers and the first cost savings have been realized. Best-practice processes were implemented in the IT organization, rationalizing IT applications and leading to a 20% reduction of IT applications in 2005.

In the longer term, All-IP is the predominant factor allowing us to achieve cost savings through FTE-reductions. In 2005 we turned our All-IP vision into an operational plan. We selected our suppliers and communicated internally as well as externally the focus on employee mobility. In 2006, we will start a pilot project to develop and test migration processes.

NATIONAL SERVICES

The national services we offer can be divided in national wholesale and national local-loop services.

Within the national wholesale services we offer a comprehensive range of services that give other telecommunication companies access to our fixed telephony network. These services include:

  • terminating services: we offer terminating access to end users connected to our network, allowing customers from other operators to reach our customers;

  • voice-originating services: we offer Carrier (Pre)Select operators access to calls originating on our network and we offer customers of our network interconnection with so-called premium numbers (with prefixes of 0800 or 0900), pagers and virtual private networks;

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  • internet-originating services: we offer ISPs the possibility to bill their customers directly for their Internet traffic volume usage through the use of special dial-up numbers (with 0676 prefix); and

  • transit services: we offer other telecommunication operators the routing of incoming and outgoing national and international calls between other operators' networks through our network.

In 2005 traffic volumes decreased for originating and terminating voice services mainly due to the lower number of end customer connections on KPN's fixed network. As a result of the substitution from Internet dial-up access to broadband Internet access services the volume of Internet-originating services declined substantially during 2005, continuing the trend of 2004. In addition to traditional competitors in the national voice market such as Versatel, MCI, BT and Enertel, competition from cable operators with their Voice over IP offerings has increased significantly over the course of 2005.

In the transit market KPN faces continuing strong competition from direct interconnection as well as competitors such as Orange and BT. Despite strong competition KPN has been successful in defending market share, resulting in increasing traffic volumes for transit voice services. The main driver behind this growth remains the continuing growth in mobile-to-mobile voice traffic.

Within the national local-loop services, we offer access services to 'the last mile' of our network. These services include:

  1. Main Distribution Frame (MDF) access: this service physically connects networks of other operators to the local loop network of KPN. With this service we offer operators direct access to homes and offices of their customers;

  2. MDF co-location: we offer other operators the possibility to install their equipment in or alongside KPN buildings, towers and masts to connect their systems and networks to our network. This service offers operators direct access to the local loop network of KPN;

  3. Bitstream access: we offer operators and ISPs the possibility to develop individual DSL-based services;

  4. Interconnect Leased Lines services: we offer a unique connection between an end-user location and the transmission network of an operator; and

  5. Wholesale ADSL: In the first quarter of 2005, we successfully introduced the Wholesale ADSL service. This service is an added value service on top of local loop unbundling, which enables ISPs and other operators to add ISP-specific value, e.g. e-mail services, spam- or virus-filters and firewalls, without the need to invest in the construction of an own ADSL network.

Due to the developments in the broadband market, there is an increase in bitstream access offers for 2005. The decrease in PSTN and ISDN connections continued in 2005 and caused further decline of MDF access offers. MDF co-location grew during 2005 mainly due to an increase in sites used by ISPs. Several Wholesale ADSL agreements have been signed since the introduction of this option in the first quarter of 2005.

INTERNATIONAL SERVICES

The international wholesale services we offer can be divided into voice services and data services. Data services are primarily handled by Connectivity, for example via KPN EuroRings. The international voice services transport international voice traffic originating outside and inside The Netherlands to any place in the world and includes:

  1. Premium Voice Services like International Direct Dialing: services for calls originating or terminating in The Netherlands;

  2. Wholesale Voice Services: we offer services through our network of international calls from one foreign network to another foreign network (voice hubbing);

  3. solutions for mobile operators: services for voice traffic and SMS-, MMS- and UMTS related services; and

  4. solutions for ISPs: voice access services connecting VoIP traffic to switched networks internationally.

In 2005 volumes further increased in a growing market of international voice traffic. New sale outlets outside The Netherlands became operational in 2005: Cape Town, Rio de Janeiro, Hong Kong and Singapore. Our main competitors in this area are the major telecommunication companies. Consolidation in this market has taken place and further consolidation is expected.

Tariffs

Our national wholesale tariffs for fixed telephony and for wholesale unbundled local loop services (in 2005 with the exception of tariffs for transit services) are subject to regulatory approval. As a result of the market analysis performed in 2005 by the Dutch Telecom Regulator our transit services are now subject to regulation since January 1, 2006. Therefore regulatory obligations like non-discrimination apply, which could lead us to change our tariffs for these services which will have a certain impact on our business results. We believe our wholesale tariffs for terminating services and originating services approximate the average tariffs of an EU benchmark. Our tariffs for transit, originating and terminating services are composed of a call set-up fee and a charge per minute. For Local Loop Services we charge a one-off connection fee and a monthly subscription fee. The ongoing liberalization and increased international competition as a result of European regulation puts continuing pressure on international tariffs. The tariffs for regulated national wholesale services remained unchanged in 2005 compared to 2004.

Customer relationship management

As per May 29, 2005 the legal merger between SNT Group N.V. and Telecommerce B.V. was completed. On May 30, 2005 SNT Group N.V. de-listed from the Amsterdam Stock Exchange. Through this merged organization KPN offers Customer Relation Management activities, as follows:

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SNT

We are currently reorganising our internal core contact center into KPN Contact, performing the contact centre activities for our strategic services, such as Inbound Internet, ADSL and KPN TV, the Business Support Desk and the Infrastructure Helpdesk. Every week, 2,100 FTEs in three different locations handle 300,000 inbound calls. Important objectives are high service levels and a cost structure that enables us to charge tariffs that are in accordance with the market. KPN Contact has implemented the COPC (specific quality certification program for contact center businesses) quality program, and a first certificate was issued to the Contact Center Activity Invoice-Services in July 2005.

In addition, we offer further non-strategic center services in The Netherlands, Belgium and Germany. As part of the restructuring of the SNT Group, we intend to sell these activities.

Our call center activities in the Benelux-countries for external clients and for the non-strategic KPN services will be contracted to a separate entity. Every week, 1,500 FTEs in five different locations handle about 700,000 calls. This part of the business implements the COPC quality standards in its business processes.

With nearly 1.5 million calls a week, 3,000 employees and seven different locations, SNT Deutschland is a large player on the German call center market, and among its customers are many large companies. In 2005, SNT Deutschland managed to play a part on the multi connect market as well.

Mobile division

We are a provider of mobile telecommunications services in Western Europe with a particular focus on Germany, The Netherlands and Belgium, where we serve 20.8 million customers (on December 31, 2005). We deliver mobile telecommunications services ranging from standard voice and value-added services (call waiting, call forwarding, voicemail and message services like text messages and MMS) to advanced data services (i-mode, video telephony and mobile broadband Internet). We expect person-to-person communication services (voice, text messaging, e-mail) to remain the main source of revenues for mobile operators in the coming years, with advanced data services becoming increasingly important. In addition, the increasing number of mobile-only users reflects the trend towards growing use of mobile networks at the expense of fixed networks.

Pursuant to license agreements with NTT DoCoMo, we have offered i-mode services in our three main markets since 2002. i-mode services comprise communication (including e-mail), information, entertainment and transaction services via so-called content sites. Our major i-mode content partners include CNN, Disney, Dow Jones and Sony. We closely co-operate with 13 other operators (including NTT DoCoMo, Bouygues Télécom, Telefónica Moviles, O2 and CosmOTE) in the i-mode Alliance.

We introduced UMTS PC cards in Germany (June 2004) and The Netherlands (July 2004), followed by UMTS-enabled handsets a few months later. UMTS enhances the functionality of mobile data services (e.g., i-mode services and mobile Internet) by adding video and increased transmission speeds. We are continuously investing in our UMTS networks to follow the market demands driven by the increased availability of UMTS-enabled handsets. We expect the introduction of UMTS-based services to accelerate the use of advanced data services in the coming years.

In October 2005, we acquired Telfort, until then the only independent mobile network operator in The Netherlands. In 2005, we also established Sympac, a European mobile communication services provider - that renders mobile voice, Internet and data services - to multinational companies.

The strategic goals of the Mobile division are summarized below:

  • in The Netherlands, to further strengthen our market leadership position; and

  • in Germany and Belgium, to establish growing profitable businesses by challenging the competition, while further improving network quality.

For details on the way we calculate customer data, please refer to 'Presentation of Financial and Other Information'.

GERMANY

We are active in the German mobile telecommunications market through our mobile network operator E-Plus. During 2005, E-Plus' customer base increased to 10.7 million customers, reflecting the

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growth of the German mobile market; the market penetration in Germany increased by 10 percentage points to 97%. In the enlarged German mobile market, we succeeded in expanding our revenue market share by half a percentage point to 12.2%.

In the middle of 2005, we changed our strategy. The strategy revision aimed to accelerate growth and to put E-Plus on a solid path to profitability. The new strategy centered on a number of initiatives:

  • E-Plus set out to move away from 'push' (heavy reliance on handset and dealer subsidies) and move to a 'pull' strategy. The new brands 'BASE' (flat fee), "Simyo" (Internet only) and "Ay Yildiz" (Turkish community) are delivering significantly improved AMPU and ARPU in comparison to the E-Plus brand. Also for the E-Plus brand subsidies were tightened;

  • 9 MVNO-type contracts were signed and implemented, with well-known German partners such as Medion (Aldi Talk), Freenet and Conrad; and

  • a start was made with the expansion of our captive distribution so far delivering 25 store openings E-Plus tested a regional marketing approach with very encouraging results.

Our growth strategy focuses on increasing our customer base, revenues and market share on the one hand and profitability on the other. We succeeded in 2005 in attracting more than 1.2 million new customers, while increasing our postpaid customer share of the total base. The number of postpaid customers as of December 31, 2005 amounted to 5.6 million - representing a 52% share of our customer base (2004: 50%) - whereas we served 5.1 million prepaid customers.

Products and services

Under the classic "E-Plus" brand, we offer a range of propositions to the business and consumer markets, with an increasing focus on postpaid customers. These propositions include bundled packages, such as 'Time & More' for consumers and 'Professional' (S, M, XL) for the business market, various postpaid propositions under the 'Privat' tariff and 'Free & Easy' prepaid packages. In addition to the standard mobile services, we also offer a wide range of value-added voice and data services under the "E-Plus" brand.

In 2005, E-Plus embarked on its multi-brand strategy with the launch of new brands featuring innovative tariff structures: "BASE" offered the first flat-fee package on the German mobile market, "Simyo" was the first web-only prepaid mobile operator and "Ay Yildiz" was the first offering tailor made for Turkish-speaking people.

In 2002, E-Plus became the first operator to introduce i-mode services in Europe. As of December 31, 2005, we served 1.0 million i-mode customers. In April 2004, we launched WiFi services based on a service provider model. In June 2004, we took the first step in delivering UMTS services with UMTS data cards for laptop users. The first UMTS-enabled handsets were launched in August. Our UMTS network currently covers 51% of the German population.

As of December 31, 2005, we offered customers the possibility to use mobile telecommunications services outside Germany in 171 countries through international roaming agreements.

Tariffs

We offer a variety of tariff structures for postpaid and prepaid customers. We have different tariffs per minute - depending on the time of the day and weekday - to stimulate off-peak calls. Under the postpaid propositions, bundled minutes at discounted rates per minute are being offered. For postpaid and prepaid offers, we provide a special tariff option for calls to fixed-line numbers. These offers aim at capturing a larger share of the total voice market.

The new "BASE" brand offers a flat fee for on-net and fixed network calls and a simple tariff structure for all other calls. "Simyo", another new brand, also offers a simple tariff structure with one tariff for every call regardless of the time of the day. "Ay Yildiz", the third new brand, offers a simple tariff structure for Turkish-speaking people.

We structure i-mode pricing either in a fixed fee per data volume used or in four packages (S, M, L and XL) based on a flat fee for a certain threshold; if a customer exceeds this threshold, charges are invoiced by data volume used. For UMTS data Cards, our customers can choose between time and data volume packages.

The German regulator Bundesnetzagentur (the former RegTP) ordered the German mobile network operators to reduce their MTA tariffs in three steps, the first two steps became effective on December 15, 2004 and 2005, respectively. The third consecutive reduction will become effective on December 15, 2006.

Competition

Four mobile network operators, all holding UMTS licenses, are currently active in the German mobile telecommunications market: T-Mobile, Vodafone, E-Plus and O2. The two largest mobile telecommunications providers - T-Mobile and Vodafone - hold an estimated combined revenue market share of 74.5%. In the past years, E-plus and O2 have been successful in growing their revenue market shares.

In addition, numerous independent service providers in Germany package and sell products and services from various network operators under either the network operators' brand or private labels. Some of these service providers operate exclusively with one network operator, while others offer competing products and services. In all cases, service providers sell to both business and private customers. The main German service providers are Debitel, Talkline, Victor Vox and MobilCom. Service provider customers form approximately 24% part of our total customer base.

As a reaction to E-Plus' new brands, our competitors have also introduced a variety of new tariffs.

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Brand strategy

During the year, E-Plus changed to a multi-brand strategy with tailored offers to well-defined customer groups concentrating on customer needs like voice telephony and simple services. Three new brands were launched: "Simyo", "BASE" and "Ay Yildiz".

Distribution and sales

We offer our products and services through our own chain of 171 shops as well as E-Plus' website. Apart from these channels, we offer our services through resellers and service providers that may repackage our offers, tailoring them to their customers' needs. Resellers include among others Debitel, MobilCom, Talkline and Alphatel. For the business market, we also use these sales channels as well as a direct sales force.

Licenses and coverage ratios

Our 2.5G-enabled network currently covers over 99% of the German population (2004: 99%). The indoor coverage at the end of the year was 79%, similar to the indoor coverage at the end of 2004. Our 3G network has a 51% outdoor population coverage by the end of 2005, exceeding the applicable 50% minimum rollout requirement under our UMTS license.

THE NETHERLANDS

In October 2005, we acquired Telfort, the only independent mobile network operator in The Netherlands. As a consequence of this acquisition, we now own two mobile operators in The Netherlands. Telfort provides a range of mobile telecommunications services - based on its own mobile network infrastructure, which covers over 99% of the Dutch population - to consumer and business customers in the Dutch market. Telfort's products and services are marketed both branded and non-branded (wholesale white label). Telfort is being consolidated as from October 4, 2005. The 2005 figures for The Netherlands include Telfort for the consolidation period, unless otherwise indicated.

As a result, we are present in the Dutch mobile telecommunications market through our mobile network operators KPN Mobile The Netherlands and Telfort. With 8.1 million customers and an estimated 39.6% share of total market revenues as of in 2005, we are the largest mobile telecommunications provider. The penetration rate in the Dutch mobile market increased from 93% by the end of 2004 to almost 100% at December 31, 2005.

During 2005, we continued our focus on customer value. This was most evident in the continued growth of our contract subscriber base. We further cleaned up the prepaid customer base with a change in our disconnection policy, which further improved the customer mix in favor of postpaid. At year-end 2005, the number of postpaid customers amounted to 3.3 million - 40% of our total customer base - while we served 4.8 million prepaid customers.

We believe our leading role in both the business and residential segments of the Dutch mobile telecommunications market is the result of our well-known "KPN" and "Hi" brands, the quality of our mobile network, our extensive distribution network, our commitment to customer care and our innovative products and services. With the Telfort acquisition, we further strengthened our market position in The Netherlands, especially in the consumer segment and in the wholesale segment.

Products and services

We offer a range of standard and value-added mobile voice and data services. We pursue a multi-brand strategy to effectively appeal to different target markets. The "Hi" brand focuses on the young consumer and on heavy text message users, whereas the "KPN" brand is dedicated to other segments of both the consumer and business markets. With the introduction of the web-only "Simyo" brand, we serve the cost-conscious consumers who prefer basic mobile services (voice and text messages only) at low tariffs and with low distribution costs.

Telfort successfully offers branded prepaid and postpaid propositions under its own "Telfort" brand to consumer and business market segments. Furthermore, Telfort opened its network to other companies and organizations that wish to offer mobile telecommunications under a private label using Telfort's network. Telfort currently serves 10 wholesale customers. The wholesale segment is an important revenue source, using the power of our wholesale partners in terms of brands, existing customer base and distribution power. Our wholesale service portfolio consists of the options MVNO, external service provider, private label prepaid (PLPP) and tailor-made products (including the Mobile Virtual Network Enabler product).

We expect the growing demand for mobile data services - particularly those based on the latest Internet technologies - to lead to increased usage of our mobile networks. i-mode services were introduced in 2002 and we served 0.7 million i-mode customers as of December 31, 2005. Furthermore, we supply data and fax transmission services, VPNs for business customers as well as multimedia services and WiFi as part of our mobile data services portfolio. Our product 'Internet Everywhere' (GPRS) is being offered in combination with WiFi access.

In July 2004, we started rendering UMTS services via UMTS data cards, the first UMTS-enabled handsets being launched in October 2004. Our UMTS network covers currently 72% of the Dutch population. The UMTS network and handset portfolio are being expanded continuously. Since May 2005, Telfort offers data services based on EDGE technology.

As of December 31, 2005, we offer customers the possibility to use mobile telecommunications services outside The Netherlands in 199 countries via international roaming agreements.

Tariffs

We render our mobile services as a postpaid or prepaid proposition. The postpaid structure combines a monthly subscription fee and traffic-based pricing for business market customers. Under our postpaid consumer offerings, we offer bundeled minutes at discounted rates per minute, committing the customer to a minimum quantity of minutes a month. Our

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prepaid proposition is mainly based on traffic-based pricing. Data services - like text messages and MMS - are charged on an events basis, wheras other data services - like i-mode and UMTS-services - are based on flat fees, traffic bundles or usage in megabytes.

In response to regulatory requirements, we reduced our MTA tariffs in January 2004, December 2004 and December 2005. The average text message retail price declined considerably in 2004 and December 2005. The average text message retail price decined cosiderably in 2004 with other retail prices for mobile services changing less dramatically. In 2005, we introduced the new web-only "Simyo" brand targeting customers who prefer limited mobile services at low tariffs and with low distribution costs.

Competition

Our competitors in the Dutch mobile market are Vodafone, T-Mobile and Orange. During the last two years, a growing number of MVNOs and service providers have entered the Dutch market; most of these resellers offer privately labeled mobile services. Some of these resellers have a direct contractual relationship with the customer, while in other cases resellers act as intermediary for KPN and Telfort, the latter ones being the customers' contractual parties. As a result of the Telfort acquisition, our revenue share generated through MVNOs and service providers has increased.

Brand strategy

We offer customers the possibility to choose between different propositions under separate brands - "KPN", "Telfort", "Hi" and "Simyo" - tailored to the needs of different customer segments. During the sales process, special attention is given to explaining the relevance of services to each individual customer.

The "KPN" brand targets both the consumer and business markets with a premium value brand. We believe KPN is offering best-in-class mobile services and - according to quality perception research - the best mobile network quality.

"Telfort" provides a branded portfolio as well as an extensive wholesale white label portfolio, offering mobile products in specific niche segments of the Dutch mobile market. The wholesale portfolio enables us to operate in market segments that cannot be reached through our branded propositions or which are uneconomic to reach on a branded basis.

"Hi" targets the more cost-conscious youth segment, an important growth market especially for data services. i-mode users are continuously encouraged to try new services, also through a hardware upgrade program for handsets with increased capabilities.

The "Simyo" brand is directed at customers preferring limited mobile services (voice and text messages only) at low tariffs and with low distribution costs; Simyo is only available via the Internet. Simyo is positioned as a smart and simple alternative.

Distribution and sales

In The Netherlands, we offer our services via third-party channels (e.g., T for Telecom and The Phone House), KPN-owned outlets (i.e., 91 Primafoon shops, 12 Business Centers, 12 Telfort shops and 60 Kral shops) and our direct-sales force. Since the end of 2005, we have also introduced 'kpn576", a new retail formula aimed at a young urban audience; 2 of the 20 planned kpn576 stores have recently opened their doors. Non-store channels are gaining in popularity and sales volumes. Wholesale services are provided to a few external service providers.

Licenses and coverage ratios

Our 2.5G-enabled network currently covers over 99% of the Dutch population (2004: 99%). The indoor coverage at year-end was 98%, which is the same as by the end of 2004. On December 31, 2005, we had 1,735 installed 3G sites, covering 250 cities or 72% of the Dutch population.

Under our UMTS licenses, we are obliged to cover all cities with over 25,000 inhabitants plus all highways and major connecting roads by January 1, 2007.

BELGIUM

The Belgian mobile telecommunications market offers growth opportunities for BASE, our mobile operator. We are the number three mobile telecommunications provider - serving 2.0 million customers as of December 31, 2005 (2004: 1.6 million) - with an estimated revenue market share of over 13% (2004: about 11%). Through our policy of combining distinctive and simple offers with tailor-made propositions for specific market niches, we have achieved a strong growth in our customer base, revenues and market share since the fourth quarter of 2003.

Products and services

We offer a portfolio of voice and data products and services directed at ease of use and supported by a clear tariff structure. We also offer product and services focused on specific market segments. Examples thereof are the "Ay Yildiz" proposition (for the Turkish-speaking community), our low-cost "Simyo" brand and a youth-oriented offer in co-operation with TV channel TMF.

As of December 31, 2005, we offer customers the possibility to use mobile telecommunications services outside Belgium in 186 countries via international roaming agreements.

Tariffs

We offer prepaid and postpaid propositions. The simplicity of the tariff structures and the possibility to opt for flat rates (EUR 7, EUR 14 or EUR 28) is characteristic for our offers. Postpaid propositions do not contain a fixed monthly subscription fee. Instead, customers buy a package with bundled minutes. In 2005, we introduced "BASE Unlimited", offering an unlimited amount of on-net calls for a monthly flat fee. i-mode customers pay fixed monthly fees excluding the subscription fees for specific content sites. In 2005, we also introduced the new web-only "Simyo" brand to Belgium, targeting customers who prefer basic mobile services at low tariffs and low distribution costs.

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Competition

The other mobile operators in Belgium are Proximus and Mobistar. Shareholders of Proximus are Vodafone (25%) and Belgacom (75%). Orange holds a 50.37% equity interest in Mobistar. Proximus is the obvious market leader in Belgium - having over half of the market's revenues - with Mobistar as the runner-up at a clear distance. BASE, the third-largest provider, is the challenger in the Belgian mobile market.

Brand strategy

We have positioned BASE as our integrated network operator, distinguishing ourselves from the competition by 'Doing things differently'. To this end, we introduced a multi-brand strategy to better suit our services to specific customer segments. For certain segments, we teamed up with partners (for instance TMF).

Distribution and sales

Our products and services are available at well-known nation-wide retail chains like BelCompany, The Phone House, Expert, Carrefour, Mediamarkt and Cora as well as at our BASE shops and web channels. Currently, we operate 43 BASE shops.

Licenses and coverage ratios

Our 2.5G-enabled network currently covers over 99% of the Belgian population (2004: 99%). The indoor coverage at the end of the year was over 97%, a slight improvement over 96% at the end of 2004. During 2005, we decided to further enhance our 2.5G-enabled network by installing EDGE technology, a technology that provides high-speed bandwidth based on the GSM infrastructure, enabling features formerly only available based on UMTS technology. The expectation is that the EDGE rollout will be completed by the middle of 2006.

The minimum UMTS rollout requirement under our UMTS license is 30% by the end of 2005; BiPT may measure the actual UMTS coverage during 2006.

Other activities

During the year under review, our other activities included our international participations (Xantic, PanTel, Infonet and EuroWeb), KPN Retail (Primafoon stores and Business Centers), KPN Sales and Corporate Center (support functions). Our Corporate Center mainly provides group internal services.

EuroWeb International Corp.

In February 2005, we reached an agreement on the sale of our remaining interest in EuroWeb, a company which provides telecommunication solutions to the Central European corporate market via the Internet. EuroWeb clients include Central European governments, multinationals, insurance companies and various media enterprises. The sale involves two tranches of which the first occurred in 2005. It is expected that the second tranche of the sale will be completed during 2006.

KPN Retail

Primafoon shops and Business Centers are retail stores where KPN's products are sold. The shops sell telephones, mobile and fixed communication solutions as well as KPN TV and for example personal computers and fax machines. In November 2005 we acquired assets from the bankrupt photo chain Kral. This transaction will enable KPN to expand its distribution strength by adding some 60 retail outlets, taking KPN's total number of outlets in The Netherlands to over 160.

Xantic

We held a 65% interest in Xantic (the other 35% was held by Telstra Australia). Xantic is a leading satellite communications provider, delivering high-level information and communication technology and services for the business-to-business environment. Xantic delivers mobile satellite communication services at sea and on land, software and consultancy for the shipping industry, broadband services, broadcast and IP services via satellite transponders and hosting and outsourcing services.

As per February 14, 2006, KPN and Telstra have transferred their total holdings in Xantic B.V. to the Canadian Stratos Global Corporation.

Infonet Services Corp.

We sold our 17.9% stake in Infonet Services Corp. to British Telecom on February 25, 2005.

PanTel

On February 28, 2005 we sold our 75.19% interest in PanTel, Hungary.

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Property, plant and equipment

Telecommunication services depend upon a core network for the transfer of data or voice information. The ongoing growth in bandwidth and services require continuous development in design and capabilities. Our existing fixed and mobile infrastructures and our development plans are described below.

Fixed networks

The fixed network can be described in two dimensions: on the one hand the network infrastructures (access networks and the backbone networks) which enables services and on the other hand the service layers (voice, video and data), that are operated on the network infrastructures. In addition to the national network infrastructure and service layers, KPN owns an international network infrastructure and service layers.

NATIONAL FIXED INFRASTRUCTURE
Access networks

Our access network consists in principal of twisted pair copper. This enables us to provide nearly all of the eight million Dutch homes with two pairs of copper wire in the access network. Despite the continuing migration to mobile-only solutions, at December 31, 2005, over 70% of the Dutch households were actively connected(1) to our access network.

At December 31, 2005, 251 CityRing areas (in 107 concentration points), forming our CityRings network, and about 347 other access areas were connected by fiber. Fiber access generally permits transmission rates in excess of 155 Mb/s. The fiber network is partly upgraded to 1 Gb/s and 10 Gb/s C/DWDM/Ethernet technology. These fiber networks are used to offer services to large business costumers.

In certain cases, wireless transmission systems are used in the access network (for example, as backup or if fiber access is not available). By the end of 2005, approximately 400 wireless transmission systems had been deployed in the access network. At hotspot locations broadband Internet access is provided using WiFi. By the end of 2005, over 600 HotSpots were operational and the use of the service grew by 100% - 300% per individual location compared to 2004. In cooperation with NS (Dutch railways) we built WiFi HotSpots in the major railway stations and we introduced operational HotSpots in moving trains. In 2006, KPN acquired Attingo B.V., the only provider of public Internet and business communication services at Amsterdam's Schiphol airport. In 2005 KPN has acquired two frequencies in the 26 Ghz Wireless Local Loop frequency band which can be used as a line of Sight point-multipoint access technology.

Backbone networks

Our backbone networks facilitate voice, video and data traffic between access points. The backbone can be divided in the Lambda DWDM-network (fiber optic backbone), Hirka SDH-network (traditional backbone), dedicated service-related networks and several long distance CityRings (fiber).

The average usage levels of our networks are summarized in the following table:

Average usage level

2005

2004

2003

Lambda DWDM (fiber optic backbone)

72%

65%

53%

HIRKA SDH (traditional backbone)

69%

67%

61%

CityRings

18%

17%(1)

17%(1)

¹restated figures due to new definition of CityRings, which now defines all fiber infrastructure as part of the access network.

The traditional backbone (Hirka) has a maximum network capacity of 155 Mb/s. To accommodate the fast growth in demand for high-speed transmission, defined as 155 Mb/s and higher, KPN has implemented a fiber optic network with synchronous digital hierarchy (SDH) and dense wavelength division multiplexing (DWDM)-based transmission technology. This fiber optic (Lambda) network became operational in 2000. As of the end of 2005, about 180 locations are interconnected with 10 Gb/s transmission routers and 270 locations will be interconnected with 2.5 Gb/s transmission routers. Each of the access areas is connected to the transmission backbone network at two separate locations to ensure continuity.

The development and rollout of cost-efficient infrastructures relies on the technically advanced MPLS (multi-protocol label switching) infrastructure, which is based on fiber techniques and suitable for advanced DSL type of services as well as broadcast IP-TV services. This network is fully integrated with our Ethernet network. This infrastructure builds upon the Lambda infrastructure interconnecting various Metro rings across the country using 1 Gb/s and 10 Gb/s fiber-optic infrastructures. Moreover, this core infrastructure is used to interconnect regional Ethernet and IP access nodes.

SERVICE LAYERS OF OUR NATIONAL NETWORK INFRASTRUCTURE

The service layers on our core infrastructure networks are comprised of switched voice, video and data network services. Service edges connect the Access Network to our Backbone.

Switched voice networks

Our public switched telephony network (PSTN) and ISDN network in The Netherlands consist of approximately 1,350 local exchange areas and 2 x 20 trunk exchanges connected by a long-distance transmission network. Our network is also connected to other operators' networks.

Our telephony network is designed and engineered to have general availability with internal blocking and outages during peak hours below 1% end-to-end, as measured on a yearly basis.

(1) By our retail access propositions

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Data networks

The switched data networks consist of FR/ATM and Ethernet networks.

FR/ATM networks

We operate a frame relay (FR) network, known as Natvan, to provide a large number of data services for:

  • the backbone infrastructure that supports the KPN dial-in network from 20 dial-in PoPs (Points of Presence) to the ISPs;

  • LAN (Local Area Network) interconnect services for corporate customers;

  • supporting the backbone infrastructure that enables the bulk transport of X.25 services through leased lines as well as through ISDN channels; and

  • native frame relay (64 Kb/s through 2 Mb/s) VPNs (Virtual Private Network).

Our Asynchronous Transfer Mode (ATM) network is used to provide flexible leased line services and a carrier network for our frame relay network and to connect ADSL/SDSL customers to our data/IP services backbone.

Ethernet network

KPN’s Ethernet is the most recent national network infrastructure KPN currently has deployed in The Netherlands. This advanced network is based upon a switched native Ethernet infrastructure, using either dark fiber or C/DWDM (dense wavelength division multiplexing) as underlying infrastructures. Within this network, Ethernet interfaces up to 10Gb/s are in use. The Ethernet network is fully integrated with KPN’s new national core MPLS (multi-protocol label switching) infrastructure.

INTERNATIONAL NETWORK INFRASTRUCTURE

The international network infrastructure can be divided in three major networks: transmission, voice and data networks.

International voice networks

For the provision of international wholesale voice services we operate an international transmission network (in consortia) that includes land and submarine cables as well as satellite transmission systems, which, based on management estimates, directly connects approximately 400 telecommunication operators worldwide. The network is partly circuit switched and partly based on IP trunking technology with a flexible capacity. Its main international switches are located in The Netherlands. In addition, we have eleven points of presence in Europe (Frankfurt, Paris, London, Brussels, Milan, Madrid, Zurich, Copenhagen, Lisbon Vienna, Warsaw) and four further points of presence outside Europe: one in Hong Kong, one in Miami, one in Singapore and an exchange point in New York.

International data networks (EuroRings)

The KPN EuroRings transmission backbone is based on KPN-owned and maintained Fiber, SDH and C/DWDM technology in The Netherlands, Germany, France, Belgium, the United States (New York) and the United Kingdom. In addition, KPN has provided access nodes over almost 20 European countries using leased infrastructures based on either 2.5Gb/s wavelength rings or protected SDH circuits. For access in the various countries KPN uses DSL, Leased line and/or Fibre technology. Other regions are connected and served via the use of partners (for example Singapore Telecommunications).

Services that we deliver on these networks include MPLS-VPN, ATM, IPT, IPLC, SDH, Wavelength, Dark Fiber, Fiber Channel.

IP/MPLS

KPN is running a European IP backbone, using more than 200 IP/MPLS (multi-protocol label switching) devices, making this infrastructure one of the largest IP infrastructures in Europe. It covers all major business centers and international Internet exchanges and assures quick access to the USA via multiple dedicated high-speed connections. Based on the MPLS network the KPN EuroRings MPLS VPN service offers an industry leading network solution for corporate clients, providing a reliable and secure environment with guaranteed quality of service including real time class of service. In 2004, KPN and Singapore Telecommunications (SingTel), Asia’s leading communications group announced a significant expansion of their IP-VPN MPLS network coverage through a partnership agreement. The interconnection of both carriers’ IP-VPN MPLS networks enables SingTel and KPN to leverage each other’s extensive networks in their respective markets in Asia Pacific and Europe. In 2005 KPN and Telefónica signed an agreement to enable the interconnection of their IP-VPN MPLS networks. This agreement will enable KPN and Telefónica to increase international coverage in almost all of Latin America and Europe. In 2005 KPN introduced International Ethernet Services which are seamless with the national service offering. The services offered can range from a totally managed solution to pure basic bandwidth services. In addition, KPN's offer will include services like Remote Access, Security Solutions, Housing and Hosting. Furthermore, KPN now has, together with its European partners (e.g., Arcor, BT, Codenet, France Télécom), deployed DSL-based access networks in five European countries.

ATM/Frame Relay

The KPN owned and managed EuroRings ATM network provides a secure closed private network with the highest guaranteed service level covering all major European business centers. The KPN EuroRings ATM network is designed to meet the most demanding requirements for flexible but secure networking. The KPN EuroRings ATM network offers both ATM and Frame Relay access, can provide integrated access to the Internet, whilst also providing the technology to support voice, data, multi media and IP applications within one single network infrastructure.

Development of the Fixed Networks

As part of our strategy to achieve a leading position in the broadband market and develop new communication services, we are rolling out services and networks based on IP and broadband. We expect that IP and broadband will become dominant and mainstream within the industry and will take over all current services and networks. We develop and upgrade our network to enable us to introduce new IP and broadband services.

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Next to the traditional transmission networks SDH and ATM, we have introduced within the last few years very high capacity transmission networks. The C/DWDM fibre backbone is recently upgraded and will this year be extended to more nodes in our network. The data networks IP-MPLS and Ethernet, first primarily used for business connectivity services, is now becoming the new high capacity transport network. In the reporting period Ethernet was rolled out to more than half of The Netherlands to support new consumer broadband services like IP-TV that will become available from 2006 on. In the coming years Ethernet will replace the SDH and ATM networks and IP-MPLS will replace the traditional data networks like Frame Relay. This will lead to both the ability to offer new broadband services to customers and reduce the operational costs of the core transmission networks.

With the introduction of VoIP and IP Television, we implemented two new IP services networks, the IMS-based platform and TV-middleware. These service platforms are independent of the underlying transmission and access networks and will in the mid-term meld together into one new services environment. This will enable us to offer converged services: fixed-mobile, voice-tv-Internet, and new business applications like security and a national victim tracking system.

We have recently upgraded our broadband DSL network to ADSL2+ in 70% of The Netherlands, with which we now offer Internet access services of up to 12 Mb/s. By the end of 2005 we have trialed new television and video services on the even higher capacity VDSL access network. Next to that we increasingly deploy Fibre to the Office to the business market and we are conducting trials for Fibre to the Home in consumer households.

During the course of 2006 we will start rolling out Fibre to the Home in newly built areas. We will also start extensive pilots with the newest access technologies that support both broadband services like VDSL2 and narrowband services like PSTN and ISDN. If these pilots are successful, we will be able to replace the current broadband nodes and telephony switches in the coming years, leading to both new services and a fundamental streamlining of the access and backbone networks.

Since telephony traffic in the fixed network is declining due to mobile only use and Voice over IP, we are minimizing the investments in the telephony network. If the above mentioned pilots on the newest access technologies are successful, we will transfer the remaining telephony customers from the telephony switches to these new multi-service access nodes over the next few years.

Mobile networks

DEVELOPMENTS

In addition to the current second-generation (2G) networks based on GSM technology, an entire range of mobile data technologies is emerging to support the need for mobile and online usage. Our strategy is to benefit from the increasing demand for mobile data services. We offer our customers secure mobile data services solutions regardless of the access technologies applied. We are in the process of deploying our third-generation (3G) UMTS networks. Supplementary to these access technologies, we offer customers convenience through WiFi (Wireless LAN). We will continue to invest in our GSM network to maintain or improve quality and coverage, while providing sufficient voice and data capacity. Our GSM network is 2.5G enabled.

Mobile broadband technologies (e.g., EDGE and UMTS) offer three advantages over narrowband technologies that we expect to be crucial for our future success:

  • increased speed: enriching our current services and making these more user friendly, such as video-like services;

  • larger data volumes: enhancing the number and types of services (e.g., pictures, clips, sounds, radio) and rendering them more useful (applications for business users); and

  • improved data service quality: making guaranteed throughput and quality possible rather than 'best-effort' services.

Our end-user oriented strategy to be 'always best connected' means we wish to provide customers with the best available network capabilities for the specific services requested and in the most cost-efficient way. Boundaries between networks are blurring. Most of our services (voice and messaging) will run with nation-wide coverage on any technology, although some (e.g., video telephony) depend on real-time high speeds and will therefore only work in geographic areas equipped with broadband networks. When all technologies are available in a certain geographic area, we make every effort to use the network capacity as efficiently as possible to keep investments and operational cost low. We expect that this will allow for competitive retail pricing that benefits our customers.

ROLLOUT

The current network rollout is focused on achieving a maximum synergy between GSM/GPRS, EDGE and UMTS, for instance with respect to infrastructure and transmission. Reutilization of 2.5G-enabled infrastructure in certain areas may provide a substantial part of the basic EDGE and/or UMTS infrastructure. Nokia and Ericsson are our EDGE and UMTS network suppliers in Germany, The Netherlands and Belgium.

We intend to comply at least with the minimum regulatory rollout requirements and are prepared to accelerate the rollout, if and where commercially attractive.

By the end of 2005, the conditions to the German and Belgian UMTS licenses required us to reach minimum UMTS coverage rates of 50% and 30%, respectively. The German and Belgian telecommunication regulators (Bundesnetzagentur and BiPT) may measure the actual UMTS coverage in their countries during 2006.

Germany

During recent years, we directed our efforts at increasing the quality and coverage of the GSM/GPRS network. We believe our

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network coverage is now at a competitive level. With the innovative Ultra High Sites concept (using tightly bundled sites located at a height of over 100 meters), we were able to increase the speed of our UMTS rollout. At the end of 2005, we had over 5,600 UMTS base stations covering 51% of the German population, including all cities of over 300,000 inhabitants.

The Netherlands

Our 2.5G-enabled network consistently scores highly on quality, reliability and coverage. Recent surveys show especially high scores on indoor coverage compared to competitors. We began the rollout of our UMTS network in 2003, while commercially launching UMTS services in the second half of 2004. By the end of 2005, we had installed 1,735 UMTS sites, covering 250 cities or 72% of the population.

With the acquisition of Telfort, we currently own and operate two 2.5G networks and one 3G network; a second 3G network is under construction. It is an important goal to reach synergies on operational costs, and we are focusing on the networks. We are currently evaluating the best scenario for integrating parts or all of the 2.5G networks and to concentrate our 3G investments. Until final decisions are made, the KPN and Telfort networks will continue ' as is', with no changes in terms of assets, licenses or use of spectrum.

Belgium

In 2005, we further increased the quality and coverage of our 2.5G-enabled network by adding about 160 GSM base stations. During 2005, we decided to further enhance our 2.5G-enabled network by installing EDGE technology, a technology that provides high-speed bandwidth based on the GSM infrastructure, enabling features formerly only available based on UMTS technology. The expectation is that the EDGE rollout will be completed by the middle of 2006.

In September 2003, the technical launch of our UMTS network took place. The minimum UMTS rollout requirement under our UMTS license was 30% by the end of 2005; BiPT may measure the actual UMTS coverage during 2006.

FACTS AND FIGURES

The tables below show the number of active base stations as of December 31, 2005, the average network usage as well as the coverage ratios of our networks as of year-end 2005:

Active base stations

Germany

Netherlands 1)

Belgium 2)

 

 

 

 

2.5G sites

15,884

3,918

2,309

3G sites

5,610

1,735

-

Total sites

21,494

5,653

2,309

Average network usage

Germany

Netherlands 1)

Belgium

 

 

 

 

Usage (in %)

43%

81%

38%

Network coverage ratios

Germany

Netherlands 1)

Belgium 2)

 

 

 

 

2.5G network

 

 

 

Outdoor - as % of population

99%

>99%

>99%

Outdoor - as % of area

96%

99%

99%

Indoor - as % of population

79%

98%

97%

 

 

 

 

3G network

 

 

 

Outdoor - as % of population

51%

72%

N/A

1) The figures mentioned concern KPN Mobile The Netherlands, excluding Telfort

2) Though BASE did invest in 3G assets during 2005, no 3G sites are active yet as the UMTS network has not been commercially launched.

Properties

KPN holds 1,823 buildings as of December 31, 2005, the majority of which are owned freehold and located principally in The Netherlands. Approximately 1,800 of our buildings house telephone and data transmission network equipment, which cannot readily be adapted to alternative uses. The remainder of the properties comprises offices, shops, storage facilities, residential properties and buildings for other miscellaneous uses.

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Research and development

On January 1, 2003, the Dutch Organization for Applied Scientific Research (TNO) acquired the research and development activities of KPN and placed it with TNO Telecom. TNO Telecom and KPN entered into a cooperation agreement, under which we have agreed to annual purchase commitments.

We intend to continue to benefit from the telecommunication and technology expertise of TNO Telecom in order to support the technological innovations required for our business. Measures have been taken to obtain the critical mass for mid- and long-term projects carried out by TNO Telecom. In 2005, we extended the cooperation agreement with TNO for one year until December 31, 2009. The total remaining commitments until December 31, 2009 amount to EUR 57.3 million.

Our research and development expenditures with TNO Telecom in 2005 totaled EUR 20 million (2004: EUR 24 million).

 

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Intellectual property

Our current portfolio of intellectual property rights consists of approximately 100 registered core trademarks and 395 patent families. We continue to invest in the growth of our intellectual property rights portfolio, among others through our spending on Research and Development. We take the necessary steps to protect these rights and we generate value from these rights where appropriate. Some of these patents are essential for the commercial exploitation of telecommunication technology and services. A number of suppliers have entered into license agreements with us related to these patents. To protect these rights, we currently rely on a combination of patents, trademarks, service marks, trade secrets, copyrights, database protection, confidentiality agreements with our employees and third parties and protective contractual provisions.

We may be subject to claims alleging that we have infringed upon third party intellectual property rights. Claims of this nature could require us to spend significant amounts of time and money to defend ourselves, regardless of their merit. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions or halt the provision of our services while we re-engineer them or seek licenses to necessary intellectual property, which might not be available on commercially reasonable terms, or at all.

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Regulatory developments

Regulatory highlights 2005: market analysis

In The Netherlands, OPTA finalized the analysis of the Dutch telecom markets in 2005. On November 14, OPTA published the decisions on the markets for mobile access and call termination on individual mobile networks. On December 21, 2005, OPTA published the decisions for the markets for fixed telephony, leased lines and broadband. These decisions are in force as from January 1, 2006. OPTA has concluded that several remedies must be applied to KPN, in markets where KPN is found to possess 'significant market power'. The decisions on the cable TV markets are expected to be published in 2006. These decisions will also be of relevance to KPN. In the following paragraphs, the main impact of OPTA's decisions is described.

In Belgium and Germany regulation of mobile call termination is also expected to be regulated. In Germany, currently the details of the regulation have not yet been decided upon. In Belgium, the regulator started the consultation process on its draft analysis of the markets for call termination on individual mobile networks on February 7, 2006. Under this draft analysis, the regulator proposes to also regulate BASE's MTA tariff and to subject BASE's current MTA tariff to a gradual reduction in the period between July 2006 and July 2008. As the consultation process is currently ongoing, no final decision has yet been taken by the regulator.

Market analysis mobile telephony The Netherlands

In The Netherlands, OPTA decided to no longer require KPN Mobile to offer special access to other market participants. OPTA found the mobile market to be competitive and decided that mandatory access is no longer justified. This means that KPN Mobile can negotiate with seekers of access on an entirely commercial basis.

OPTA also decided that all mobile operators - and Tele2 as an MVNO - have significant market power in the mobile call termination markets on individual networks and imposed cost-based regulation on the mobile terminating access (MTA) tariffs. The mobile operators and Tele2 have to reduce their MTA tariffs in three equal steps towards ultimately a cost level as of July 1, 2008. This cost level will be based on a Long Run Incremental Cost system to be developed by OPTA (which contracted Analysys as its consultant), which is expected before the summer of 2006. In principle, all mobile operators will have the same mobile terminating tariff from July 1, 2008, except for cost differences resulting from different frequency allocations (GSM 900 / DCS 1800). OPTA has decided that the networks of KPN Mobile and Telfort must have the same level of MTA tariffs from July 2006 on because both networks belong to the same company. KPN has appealed against this decision. Under the current Telecommunications Act, the Trade and Industries Appeals Tribunal will handle this appeal in one instance.

Beginning 2006 the European Commission announced that it would investigate the possibilities to directly regulate the international roaming tariffs.

Market analysis fixed telephony, broadband and leased lines in The Netherlands and resulting regulation from January 1, 2006 onwards

Fixed voice telephony: access and calls

KPN has significant market power on the retail and wholesale markets for access and for national calls. Tariff regulation, accounting separation, non-discrimination and transparency requirements are the imposed remedies. The market for international calls is competitive.

Price cap

The retail tariffs for telephone lines are subject to a price cap system. This means that the tariffs have to be below a maximum set in advance by OPTA. This price cap is initially set at the current tariff level. From the moment our wholesale line rental (WLR) offer is accepted by OPTA, we will be able to raise our tariffs in line with inflation correction.

Price floor regulation

OPTA has decided that retail call charges remain subject to ex ante regulation. OPTA maintains price floor regulation for calls to prevent KPN from undercutting its competitors in an anti-competitive way. OPTA developed a new price floor for the retail call charges on the basis of the tariffs of the relevant wholesale inputs from the KPN network. A retail tariff package should recover its incremental costs based on the tariffs of the required wholesale inputs plus the relevant incremental retail costs. In addition, retail revenues should cover the total integral costs on each of the relevant markets on a yearly basis, while the resulting retail return on sales in each market is required to be at least 5%. OPTA has introduced a new procedural system where new tariffs do not need to be approved ex ante by OPTA but will remain subject to ex-post price control. Under the new system, KPN will have more flexibility to respond to competitive developments. Flat fee offers will be possible in the new system. OPTA also introduced a specific price floor regime for bundles of fixed telephony services with unregulated services.

Regulation of Voice over Broadband (VoB)

OPTA has ruled that price floor regulation should also apply to KPN’s retail VoB. No further retail or wholesale regulation is applied to VoB other than a price cap on the wholesale IP call termination charges. The price floor is set such as to reflect the economic advantages of providing voice telephony on a broadband network compared to a traditional PSTN network. KPN expects to appeal OPTA’s decision regarding the price floor regulation before the Trade and Industry Appeals Tribunal on the ground that there is fierce competition for these services and that entry barriers are low.

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Segment of business users within the fixed telephony markets

OPTA applies ex ante price cap and price floor regulation including non-discrimination and transparency requirements also for tariffs for business users. KPN expects to appeal this part of the decision because the intensive competition between KPN and other telecom suppliers for corporate and business customers is not taken into account by OPTA and ex ante retail regulation is not justified in this segment.

International telephony

OPTA has decided to no longer regulate the market of international telephony. As from January 1, 2006, the tariffs of international telephony are no longer regulated by OPTA in any way.

Wholesale call origination, transit and call termination

OPTA intends to impose a three-year wholesale price cap for the wholesale services on almost all wholesale markets, taking into account as far as relevant an efficiency benchmark with US Telephony operators. Furthermore the remedies non-discrimination, transparency - including in most cases a reference offer - and accounting separation are imposed on the wholesale markets as well.

The wholesale price cap will not be applied to inter tandem conveyance services and transit services between networks. Price floor regulation will be in force for inter tandem conveyance services, whereas the tariffs for KPN’s transit services between networks have to be non-discriminatory as from January 1, 2006. OPTA has decided that price differentiation is anti-competitive in the transit market and that the tariff schemes for transit services that we offered in the past have to be withdrawn. KPN does not agree with this view and believes that the direct interconnection between parties and alternative transit operators provide significant competition. We intend to lodge appeal proceedings with the Trade and Industry Appeals Tribunal.

Resale of the telephone access line

OPTA requires KPN to allow Carrier Pre-Select (CPS) providers to rent telephone access lines (PSTN and ISDN-2) on wholesale terms from KPN and resell the lines to customers, providing a single bill that covers both line rental and telephone calls. This is also known as wholesale line rental (WLR). The WLR tariff is to be based on a retail minus rule meaning that the tariff of WLR will be based on the retail tariffs of KPN's PSTN and ISDN1 and -2 service minus certain retail marketing costs of KPN. The WLR service is to be developed in an industry group starting in the first half of 2006.

Wholesale broadband access

OPTA distinguishes a market for wholesale broadband access of high quality as opposed to a market for wholesale broadband access of standard quality. High quality wholesale broadband access is used in particular as a building block to supply data communication services to multi-site business customers, while standard quality wholesale broadband access is used in particular for broadband Internet access and combined VoB/Internet access packages for the benefit of residential users.

OPTA has decided not to change the regulatory situation, which was in force prior to the implementation of the new regulatory framework. Standard quality wholesale broadband access is not regulated since KPN is found not to possess market power; for high quality access though, KPN was found to possess market power to a certain extent and therefore this bitstream service has to be offered on a non-discriminatory basis.

Leased lines

OPTA has decided that retail leased lines of 2 Mb/s capacity should no longer be regulated since market analysis showed KPN no longer has significant market power as was already concluded for all services upwards 2 Mb/s; OPTA introduced retail price regulation for analogue lines as well as for digital leased lines up to but not including 2 Mb/s. The price regulation consists of a price cap system.

The regulation for termination segments of leased lines with a capacity higher than 2 Mb/s has been withdrawn. However, KPN may only terminate existing contracts subject to nine months' notice. Termination segments of leased lines up to 2 Mb/s are regulated under the wholesale price cap regime.

The market for trunk segments of leased lines is competitive and not regulated anymore.

Regulation Fixed telephony and leased lines in The Netherlands

Under the regime which was in force prior to the implementation of the new regulatory framework as from January 1, 2006, we were required to charge cost oriented prices for fixed public telephone services, consisting of telephone lines, local telephone calls, national telephone calls, fixed-to-mobile telephone calls, standard telephone directory listings and the directory enquiry services. Since July 1, 2002, the determination of cost-oriented prices was made through a system of safety caps. Under this system, the prices of telephone lines, local telephone calls, national telephone calls and fixed-to-mobile telephone calls are allowed to increase only with the rate of inflation. For the period from July 1, 2004 through July 1, 2005, inflation has been pegged at 2.1%, and for the period from July 1, 2005 through July 1, 2006 at 1.2%. In 2005, we did not raise our one-off and recurring charges for telephone lines, or our minute prices for traffic.

On November 28, 2005, OPTA announced to impose a fine of EUR 17 million on us following the conclusion of its investigation into discounts given to certain fixed telephony business customers. We will not appeal this decision. Furthermore, without admitting any liability and with the sole purpose of ending a potentially protracted and damaging dispute, we have offered EUR 18 million to competitors, which offer has been accepted. OPTA has

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taken this offer into account in determining the fine. On October 11, 2004, we informed OPTA about the discounts while the Supervisory Board's Audit Committee, with the full support of KPN's management board, launched an independent investigation. The outcome of the independent investigation was published on December 22, 2004, and confirmed KPN's earlier estimates that the value of the discounts in question was approximately EUR 20 million in aggregate, paid over the period 2003 and 2004. Since that time, KPN has significantly strengthened its internal controls and compliance procedures, started an intensive employee training program and has appointed a compliance officer.

In connection with the fixed terminating access ('FTA') fees of other fixed operators (not designated by OPTA as having significant market power) OPTA announced a policy change in July 2004 in the way in which our retail tariffs for off-net calls to other fixed operators are tested against the requirement of cost orientation. Effective immediately, our fixed-to-fixed off-net tariffs are no longer considered to be cost-oriented if the FTA fee included in the tariff exceeds the maximum fair fee set out in OPTA’s April 2003 policy guidelines (based on so-called delayed reciprocity, i.e. linked to KPN's FTA rates three years back). In spite of these guidelines, which are the subject matter of various disputes and appeal proceedings, Versatel applies FTA tariffs that are higher. As a result of said policy change we are no longer allowed to pass on the excess amount to our retail customers. OPTA withheld its required consent to a proposed increase of our end-user prices for calls destined for the Versatel network that would have mirrored the FTA fees of Versatel, which are in excess of the maximum fair fee, which we appealed. In June 2005, the Trade and Industry Appeals Tribunal upheld OPTA's policy guidelines and rejected KPN's request for strict reciprocity. At the same time, the Tribunal upheld Versatel's appeal because OPTA had provided insufficient arguments as to why Versatel was not entitled to the exceptional provision in the guidelines allowing for even higher FTA fees if justified by higher costs. OPTA advised that no indication could be given as to when a new decision will be taken on this matter.

On July 16, 2004, OPTA issued a decision imposing a EUR 225,000 fine on KPN alleging that we had intentionally violated the non-discrimination principle by allowing Carrier (Pre)Select (CPS) providers access to less telephone number information at a higher price than KPN's own retail organization. In July 2005, the Rotterdam District Court quashed OPTA's decision on the grounds that access to telephone number information is not part of our CPS obligations. Therefore, the non-discrimination principle contained in the Telecommunications Act is not applicable and OPTA had no power to impose the fine on KPN. OPTA has appealed this judgment to the Trade and Industry Appeals Tribunal. The hearing is scheduled for March 8, 2006.

Interconnection

Under the regime, which was in force prior to the implementation of the new regulatory framework as from January 1, 2006, the prices we charged competitors for the use of our fixed network must be cost oriented. Our charges were reviewed once a year and, no later than July 1 each year, OPTA assessed the prices for the coming twelve months. The cost basis deemed to exist for a hypothetical efficient operator was used as the yardstick for cost oriented prices for the terminating access service. This cost basis has been modeled on the ‘Bottom-up Long Run Incremental Costs’ (BU-LRIC) cost allocation model. Our actual cost basis was taken as the criterion for prices for originating access services (special access) and unbundled access services. The Embedded Direct Cost (EDC) model was used to allocate these costs.

As regards the tariffs that apply for the period starting on July 1, 2004, OPTA decided on a transitional regime based on the cost allocation systems (EDC VI and BU-LRIC III) approved by OPTA. This transitional regime will remain in force until the new legal framework takes effect. The outcome of this transitional regime is acceptable to us, but not to Tele2 and ACT who have filed objections. Most of their arguments, such as the non-regulation of our tariffs for transit services, had been put forward on earlier occasions (and dismissed by OPTA), but new objections have been raised against the fact that OPTA has not distinguished between terminating/originating access tariffs to/from PSTN/ISDN connections and terminating/originating access tariffs to/from VoDSL connections, as well as against the fact that OPTA has not applied cost orientation to the tariffs for Bitstream access. All of these objections have been dismissed by OPTA. Tele2 and ACT have appealed this decision. The hearing is scheduled for May 18, 2006.

Within the context of appeal proceedings against OPTA's decisions to approve KPN's cost allocation systems for the periods 1999/2000, 2000/2001, 2001/2002 and 2002/2003, several market parties put forward a number of grounds for appeal, most importantly against OPTA's decision not to impose an obligation for cost orientation on KPN's tariffs for transit and inter-region connect services. In addition, Tele2 claimed that KPN's charges for originating access should also be based on the BU-LRIC cost allocation system. On December 23, 2004 the Rotterdam District Court decided that, although OPTA has discretionary power to distinguish between different cost allocation systems tailored to certain market characteristics, OPTA had no power not to instruct KPN to submit for approval a cost allocation system for transit and inter-region connect services. As regards Tele2's claim, the Court decided that OPTA had insufficiently motivated why - after its earlier announcement that the EDC model did not meet the requirements - it had decided to continue to use the EDC model rather than the BU-LRIC model as the cost allocation model for originating access services. The Court ordered OPTA to take a new decision. Both OPTA and KPN have lodged an appeal to the Trade and Industry Appeals Tribunal. Judgment is pending. The case was heard on January 25, 2006. The Tribunal is expected to pass judgment within six weeks of the hearing. This period may be extended however.

In May 2005, the Trade and Industry Appeals Tribunal rejected our appeal against OPTA's decision on our IP and data networks IND/UDS, arguing that we are not allowed to charge other

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operators transit fees for reaching our IND/UDS networks because these networks are part of our fixed telephone network. The impact of this judgment is that we have to pay back the transit fees paid by other operators, although the Tribunal stresses that we may recover the cost for the IND/UDS networks through an increase of our termination fees.

Carrier (Pre)Selection (CPS) is currently available for four types of calls: local, national, fixed-to-mobile, and international calls. Tele2 has filed a request with OPTA to settle a dispute between Tele2 and KPN, requesting OPTA to impose on KPN the obligation to include non-geographic calls (to all existing and future non-geographic numbers) in the list of calls for which CPS is available. In our statement of defense we have pointed out that KPN cannot comply with Tele2's request without infringing its statutory and contractual obligations towards the service providers offering their services via non-geographic numbers to our customers on the basis of special access to the KPN network, and emphasized the necessity to consult these service providers before any decision can be taken. However, on December 23, 2004, OPTA ruled in favor of Tele2. In December 2005, the Trade and Industry Appeals Tribunal dismissed our appeal.

Unbundled access

We are required to provide our competitors (on the same basis as our own services and our associated companies) with full and shared unbundled access to our local copper loops on fair, transparent and non-discriminatory terms and at cost-oriented prices. We must also allow a new entrant to co-locate its own network equipment. We are engaged in legal proceedings against OPTA's interventions in our periodic co-location charges (rent and electricity). In August 2005, the Rotterdam District Court dismissed our appeal that argued the tariffs determined by OPTA were not cost oriented because they are not based on a cost allocation system. As regards the rent per square meter, the Court decided, however, that OPTA had wrongfully failed to distinguish between industrial premises in business and residential areas. OPTA has appealed this judgment.

In its December 19, 2003 decision, OPTA imposed a EUR 90,000 and a EUR 180,000 fine on us for allegedly violating the obligation to charge cost-oriented prices and the prohibition on discrimination in providing unbundled access to competing providers of DSL services, respectively. We have submitted a notice of objection to this ruling, which was rejected by OPTA in May 2004. We have appealed this decision before the Rotterdam District Court, but without success, and we have now brought appeal proceedings to the Trade and Industry Appeals Tribunal. The case will be heard on March 8, 2006.

In July 2005, the Rotterdam District Court quashed OPTA's March 2003 decision to impose a EUR 375,000 fine on KPN for allegedly violating the prohibition on discrimination in providing unbundled access to KPN's business unit that offers DSL services and to competing providers of DSL services. The business unit allegedly had access to information on KPN subscribers that allowed it to place orders for unbundled access lines easier and more accurately. OPTA held this to be at the disadvantage of competing operators because they lacked the same details. According to the Court, however, the helpdesk facilities offered by KPN to its competitors to help them to "clean" rejected orders is sufficiently equivalent to the facilities used internally, provided the information is made available within a reasonable period of time. If the required information is made available within one day - as KPN stated during the court session - then there is no undue advantage for our internal business units. The Court referred the case back to OPTA, instructing OPTA to investigate the helpdesk facilities offered by KPN and to take a new decision taking the court's judgment into account. OPTA has lodged an appeal with the Trade and Industry Appeals Tribunal. The hearing has not been scheduled yet. OPTA informed us that it will defer a new decision on this matter pending the outcome of the appeal proceedings.

Mobile telecommunications - International Roaming

The market for international roaming has been under investigation by the European Commission since 1999 with an initial sector inquiry resulting in a working document in December 2000 and unannounced inspections of the offices of mobile network operators in the United Kingdom and Germany, including E-Plus, in July 2001. The Commission said it was seeking evidence of collusion and/or excessive prices in relation to both retail and wholesale roaming charges, and the Commission has subsequently sought, or been provided with, additional information about roaming charges. In July 2004, the Commission sent so-called Statements of Objections to Vodafone UK and O2 UK, in which these parties were accused of abusing their dominant positions on the market for wholesale international roaming, by charging excessive tariffs (so-called Inter Operator Tariffs, or IOT). In February 2005, in a similar investigation in the German market the European Commission sent statements of objectives to T-Mobile Germany and Vodafone Germany. Hearings in these cases were held during the summer of 2005, but no decision has been made public.

One of the markets defined in the Recommendation under the new European regulatory framework to be investigated by NRAs is the wholesale international roaming market. In December 2004, all NRAs of the European Union, Norway, Iceland and Liechtenstein sent out a harmonized questionnaire to all operators. Based on the first analysis of the information, the European Regulators group published a common position on wholesale international roaming in May 2005. The NRAs of Member States will evaluate the national markets based on this common position, but it is still very uncertain if any of the NRAs will impose obligations upon their national operators.

Mobile telecommunications - Germany

On May 19, 2004, 01081 Telecom AG submitted a formal request to the telecommunications regulator for interconnection with E-Plus' GSM network, because it was not prepared to accept the MTA tariffs offered by E-Plus (EUR 0.149 as from December 15,

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2004 and EUR 0.124 as from December 15, 2005). On September 20, 2004, the regulator decided that E-Plus is obliged to interconnect 01081 Telecom AG's network. On December 28, 2004, the regulator determined in a separate procedure the 2005 MTA tariffs to be EUR 0.149 in line with our tariffs, which decision is being challenged by 01081Telecom AG.

In spring 2005, the German telecommunications regulator Bundesnetzagentur started a consultation on E-GSM frequencies. Until the end of 2004, military services had exclusive use of those frequencies. E-Plus was involved in the consultation procedure. On November 30, 2005, the Bundesnetzagentur published its adopted GSM concept. The concept foresees that E-Plus and O2 should be allocated E-GSM-frequencies (of 5 MHz each). Furthermore, in exchange for these E-GSM-frequencies, E-Plus and O2 will be required to return 5 MHz of the already allocated 1800 MHz spectrum. In addition, T-Mobile, Vodafone and E-Plus shall get an extension of their GSM licenses. There is no legal appeals process against this GSM concept. The GSM concept is politically challenged by Deutsche Bahn. Deutsche Bahn requests the frequencies to deploy its GSM-R network. On December 21, 2005, a high-level meeting with the Bundesnetzagentur, Deutsche Bahn, the Ministry of Economic Affairs, the German railways regulator Eisenbahnbundesamt, O2 and E-Plus took place. The regulator urged all interested parties to seek for a compromise in order to avoid court proceedings. E-Plus stated that according to the information provided by Deutsche Bahn, an additional demand for frequencies could not be justified. Bundesnetzagentur informed all parties that it would allocate the frequencies in early 2006. On February 3, 2006, Bundesnetzagentur allocated 5 MHz bandwidth of the E-GSM band to E-Plus. The assignment is linked to a provision to reallocate these frequencies to Deutsche Bahn, if the latter can prove the need for those frequencies. The provision expires by the end of 2009. As a result, E-Plus is now able to deploy a GSM 900 network and hence enhance the quality of its GSM network.

The German regulator has completed its analysis of the termination market. According to the decision, all four GSM mobile operators are considered to have significant market power on the call termination market. The regulator will decide in 2006 on the remedies. The access market (Market 15 of the recommendation and the international roaming market) will be analyzed in 2006.

Mobile telecommunications - The Netherlands

Licenses

With the acquisition of Telfort, KPN now holds the licenses of KPN Mobile The Netherlands (GSM 900, DCS 1800 and UMTS) and Telfort (DCS 1800 and UMTS). The GSM 900 licenses of KPN Mobile The Netherlands and Vodafone will expire on April 1, 2010, unless the Minister of Economic Affairs would decide to extend those. The DCS 1800 licenses of KPN and Telfort will expire on February 26, 2013. In late 2005, the Ministry started a consultation process on the possible reallocation of spectrum and/or the extension of licenses, the outcome of which is still pending. Following a potential integration of the networks of KPN Mobile and Telfort, KPN may potentially sell and transfer licenses with the consent of the Minister or return them. Meanwhile, the licenses are available to KPN Mobile and Telfort.

Orange instituted civil proceedings against the State of The Netherlands claiming damages in relation to the DCS 1800 licensing, for which Orange paid approximately EUR 270 million in an auction. According to Orange, the State allowed the creation of an uneven playing field in the Dutch mobile market, because KPN Mobile and Vodafone were not required to pay fees for their GSM 900 frequencies. These claims were rejected in the first instance, but Orange has lodged an appeal, which is still pending.

Mobile terminating access

On January 1, 2004, the mobile operators in The Netherlands voluntarily reduced their MTA tariffs, upon which the NMa halted its investigation into a potential abuse of dominant positions in relation to these tariffs. In the many disputes between operators at that time, OPTA decided that the reduced tariffs were reasonable. As from December 1, 2005, these tariffs are EUR 0.11 for KPN Mobile The Netherlands and Vodafone and EUR 0.124 for all the other operators (Orange, Telfort, T-Mobile and the MVNO Tele2). Determining that all mobile operators possess significant market power with respect to call termination, OPTA required these tariffs to be further reduced (in equal steps) on July 1, 2006, 2007 and 2008, resulting in cost-oriented tariffs on the last date. The cost-oriented tariffs will be based on a Long-Run Incremental Cost system to be developed by OPTA. OPTA decided that as from July 1, 2006, Telfort’s tariffs should be equal to those of KPN Mobile The Netherlands.

Versatel, MCI and KPN Telecom appealed OPTA’s decisions in pending MTA tariff-related disputes, in which OPTA ruled not to intervene for periods prior to January 1, 2004 and to apply the agreed tariffs as from that date. In its ruling on the appeals, the Rotterdam District Court annulled these decisions for lack of reasons provided by OPTA in its original decision. OPTA appealed the Rotterdam Court’s decisions to the Trade and Industries Appeals Tribunal, which will decide on the instance. If the Court’s decisions are upheld, OPTA will have to reopen these cases.

Dealer commissions

Following an investigation into the reduction of subsidies given to mobile handset retailers by mobile operators in The Netherlands in 2001 (including KPN Mobile The Netherlands), the NMa concluded that all five mobile operators coordinated a concerted decrease of their dealer commissions and the handset subsidies given to prepaid subscribers. On December 30, 2002, the NMa published its decision, fining the operators for a total amount exceeding EUR 88 million. The fines were revenue-related and KPN Mobile The Netherlands' fine amounted to EUR 31.3 million. Upon objections by KPN Mobile The Netherlands and the other mobile operators, the NMa reduced the level of fines in September 2004 to an approximate total of EUR 52 million. KPN Mobile The Netherlands' fine was

42


reduced to EUR 12.6 million and that of Telfort to EUR 4.5 million. Appeal procedures have been initiated and are still pending.

Mobile telecommunications - Belgium

Peak/off-peak litigation against Proximus

As from October 2003, BASE changed its peak hours for interconnections from 8-19 to 10-22 hours and abolished its low weekend interconnect tariff. BiPT confirmed the reasonableness of BASE's interconnection request in a decision dated August 29, 2003. Proximus appealed this decision before the Brussels Court of Appeals and BASE intervened in this procedure. In two decisions dated June 18, 2004 and September 15, 2005, the Court annulled the BiPT decision and, consequently, overruled BiPT’s decision to impose an amended interconnection agreement with BASE on Proximus. BiPT and BASE have lodged an appeal with the Supreme Court (Hof van Cassatie) in order to overturn the first judgment by the Court of Appeals. A similar appeal against the second judgment is being prepared. In addition, because of Proximus’ continuous refusal to accept BASE’s new peak/off-peak structure, BASE was forced to take the following initiatives:

  • to terminate its direct interconnection agreement with Proximus as from the end of October 2005, as far as the termination of Proximus' voice traffic on BASE's network is concerned This traffic is now routed over Belgacom's network; and

  • to start formal procedures in order to claim the approximately EUR 8 million withheld by Proximus due to its refusal to accept BASE's new peak/off-peak structure.

Abuse of dominant market position: litigation against Proximus (1)

On June 25, 2003, BASE initiated court proceedings against Proximus for the alleged abuse of its dominant market position. BASE seeks a reduction in Proximus’ interconnection rates as well as a compensation for damages suffered due to this anti-competitive behavior (tentatively estimated at EUR 560 million). On March 1, 2004, Mobistar voluntarily intervened in this procedure, estimating its claim against Proximus to amount to EUR 106 million. The parties are currently exchanging written arguments. Pleadings are scheduled for January 2007.

Abuse of dominant market position: litigation against Proximus (2)

On February 18, 2005, BASE launched an additional procedure against Proximus for the latter’s alleged abuse of its dominant position on the Belgian mobile market. This procedure is based on the argument of discrimination and aims at obtaining a "cease and desist" order against the disadvantageous on-net tariffs applied by Proximus. In December 2005, the Commercial Court dismissed BASE’s claim. BASE will appeal this decision.

Abuse of dominant market position: litigation against Belgacom

By not accepting the MTA tariffs set by BASE, Belgacom has in BASE's view abused its dominant position on the transit market of international incoming traffic over the last years. Because negotiations to reach an amicable settlement failed, BASE lodged a complaint against Belgacom before the Belgian Competition Council on June 2, 2004. This procedure is currently pending.

Belgacom Happy Time

At the end of 2005, BiPT issued a decision on Belgacom's Happy Time retail tariff (unlimited free calls during off-peak hours and peak calls at increased tariffs). In view of the potential impact of this decision on Belgacom's cost-orientation obligation at retail level, BASE joined an appeal procedure initiated against BiPT's decision. This procedure is currently pending.

Number portability - porting costs: annulment procedure

A specific clause of the royal decree of September 23, 2004 on number portability authorizes BiPT to determine the costs that mobile operators may charge one another for performing the porting-out of a customer to a competitor. The basis for these charges should be the costs ‘of an efficient operator’. Specifically against this clause, BASE has launched an annulment procedure before the State Council. This procedure is currently pending.

Number portability - porting costs: appeal procedure

In a decision of September 16, 2003, BiPT determined the costs that mobile operators may charge one another for performing the porting-out of a customer to a competitor. Following an appeal by Mobistar, the Court of Appeals, by judgment of October 14, 2004, suspended the decision of BiPT, and has asked a number of ‘prejudicial’ questions to the European Court of Justice in relation with the directives 2002/22 (universal service) and 2002/21 (framework directive).

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OPERATING RESULTS

Our Financial Statements are prepared in accordance with IFRS, which varies in certain significant respects from US GAAP. Information relating to the nature and effect of such differences is presented in 'Information on US GAAP' in the Notes to the Consolidated Financial Statements. The following discussion includes various forward-looking statements. Please see 'Forward-Looking Statements', as well as 'Risk Factors' for a description of certain factors, many of them outside our control, that may affect our operating results. For additional information about how we calculate customer data, including ARPU, see 'Presentation of Financial and Other Information'.

Consolidated Results of Operations

In millions of euro

2005

2004

 

 

 

Net sales

11,685

11,630

Other revenues

126

116

Total revenues

11,811

11,746

 

 

 

Other income

125

73

Total

11,936

11,819

 

 

 

Own work capitalized

-112

-147

Cost of materials

1,044

984

Work contracted out and other expenses

4,075

3,911

Salaries and social security contributions

1,441

1,706

Depreciation, amortization and impairments

2,376

2,190

Other operating expenses

764

530

Total operating expenses

9,588

9,174

 

 

 

Operating profit

2,348

2,645

 

 

 

Finance costs - net

-547

-589

Share of the profit of associates and joint ventures

13

1

Profit before taxes

1,814

2,057

 

 

 

Income taxes

-360

-300

Profit for the period

1,454

1,757

Profit attributable to minority shareholders

-17

-50

Profit attributable to equity holders of the parent

1,437

1,707

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In millions of euro, unless otherwise stated

2005

2004

 

 

 

- Total revenues Fixed division

6,867

7,242

- Total revenues Mobile division

5,773

5,254

- Total revenues 'Other'

230

333

- Intercompany revenues

-1,059

-1,083

Total revenues

11,811

11,746

 

 

 

Other income

125

73

Total

11,936

11,819

 

 

 

- Operating expenses Fixed division

5,367

5,440

- Operating expenses Mobile division

5,100

4,383

- Operating expenses 'Other'

180

434

- Intercompany expenses

-1,059

-1,083

Total operating expenses

9,588

9,174

 

 

 

Operating profit

2,348

2,645

Operating profit Fixed

1,516

1,809

Operating profit Mobile

757

881

Operating profit 'Other' (including intercompany)

75

-45

HIGHLIGHTS AND TRENDS

  • Line losses in traditional markets accelerated

  • Available infrastructure for new services as VoIP and IP-TV

  • Increased ISPs’ market share

  • FTE reduction program on track

  • KPN Mobile The Netherlands

    • increased revenue due to revised strategy as from mid 2004

    • acquisition of Telfort

  • E-Plus revised strategy mid 2005

  • BASE continued growth

REVENUES

Total revenues rose by EUR 65 million (0.6%) to EUR 11,811 million in 2005. The EUR 519 million increase in revenues of our Mobile division more than offset the EUR 375 million decline experienced by our Fixed division.

The improved revenues in the Mobile division were driven by all our operators in The Netherlands, Germany and Belgium. The increase also includes a EUR 93 million contribution from Telfort (consolidated from October 4, 2005) and a positive effect of the NTT DoCoMo settlement amounting to EUR 26 million with respect to royalties. The total agreement with NTT DoCoMo resulted in total revenues and other income amounting to EUR 110 million. An amount of EUR 84 million with respect to the NTT DoCoMo settlement is recognized as other income (see below) and relates to a settlement for trademark damage (EUR 25 million) and negative goodwill (EUR 59 million). Revenues were negatively affected by EUR 178 million relating to MTA tariff reductions.

Revenues of our Fixed division decreased by 5.2%. More than half (EUR 195 million) of this decrease (2.7%) was due to regulatory MTA tariff reduction. The remainder of the decrease results from an accelerating trend of traditional voice services shifting to ADSL and IP based platforms and a fiercely competitive market, including mobile operators and cable VoIP offers. Although revenues from new technology-based products and services have increased steadily, the increase did not fully offset the decline from traditional services.

Revenues for 2005 for our other activities amounted to EUR 230 million, down from EUR 333 million in 2004. The difference relates mainly to the sale of PanTel in February 2005.

OTHER INCOME

Other income in 2005 relates for an amount of EUR 84 million to the NTT DoCoMo settlement, as discussed under revenues. Also included in other income are book gains on the sale of properties amounting to EUR 18 million (in 2004: EUR 17 million), sale of Infonet and Intelsat in 2005 (EUR 21 million) and the sale of PTC and Eutelsat in 2004 (EUR 56 million).

OPERATING EXPENSES

Group operating expenses increased by EUR 414 million to EUR 9,588 million (4.5%), which is more than the 1.0% increase in revenues and other income. The increased operating expenses are mainly caused by EUR 717 million increased operating expenses within our Mobile division, partly compensated by lower operating expenses within the Fixed division (EUR 73 million) and lower operating expenses 'other' (EUR 254 million).

The operating expenses of the Mobile division increased more than proportionally (16.4%) compared to the 9.9% increase in revenues mainly as a result of the first full year amortization of UMTS licenses (impact of EUR 201 million) and as a result of the consolidation of Telfort (EUR 147 million), compensated by lower expenses as a result of MTA tariff reductions.

Implementation of the restructuring initiatives announced in March 2005 is well on track. The workforce in the Netherlands was reduced by nearly 10%, or 2,106 FTEs, exceeding the stated objective of a minimum of 1,500 FTE reductions per annum. As a result in 2005 we recognized EUR 92 million for restructuring costs (in 2004: EUR 59 million), of which EUR 54 million (2004: EUR 25 million) related to the Fixed division, EUR 3 million in the Mobile division (2004: 11 million) and EUR 35 million in Other activities (2004: 23 million).

Operating expenses within our Fixed division includes a fine of EUR 17 million to OPTA and a payment of EUR 18 million to competitors (without admitting any liability) following the conclusion of the investigation into discounts given by KPN to certain fixed telephony business customers.

Operating expenses 'Other' decreased mainly as a result of the sale of PanTel in February 2005 and due to the fact that EUR 63 million is released from the pension provisions. Following the conclusion of a new Collective Labor Agreement (agreed in principle in December 2005), certain (pre) pension plans were

45


amended and partly abolished resulting in a lower required pension provision.

OPERATING PROFIT

The operating profit in 2005 decreased by 11.2% (EUR 297 million) compared to 2004.

For a further discussion of the factors underlying the developments in operating profits, we refer to the above sections and the discussion on the segmental results of operations.

Summarized, the operating profit in 2005 was influenced significantly by, among others, the following elements:

  • regulatory MTA reductions resulting in EUR 121 million lower operating result;

  • full-year amortization on UMTS licenses in Germany and The Netherlands (impact: EUR 201 million);

  • a fine of EUR 17 million to OPTA and a payment of EUR 18 million to competitors; and

  • a release of the pension provision amounting to EUR 63 million.

FINANCIAL INCOME AND EXPENSE

Net financial expenses in 2005 decreased by EUR 42 million to EUR 547 million due to reduced interest charges following early and scheduled debt redemptions in 2004. Costs associated with the early redemptions in 2004 amounted to EUR 50 million.

SHARE OF THE PROFIT OF ASSOCIATES AND JOINT VENTURES

The share of the profit of associates and joint ventures relates to the result from Schiphol Telematics, Tetraned, Mobirail and Zeus Telecom.

INCOME TAXES

The 2005 tax charge amounted to EUR 360 million (2004: EUR 300 million), the effective tax rate being 20.0% in 2005 (2004: 14.6%).

The 2004 tax charge was influenced by the 2004 agreement reached with the Dutch tax authorities, the application of thin-capitalization rules in Germany, changed Dutch corporate tax rates and reduced valuation allowances on deferred tax assets for tax loss carry forwards. These influences continued during 2005. Particularly, the 2005 tax charge showed the effects of further lowered Dutch corporate tax rates as well as further reduced valuation allowances on deferred tax assets for tax loss carry forwards, albeit the effects were smaller than in 2004.

The deferred tax position was influenced by a further reduction of the Dutch corporate tax rate to 29.6% for 2006 and 29.1% for 2007 (after the 2004 announcement of Dutch corporate tax rate reductions from 34.5% to 31.5% in 2005, 30.5% in 2006 and 30% as from 2007). In 2005, the change in the Dutch corporate tax rate resulted in a EUR 24 million (2004: EUR 128 million) downward adjustment of Koninklijke KPN's deferred tax asset and a EUR 72 million gain (2004: EUR 307 million) resulting from a downward adjustment of KPN Mobile's and Telfort's deferred tax liabilities.

In 2005, we reduced the valuation allowance on BASE's deferred tax asset for corporate tax loss carried forwards by EUR 73 million (2004: EUR 138 million). These reductions were the result of improved profitability outlooks.

Depending on general economic, market and business developments, KPN expects not to move into a taxpaying position before 2007.

PROFIT ATTRIBUTABLE TO MINORITY SHAREHOLDERS

In 2005, profit attributable to minority shareholders represents the profit attributable to minority interests of Telstra in Xantic amounting to 35% (2004: 35%) and of various third parties in Digitenne (60%) and 2.16% attributable to NTT DoCoMo up to October 2005.

In 2004 profit attributable to minority shareholders related to the profit attributable to the minority stakes of NTT DoCoMo in KPN Mobile, Telstra in Xantic, Digitenne, and various third parties in SNT and PanTel. As Digitenne had a negative equity, the minority interest of third parties could not be fully attributed. Therefore, KPN recorded a loss of EUR 26 million on Digitenne.

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Segmental Results of Operations

FIXED DIVISION

In millions of euro

2005

2004

 

 

 

Net sales Consumer

2,384

2,441

Net sales Business

2,647

2,941

Net sales Wholesale and Operations

4,941

5,217

Other net sales (including intercompany revenues)

-3,144

-3,399

Total net sales

6,828

7,200

Other revenues

39

42

Total revenues

6,867

7,242

- of which external revenues

6,294

6,674

 

 

 

Other income

16

7

Total

6,883

7,249

 

 

 

Own work capitalized

-21

-24

Cost of materials

271

235

Work contracted out and other expenses

1,889

1,992

Salaries and social security contributions

914

1,002

Depreciation, amortization and impairments

1,276

1,309

Other operating expenses

278

161

Intercompany expenses

760

765

Total operating expenses

5,367

5,440

 

 

 

Operating profit

1,516

1,809

In millions of euro

2005

2004

 

 

 

Consumer

2,384

2,441

Business

2,649

2,949

Wholesale and Operations

4,973

5,249

Other Fixed (including intercompany)

-3,139

-3,397

Total revenues

6,867

7,242

 

 

 

Other income

16

7

Total

6,883

7,249

 

 

 

Total operating expenses

5,367

5,440

 

 

 

Operating profit

1,516

1,809

- Consumer

338

377

- Business

281

382

- Wholesale and Operations

881

1,041

- Other (including intercompany)

16

9

Our principal sources of revenue are:

Traffic revenues, which include:

  • traffic revenues with respect to the fixed switched telephony network;

  • national and international wholesale services; and

  • portal enabling services.

Access revenues like subscription revenues and one-off connection revenues, which include:

  • monthly subscription revenues and one-off connection revenues for traditional fixed telephony and flat fees for broadband xDSL and IP-VPN connections based on capacity provided;

  • transmission services: include service revenues for fixed-network connections; and

  • local loop services: monthly rental fees and initial fees paid for MDF Access and Co-location.

Other sources of revenue include:

  • inbound and outbound call services and e-mail handling services, as well as sales support services and directory assistance;

  • monthly subscription fees for dial-up Internet, shares in telephony usage revenues, TV-subscription fees, online advertising revenues and the sales of modems, Internet portal services and Internet content;

  • IP services like IP Dial-In Services, billed at local tariffs based on minutes used; and

  • integrated, outsourced and managed solutions.

For a more detailed description of the services we offer and the corresponding sources of revenues, please refer to the section ‘Information about the Company’.

2005

In 2005, total revenues decreased by 5.2% from EUR 7,242 million to EUR 6,867 million.

  • Within the consumer market the decline in fixed voice traffic and subscription revenues accelerated (minus EUR 82 million). This unfavourable trend reflects competition, price reductions and in particular technological and behavioural changes that drive customers away from traditional telephony services towards mobile and IP-based communication solutions. As a result, total revenues decreased by 2.3% to EUR 2,384 million. This decline was partly offset by an increase of Internet related revenues (EUR 16 million).

  • In the Business segment the total revenues decreased by 10.2% from EUR 2,949 million to EUR 2,649 million. These lower revenues were mainly caused by the effect of fierce price competition, as well as the migration from traditional voice traffic, equipment and leased lines towards new, mostly IP-based services. These new services are mostly rendered at lower tariffs and the revenues of these new growth areas did not offset the decrease in the traditional services.

  • In 2005, total revenues from Carrier Services decreased by 5.0% to EUR 4,182 million. Traffic revenues fell by 9.2%, mainly arising

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    from the decrease of national traffic volumes, partly compensated by an increase in International and transit volumes. The revenues from local loop and core services increased by 1.9%.

Operating expenses decreased by 1.4% from EUR 5,440 million to 5,367 million due to:

  • savings in the infrastructural and IT costs (headcount reduction and other savings);

  • an additional charge to the restructuring provisions amounting to EUR 29 million in 2005 (in 2005 totaling to EUR 54 million, while in 2004 EUR 25 million was charged);

  • higher operational expenses for TV and broadband services;

  • higher purchase cost in wholesale market as a result of increased transit and International wholesale volumes; and

  • other operating expenses, which also includes a fine of EUR 17 million to OPTA and a payment of EUR 18 million to competitors (without admitting any liability) following the conclusion of OPTA's investigation into discounts given by KPN to certain fixed telephony business customers.

Segment consumer

In millions of euro

2005

2004

 

 

 

Voice Consumer

1,674

1,756

Internet

699

683

Other (incl. Intrasegment revenues)

11

2

Total net sales

2,384

2,441

Other revenues

0

0

Total revenues

2,384

2,441

- of which External revenues

2,365

2,414

 

 

 

Cost of materials

57

51

Work contracted out and other expenses

81

79

Salaries and social security contributions

60

62

Depreciation, amortization and impairments

42

19

Other operating expenses

93

92

Intercompany expenses

1,713

1,761

Total operating expenses

2,046

2,064

 

 

 

Operating profit

338

377

Revenues

Last year was again a year in which the number of broadband and mobile-only households saw a significant increase. Mobile-only usage increased to about 16% of the Dutch households (excluding the Small offices and Home offices market) by the end of 2005. The Dutch penetration rate for residential broadband (including cable) is the highest in Europe. Broadband penetration1 has increased from 45 per 100 households in the fourth quarter of 2004 to about 58 per 100 households in the fourth quarter of 2005. This growth in broadband connections into a very significant potential market scale in 2005 was also a main reason for the VoIP rollout in the residential market.

Growth in the number of broadband subscribers meant that KPN saw an increase in Internet-related revenues (EUR 16 million). KPN’s decision at the end of 2004 to start a television portfolio is reflected in increased other net sales (EUR 9 million).

These developments did not offset the higher rate of declining fixed voice revenues (EUR 82 million). This decline is mainly due to mobile substitution, a declining number of access lines, emerging VoIP offerings and lower prices for, in particular fixed-to-mobile, calls. As a result, total revenues decreased by 2.3% to EUR 2,384 million.

Operating expenses

Operating expenses decreased in 2005 by 0.9% from EUR 2,064 million to EUR 2,046 million as compared to a 2.3% decrease in revenues. Overall, the decrease shows that the effects of cost-cutting programs and MTA tariff reductions were almost fully offset by higher marketing costs for the Internet and TV business lines, reflecting the competitive nature of these markets.

Intercompany expenses decreased by EUR 48 million, mainly as a result of lower purchases from Carrier Services following the decrease in voice traffic and fixed lines. Other intercompany expenses for billing, IT and management fees decreased slightly due to cost reduction at these departments.

VOICE CONSUMER

Revenues (in millions of euro)

2005

2004

 

 

 

Traffic fees

596

661

Subscriptions, connection fees and other

1,078

1,095

Total net sales Voice Consumer

1,674

1,756

Number of connections (in thousands)

2005

2004

 

 

 

PSTN

4,518

4,836

ISDN

481

523

Total number of connections

4,999

5,359

Traffic volumes (in billions of minutes)

2005

2004

 

 

 

Domestic local

6.67

7.27

Domestic long-distance

2.82

3.11

Total domestic

9.49

10.38

Fixed-to-mobile

1.12

1.10

International

0.37

0.41

Total Voice Consumer

10.98

11.89

1. Mobile-only and broadband penetration rates are based on estimates

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Tariffs (in EUR/minute)

2005

2004

 

 

 

Average local tariff

0.028

0.028

Average domestic long-distance tariff

0.034

0.034

Average fixed-to-mobile tariff

0.184

0.207

Average international tariff

0.189

0.198

In 2005, the market for fixed line telephony was marked by an accelerating decrease in traffic and subscription revenues. This unfavorable trend reflects competition, price reductions and in particular technological and behavioral changes that drive customers away from traditional telephony services towards mobile and IP based communication solutions. The impact of Voice over IP (VoIP) on Business Line Voice’s operations is accelerating. The Dutch fixed voice market is moving towards broadband-centric customers expecting to benefit from the advantages of digital communications such as free calling and flat-rate pricing. In the second half year of 2005, VoIP was especially strong amongst the cable operators. KPN introduced its own VoIP product “InternetPlusBellen” during 2005 at a slow pace. At the end of 2005, InternetPlusBellen has reached its point of required quality for a national rollout in 2006.

In 2005, total revenues of Voice consumer decreased by 4.7% to EUR 1,674 million. Net sales from subscriptions (including other revenues) of EUR 1,078 million (2004: EUR 1,095 million), decreased by 1.6% whereas net sales from traffic decreased by 9.8% to EUR 596 million (2004: EUR 661 million).

The trends towards more mobile-only and VoIP-only households is eroding our PSTN/ISDN customer base and by that our revenue base. Our installed base decreased by 360,000 PSTN and ISDN connections. As a result, subscription and connection revenues declined by 1.6% There was no change in tariffs during 2005.

The decrease in sales from traffic was driven by both a substantial decline in traffic volumes and a decrease in the fixed-to-mobile tariffs as per December 2004 and December 2005 (total impact EUR 27 million). A substitution in communication from switched voice to voice over IP, MSN and peer-to-peer VoIP products such as Skype also contributed to the decrease in total market of voice minutes. The traffic volumes in billions of minutes dropped by 7.7% to 11.0 billion (2004: 11.9 billion). Minutes in all traffic categories declined except for Fixed-to mobile, which illustrates a mix effect of increased mobile-only usage and decreased fixed-line subscriptions. Domestic traffic volumes decreased, as a result of a declining overall switched telephony market (both lines and traffic) and ongoing competition from Carrier (Pre)Select and direct access operators. The effect of competition in the switched telephony market, however, diminished during 2005 as result of more effective customer retention efforts. This is illustrated in a steadily rising share in the switched minute market.

Internet

Net sales (in millions of euro)

2005

2004

 

 

 

ADSL end user revenues

473

349

Internet dial-up revenues

96

186

Other (including value-added services)

130

148

Total

699

683

 

 

 

Total ADSL connections KPN (*1000)

1,740

1,381

Total ADSL connections KPN ISPs (*1000)

1,485

936

Internet dial-up traffic volumes (in billions of minutes)

2.61

5.31

Market share of retail consumer broadband

36.1%

29.7%

Market share of consumer broadband

42.3%

43.8%

In 2005, total net sales of Internet increased by 2.3% to EUR 699 million (2004: EUR 683 million). Higher revenues from increased ADSL connections more than offset lower revenues from dial-up minutes (a decrease of 48%). The number of ADSL connections increased by 26% to 1,740,000 at the end of 2005 (of which 1,485,000 through our own ISPs and Direct ADSL and 255,000 through third party ISPs). As a result of the aggressive competition in the broadband and Internet market, the KPN market share of the total broadband market decreased slightly to 42,3% (including cable-users). However, due to intensive acquisition programs, takeovers of ISPs Freeler and Hcc!Net, and the takeover of the KPN ADSL Tiscali customers, the ISP market share increased from 29.7% to 36.1% in 2005. The KPN ISP customer base increased by 549,000 to approximately 1,485,000 by the end of 2005.

Due to market competition the bandwidth capacity of each broadband package increases at stable price levels. KPN has introduced new packages to accommodate a wider range over bandwidth demand. Bandwidth capacities were also upgraded for all packages during the year. The number of ADSL connections with a relatively low price and corresponding bandwidth increased strongly resulting in a changed customer mix, partly due to migration of dial up customers to the lower end of our ADSL portfolio (e.g. ”ADSL Tijdsurfen”).

49


The mix of ADSL connections is as follows:

Installed base (in % total DSL connections)

2005

2004

 

 

 

- % Slim/Time (varying from 375 to 750 kb/s down - 128 kb/s up)

5%

4%

- % Go (1500 kb/s down - 256 kb/s up)

41%

27%

- % Lite/Quick (varying from 3000 to 4000 kb/s down - 256 to 512 kb/s up)

38%

46%

- % Basic (6,000 kb/s down - 768 kb/s up)

13%

20%

- % Plus/Extra/Fast/ (varying from 8000 to 20,000 kb/s down - 1,024 kb/s up)

3%

3%

Other

In millions of euro

2005

2004

 

 

 

Net sales

11

2

Net sales of 'Other' include revenues from TV and Hotspots (wireless Internet access points at public locations). The number of Digital TV subscriptions increased to approximately 184,000 at the end of 2005 (including approximately 60,000 Digitenne subscriptions).

Segment Business

In millions of euro

2005

2004

 

 

 

Voice Business

1,240

1,383

Connectivity

732

788

Integrated & Managed Solutions

406

419

EnterCom

406

439

Other (incl. intrasegment revenues)

-137

-88

Total net sales

2,647

2,941

 

 

 

Other revenues

2

8

Total revenues

2,649

2,949

- of which External revenues

2,489

2,790

 

 

 

Other income

4

0

Total

2,653

2,949

 

 

 

Own work capitalized

0

-1

Cost of materials

149

124

Work contracted out and other expenses

191

214

Salaries and social security contributions

225

267

Depreciation, amortization and impairments

77

67

Other operating expenses

69

59

Intercompany expenses

1,661

1,837

Operating expenses

2,372

2,567

 

 

 

Operating profit

281

382

Revenues

Total revenues of segment Business decreased by 10.2% (EUR 300 million) compared to 2004 to EUR 2,649 million due to lower net sales of Voice, Connectivity, Equipment and Solutions (Entercom) and Integrated & Managed Solutions. The lower revenues were mainly caused by the effects of increasing (price) competition, as well as the migration from traditional voice traffic, equipment and leased lines to new mostly IP-based services, which are rendered at lower tariffs. Voice experienced an ongoing migration towards broadband and mobile solutions combined with market share loss in the traditional voice market and the MTA tariff decline (EUR 29 million) as a result of OPTA regulation.

The increase in broadband penetration causes a decline of fixed line usage, particularly in Internet dial-up airtime usage but also partly in voice airtime usage due to voice-to-data substitution (e.g. voice over IP, e-mail, MSN-messenger). For cable operators and alternate xDSL providers it is increasingly attractive to introduce a low priced first line VoIP service.

More and more (larger) companies are opting for IP-VPN connectivity. As IP-VPN penetration rates increase, spending will shift away from fixed telephony based solutions, e.g. leased lines. This effect worsened in 2005 due to the fact that IP-VPN solutions are offered in the market at lower tariffs. The number of mobile-only sites is growing, particularly in the small offices segment. This resulted in loss of both subscription and traffic revenues.

Operating expenses

Total operating expenses in 2005 compared to 2004 decreased by EUR 195 million (7.6%) to EUR 2,372 million.

The cost of materials increased by EUR 25 million mainly due to higher purchases for large Managed Services programs (e.g. Porto phones LARA/C2000, NAM and Stork/KVWS). This was partly compensated by lower material costs for equipment due to lower sales.

The cost of work contracted out and other external expenses decreased by EUR 23 million mainly caused by lower sales volumes in traditional voice-equipment deliveries, lower international costs for connections and network maintenance expenses.

The costs of salaries and social security contributions decreased by EUR 42 million compared to 2004, mainly caused by increased efficiency and reduction of workforce by 440 FTE and the selling of Application Consultancy (end of 2004) resulting in a reduction of approximately 117 FTEs.

Other operating expenses increased by EUR 10 million mainly caused by a fine of EUR 17 million to OPTA and a payment of EUR 18 million to competitors following the conclusion of OPTA’s investigation into certain discounts offered to certain business customers. This increase was partly offset by a EUR 22 million lower net addition to the reorganization provision than in 2004.

50


Total depreciation, amortization and impairments increased by EUR 10 million mainly caused by the fact that 2004 included reversals of impairments on certain fixed assets totaling EUR 8 million.

Intercompany costs decreased by EUR 176 million mainly caused by lower costs for production at Connectivity due to a decreasing Installed Base of Connectivity’s traditional portfolio resulting in EUR 52 million lower intercompany expenses. In addition intercompany expenses at Voice decreased by EUR 102 million due to lower revenues and a decrease in the mobile terminating tariffs.

VOICE BUSINESS

Net sales (in millions of euro)

2005

2004

 

 

 

Traffic fees

687

829

Subscriptions, connection fees and other

553

554

Total net sales

1,240

1,383

 

 

 

Number of connections (in thousands)

2005

2004

 

 

 

PSTN

965

1,024

ISDN

943

964

Total number of connections

1,908

1,988

 

 

 

Traffic volumes (in billions of minutes)

 

 

Domestic local

3.67

4.48

Domestic long-distance

3.29

3.99

Total domestic

6.96

8.47

Internet-related

1.40

2.89

Fixed-to-mobile

1.29

1.32

International

0.52

0.59

Total Voice Business

10.17

13.27

Tariffs in EUR/minute

2005

2004

 

 

 

Average local tariff

0.036

0.035

Average Internet tariff

0.029

0.026

Average domestic long-distance tariff

0.053

0.052

Average fixed-to-mobile tariff

0.188

0.210

Average international tariff

0.187

0.184

Net sales

In 2005, Voice Business net sales decreased by 10.3% to EUR 1.240 million. Net sales from subscriptions, connection fees and other remained stable, whereas net sales from traffic decreased by 17.1% to EUR 687 million (2004: EUR 829 million).

The fixed telephony business is in continuous decline caused by an ongoing migration towards broadband and mobile solutions combined with market share loss in the traditional voice market. Both broadband and mobile services are negatively affecting fixed line revenues of both traffic and subscriptions.

The traffic volumes in billions of minutes dropped by 23.4%. Minutes in all traffic categories fell, but the decline was most notable for Internet traffic, as a result of accelerated broadband penetration, which resulted in higher churn of dial-up customers. Domestic traffic volumes declined, as a result of a declining overall telephony market and ongoing competition from Carrier (Pre)Select and direct access operators (e.g. BT, Versatel). The decrease in the number of connections also contributed to the decline in the number of calls and traffic volumes. In 2005, however, our market share declined slower than in 2004, due to improved customer retention efforts. The average tariff per minute for total traffic increased in 2005. This increase is a result of a change in the mix of traffic categories. Traffic volumes of Internet and local calls are declining in relation to fixed-to-mobile and international calls. As a result of OPTA regulation for mobile terminating tariffs (total effect of EUR 29 million in 2005) fixed-to-mobile tariffs declined.

The decrease in revenues from subscriptions and connection fees was caused by a 4.0% decrease in the number of connections in 2005. Both the number of PSTN and ISDN connections decreased, although the decrease in PSTN connections was larger. The decrease in the number of connections is the result of both accelerated penetration of mobile-only usage as well as broadband access competition, VoIP offerings in the Small and Medium sized Enterprises (SME) market and direct access offerings in the corporate market. ISDN2 customers who have opted for ADSL are migrating back to PSTN or to a cheaper variant of ISDN, named ISDN1.

CONNECTIVITY

In millions of euro

2005

2004

 

 

 

Net sales

732

788

 

2005

2004

 

 

 

Number of analog leased lines (in '000)

38

43

Number of digital leased lines (in '000)

10

17

IP-VPN connections (Epacity) (in '000)

39

30

VPN (customers)

1,760

1,409

Net sales

In 2005, net sales for Connectivity decreased by 7.1% to EUR 732 million. Revenues from transmission services both nationally and internationally decreased by 21.5% mainly due to the continued decrease in the number of leased lines, both analog and digital. Revenues from broadband services showed an increase of 6.4% in 2005 due to growing demand for broadband services.

The decline in revenues from traditional transmission services was partly offset by a growth in revenues from network services. Both IP-VPN and Ethernet VPN revenues increased in 2005 due to the continued migration from traditional services such as leased

51


lines and Frame Relay. (Zakelijk)DSL revenues also benefited from migration of ISDN lines to xDSL connections in 2005. As a result total revenues of network services increased by 11.5%.

While revenues decreased in 2005, the market share of Connectivity in traditional services such as leased lines remained stable (according to management estimates) while its market share on new services such as IP-VPN continued to increase. Despite the fact that average prices for new services are much lower than for traditional services (e.g. 100: 33 for digital leased lines versus IP-VPN), Connectivity managed to limit the decrease in revenues.

INTEGRATED & MANAGED SOLUTIONS

In millions of euro

2005

2004

 

 

 

Net sales

406

419

 

2005

2004

 

 

 

Number of Customer programs

121

106

Managed VPN (in '000)

12

10

Net sales

Total net sales decreased by EUR 13 million (3.1%) in 2005, mainly as a consequence of the sale of Application Consultancy in December 2004 (revenue in 2004: EUR 16 million), which was only partly compensated by Customer Programs. The number of Customer Programs increased by 15, but with a lower average revenue per program due to price erosion.

ENTERCOM

In millions of euro

2005

2004

 

 

 

Net sales

406

439

Net sales

Net sales decreased by 7.5% to EUR 406 million. The decline in sales was mainly caused by reduced sales volumes in traditional voice deliveries due to a highly competitive market combined with lower service revenues as a result of a decrease in installed base.

Although revenues from data solutions and related services such as Managed IPT increased, this could not offset the aforementioned lower volumes of traditional voice equipment. Outsourcing revenues declined by approximately 3.8% due to lower prices.

Wholesale and Operations

In millions of euro

2005

2004

 

 

 

Carrier Services

4,182

4,403

SNT

386

370

Other (incl. Intra-segment revenues)

373

444

Total net Sales

4,941

5,217

Other operating revenues

32

32

Total revenues

4,973

5,249

- of which External revenues

1,433

1,460

 

 

 

Other income

12

7

Total

4,985

5,256

 

 

 

Own work capitalized

-21

-22

Cost of materials

64

53

Work contracted out and other expenses

1,613

1,695

Salaries and social security contributions

600

645

Depreciation, amortization and impairments

1,157

1,223

Other operating expenses

106

9

Intercompany expenses

585

612

Operating expenses

4,104

4,215

 

 

 

Operating profit

881

1,041

Revenues

Wholesale and Operations total revenues were down by 5.3% (EUR 276 million), with more than half of this decrease (EUR 139 million) related to MTA reductions. The remainder mainly arose from lower internal traditional revenues, partly compensated for by national and international wholesale services.

Assets and network support and IT operations are allocated to the segment Wholesale and Operations. The segment delivers semi-finished products to the segments described above. The introduction of transfer-pricing relationships in the reporting structure has made our reporting simpler and more transparent. When analyzing the segment revenues, we will focus on external revenues, because internal revenues are directly related to business developments in retail segments.

Operating expenses

Operating expenses decreased by 2.6% to EUR 4,104 million. The main reasons were lower depreciations due to a reduced asset base and MTA reductions, partly offset by increased purchase cost following increased international and transit wholesale volumes.

52


Cost of materials increased by EUR 11 million, mainly resulting from increased energy expenses for infrastructure and real estate.

The costs of work contracted out and other external expenses decreased as a result of lower interconnect charges to third party mobile operators resulting from MTA tariff reductions (total effect of EUR 139 million) partly offset by higher purchasing costs because of increased wholesale services.

The salaries and social security contributions decreased by 7.0% due to a reduction of the number of employees (approximately 600 FTEs).

Depreciation, amortization and impairment charges continued to decrease due to investment optimization, resulting in a lower asset base. During 2005, we recorded an impairment charge on the SNT goodwill amounting EUR 40 million.

Other operating expenses included an additional restructuring provision amounting to EUR 52 million (in 2004: EUR 1 million) in connection with the implementation of the restructuring initiatives announced in March 2005.

Interdivision settlements decreased by 4.4% to EUR 585 million reflecting business developments in our retail segments and due to lower mobile terminating interconnect charges.

CARRIER SERVICES

Net sales (in millions of euro)

2005

2004

 

 

 

Traffic revenues

2,544

2,803

Local Loop Network revenues

1,269

1,194

Core Network revenues

771

808

Other (including intercompany revenues)

-402

-402

Total net sales

4,182

4,403

- of which Intercompany revenues within KPN

2,916

3,099

- of which External revenues

1,266

1,303

Traffic revenues

Traffic volumes (in billions of minutes)

2005

2004

 

 

 

Terminating

13.49

13.57

Originating - voice

10.96

11.95

Originating - Internet

1.99

3.94

Transit

6.78

6.11

International

7.93

6.89

Total Carrier Services

41.15

42.46

In 2005, total net sales from Carrier Services decreased by 5.0% to EUR 4,182 million. Traffic revenues fell by 9.2%, whereas the revenues from local loop network services increased by 6.3%.

Traffic revenues fell by EUR 259 million (of which EUR 67 million were external) due to an overall decline in volumes from 42.5 billion minutes in 2004 to 41.2 billion minutes in 2005 and reductions of tariffs as a consequence of OPTA regulation for MTA tariffs (EUR 139 million).

National traffic volumes decreased by 6.6% to 33.2 billion in 2005, mainly due to the decrease in originating Internet minutes and lower traditional voice services. The decrease in originating Internet minutes amounting to 49.5% reflects the migration to ADSL. The reduced volumes in traditional voice and originating voice result from increasing competition. The increase of the number of “mobile only users” is partly compensated for by the rise in transit volumes.

International traffic volumes increased by 15.1% as a result of strong growth of mobile traffic services and increased volume by new and existing parties. International call volumes have benefited from the fast developing global market for the trading of minutes, mainly in Asia, Africa and the Middle East. The average revenue per minute fell as a result of fierce competition in the wholesale carrier market and the impact of MTA regulation mainly in European countries.

Revenues from Local Loop Services

Revenues in 2005 from Local Loop Services increased mainly because of the introduction of Wholesale DSL and higher revenues from Bitstream and MDF access due to increased broadband usage in The Netherlands.

Revenues from Core Network Services

Revenues in 2005 from Core Network Services decreased by 4.6% mainly due to decrease in volumes of Digistream and ISDN/MTN partly offset by increases sales of Interconnecting leased lines.

SNT

Net sales (in millions of euro)

2005

2004

 

 

 

Net sales

386

370

Of which intercompany within KPN

251

265

Of which External revenues

135

105

Net sales

Net sales in 2005 increased by EUR 16 million compared to 2004, caused by increased activities in Germany and Avalanche, partly offset by decreased activities within the Benelux. The Interview/NSS and Avalanche businesses have been sold during 2005.

53


MOBILE DIVISION

Due to our acquisition of Telfort in October 2005, we now own two mobile operators in The Netherlands. Telfort is being consolidated as from October 4, 2005 and forms part of The Netherlands' figures.

Amounts in millions of euro

2005

2004

 

 

 

Service revenues

5,370

4,847

Of which: - Germany

2,461

2,291

- The Netherlands

2,368

2,139

- Belgium

541

417

 

 

 

Hardware and other revenues

403

407

Revenues

5,773

5,254

- of which External revenues

5,286

4,739

 

 

 

Other income

84

10

Total

5,857

5,264

 

 

 

Own work capitalized

-91

­­-122

Cost of materials

734

706

Costs of work contracted out and other external expenses

2,005

1,693

Salaries and social security contributions

391

399

Depreciation and impairments

695

643

Amortization and impairments

383

184

Other operating expenses

378

284

Inter-division settlements

605

596

Total operating expenses

5,100

4,383

 

 

 

Operating profit

757

881

Due to developments in our mobile telecommunication markets - especially the introduction of postpaid flat fee offerings - we decided to change the way we present our operating revenues. Until last year, we used to split operating revenues into traffic revenues, fixed monthly subscription fees, hardware revenues and other operating revenues.

As from this financial year, the Mobile division's revenues are presented as follows:

  • Service revenues, consisting of:

    • traffic revenues. These are charged at an agreed price for a fixed duration of time or capacity. Airtime rates vary depending on proposition (prepaid vs. postpaid) as well as destination and time of the call. Traffic revenues also include:

      • traffic bundles, offered in combination with a subscription;

      • value-added service revenues, charged for our value-added mobile voice and data services (i-mode, messaging services, voice mail and information services);

      • roaming revenues, received from other network operators for their clients’ calls placed on our networks; and

      • termination revenues, charged to other telecommunication companies for calls originating on their networks and terminating on our networks.

    • fixed monthly subscription fees. These are billed monthly to our contract customers for providing them access to our network irrespective of their actual airtime usage. The fees include handset service fees.

  • Hardware and other revenues. These include revenues other than service revenues and comprise primarily hardware revenues - revenues from the sale of SIM cards, handsets and accessories - as well as income from intellectual property rights (IPR) and site sharing.

On October 24, 2005, KPN acquired the outstanding 2.16% interest in KPN Mobile N.V. held by NTT DoCoMo - then having a book value of EUR 115 million - for a net consideration of EUR 5 million, while agreeing to allow the use by O2 in Germany of NTT DoCoMo technology, a right previously granted exclusively to KPN. The resulting gain of EUR 110 million was recorded in the Revenues (EUR 26 million) and Other income (EUR 84 million). Of the gain, KPN allocated EUR 26 million to IPR income and EUR 25 million to trademark damages (of which EUR 13 million recorded by KPN Mobile The Netherlands and EUR 38 million by E-Plus) as well as EUR 59 million to negative goodwill (recorded by KPN Mobile Holding).

GERMANY

Amounts in millions of euro

2005

2004

 

 

 

Service revenues

2,461

2,291

Hardware and other revenues

336

307

Revenues

2,797

2,598

- of which External revenues

2,750

2,552

 

 

 

Other income

25

10

Total

2,822

2,608

 

 

 

Own work capitalized

-70

-91

Cost of materials

504

468

Costs of work contracted out and other external expenses

1,146

1,040

Salaries and social security contributions

209

202

Depreciation and impairments

425

392

Amortization and impairments

253

147

Other operating expenses

237

186

Interdivision settlements

123

103

Total operating expenses

2,827

2,447

 

 

 

Operating profit

-5

161

Revenues and other income

Our revenues and other income increased by 8.2% mainly driven by growth in our customer base. The growth of the German mobile market and our increased share of that market were reflected in our increased customer base, up to 10.7 million at year-end 2005. In 2005, our strategy of focusing on growth in customer base, revenues and market share on the one hand and profitability on the other helped to attract new customers with an increasing share of profitable postpaid customers. With an estimated 12.2% market

54


share as of December 31, 2005 (2004: 11.7%), E-Plus continues to strengthen its position in the German market. As of December 2005, we served 5.6 million postpaid customers, constituting 52% of our total customer base (2004: 50%).

Although the number of subscribers rose, ARPU decreased to EUR 21 mainly due to regulatory MTA tariff reductions and the introduction of flat-fee propositions, which more than offset the positive AMPU development. Service revenues increased by 7.4% on higher traffic volumes. Hardware and other revenues (up EUR 29 million) benefited from EUR 13 million IPR income due to the NTT DoCoMo settlement.

The below tables summarize the developments in customer base, traffic volumes, average revenues and gross churn ratios of E-Plus:

CUSTOMER BASE DEVELOPMENT

Number of customers in thousands at December 31,

2005

2004

 

 

 

Postpaid

5,574

4,724

Prepaid

5,174

4,787

Total

10,748

9,511

of which i-mode

1,048

1,093

TRAFFIC VOLUMES, AMPU, ARPU AND CHURN

 

2005

2004

 

 

 

Total traffic volumes (in millions of minutes)

9,376

7,943

 

 

 

Weighted monthly AMPU (in minutes)

79

76

Postpaid

135

134

Prepaid

21

22

 

 

 

Total monthly ARPU (in EUR)

21

22

Postpaid

35

38

Prepaid

6

7

 

 

 

Gross churn ratio

23%

20%

Postpaid

16%

19%

Prepaid

30%

21%

Prepaid customers forfeit call credits if their prepaid cards have not been recharged during any 12-month period. After one additional month, those customers are removed from our customer base. In 2005, the prepaid gross churn rose due to clearing inactive customers.

Operating expenses

In 2005, operating expenses increased by 15.5%, or EUR 380 million, primarily due to growth in the customer base, but also as a result of a full year's amortization of the UMTS license (impact EUR 132 million). Amortization and depreciation expense rose in 2005 as the amortization of UMTS licenses started in September and October 2004 respectively. Cost of materials increased as the number of postpaid handsets sold rose. Work contracted out increased due to increased traffic volumes. Although we reduced the dealer commission per new customer in line with our new strategy, the total amount spent on dealer commissions was still higher than last year due to the increased gross additions. Our network costs increased in line with the rollout of new sites. The increase in other operating expenses reflects the fact that we spent more on marketing and brand communications, rather than focus on dealer commissions and discounts.

THE NETHERLANDS

As a consequence of our acquisition of Telfort in October 2005, we now own two mobile operators in The Netherlands. Telfort is being consolidated as from October 4, 2005. The 2005 figures for The Netherlands including and excluding the effects of the Telfort acquisition are shown below.

Amounts in millions of euro

2005 (incl. Telfort)

2005 (excl. Telfort)

2004

 

 

 

 

Service revenues

2,368

2,247

2,139

Hardware and other revenues

115

110

132

Revenues

2,483

2,357

2,271

- of which External revenues

2,016

1,923

1,780

 

 

 

 

Own work capitalized

-20

-19

-27

Cost of materials

206

196

215

Costs of work contracted out and other external expenses

655

596

490

Salaries and social security contributions

129

120

128

Depreciation and impairments

169

157

144

Amortization and impairments

111

87

31

Other operating expenses

89

80

54

Interdivision settlements

496

490

507

Total operating expenses

1,835

1,707

1,542

 

 

 

 

Operating profit

648

650

729

Revenues

Our 2005 revenues were up by 9.3% or EUR 212 million, primarily due to the acquisition of Telfort (5.5% or EUR 126 million). Service revenue growth for KPN Mobile The Netherlands (excluding Telfort) amounted to 5.0% or EUR 108 million, despite a EUR 81 million adverse impact from regulatory MTA tariff reductions. KPN Mobile The Netherlands' hardware and other revenues were EUR 22 million or 16.7% lower, mainly due to reduced handset sales (EUR 15 million) and higher discounts (EUR 16 million), despite the EUR 13 million IPR income from the NTT DoCoMo settlement.

55


Growth in our Dutch 2005 service revenues was attributable to a larger postpaid customer base, despite a slightly lower postpaid AMPU. Reduced tariffs and migration from prepaid to postpaid propositions reduced the postpaid ARPU. The prepaid ARPU decreased as well due to lowering MTA tariffs and the migration of high-end prepaid customers to postpaid propositions. The increased postpaid base and the rising popularity of postpaid bundles caused service revenues to increase by 10.7%.

Through the acquisition of Telfort, we strengthened our leading position in the Dutch market. The combined revenue market share approximated 39.6% in 2005 (KPN Mobile The Netherlands only: 37.5%; 2004: 37.4%). If Telfort were consolidated for the full year, our combined revenue market share would have been 45.3%. Total mobile market penetration in The Netherlands further increased to around 100% (2004: 93%).

With four remaining mobile network operators and numerous mobile service providers, the Dutch market remains competitive. In this maturing market, we want to focus on customer value over customer numbers by emphasizing our postpaid propositions. Increased marketing and sales efforts - aimed at stimulating high-end prepaid customers to migrate to postpaid propositions - contributed to a 20.7% standalone growth of KPN Mobile The Netherlands' postpaid customer base.

Furthermore, we reduced the level of handset subsidies on prepaid contracts and cleared a large number of inactive customers from our customer base, resulting in a 20.3% standalone decrease in prepaid customers. In 2003 and 2004, we had extended the validity period of our prepaid propositions: KPN-branded customer propositions were extended indefinitely under the condition of commercial activity at least once every 6 months, whilst Hi propositions were made valid for 12 months irrespective of the level of activity. This change caused the prepaid churn to fall to a very low level in 2004. During 2005, many prepaid connections became inactive under the new definitions, resulting in an increased prepaid churn.

The tables below summarize the developments in customer bases, traffic volumes, average revenues and gross churn ratios of our mobile operators in The Netherlands. The 2005 figures for The Netherlands including and excluding the effects of the Telfort acquisition are shown below.

CUSTOMER BASE DEVELOPMENT

Number of customers in thousands at December 31,

2005 (incl. Telfort)

2005 (excl. Telfort)

2004

 

 

 

 

Postpaid

3,260

2,639

2,186

Prepaid

4,812

3,101

3,890

Total

8,072

5,740

6,076

of which i-mode

704

704

661

TRAFFIC VOLUMES, AMPU, ARPU AND CHURN

 

2005 (incl. Telfort)

2005 (excl. Telfort)

2004

 

 

 

 

Total traffic volumes (in millions of minutes)

9,819

9,059

8,081

 

 

 

 

Weighted monthly AMPU (in minutes)

123

124

122

Postpaid

271

268

273

Prepaid

29

29

35

 

 

 

 

Total monthly ARPU (in EUR)

30

31

32

Postpaid

63

65

70

Prepaid

8

8

10

 

 

 

 

Gross churn ratio

32%

32%

14%

Postpaid

15%

14%

17%

Prepaid

43%

44%

13%

KPN Mobile The Netherlands' standalone growth in traffic volumes amounted to 12.1% in 2005, with strong growth in postpaid traffic volumes but a decrease in prepaid traffic volumes (both in line with customer base developments). Weighted monthly AMPU and total monthly ARPU did not change significantly as a result of the Telfort acquisition.

Operating expenses

Operating expenses were up by 19.0%, also as a result of the acquisition of Telfort in the fourth quarter (8.3% or EUR 128 million). Our efforts to acquire and retain postpaid customers resulted in higher dealer commissions and bonuses (4% or EUR 60 million) comprised in costs of work contracted out. Increased costs resulting from the larger customer base and related increase in traffic volumes were almost fully compensated for by lower access tariffs, partially due to MTA tariff reductions due to OPTA regulation. Moreover, 2005 is the first full year in which we utilized the UMTS network and licenses; therefore, amortization and depreciation charges related to this 3G network increased by EUR 69 million, being 3.8% of the total operating expenses in 2005.

56


BELGIUM

Amounts in millions of euro

2005

2004

 

 

 

Service revenues

541

417

Hardware and other revenues

7

11

Revenues

548

428

- of which External revenues

518

407

 

 

 

Own work capitalized

-1

-4

Cost of materials

23

23

Costs of work contracted out and other external expenses

200

165

Salaries and social security contributions

47

62

Depreciation and impairments

100

108

Amortization and impairments

19

6

Other operating expenses

51

42

Interdivision settlements

24

21

Total operating expenses

463

423

 

 

 

Operating profit

85

5

Revenues

Our revenues increased by 28.0% primarily due to growth of its customer base. The number of customers we serve in Belgium increased from 1.6 million to 2.0 million, up 21.5%. We also succeeded in reducing both prepaid and postpaid churn, which contributed to the favorable development of our customer base. As a result, we believe we now earn more than 13% of revenues in the Belgian mobile market (2004: about 11%).

Blended ARPU remained stable throughout the year. Postpaid ARPU decreased by EUR 4 or 6.2% - in spite of a significant increase in postpaid AMPU - due to introduction of flat-fee plans. Prepaid ARPU increased to EUR 15 despite a slightly lower AMPU due to the reduced amount of free minutes.

The tables below summarize the developments in customer base, traffic volumes, average revenues and gross churn ratios of our mobile operators in Belgium.

CUSTOMER BASE DEVELOPMENT

Number of customers in thousands at December 31,

2005

2004

 

 

 

Postpaid

429

323

Prepaid

1,572

1,324

Total

2,001

1,647

of which i-mode

20

28

TRAFFIC VOLUMES, AMPU, ARPU AND CHURN

 

2005

2004

 

 

 

Total traffic volumes (in millions of minutes)

2,579

1,850

 

 

 

Weighted monthly AMPU (in minutes)

117

107

Postpaid

271

213

Prepaid

78

80

 

 

 

Total monthly ARPU (in EUR)

24

24

Postpaid

61

65

Prepaid

15

14

 

 

 

Gross churn ratio

17%

19%

Postpaid

20%

24%

Prepaid

16%

17%

Under the new tariffs and conditions recently introduced by BASE, prepaid customers are removed from the customer base after one year of inactivity (i.e., neither incoming nor outgoing traffic).

Operating expenses

Operating expenses were up 9.5%; salaries and social security contributions were 24.2% lower because of the reduction of the number of employees during the year. We are progressively outsourcing non-core activities, which is reflected in the increased costs of work contracted out. Of the EUR 35 million increase in costs of work contracted out and other external expenses, EUR 19 million reflects higher interconnect costs caused by increased traffic volumes, while EUR 9 million relates to risen dealer commissions. Compared to 2004, amortization of licenses increased from EUR 6 million to EUR 19 million, primarily due to the effect of a (partial) UMTS license impairment reversal (EUR 16 million) in 2004.

Other activities

Amounts in millions of euro

2005

2004

 

 

 

Total net sales

230

327

Other revenues

-

6

Total revenues

230

333

Other income

25

56

Total

255

389

 

 

 

Operating expenses

180

434

 

 

 

Operating result

75

-45

57


Revenues

Total revenues decreased to EUR 230 million mainly as a result of EUR 97 million lower net sales. This decrease is mainly caused by the divestiture of PanTel in February 2005 resulting in EUR 80 million lower sales and EUR 11 million lower sales at Xantic as a result of the restructuring of certain activities in 2004. Other income in 2005 included the bookgains on the sale of Intelsat and Infonet amounting in total to EUR 21 million and in 2004 book gains of EUR 36 million on the sale of KPN's interest in Eutelsat and of EUR 20 million on the sale of PTC.

As per February 14, 2006, KPN and Telstra have transferred their total holdings in Xantic to the Canadian Stratos Global Corp.

Operating expenses

Operating expenses decreased by 254 million, mainly as a result of lower operating expenses following the sale of PanTel. In addition an amount of EUR 63 million relating to the provision for pension charges has been released into the income statement. In 2004 we released EUR 18 million relating to a restructuring provision related to revenue guarantees for Atos Origin and an additional goodwill impairment charge of EUR 7 million within Xantic.

Other Consolidated Results of Operations

Sale of activities and assets

During the last two years, we sold various activities and assets. The below table reflects the estimated impact of the asset disposals on our external revenues, operating result and total assets. The figures are based on the last full year of consolidation or the moment of disposal in case of participating interests.

Amounts in millions of euro

Year of disposal

Impact on external revenues

Impact on operating result

Impact on total assets

 

 

 

 

 

Eutelsat

2004

None

None

36

PTC

2004

None

None

-

KPN Netwerk Bouw

2004

None

None

24

Infonet

2005

None

None

116

Intelsat

2005

None

None

25

PanTel

2005

100

6

136

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LIQUIDITY AND CAPITAL RESOURCES

Cash flow information

The following table provides a two-year summary of our cash flows for the years ended December 31, 2005 and 2004:

NET CASH FLOWS

Amounts in millions of euro

2005

2004

 

 

 

Net cash flow provided by operating activities

3,833

3,957

Net cash flow used in investing activities

-2,206

-1,574

Net cash flow used in financing activities

-2,918

-2,639

Change in cash and cash equivalents

-1,291

-256

OPERATING ACTIVITIES

In 2005 our net cash flow from operating activities decreased by EUR 124 million compared to 2004. This decrease is mainly caused by a decrease in operating profit, partly compensated by lower interest payments (EUR 139 million) and an increased working capital position.

Net interest payments amounted to EUR 484 million in 2005, a decrease of 22% compared to 2004 due to the refinancing of bonds and renewal of the credit facility in the third quarter of 2004.

INVESTING ACTIVITIES

The table below is a two-year summary of our investments and additions and reconciliation to the cash flow used in investing activities:

Amount in millions of euro

2005

2004

 

 

 

Acquired group companies

-1,178

-75

Additions to intangible fixed assets (licenses, software and other)

- 223

-134

Additions to property, plant and equipment

-1,201

-1,567

Additions to financial fixed assets and non current receivables

-4

-8

Total investments and additions

-2,606

-1,784

 

 

 

Less: non-cash items

158

-17

Less: proceeds from sale of assets

242

227

Total cash flow used in investing activities

-2,206

-1,574

Acquired group companies

In 2005, additional investments in group companies mainly relate to the acquisition of Telfort for EUR 1,131 million (of which EUR 489 million goodwill), the acquisition of the 2.16% minority interest in KPN Mobile from NTT DoCoMo for EUR 5 million, additional investments in SNT for EUR 31 million and the acquisitions of Freeler and Hcc!Net. An amount of EUR 132 million related to the acquisition of Telfort is expected to be settled in 2006.

During 2004, we increased our interest in SNT from 50.78% to 93.7% for an amount of EUR 75 million.

Additions to intangible fixed assets

In 2005, investments totaled EUR 223 million (2004: EUR 134 million). These relate for EUR 207 million to software (2004: EUR 111 million) as well as to investments in customer bases of Tiscali (EUR 13 million) and Cistron (EUR 3 million).

Non-cash items

Non-cash items include the expected deferred payment amounting to EUR 132 million with respect to the Telfort acquisition, additional asset retirement obligations included as an addition to Property, plant and equipment for EUR 15 million (2004: EUR 30 million), an additional investment in SNT through issuance of 3 million shares (EUR 20 million). 2004 also included a release relating to lease and dismantling obligations amounting to EUR 20 million.

Proceeds from sale of assets

During 2005, the total proceeds from sale of assets amounted to EUR 242 million and included Intelsat (EUR 29 million), Infonet (EUR 129 million) and PanTel (EUR 9 million). Additionally, the proceeds included EUR 45 million (GBP 30 million) from a redeemed loan related to the sale of our 15% shareholding in Hutchison 3G UK to Hutchison Whampoa Limited in 2003 as well as the proceeds of property sales (EUR 31 million).

In 2004, total proceeds from sales of assets amounted to EUR 227 million. These included amounts of EUR 73 million from the sale of Eutelsat, EUR 30 million from the sale of PTC, EUR 73 million from the sale of various Property, plant and equipment, EUR 24 million from the sale of Volker Wessels Netwerk Bouw and a EUR 27 million repayment by MobilCom of their loan.

FINANCING ACTIVITIES
2005

In 2005, total cash flow used in financing activities amounted to EUR 2,918 million, consisting of a cash inflow of EUR 1,381 million, offset by a cash outflow of EUR 4,299 million

In 2005 we paid EUR 609 million dividend for 2004 and EUR 281 million as an interim dividend for 2005.

In 2005, we repurchased 238.9 million shares. During the completion of the share repurchase program we also repurchased 5.2 million shares for a total amount of EUR 33 million to cover share option plans. In addition, on December 16, 2005 we repurchased the special share, which was until then held by the State of the Netherlands for an amount of EUR 0.48. For details of our share

59


repurchases in the reporting period see the table included in the Corporate Governance section.

In accordance with our regular redemption schedule, we redeemed a total amount of EUR 1,662 million, which consisted of the EUR 204 million syndicated loan, the EUR 333 million Global bond 2000 - 2005, the EUR 659 million Global bond 2000 - 2005 and the EUR 327 million Convertible Bond 2000-2005. We redeemed EUR 40 million of our private loans of which EUR 9 million were early redemptions. We also redeemed EUR 99 million of other loans, of which EUR 38 million were early redemptions.

In June 2005, we issued an EUR 1 billion Eurobond with a maturity of ten years and a coupon of 4%. We have drawn temporarily on our credit facility in the fourth quarter of 2005 for an amount of EUR 350 million as per December 31, 2005.

2004

In 2004, total cash flow used in financing activities amounted to EUR 2,639 million, consisting of a cash inflow of EUR 1,148 million, and by a cash outflow of EUR 3,787 million.

In 2004, we repurchased 164 million shares for an initial amount of up to EUR 1,009 million. We also repurchased an amount of EUR 33 million worth of our own shares, with an average purchase price of EUR 6.04 per share, to cover exposure related to share option plans.

In 2004 we paid EUR 606 million as dividend for 2003 and EUR 190 million as interim dividend for 2004.

In February 2004, we used an interest rate swap to change the interest rate profile of the Eurobond 1998 - 2008 from a fixed rate of 4.75% to a 6 months floating rate with a spread above EURIBOR of 1.24%. Also in February 2004, we entered into a cross currency swap transaction to change the interest rate profile of the Eurobond 2001 - 2008 GBP from a fixed rate of 7.9% to a 6 months floating rate with a spread above EURIBOR of 3.14%. This cross currency swap transaction became effective as of April 11, 2004. Because of the negative market value of the original swaps, the new hedge resulted in a cash outflow of EUR 39 million. The lower GBP rate in the new hedge resulted in a decrease of the euro equivalent of the Eurobond 2001 - 2008 GBP, resulting in a gross debt reduction of EUR 22 million. The remaining cash outflow of EUR 17 million represents differences in future interest expenses and is recognized as part of the net cash flow provided by operating activities.

We redeemed EUR 875 million of the Eurobond we issued in June 1999.

On July 21, 2004, we completed

  1. our offer to exchange our Eurobond 2001 - 2006 with a nominal value of EUR 1,005 million for the Eurobond 2004 - 2011; and

  2. our offer to purchase for cash our outstanding Eurobond 1996 - 2006 with a nominal value of EUR 156 million and our outstanding Convertible Bond 2000 - 2005 with a nominal value of EUR 800 million. In total, a nominal amount of EUR 1,961 million was exchanged and repurchased, which was financed through a new issuance of a Floating Rate Note due 2009 for a total amount of EUR 700 million and of a Eurobond due 2011 for a total amount of EUR 1,425 million. The EUR 700 million Floating Rate Notes due 2009 were swapped through an interest rate swap from a floating interest rate into a fixed coupon of 4.02%.

Finally, the category Other in 2004 included, (early) redemptions of EUR 31 million of Private Loans maturing in 2005 and 2006 and EUR 44 million of financial leases of E-Plus. On the other hand, E-Plus contracted EUR 30 million of financial leases in December 2004.

Credit rating

Following the announcement on February 7, 2006 of our revised financial framework, Standard & Poor's and Moody's lowered our credit rating to BBB+ with negative outlook and Baa2 with stable outlook respectively.

Commitments and contingencies

The following table sets forth our contractual obligations over the coming years:

CONTRACTUAL OBLIGATIONS

 

Amounts due by period

Amounts in millions of euro

Total

Less than 1 year

1 - 3 years

3 - 5 years

More than 5 years

Debt obligations (excluding financial lease obligations)

9,805

2,029

1,758

2,702

3,316

Financial lease obligations

81

24

16

14

27

Total debt and financial lease obligations

9,886

2,053

1,774

2,716

3,343

Capital commitments

374

333

21

20

0

Rental lease contracts

2,288

359

526

449

954

Operational lease contracts

142

60

53

22

7

Guarantees

40

3

4

3

30

Purchasing commitments

951

646

201

63

41

Other

1

1

-

-

-

Total

13,682

3,455

2,579

3,273

4,375

On the basis of our current redemption profile and current interest rates, we expect our interest payments to amount to EUR 448 million in 2006, EUR 389 million in 2007 and EUR 381 million in 2008.

60


Our budgeted 2006 capital expenditures amount to approximately EUR 1.6 billion up to EUR 1.8 billion. Our capital expenditures for the All-IP migration for the next 5 years are estimated between EUR 1.0 billion and EUR 1.5 billon. We expect to use significant proceeds from the sale of our technical buildings in the financing of these capital expenditures. The level and timing of capital expenditures we actually make will depend on the pace of network build-outs and upgrades, product roll outs and acquisitions, among other things.

KPN intends to implement EUR 1 billion share repurchase program, to be executed during 2006 subsequent to the pre-funding of scheduled (April and July) debt redemptions and only at a price which enhances value for the remaining shareholders.

KPN also intends that the total amount of dividend paid over the fiscal years 2006 and 2007 will at least be equal to the total amount of dividend paid over the fiscal year 2005 (EUR 950 million).

There are no off-balance sheet arrangements, other than those disclosed in the section titled 'Commitments, contingencies and legal proceedings' in the notes to our Consolidated Financial Statements, that have or are reasonably likely to have a material current or future effect on our financial position and results that is material to investors.

For additional information (also on our debt profile), please refer to the sections titled 'Financing - and Financial Instruments' and 'Commitments, contingencies and legal proceedings' in our Consolidated Financial Statements.

Available financing sources in 2006

We believe that our working capital and available financing resources will be sufficient to fund our present business requirement, including our budget capital expenditures. However, we expect to issue additional debt aimed at refinancing the upcoming redemptions in 2006. Our ability to effect such refinancing will be dependent upon our financial performance and market conditions at such time. We may also elect to redeem debt in advance of its scheduled redemption date. For more information on our debt profile, please refer to the section titled ‘Financing and Financial Instruments’ in our Consolidated Financial Statements.

Due to German Capital Maintenance Rules, we are obliged to keep certain funds available at E-Plus. As of December 31, 2005, we had cash and cash equivalents of approximately EUR 1,065 million, of which EUR 758 million at E-Plus.

In addition to the available cash and cash equivalents, cash flows from operations and cash flows from any further sales of non-core assets, we have the following financing resources available:

EUR 1.5 billion multi-currency revolving credit facility

We have a EUR 1.5 billion credit facility maturing on August 17, 2009 at our disposal. The credit facility can be used for general corporate purposes, working capital or refinancing of indebtedness of KPN or subsidiaries. As per December 31, 2005 we have temporarily drawn an amount of EUR 350 million on this facility.

Overdraft facilities

During the third quarter of 2005, we entered into four uncommitted overdraft facilities with four banks worth EUR 50 million each. These overdraft facilities have replaced the EUR 200 million Securitization Program.

Global Medium Term Note Program

In September 2005, we updated our EUR 10 billion GMTN program to meet new EU disclosure requirements. The available borrowing capacity as of December 31, 2005 under our EUR 10 billion Global Medium Term Note (GMTN) program (available since April 1997) amounted to EUR 4,553 million. The GMTN program contains no commitment from investors to provide funding to us. Funding will be available subject to market conditions and other factors at the relevant time.

Capital resources covenants

Our existing capital resources contain the following covenants, which could trigger additional financial obligations or early redemption of the outstanding indebtedness:

Our Eurobond 2001-2006 (EUR) and Eurobond 2001-2008 (GBP) contain a rating step-up provision which offers each note holder a 0.375% increase in the interest rate for each notch downgrade of our unsecured long-term debt below either Baa2 by Moody's or BBB by Standard & Poor’s, and a rating step-down provision which results in a 0.375% decrease in the interest rate for each notch upgrade (up to the initial interest rate).

Additionally, we may be required to redeem the outstanding notes early, in the event that:

  1. we consolidate with or merge into another entity (other than a merger of a subsidiary into KPN in which KPN is a continuing corporation) or convey, transfer or lease all or substantially all of our properties and assets to another person or entity without the prior approval by the note holders; and

  2. the rating assigned to the notes after giving effect to any such transaction is lower either than Baa3, in the case of Moody's, or BBB-, in the case of Standard & Poor’s.

As of December 31, 2005, the total outstanding amount under these bonds amounted to EUR 822 million.

In addition, many of our capital resources contain a covenant prohibiting us to enter into any amalgamation, demerger,

61


merger, corporate restructuring or reorganization, unless prior written consent has been given by the lenders or noteholders (e.g, as in the EUR 1.5 billion multi-currency revolving credit facility) or the resulting company assumes all of our rights and obligations with respect to the notes.

Financial and dividend policy

The Board has decided on a further optimization of KPN's capital structure taking into account KPN's experience of operating under its existing financial policy, KPN's current and expected trading, overall developments in the European telecommunications market and credit rating agency considerations with respect to KPN. We expect that the redefined financial policy will allow KPN to continue with its policy of accommodating an attractive dividend policy, whilst maintaining flexibility to grow and invest in its business.

Henceforth, KPN will seek to ensure that net debt to operating result plus depreciation, amortization and impairments remains within the range of 2 to 2.5 times. Furthermore, KPN intends to maintain a minimum credit rating of Baa2 (Moody's) and BBB (S&P). This ratio replaces the previous criteria to contain net debt to no more than twice the operating result plus depreciation, amortization and impairments, and to maintain a net interest coverage (defined as operating result plus depreciation, amortization and impairments divided by financial income and expenses) of at least 6 times.

Within the context of the new financial policy, KPN plans for a further EUR 1 billion of share repurchases, to be executed during 2006 subsequent to the pre-funding of scheduled (April and July) debt redemptions and only at a price which enhances value for the remaining shareholders.

KPN proposed to declare a cash dividend of EUR 0.45 per share in respect of the year ending December 31, 2005, of which EUR 0.13 was paid out as an interim dividend in August 2005. The proposed dividend will be presented for approval at the Annual General Meeting of Shareholders to be held on April 11, 2006 and, upon approval, paid out shortly thereafter.

Also, KPN intends to maintain its mid-term dividend policy according to which KPN expects to pay out a dividend between 35 and 50 per cent of its annual free cash flow, defined as net cash flow provided by operating activities minus capital expenditures.

KPN also intends that the total amount of dividend paid over the fiscal years 2006 and 2007 will at least be equal to the total amount of dividend paid over the fiscal year 2005 (EUR 950 million).

These policies may change and are based on a number of assumptions concerning future events and are subject to uncertainties and risks that are outside our control.

Information about market risk

As a result of our international operations, we are exposed to various kinds of market risks in the ordinary course of business. These risks include foreign currency exchange rate risks, interest rate risk, credit risk, legal risks and country risks.

We have established policies that deal with the use of derivative financial instruments in order to reduce foreign currency exposure and to manage our interest rate profile. Our centralized Treasury department matches and manages all intercompany and external foreign currency reported by our various business operations and group companies. Hedges are applied on a full coverage basis, when economically feasible. With regard to our interest rate risk exposure we establish periodically the desired mixture of fixed and floating interest rate liabilities. At December 31, 2005, approximately 61% of interest-bearing debts are subject to fixed interest rates. The Treasury department may enter into interest rate derivatives to modify the interest payments on the liabilities to the desired mixture.

Derivative financial instruments are used solely for the purpose of hedging underlying exposures. We are not allowed to enter into derivative financial instruments for speculative purposes.

Given our business profile, we have limited exposure to foreign exchange rates of currencies outside the euro zone. The cash and cash equivalents at December 31, 2005 are denominated in euro (99%), US dollar and other currencies (1%).

Credit risk is mitigated by strict policies on client acceptance and counter party limits. Local management and our centralized legal department review legal and country risks on a case-by-case basis.

For more information, please refer to the section titled 'Fair Value of Financial Instruments' in our Consolidated Financial Statements.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

KPN's significant accounting policies based on IFRS are set out on pages 106 to 112 of the Consolidated Financial Statements. The following discussions are based on IFRS and accounting principles generally accepted in the United States (US GAAP). For differences between our reporting under IFRS and US GAAP we refer to 'Information on US GAAP'.

The preparation of our financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts in our Consolidated Financial Statements, accompanying Notes and the Information on US GAAP.

We base our estimates about the carrying values of assets and liabilities that are not readily apparent from other sources on historical experience, independent valuations and various other assumptions that we believe are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following Critical Accounting Policies and Estimates affect our significant estimates, judgments and assumptions used in the preparation of our Consolidated Financial Statements and Information on US GAAP:

  • impairments of goodwill and other long-lived assets;

  • useful lives of long-lived assets and valuation of acquired assets;

  • income taxes;

  • pensions and other post-retirement benefits;

  • provision for litigation and contingencies; and

  • financial instruments.

Impairments of goodwill and other long-lived assets

The inherent management estimates and assumptions used in determining whether an impairment charge should be recognized are as follows:

  • determining our cash generating units and reporting units;

  • timing of impairments tests;

  • projecting cash flows for determining recoverable amounts or fair values; and

  • determining discount rates.

DETERMINING CASH GENERATING UNITS

Goodwill

Goodwill is allocated to cash-generating units (US GAAP reporting unit) for the purpose of impairment testing. The allocation is made to those cash-generating units or groups of cash-generating units that are expected to benefit from the business combination in which the goodwill arose.

At December 31, 2005 our total goodwill under IFRS amounts to EUR 4,611 million (EUR 3,850 million under US GAAP). The allocation to cash generating units (or Reporting units under US GAAP) is shown below.

Amounts in millions of euro

Cash generating unit

Reporting unit

December 31, 2005

December 31, 2004

 

 

 

 

 

E-Plus

E-Plus

E-Plus

4,026

4,026

Telfort

KPN Mobile The Netherlands

KPN Mobile The Netherlands

489

-

BASE

BASE

BASE

28

28

Other

 

 

68

85

Total

 

 

4,611

4,139

Other goodwill is mainly related to assets held for sale (Xantic and certain SNT activities) and is tested per separate activity.

Other long-lived assets

In accordance with IFRS and US GAAP, we assess the impairment of intangible fixed assets (such as our licenses) and property, plant and equipment on the lowest cash generating unit. For the majority of our assets we determined that the segment level is the lowest cash generating unit, where the mobile activities are divided into the geographical areas Germany, The Netherlands and Belgium. Assets to retire or to sell are tested separately.

Until 2004 we performed separate impairment tests for our GSM and UMTS activities per geographical area. As from 2005, we believe that the cash flows from GSM and UMTS activities can no longer be determined largely independent from each other, while achieving reliable outcomes. The following developments are the basis for this conclusion:

  • users switch between GSM and UMTS networks without noticing and without being invoiced separately;

  • innovations like EDGE did gradually decrease the technical separation between GSM and UMTS;

  • in some European countries (including Germany) the discussions have started to extend GSM licenses, which indicates that UMTS is not likely to replace GSM but will rather be complementary to GSM;

  • GSM and UMTS networks use common infrastructure; and

  • the business is managed and monitored as one integrated operation.

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Timing impairment tests

Goodwill

Goodwill is tested on an annual basis, or in the case of a triggering event (see Other long lived assets).

Other long-lived assets

In accordance with IFRS and US GAAP, we assess the impairment of intangible fixed assets (such as our licenses) and property, plant and equipment. Factors that we consider important, which could trigger an impairment review, include the following:

  • significant declines in the asset market value, more than would be expected as a result of the passage of time or normal usage;

  • significant changes in the manner of use of the acquired assets or the strategy for our overall business;

  • significant underperformance relative to expected historical or projected future operating results;

  • regulatory developments affecting our business;

  • significant adverse industry or economic trends; and

  • significant obsolescence or physical damage of an asset.

When one or more of the above indicators of impairment exist, we review the recoverability of the carrying value of the assets.

PROJECTING CASH FLOWS

We believe that estimates of recoverable amounts, being the higher of value in use and fair value less cost to sell, are susceptible to change from one period to the next because they require management to make assumptions about future cash flows from sales, purchases and capital expenditures. In estimating future sales, we use our internal projections, which are developed based on our strategic plan for existing and new product offerings and expected average revenues per user, and customer base growth. Estimates of our future purchases and capital expenditures are developed based on our expected levels of revenue growth, the timing of the building and maintenance of our networks and potential changes in governmental regulations and requirements. The judgments underlying our projections can vary significantly from year to year due to economic or market conditions, technological advances, changes in the business or regulatory environment, or other factors outside our control. If our projections of cash flows change as a result of these factors, especially in our business models, our anticipated timeframe of the rollout of the UMTS network, communication technology or the regulatory environment, we may have to recognize additional impairment charges on goodwill, licenses and other long-lived assets. In certain cases we involve a third party valuation specialist to support us in estimating the underlying fair value taking into account market comparisons and recent transactions. In addition to the use of independent valuation firms, the Company performs internal valuation analysis and considers market information that is publicly available.

If the recoverable amount of the cash generating units is lower than the carrying value of the assets involved an impairment should be recognized.

DETERMINING DISCOUNT RATES

We determine the discount rate based on the time value of money, taking into account the risks specific to the cash generating units. In determining the discount rates we make use of market data for comparable companies and we involve a third party valuation specialist to support us in estimating the discount rates.

SENSITIVITIES

IFRS

Under IFRS we recognized the following impairment charges (and reversed charges) on our goodwill and other fixed assets in the years 2005 and 2004:

Amounts in millions of euro

2005

2004

 

 

 

Total impairments on goodwill

40

8

 

 

 

Total impairments (reversal) on licenses and other intangibles

4

-16

 

 

 

Total impairments and retirements on property, plant and equipment

34

24

 

 

 

Total impairments on financial fixed assets and non-current receivables

11

12

 

 

 

Total impairments

89

28

At December 31, 2005 the carrying value of the E-Plus related assets amounted to EUR 9,418 million. Based on our impairment analyses using a discount rate of 7.8% after tax, our conclusion was that there is no need for an impairment adjustment.

We also performed sensitivity analyses by using (1) a higher discount rate of 9% and by using (2) 10% less cash flows in our projections. Under IFRS each of these scenarios would individually not lead to an impairment.

Telfort was acquired in October 2005. We have performed a purchase price allocation leading to EUR 489 million of goodwill. On February 28, 2006, with the signing of Memoranda of Understanding with Ericsson and Huawei, we announced our decision of the full integration of KPN Mobile The Netherlands' and Telfort's networks. This decision will lead to accelerated depreciation and/or impairments of (some parts of) these

64


networks and to accelerated amortization and/or impairments of (some of) our licenses. At year-end 2005, we estimate that the book value of the affected assets of Telfort and KPN Mobile The Netherlands amounted to EUR 450 million at maximum. We expect that this decision leads to savings of capital expenditures of several hundred million euros over the coming years.

US GAAP

Under US GAAP, we recognized the following impairment charges on our goodwill and other fixed assets in the years 2005, 2004:

Amounts in millions of euro

2005

2004

 

 

 

Total impairments on goodwill

33

1

 

 

 

Total impairments on licenses and other intangibles

11

-

 

 

 

Total impairments on property, plant and equipment

34

47

 

 

 

Total impairments and retirements on financial fixed assets

11

12

 

 

 

Total impairments

89

60

The US GAAP method differs in some aspects from the IFRS approach. If the fair value is lower than the book value then a hypothetical purchase price allocation is performed to determine the implied fair value of goodwill. This fair value of goodwill is then compared to the carrying value of goodwill. If the implied fair value is lower than the carrying value, an impairment is recorded for the difference.

For intangibles with a finite life the first step is to compare the undiscounted cash flows with the carrying value. If the undiscounted cash flows exceed the carrying value no impairment should be recognized. In any other case an impairment is recognized for the difference between the fair value and the carrying value of the asset.

At December 31, 2005, the carrying value of the E-Plus related assets amounted to EUR 10,010 million. Based on our impairment analyses using a discount rate of 7.8% after tax, our conclusion was that there is no need for impairment.

We also performed sensitivity analyses by using (1) a higher discount rate of 9% and by using (2) 10% less cash flows in our projections. Under US GAAP scenario (1) with a higher discount rate would require step two of the impairment test as the outcome of this value was approximately EUR 300 million lower than the carrying value of the assets related to E-Plus. We have not simulated step two of the US GAAP impairment test. Scenario (2) would not lead to an impairment under US GAAP.

Useful lives of long-lived assets and valuation of acquired assets

USEFUL LIVES OF LONG-LIVED ASSETS

Long-lived assets, consisting primarily of property, plant and equipment and intangibles, comprise a significant portion of our total assets. Changes in our intended use of these assets, technological development and market conditions may cause the estimated period of use or the value of these assets to change. We perform internal studies on an annual basis to confirm the appropriateness of our estimates of the economic useful lives for each category of current property, plant and equipment and other long-lived assets. In determining the initial and remaining estimated useful life of a fixed asset, management estimates:

(1) the physical life of the asset;

(2) the technological life of the asset;

(3) the lives for similar productive assets; and

(4) the expected period that benefits will be derived from the asset.

The foregoing estimates and assumptions are inherently uncertain and subject to change, including as a result of factors outside our control. If the estimated useful life is shortened, we depreciate or amortize the remaining value of the asset over the revised remaining life of the asset. Likewise, if the anticipated technological or other changes occur more slowly than expected, the life of the group could be extended based on the life assigned to new assets added to the group. This could result in a reduction of depreciation and amortization expense in future periods. Our estimates of useful lives affect the amount of gains or losses reported on the disposal or retirement of long-lived assets.

Under IFRS, we recognized the following results on disposals or retirement of fixed assets:


Amounts in millions of euro

2005

2004

 

 

 

Impairments due to retirement of PP&E

34

24

Gains on sale of PP&E

18

17

VALUATION OF ASSETS FOR PURCHASE ACCOUNTING

By performing a purchase price allocation we allocate the cost of acquired companies to tangible and identifiable intangible assets and liabilities acquired by reference to their estimated fair values at the time of acquisition. The remaining amount is recorded as goodwill. Any value assigned to the identifiable assets is determined by reference to an active market, independent appraisal, or estimated by our management based on cash flow projections which include estimates and judgment regarding expectations for the economic useful lives of the products and technology acquired.

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VALUATION OF ASSETS AT DEEMED COSTS

KPN elected the exemption (IFRS 1) to revalue certain of its fixed assets at the transition date, to its fair value and use this fair value as its deemed cost. KPN used the depreciated replacement cost method to determine this fair value. This relates to cables, which are part of property, plant and equipment within the Fixed division. At transition date the fair value adjustment amounted to EUR 567 million. At December 31, 2005, the remaining book value of the fair value adjustment amounted to EUR 415 million.

Income taxes

As part of the process of preparing our Consolidated Financial Statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. The estimates are consistently applied under both IFRS and US GAAP. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from different treatment for tax purposes compared to IFRS, such as the valuation of our tangible fixed assets and provisions. These differences result in deferred tax assets and liabilities, which are recognized in the Consolidated Balance Sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income, and to the extent we believe that recovery is likely we recognize a deferred tax asset. To the extent the likelihood of a recovery of deferred tax assets changes, we include an expense or a gain within the tax charge in our Income Statement for the relevant period. Significant management judgment is required in the valuation of our deferred tax assets. We consider future taxable income projections, historical results and ongoing tax planning strategies in assessing the recoverability of deferred tax assets. In the event that actual results differ from these estimates due to future changes in income tax law or results from final review of our tax returns by tax authorities, we may need to adjust the valuation of our deferred tax assets, which could materially impact our financial position and results of operations.

Following an agreement with the Dutch tax authorities in 2004, we recognized a fiscal loss of EUR 6,000 million in The Netherlands related to the year ended December 31, 2002. We recognized a related deferred tax asset of EUR 2,070 million, based on the loss at a nominal tax rate of 34.5%. After deducting the taxation on the taxable results from 2002 through 2005, applying the carry back rules and the adjustment to the lower nominal tax rate in The Netherlands, the related deferred tax asset remaining at December 31, 2005 amounted to EUR 591 million. We expect a complete recovery of this asset before the end of 2007.

In 2005, we have adjusted the valuation of the deferred tax asset for corporate tax loss carry forwards of BASE by EUR 73 million to EUR 211 million. The adjustment was the consequence of an improved business case. In our analyses, we took into account a seven-year forecast.

Pensions and other post-retirement benefits

Retirement benefits constitute a current cost of our normal business operations but represent obligations that will not be definitively settled until far in the future. We have two pension plans: Stichting Pensioenfonds KPN and Stichting Ondernemingspensioenfonds KPN.

Pension costs are determined by actuarial valuations. These valuations include various assumptions like, employee turnover, discount rate, mortality, retirement age, expected return on plan assets, future wage increases and related indexation of the benefits. These assumptions are normally updated on an annual basis at the beginning of each fiscal year. Actual circumstances may vary from these assumptions, giving rise to a different pension liability, which could result in an additional gain or loss in our Consolidated Income Statement.

Changes in the related pension benefit costs may occur in the future due to changes in assumptions. The key assumptions used in computing our fiscal year 2005 pension benefit cost were a 4.5% discount rate, 6.6% expected return on plan assets and a 2.5% future wage increase. In 2005 our pension costs amounted EUR 172 million, compared to EUR 201 million in 2004. Our pension benefit cost is expected to decrease to approximately EUR 137 million in 2006, primarily the result of lower service costs due to a lower expected indexation of the pension benefits. A decrease in the discount rate of 0.5% point would have resulted in EUR 221 million pension cost for 2005.

Provision for litigation and contingencies

We exercise considerable judgment in recording our accrued liabilities and our exposure to contingent liabilities related to pending litigation or other outstanding claims subject to negotiated settlement, mediation, arbitration or government regulation as well as other contingent liabilities. We are a party to lawsuits, claims, investigations, and proceedings, consisting primarily of commercial matters, which are being handled and defended in the ordinary course of business. We review the current status of any pending proceedings with our legal counsel on a quarterly basis. Judgment is used in assessing the likelihood that a pending claim will succeed or a liability will arise and to quantify the possible range of the final settlement. In determining whether provisions are required with respect to pending or threatened litigations, management reviews the following:

  1. period in which the underlying cause of the pending or threatened litigation or of the actual or possible claim or assessment occurred;

  2. degree of probability of an unfavorable outcome; and

  3. ability to make a reasonable estimate of the amount of loss.

Upon considering the above items and other known relevant facts and circumstances, we recognize any loss that we consider more likely than not and reasonably estimable as of the balance sheet date. Actual results may differ materially from estimates.

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Under US GAAP, we record an accrual for liabilities when a loss contingency is considered to exist and when a loss is considered probable and can be reasonably estimated. Because of the inherent uncertainties in this evaluation process, actual losses may be different from the originally estimated amount accrued.

Financial instruments

We believe the following estimates are critical:

  • allocation of financial instruments to the categories: held to maturity, held for trading, available for sale, loans and receivables;

  • determination of hedge effectiveness; and

  • determination of fair value.

For further details, we refer to the section Financing and Financial Instruments in the Consolidated Financial Statements.

Recent accounting pronouncements

IFRS accounting pronouncements

In December 2004, the International Financial Reporting Interpretations Committee (IFRIC) issued IFRIC 4, 'Determining whether an Arrangement contains a Lease'. IFRIC 4 is an interpretation of the accounting standard leases and gives guidance on determining whether arrangements that do not take the legal form of a lease should be accounted for in accordance with the accounting standard regarding leases (IAS 17). This interpretation clarifies that an arrangement contains a lease if it depends on the use of a specific asset and conveys a right to control the use of that asset. We will apply this interpretation in reporting periods beginning January 1, 2006. We do not expect that this accounting pronouncement will have a material impact on our financial position or result of operations.

US GAAP accounting pronouncements

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, 'Accounting Changes and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3' (SFAS 154), which changes the requirement for the accounting and reporting of a change in accounting principle. SFAS 154 eliminates the requirement in APB Opinion No. 20, “Accounting Changes,” to include the cumulative effect of changes in accounting principle in the income statement in the period of change. Instead, to enhance the comparability of prior period financial statements. This statement requires that changes in accounting principles are retrospectively applied, unless directed otherwise by a new pronouncement. The standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The adoption of SFAS 154 is not expected to have a material impact on our financial position or result of operations.

In June 2005, the FASB ratified the recognition and measurement guidance for specific retirement plans as described in Emerging Issues Task Force (EITF) 05-5, ' Accounting for Early Retirement or Postemployment Programs with Specific Features (Such As Terms Specified in Altersteilzeit Early Retirement Arrangements)'. The recognition and measurement guidance will be applied to the Alterszeit Early Retirement Arrangements within our subsidiary E-Plus in reporting periods beginning January 1, 2006. We do not expect that this accounting pronouncement will have a material impact on our financial position or result of operations.

In September 2005, the FASB ratified the guidance regarding the determination of the amortization period for leasehold improvements in operating leases as described in Emerging Issues Task Force (EITF) 05-6, ' Determining the Amortization Period for Leasehold Improvements Purchased after Lease Inception or Acquired in a Business Combination'. This guidance is effective for leasehold improvements purchased or acquired in reporting periods beginning after June 29, 2005. We do not expect that this accounting pronouncement will have a material impact on our financial position or result of operations.

In October 2005, the FASB Staff Position (FSP) regarding FSP No. FAS 13-1, 'Accounting for Rental Costs Incurred during a Construction Period', was issued. This FSP addresses that rental costs associated with ground or building operating leases that are incurred during a construction period shall be recognized as rental expense and not capitalized. This guidance will be applied in reporting periods beginning January 1, 2006. We do not expect that this accounting pronouncement will have a material impact on our financial position or result of operations.

In November 2005, the FASB Staff Position (FSP) regarding FSP No. FAS 115-1 and FSP No. FAS 124-1, 'The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments' was issued. This FSP addresses the determination as to when certain investments are considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This guidance will be applied in reporting periods beginning January 1, 2006. We do not expect that this accounting pronouncement will have a material impact on our financial position or result of operations.

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CORPORATE SOCIAL RESPONSIBILITY

KPN is committed to the community. Our services make a significant contribution to the Dutch economy by providing communications services which are indispensable for many people and companies. Because electronic communication brings people into contact without the need to travel, it helps to create a more sustainable society by reducing traffic and carbon dioxide emissions. We are conscious of the responsibilities our position in the community brings, which is why we believe in working in a sustainable way.

Our 2005 Sustainability Report, which will be available in April 2006 on our website (www.KPN.com), will report on this commitment. It will detail information on the sustainability efforts and results for all our activities, other than for SNT.

ENVIROMENTAL POLICY

We began to implement our 2005-2007 environmental policy in January 2005; its aim is to reduce energy consumption, carbon dioxide emissions and waste, and achieve a higher degree of waste separation.

SOCIAL POLICY

Our future rests on the quality and motivation of our people, our cost-effectiveness and our ability to keep pace with an increasingly competitive market. In 2005, we introduced our corporate values internally; they are:

  1. personal;

  2. trust; and

  3. simplicity.

We face a continuing need to decrease the number of people we employ while, at the same time, retaining and motivating those who will ensure our future competitiveness.

In 2005, we embarked on discussions with employees about their career prospects and agreed guidelines with our Central Works Council for assessing employees’ suitability for future job requirements. A new collective labor agreement, which links remuneration to performance, as well as a mobility agreement was agreed in principle in December 2005. During the year, we made efforts to improve the appraisal process. Our aim is for this to result in clear expectations and agreements on personal training and developments; in the distribution of skills across divisions; and in the retraining and reassignment of employees before severance is considered.

We introduced a variable pay plan, with group targets, in 2004 and the “on-target-performance” payout of 3.5%, with a ceiling of 5.5% of gross annual salary, was paid for the first time in 2005. We improved the plan in 2005: operational managers and the Central Works Council will, in future, be more closely involved and greater attention will be paid to communicating interim results.

 

During the year, we redesigned our retirement schemes to comply with new laws in The Netherlands, which cover early retirement, pre-pension plans and the right to save up leave. Because the new law includes penalties for retirement schemes that allow pre-pension before the age of 65, we have introduced structural retirement schemes that start at the age of 65.

At the year end, sick leave at KPN in The Netherlands was 4.6% (2004: 4.3%), at E-Plus 2.9% (2004: 2.9%) and at BASE 3.3% (2004: 4.3%).

Employment opportunities continued to be under pressure. Our workforce decreased by 1,458 full-time equivalents (FTEs) to 26,598 FTEs. The total number of FTEs is down from 28,056 at the end of 2004.

Mobility continues to be a key issue: it is still insufficient to achieve the required downsizing and workforce renewal. During 2005, we began negotiations with the Central Works Council and unions as part of the Collective Labor Agreement for 2006 and for the new Social Plan, which will allow a period of mobility before we start the necessary legal procedure to reduce staff levels. Employees selected for severance will receive higher financial compensation if they find employment elsewhere within their mobility period and our Mobility Shop will be outsourced to ensure that there is adequate preparation for prospects in the external labor market.

We fill management positions through executive development programs for talented employees to reach mainstream management positions as well as through recruitment. In 2005, we also launched a leadership development program for senior managers. A survey on the image of large employers, revealed that young graduates consider us to be one of the top 15 attractive employers in The Netherlands. To attract the best potential employees, in July 2005, for the first time for five years, we organized a highly successful Business Course and plan to organize similar events in 2006.

COMMITMENT TO SOCIETY

In addition to being a provider of commercial services, a large company such as ours is an employer and a stakeholder in society and we demonstrate our commitment to it in many ways. In 2005, we implemented our social commitment policy, which had been modernized in 2004 with the aim of using communications to reduce inequalities, particularly in healthcare and education, with a focus on the elderly and children.

Several of our employees are coaching secondary school pupils in The Hague. These volunteers help the students bridge the gap between education and work and between different social and cultural groups. We have set up a similar program specifically for well-educated Moroccan teenagers.

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Our offer of three years’ free broadband Internet access for primary, secondary, vocational and adult education institutions in The Netherlands launched in March 2004, promotes the growth of the knowledge economy by creating opportunities for pupils to connect to the information society. Of 11,000 schools, more than 8,000 signed up for the offer, which has proved to encourage schools to invest in ICT.

In response to teachers’, parents’, special interest organizations’ and authorities’ pleas for advice and support from their Internet Service Provider in overseeing children’s use of the Internet, we launched two websites - www.mijnkindonline.nl and www.mijnleerlingonline.nl - in 2004, and published a book in 2005, to provide valuable tips. We will devote even more attention in 2006 to the responsible use, particularly by children, of new media, and have created a charitable foundation 'Mijn kind online'.

Our commitment to education extended to supporting the charity SchoolNet Africa when we agreed to give it all our used computers. We have, so far, donated thousands of computers and have promised to donate at least 10,000. This organization also is responsible for the Global Teenager Projects, which KPN has sponsored for several years. This project enables children worldwide to discuss topics such as human rights, music, nature and communications in digital classrooms.

KPN has a range of products and services for people that have a physical disability or for senior citizens. We launched a pilot project with a mobile text telephone service to make it easier for deaf and hard-of-hearing people to communicate. We also began to help senior citizens participate in the knowledge economy through a cooperation with Seniorweb, which enables people who did not grow up in the information age to explore and experience the possibilities computers offer. Access and training courses are designed for and by senior citizens. We have also introduced a number of user-friendly products including a special computer and mobile phone aimed at the elderly.

In September 2005, we asked our employees to choose one of four good causes. We will support the preferred choice, the Ronald McDonald children’s fund, for the coming two years, not only financially but, more importantly, by providing knowledge, products, services and advice on, for example, its telecoms organization. In addition, we donated the amount we saved by sending our 2005 seasonal greetings electronically to the children’s fund. Our Operations Fixed Net also supports children in deprived areas of Amsterdam by giving them ICT training.

Over the past few years, we have helped the victims of disasters that have occurred, including the free provision of our call center services to help the victims of the 2005 earthquake in Pakistan as well as a donation.

CODE OF CONDUCT

For details of the KPN Code of Conduct, please refer to the section headed “Corporate Governance - Compliance”.

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CORPORATE GOVERNANCE

Introduction

DEVELOPMENTS IN 2005
Compliance with the Dutch Corporate Governance Code

In 2005, we pursued a consistent policy to enhance and improve our corporate governance in line with the Dutch Corporate Governance Code (the 'Dutch Corporate Governance Code') that was published by the Tabaksblat Committee on December 9, 2003.

The Dutch Corporate Governance Code has its statutory basis in Book 2 of the Dutch Civil Code and applies to companies with their registered office in The Netherlands whose shares are listed on a stock exchange either domestically or abroad. The Dutch Corporate Governance Code is based on the apply-or-explain principle and is a considerable step forward for Dutch standards on corporate governance. The Dutch Corporate Governance Code defines a company as a long-term form of collaboration between the various parties involved. The Board of Management and the Supervisory Board have overall responsibility for considering the interests, generally with a view to ensure the continuity of the enterprise. In doing so, the Company endeavors to create long-term shareholder value and the Board of Management and Supervisory Board should take account of the interests of the different stakeholders.

We fully support the principles of the Dutch Corporate Governance Code and we are nearly fully compliant with its best practice provisions. It should be noted that we do not fully apply provisions II.1.1 (a management board member is appointed for a maximum period of four years. A member may be reappointed for a term of not more than four years at a time), if the Company, notwithstanding best practice provision II.2.1, grants unconditional options to management board members, it shall apply performance criteria when doing so and the options should, in any event, not be exercised in the first three years after they have been granted II.2.6 (a management board member shall give periodic notice, but in any event at least once a quarter, of any changes in his holding of securities in Dutch listed companies to the compliance officer or, if the Company has not appointed a compliance officer, to the chairman of the supervisory board) and III.7.3 containing a similar rule for Supervisory Board members.

We apply provision II.1.1 as of 2004 meaning that Mr. Smits, who was appointed in April 2004, was appointed for a term of four years. We respect however the indefinite appointment term of Mr. Scheepbouwer and Mr. Demuynck, which is also laid down in their employment agreements, as we endorse the premise that existing agreements should be respected. Also due to this premise, we do not apply provision II.2.2 in full on the options we grant to Mr. Scheepbouwer. We agreed with him, at the time of his appointment, that our Supervisory Board could annually grant him unconditional options. As contractually agreed at the time of appointment, these stock options are not linked to performance. We do however apply provision II.2.1 (options to acquire shares are a conditional remuneration component, and become unconditional only when the management board members have fulfilled predetermined performance criteria after a period of at least three years from the grant date) to our other members of the Board Management. Under provisions II.2.6 and III.7.3, we require our members of the Supervisory Board and Board of Management to inform the compliance officer only once every year of their shareholding in Dutch listed companies (other than KPN) rather than every quarter. We do not believe that there is any merit in informing the compliance officer on a more regular basis, as it does not address the real issue at stake, being that members of these boards should dedicate sufficient tome to their primary function and should not have conflicting interests. Besides, it only increases the administrative burden on both the members of these boards as on the compliance officer. Our position vis-à-vis all best practice provisions is available on our website.

We remain of the opinion that a governance regime should strike the right balance between transparency of rules and avoidance of bureaucracy caused by excessive detail in order for Dutch companies to remain internationally competitive. Application of sound corporate governance principles is important for a company but it should not be an end in itself. The true aim is to achieve and maintain a culture of honesty and integrity. This aim can, ultimately, be achieved only if the culture and behavior in a company are in all respects positive and transparent.

Other corporate governance requirements

We are listed on the New York Stock Exchange ('NYSE') and qualify as a foreign private issuer under the NYSE stock exchange rules. As such we need to disclose significant differences between NYSE's corporate governance requirements for U.S. issuers and our corporate governance practices in The Netherlands. An overview disclosing these differences is available on our website www.KPN.com under the section Investor Relations, Corporate Governance and Risk Management and Internal Control. In addition, on August 23, 2005 we affirmed to the NYSE without qualification that we have an Audit Committee meeting the requirements of SEC rule 10A-3 under the securities Exchange Act of 1934, as amended.

We are also listed on Euronext Amsterdam, the London Stock Exchange and the Frankfurt Stock Exchange.

Legal structure of the Company

Under Section 6, Part 4 of Book 2 of the Dutch Civil Code, the rules for large companies are mandatory for us. As such, we have a two-tier management structure with a Board of Management and a Supervisory Board. Among the powers vested in the

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Supervisory Board is the power to appoint and remove members of the Board of Management. Some of the resolutions of our Board of Management are also subject to the approval of the Supervisory Board. As a result of a change in Dutch company law per October 1, 2004, shareholders rights have increased while the rights of the Supervisory Board have decreased. Under the new legislation, shareholders are entitled to approve decisions of the Board of Management that have a company transforming effect, to approve the remuneration policy and share (option) plans, to appoint members of the Supervisory Board upon proposal by the Supervisory Board, and to dismiss the Supervisory Board. On April 12, 2005, our Annual General Meeting of Shareholders approved the proposal to amend our articles of association, to reflect these changes.

Ongoing impact of the US Sarbanes-Oxley Act

Given our listing on the New York Stock Exchange, we have to comply with certain requirements of the U.S. Sarbanes-Oxley Act. During 2005, our compliance efforts focused on further improving our internal controls over our financial reporting. In March 2005, the SEC extended the deadline for compliance with the US Sarbanes-Oxley Act 404 by one year. As a consequence, KPN will have to comply with Section 404 of the US Sarbanes-Oxley Act for the financial year 2006.

Management

SUPERVISORY BOARD

The current members of our Supervisory Board are Mr. A.H.J. Risseeuw (Chairman), Mr. D.G. Eustace (vice-Chairman), Mr. M. Bischoff, Mr. V. Halberstadt, Mr. D.I. Jager, Ms. M.E. van Lier Lels and Mr. J.B.M. Streppel. For a description of the curriculum vitae of the current members of our Supervisory Board, refer to the section titled 'Report by the Supervisory Board'. The business address of each of the members of the Supervisory Board is Maanplein 55, 2516 CK, The Hague, The Netherlands.

The Supervisory Board oversees strategic and organizational policymaking by the Board of Management and the way in which it manages and directs our operations and affiliated/associated companies. It oversees and supervises the Board of Management. Members of the Supervisory Board are appointed by the Annual General Meeting of Shareholders upon binding nomination by the Supervisory Board. The Central Works Council has an enhanced right of recommendation with respect to one third of the Supervisory Board, meaning that the Supervisory Board must nominate those recommended unless it is of the opinion that

  1. any such person would be unsuitable to fulfill the duties of a Supervisory Board member; or

  2. such appointment would cause the Supervisory Board to be improperly constituted.

According to our Articles of Association, our Supervisory Board must consist of at least five and not more than nine members. In 2005, our Supervisory Board consisted of seven members. Members of the Supervisory Board resign according to a schedule set by the Supervisory Board. They step down at the first General Meeting of Shareholders following their four-year term of office. Under the by-laws of the Supervisory Board, they can be reappointed twice, leading to a maximum term of office of twelve years. See the 'Report by the Supervisory Board' for the rotation schedule.

In 2005, the Supervisory Board, following consultation with the Annual General Meeting of Shareholders and the Central Works Council, updated its profile, defining the basic principles for the composition of the Supervisory Board. All nominees for the election to the Supervisory Board must fit within this profile. According to this profile, the Supervisory Board must be composed in such a way that members of the Supervisory Board are able to operate independently of each other and of the Board of Management.

The by-laws contain, among other things, rules regarding the members’ duties, powers, working methods, decision-making, approval of decisions by the Board of Management, training and conflict handling. The by-laws of the Supervisory Board were reviewed and renewed during 2005. The by-laws are available on our website www.KPN.com under the section Investor Relations, Corporate Governance.

Committees of the Supervisory Board

In 2005, three committees assisted the Supervisory Board: an Audit Committee, a Remuneration & Organization Development Committee and a Nominating & Corporate Governance Committee. The committees, which consist of members of the Supervisory Board, assist the Supervisory Board in its decision taking and report their findings to the Supervisory Board. The committees are not empowered to take decisions. The activities of the committees are governed by written charters, available on our website www.KPN.com under the section Investor Relations, Corporate Governance.

Audit Committee

The Audit Committee consists of three Supervisory Board Members, Mr. Eustace (Chairman), Mr. Streppel and Mr. Bischoff.

The Audit Committee's task is to supervise in particular the (quality of the) accounting and financial reporting practices, including quarterly and annual reporting, accounting and financial reporting policies and procedures, the (quality of the) internal control system and internal audit function, the independent external audit of the Financial Statements, the performance and evaluation of the external auditor and the compliance with relevant legislation and regulations. The task of the Audit Committee in the area of financial reporting and accounting practices is to provide reasonable assurance that the financial disclosures prepared by management adequately reflect KPN's financial condition, results of operations, cash flows and long-term commitments. We consider Mr. Eustace and Mr. Streppel to be our financial experts within the meaning of the Dutch Corporate Governance Code and Rule 10 A-3 under the Securities Exchange Act of 1934, as amended. All members of the Audit Committee are independent within the meaning of Rule

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10A-3 and for purposes of the listing standards of the NYSE as they are applicable to KPN. For a discussion of the activities of the Audit Committee in 2005, see the 'Report by the Supervisory Board'.

Remuneration & Organization Development Committee

The Remuneration & Organization Development Committee consisted in 2005 of four Supervisory Board Members, Mr. Jager (Chairman), Mr. Halberstadt, Ms. Van Lier Lels and Mr. Risseeuw.

The task of the Remuneration & Organization Development Committee is to assist the Supervisory Board regarding the development and appropriate application of remuneration policies for our Board of Management, including the remuneration of the members of the Board of Management for the coming year; the individual bonuses of members of the Board of Management on the basis of the policy framework for performance related pay, achieved targets and goals; allocation policies for options (to members of the Board of Management and to other KPN senior management) and the conditions under which options are granted; and the remuneration of members of the Supervisory Board for submission to the Supervisory Board and to the General Meeting of Shareholders. For a discussion of the activities of this committee in the year under review, see the 'Report by the Supervisory Board'.

Nominating & Corporate Governance Committee

The Nominating & Corporate Governance Committee consisted in 2005 of four Supervisory Board Members, Mr. Risseeuw (Chairman), Mr. Halberstadt, Mr. Jager and Ms. Van Lier Lels.
The task of the Nominating & Corporate Governance Committee is to assist the Supervisory Board with respect to the nomination of the Board of Management and the Supervisory Board and the oversight of development policies for senior management, as well as the Company's corporate governance policies. For a discussion of the activities of this committee in the year under review, see the 'Report by the Supervisory Board'.

BOARD OF MANAGEMENT

The Board of Management, supervised and advised by the Supervisory Board, manages our strategic, financial and organizational matters and appoints senior managers. The Supervisory Board appoints and discharges members of the Board of Management and establishes their individual remuneration within the boundaries of the remuneration policies approved by the Annual General Meeting (see the ‘Remuneration report’ below for more detailed information on remuneration) and the recommendations by the Remuneration & Organization Development Committee. On the basis of the Dutch Civil Code, our articles of association and the by-laws of the Board of Management, certain decisions of the Board of Management require the approval of the Supervisory Board. These decisions include approval of the annual plan and budget, approval of resolutions that exceed certain thresholds, expanding the business materially affecting the existing business and the closing down of business if this results in a material change for a considerable number of employees. A complete overview of such decisions is included in the by-laws of both our Supervisory Board and Board of Management which are available on our website www.KPN-corporate.com under the section Investor Relations, Corporate Governance. The by-laws of the Board of Management were reviewed and renewed during 2005.

In 2005, our Board of Management consisted of three members: the Chairman of the Board, the Chief Financial Officer and the Managing Director of the Mobile division.

The current members of our Board of Management are:

Name

Date of birth

Position

Appointed on

A.J. Scheepbouwer

July 22, 1944

Chairman of the Board and Chief Executive Officer

November 1, 2001

M.H.M. Smits

September 14, 1961

Member of the Board

Chief Financial Officer

August 9, 2004

September 11, 2004

G.J.M. Demuynck

March 21, 1951

Member of the Board

January 1, 2003

Mr. A.J. Scheepbouwer was appointed Chairman of our Board of Management and Chief Executive Officer on November 1, 2001. As from December 23, 2004 he is, on an ad interim basis, also responsible for our Fixed division. The current employment contract of Mr. Scheepbouwer, which was due to terminate on the 1st of July, 2006, has been extended until ultimately the 1st of July, 2009. From 1976 to 1988, Mr. Scheepbouwer was President of the Airfreight division of Pakhoed Holding N.V. (Pandair Group). In 1988, he was appointed as Managing Director of PTT Post, then part of the Dutch national post and telecommunications operator, Koninklijke PTT Nederland N.V. In 1992, Mr. Scheepbouwer joined the Board of Management of Koninklijke PTT Nederland N.V. In June 1998, the mail, express and logistics activities were demerged from Koninklijke PTT Nederland N.V. and incorporated as a separate company, TPG N.V., of which Mr. Scheepbouwer became Chief Executive Officer. From June 1998 until September 9, 2001, he was a member of our Supervisory Board. He is currently chairman of the Supervisory Board of KPN Mobile N.V., member of the Supervisory Board of E-Plus Mobilfunk Geschäftsführungs GmbH, and chairman of the Supervisory Board of Havenbedrijf Rotterdam N.V.

Mr. M.H.M. Smits was appointed member of the Board of Management on August 9, 2004 and has been the Chief Financial Officer since September 11, 2004. He is former member of the Board of Management and Chief Financial Officer of Vendex KBB N.V. Before that he held various (financial) management positions at Unilever. He is currently member of the Supervisory Board of E-Plus Mobilfunk Geschäftsführungs GmbH, of the Supervisory Board of KPN Mobile N.V. and of the Supervisory Board of the Delta Lloyd Insurance Company.

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Mr. G.J.M. Demuynck was appointed member of the Board of Management on January 1, 2003 and is responsible for our Mobile division and is managing director of KPN Mobile The Netherlands. He joined our Company from Royal Philips Electronics N.V., where he had been CEO of the Consumer Electronics Division since 2000. He has been with Philips since 1976 and worked for the Company in the USA as Vice-President Marketing Audio, in South Korea as the Chief Executive Officer of Philips Electronics South Korea, and in Hong Kong as General Manager Business Group Audio. He was appointed member of the Group Management Committee in April 2000 and was responsible for the Division of Consumer Electronics until December 31, 2002. He is currently Chairman of the Supervisory Board of E-Plus Mobilfunk Geschäftsführungs GmbH, Chairman of the Supervisory Board of Xantic B.V., member of the Supervisory Board of TomTom N.V. and member of the Advisory Council of Arthur D. Little. Mr. Demuynck will leave KPN on July 1, 2006 in connection with his acceptance of a management position with another company.

The business address of each of the members of the Board of Management is Maanplein 55, 2516 CK, The Hague, The Netherlands.

MANANGEMENT OF THE DIVISIONS

In 2005, Mr. A.J. Scheepbouwer was, on an ad interim basis, responsible for our Fixed division and Mr. Demuynck was responsible for our mobile operations. Mr. Eelco Blok has been appointed as Chief Operating Officer (COO) of our Fixed division as of January 1, 2006. The Fixed division and our mobile operations consist of several reporting units. In May 2005, we restructured our international mobile activities in Germany and Belgium, bringing them under the sole leadership of Mr. Stan Miller, who was the CEO of BASE, KPN's mobile operator in Belgium. For further information, please see "Information about the Company, Mobile division".

Management teams assist the responsible management of our divisions and they are responsible for achieving targets defined for the divisions and for organizing, managing and controlling business processes within the divisions. The divisions are required to observe our Business Control Framework governing such matters as financial accounting, investment decisions, cash management and internal control.

Managerial matters

COMPLIANCE

We significantly expanded our compliance efforts in 2005. We introduced a new Code of Conduct in April 2005 that sets out our standards and values. We are conscious of our social and ethical responsibilities and we wish to ensure that work practices across the Company are in strict compliance with the law and consistent with social and ethical norms. Our key values are: personal, trust and simplicity. We can be held accountable for our performance in this regard by all of our stakeholders (customers, shareholders, employees, business associates, competitors, environmental organizations, international business relations and the community in the widest sense). The Code of Conduct is available on our website.

To translate the Code of Conduct into practical terms for employees, we have introduced in recent years a number of separate codes to clarify our internal rules. These separate codes, which were updated in 2005, are bundled into four clusters:

  1. integrity;

  2. competition and telecommunication law;

  3. insider trading; and

  4. information security.

The integrity cluster contains rules for all our employees with respect to secondary employment outside KPN and also with respect to business transactions and business gifts. This cluster contains furthermore our Code of Ethics for our financial management, which sets rules to protect the integrity of our financial management. It applies to our Chief Executive Officer, Chief Financial Officer, the director of our Corporate Control Department and all other financial managers. We did not grant any waivers in 2005 under this code. The competition and telecommunication law cluster contains rules with respect to the use of customer information, anti-trust issues, retail offerings and wholesale issues. The insider trading cluster contains rules to prevent insider trading. The information security cluster contains rules with respect to the use of information regarding our Company and the use of information and communication tools provided to our employees. To complement the rules in the separate codes we have introduced three general guidelines: the whistleblower policy, the fraud policy and the protocol on integrity investigations. Pursuant to the whistleblower policy, employees can report questionable accounting or auditing matters or fraud to the Chairman of the Audit Committee. Any reports or complaints by employees under this code will be dealt with in strictest confidence and investigated promptly by management or the Chairman of the Audit Committee, as the case may be. In 2005, we introduced the KPN fraud policy. We promote consistent organizational behavior by providing guidelines and assigning responsibility for the development of controls that will aid in the detection and prevention of fraud against KPN (financial and telecom fraud and other inappropriate misconduct). Since 2002, the protocol on integrity investigations has been effective. Purpose of this protocol is to create the framework to prove or rule out the involvement of employees and/or third parties connected to KPN in violating internal or legal rules. We have communicated the updated Code of Conduct and the separate codes widely among our employees in 2005 in order to further increase awareness of these rules.

In 2005, we introduced a mandatory training program regarding competition and telecommunications law for an important number of our employees in the Fixed division. The objective of the training program was to increase the awareness and the knowledge of employees regarding competition and telecommunication law. The training program consisted of workshops, an in-house designed and tailor-made e-learning

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tool and an e-test. As the workshops gave the possibility to more in-depth discussions, they were focused on increasing knowledge of the relevant rules whereas the e-learning tool focused especially on increasing awareness.

We organized over 60 workshops of 2.5 to 3 hours each, which were attended by approximately 1,350 employees. These employees were selected to participate in these workshops as they encounter competition and telecommunications law issues on a fairly regular basis.

We are well on track with the training of the relevant employees via the e-learning module. These employees were selected to participate in the compliance training as they encounter competition and telecommunications law issues just now and then. The training was ended with an e-test by means of which the employees should show their comprehension of what was trained and to obtain a certificate of participation. We targeted the employees in our Fixed division first as the business in our Fixed division is more regulated than the business in our Mobile division. The training program will be extended to the employees of our Mobile division in 2006.

To comply with new Dutch insider trading legislation, we also introduced a new code that sets stricter rules for insider trading. All employees that we consider to be insider received this new code and an explanation of the new rules. We also organized a number of workshops with management and employees to give a further explanation of the new rules. During 2005, we furthermore accelerated our compliance efforts to increase awareness by a top-down approach in which management and employees were trained regarding the KPN rules on information security and company assets.

We appointed in 2005 a group Compliance Officer responsible for increasing compliance awareness. We also installed a Compliance Board that is responsible for coordinating the various compliance efforts we undertake. The Compliance Board is chaired by the group Compliance Officer.

We encourage our employees to actively report any (suspected) breach of the Code of Conduct or the separate codes. Our internal Security department plays a key role in this by offering support via a helpdesk, where employees can anonymously report such breaches and also obtain information regarding the principles underlying the codes. In the event a breach is reported, our Security department will conduct an investigation on a strictly confidential basis. The outcome of the investigation is reported to local management.

We check employee awareness of the codes each year as part of the Annual Employee Satisfaction Survey.

INTERNAL RISK MANAGEMENT AND CONTROL SYSTEM

KPN has combined the existing elements of its internal risk management and control system in a Business Control Framework, including the relevant criteria for financial procedures, set forth in COSO (integrated internal control framework by the Committee of Sponsoring Organizations of the Treadway Commission). Some main elements of the Business Control Framework are:

  • policies and procedures, which reporting units must comply to;

  • a Code of Conduct and separate codes like a Code of Ethics for the financial function and the whistleblower procedure (please refer to 'Compliance' for further information);

  • periodic risk analyses of the operational, financial, strategic and compliance objectives of our Company and an assessment of our internal control system to secure its effectiveness (for the most important risks identified, please refer to the section Risk Factors in this Annual Report);

  • a financial planning and control cycle including monthly reviews with the CEO and CFO (please refer to 'Managerial Measures' for further information);

  • Disclosure Committee with representatives from the main businesses and main corporate staff departments (please refer to 'Managerial Measures' for further information);

  • the Internal Audit department, which plays an important role in assessing the quality and effectiveness of KPN's internal risk management and control system. The Internal Audit department conducts systematic and ad hoc audits. The audit findings are discussed with management of the related reporting units. Every quarter the main findings are reported to the Board of Management and the Audit Committee; and

  • a tightening of our compliance procedures. For further information, please see the paragraph 'Compliance'.

Our internal risk management and control system cannot provide absolute assurance, but aims at a reasonable level of assurance, that realization of strategic and operational objectives is monitored, the financial reporting is reliable and where relevant applicable laws and regulations are complied to.

In accordance with the requirements of recommendation II.1.4 of the Dutch Corporate Governance Code and the recommendation of the Corporate Governance Code Monitoring Committee on the application thereof, the Board of Management, to the best of its knowledge, believes that, with regard to the financial reporting risks, our internal risk management and control systems provide a reasonable level of assurance that they do not contain material inaccuracies, have operated effectively in the year 2005 and that there are no indications that they will not operate properly in the current year. Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements, inaccuracies, errors, fraud and non-compliance with laws and regulation. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

The aforementioned statement by the Board of Management does not imply a statement regarding the adequacy and effectiveness of KPN's internal controls over financial reporting as required by the Sarbanes-Oxley Act Section 404.

Our internal risk management and control system was discussed in the Audit Committee and Supervisory Board.

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CONTROLS AND PROCEDURES STATEMENT UNDER THE SARBANES-OXLEY ACT

As discussed under the headings 'Ongoing impact of the US Sarbanes-Oxley Act' and 'Internal risk management and Control system', the Company has undertaken significant steps to improve the adequacy and effectiveness of its internal controls over financial reporting and the documentary evidence thereof in preparation for compliance with requirements of section 404 of the Sarbanes-Oxley Act of 2002. The scope of this project includes assessment of and, where necessary, strengthening the Company’s policies, procedures, systems and personnel with respect to financial reporting under both IFRS and US GAAP.

As of the end of the period covered by this report, the Company's management (with the participation of its Chief Executive Officer and Chief Financial Officer) conducted an evaluation pursuant to section 302 of the US Sarbanes-Oxley Act and Rule 13a-15 promulgated under the US Securities Exchange Act of 1934, as amended of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report, such disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by the Company in reports it files or submits under the US Securities Exchange Act of 1934, as amended is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission.

MANAGERIAL MEASURES

The reporting units in the Fixed and Mobile division report their financial and operational performance on a monthly basis to the relevant director and his management team, with a copy to our CEO and CFO. The management of the reporting units also provides the director with a letter of representation, thereby representing the accuracy of the reporting and compliance with prescribed policies. The reports are checked and reviewed by the control departments of the respective divisions. The director reviews the performance of the reporting units on a monthly basis. The director, with the assistance of management of the reporting units, discusses (on a monthly basis) the performance of the division with our CEO and CFO. Our Corporate Control department assists our CEO and CFO in these discussions.

A Disclosure Committee, established in January 2003, evaluates disclosure and internal control procedures to ensure that relevant information on the Company is brought to the attention of the Board of Management. This Committee also examines reports and other materials that are to be issued externally to ensure that they are correct, timely and complete. The Disclosure Committee advises the Board of Management. This committee consists of the directors of Corporate Control, Corporate Treasury & Risk Management, Corporate Legal, Corporate Communications and Investor Relations, the Secretary to the Board of Management and the finance directors of the Fixed division and the Mobile operators and the director Internal Audit. The committee met on 11 occasions in 2005 and reviewed our disclosure controls and procedures, our internal controls and procedures and our public disclosures.

AUDITOR

Our external auditor is responsible for auditing the financial statements. Following recommendation by the Audit Committee and upon proposal by the Board of Management and the Supervisory Board, the General Meeting of Shareholders appoints each year the auditor to audit the financial statements of the current financial year. The external auditor reports to our Supervisory Board and Board of Management. The external auditor is present at the meetings of the Audit Committee and the Supervisory Board when our quarterly and annual results are being discussed.

At the request of the Board of Management and the Audit Committee, the Internal Audit department reviews in advance each service to be provided by the auditor to identify any possible breaches of the auditor’s independence. The Audit Committee pre-approves every engagement of our external auditor.

In 2005 and 2004, total fees from PricewaterhouseCoopers, our external auditor, amounted to:

Amounts in millions of euro

2005

2004

 

 

 

Audit fees

10.9

10.4

Audit-related fees

3.4

10.8

Tax fees

0.0

0.3

All other fees

0.3

0.2

Total

14.6

21.7

The audit fees include the aggregate fees billed in each of 2005 and 2004 for professional services rendered for the audit of our annual financial statements and annual statutory financial statements of subsidiaries or services that are normally provided by the auditor in connection with the audits and regulatory filings or engagements for those financial years. The audit-related fees include the aggregate fees billed in each of 2005 and 2004 for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements and are not reported under audit services. This includes advice with regard to the IFRS conversion and services related to Sarbanes-Oxley and revenue assurance projects. The tax fees mainly relate to tax compliance services. Other fees relate to permitted services not included in the above categories.

Shareholders’ rights

SHARE CAPITAL

Our authorized capital stock totals EUR 1,920,000,000, divided into 4 billion ordinary shares of EUR 0.24 each, one special share of EUR 0.48 and 3,999,999,998 Class B preferred shares of EUR 0.24. As of December 31, 2005, a total of 2,151,360,368 ordinary shares

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had been issued, plus the special share. In December 2005, we purchased the special share from the State. For further information, please see "The State of the Netherlands". We have agreed with the State to propose to the General Meeting of Shareholders to cancel the special share and remove the concept of a special share from our Articles of Association. Dutch laws prohibits us to cast a vote on shares we hold, including the special share. The ordinary shares and Class B preferred shares carry the right to cast one vote each; the special share carries the right to cast two votes. For a description of the preferred shares, please refer to the section titled 'Foundation for the Protection of KPN'. The ordinary shares are registered or payable to bearer. Shareholders may request the Company to convert their registered shares to bearer shares but not vice versa. The General Meeting of Shareholders has authorized the Board of Management to issue new shares. The present authorization of the Board of Management is valid until October 12, 2006. The Board of Management is authorized to issue new shares up to 10% of the issued share capital at the time of issue, plus an additional 10% in the event of a merger or takeover by KPN. Subject to the approval of the Supervisory Board, the Board of Management is also authorized to issue all non-issued Class B preferred shares in the event of a hostile take-over bid. Under Dutch law, the holders of ordinary shares generally have preemptive rights on the issue of new ordinary shares. Preemptive rights can be excluded under certain circumstances.

PURCHASE OF SHARES IN THE COMPANY’S OWN CAPITAL

The shareholders have authorized our Board of Management (until October 12, 2006) to purchase shares in the Company's own capital at a price of not less than EUR 0.01 and not more than the stock market price plus 10%. The stock market price is defined as the average of the closing prices in the five days of trading preceding the date of purchase. Any such purchase requires the approval of the Supervisory Board. If the purchase amounts to more than 1% of the total number of issued shares, the resolution also is subject to the approval of the holder of the special share. Votes may not be cast on purchased shares and they do not count towards determining the number of votes required at a General Meeting of Shareholders. However, purchased shares do carry a right to dividends. We may only purchase shares in our own capital if the shares are fully paid-up and the distributable part of the shareholders' equity is at least equal to the purchase price. We may not acquire or hold more shares with an aggregate nominal value exceeding 10% of our issued capital. On September 12, 2005, KPN has completed its EUR 250 million share repurchase program. During 2005, 244,916,137 shares were repurchased for an average price of EUR 7.28 per share, of which 5,166,000 shares repurchased for option plans. 153,341,137 shares have been repurchased via the secondary trading line instated for reasons of tax efficiency. On December 6, 2005, 181,039,631 shares were cancelled. As of December 31, 2005, 60,000,000 repurchased shares still had to be cancelled. On February 7, 2006, KPN announced plans for a further EUR 1 billion share repurchase program, to be executed during 2006, subsequent to the pre-funding of scheduled debt redemptions and only at a price, which KPN believes enhances value for the remaining shareholders.

ISSUER PURCHASE OF EQUITY SECURITIES

Period

Total number of shares repurchased

Average price paid per share in euro

Number of shares purchased as part of publicly announced programs

Maximum amount of share repurchases yet to be done under the programs (in millions of euro)

Settled in January 2005; purchased in 2004

894,631

7.01

894,631

485

 

 

 

 

 

2005:

 

 

 

 

January

-

-

-

485

February

-

-

-

485

March

32,475,000

7.02

32,475,000

757

April

44,000,000

6.77

44,000,000

459

May

47,300,000

6.55

42,134,000

183

June

27,454,072

6.65

27,454,072

-

July

-

-

-

-

August

18,000,000

7.56

18,000,000

114

September

14,792,434

7.70

14,792,434

-

October

-

-

-

-

November

-

-

-

-

December

60,000,000

8.47

-

-

Subtotal purchased in 2005

244,021,506

6.89

178,855,506

-

- of which purchased for option plans

5,166,000

6.38

 

 

Total settled in 2005

244,916,137

7.28

179,750,137

-

ANNUAL GENERAL MEETING OF SHAREHOLDERS

Within six months of the end of a fiscal year, an Annual General Meeting of Shareholders is held at The Hague, Amsterdam or Groningen, where the discussion of the Annual Report and approval of the Financial Statements are put on the agenda. The Board of Management or the Supervisory Board convenes a meeting subject to advance notice of at least 15 days, which also fulfills the requirements of the NYSE (10 business days). Other General Meetings of Shareholders are held as often as the Supervisory Board or Board of Management deems necessary. One or more shareholders together representing at least 10% of the subscribed capital stock may request the Board of Management and the Supervisory Board, in writing, to convene a

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General Meeting of Shareholders. If the Boards fail to organize such a meeting within six weeks, the District Court may authorize those shareholders to convene a General Meeting of Shareholders.

The Board of Management and the Supervisory Board determine the agenda of the General Meeting of Shareholders. Shareholders who individually or collectively represent at least 1% of the issued capital, or alone or in the aggregate, at least a value of fifty million euros (EUR 50,000,000) according to the Official Price List, have the right to propose items for the agenda. Such requests will be honored on the condition that grave interests of the Company do not dictate otherwise. The request must be submitted in writing at least 60 days prior to the date of the meeting. The Chairman of the Supervisory Board chairs the meeting.

Every shareholder has the right to attend a General Meeting of Shareholders in person or through written or electronic proxy, to address the meeting and to exercise voting rights. To exercise voting rights, holders of ordinary bearer shares must lodge their share certificates in the way specified in the notification convening the General Meeting of Shareholders. The record date stated in the notice convening the General Meeting shall not be earlier than the seventh day before the General Meeting. From the date of the lodging of the share certificates up to and including the record date, the share certificates may be blocked. Holders of ordinary registered shares must inform the Board of Management in writing of their intention to attend the meeting.

All resolutions at a General Meeting of Shareholders are passed on a simple majority of votes cast, with the provision that a majority of at least two-thirds of the votes cast is required for resolutions to reduce capital or restrict or exclude priority rights, or to designate a Company body with authority to do so, if proposed at the meeting at which less than half the issued capital is represented. Some resolutions additionally require the approval of the holder of the special share.

ADOPTION OF FINANCIAL STATEMENTS AND DISCHARGE OF RESPONSIBILITY

Within five months of the end of every fiscal year, the Board of Management must prepare the Financial Statements accompanied by an Annual Report. The General Meeting of Shareholders may extend this period to a maximum of six months in exceptional circumstances. The Financial Statements are submitted to the Supervisory Board for approval. The Supervisory Board submits the approved Financial Statements to the General Meeting of Shareholders for adoption together with the Annual Report for discussion. At the same time, the Supervisory Board submits the approved Financial Statements to the Central Works Council. Adoption of the Financial Statements does not automatically discharge the Board of Management or the Supervisory Board from liability. This requires a separate resolution by the General Meeting of Shareholders.

DIVIDENDS

Under the Articles of Association, the special share and Class B preferred shares carry preferred dividend rights. Subject to the approval of the Supervisory Board, the Board of Management will determine what proportion of the profit remaining after satisfaction of these preferred dividend rights will be appropriated to the reserves. The Board of Management may decide to allocate the complete remainder to the reserves. Any remaining profit resulting after this appropriation is available for distribution on the ordinary shares. The decision to pay out dividend is made by the General Meeting of Shareholders, upon proposal by the Board of Management with the approval of the Supervisory Board. In addition, the Board of Management may, subject to approval by the Supervisory Board and the holder of the special share, decide to pay out the entire dividend on ordinary shares in shares instead of in cash. Subject to Supervisory Board approval and certain legal requirements, the Board of Management may furthermore decide to pay out interim dividends on ordinary shares. Please refer to the section titled 'Information on the KPN share - Dividend Policy' for more information.

AMENDMENT OF THE ARTICLES OF ASSOCIATION; DISSOLUTION; LEGAL MERGER; DEMERGER; REDUCTION OF CAPITAL

The General Meeting of Shareholders may pass resolutions to effect a merger, split-up or dissolution of the Company or amend its Articles of Association only upon a proposal by the Board of Management. The Supervisory Board must approve such a proposal. An absolute majority of the votes cast is required to adopt such a shareholders' resolution. The shareholders' resolution must be approved by the holder of our special share (only when held by a third party) in case of a merger, split-up, or dissolution and certain amendments to our Articles of Association.

LIQUIDATION

In the event of dissolution or liquidation, the assets remaining after payment of all debts will be divided among shareholders in the following way: the holder of the special share and holders of issued and outstanding Class B preferred shares will first receive the par value paid for the shares and any amount owed by way of dividend on the shares, in so far as not already paid out in previous years. Secondly, the remaining amount will be distributed to holders of ordinary shares in proportion to the total number of shares possessed by each holder.
As of December 31, 2005, 57 ADR record holders held 11,528,996 ordinary shares in the form of American Depository Shares representing 0.54% of our outstanding ordinary shares.

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RESTRICTIONS OF NON-DUTCH SHAREHOLDERS’ RIGHTS

Under our Articles of Association, there are no limitations on the rights of non-resident or foreign shareholders to hold or exercise voting rights in respect of our securities, and there are no such restrictions under Dutch corporate law.

MAJOR SHAREHOLDERS AND CONTROL OF THE COMPANY
General

The table below sets forth, as of the period indicated, the number of shares of each class of our voting shares held by anyone who owns 5% or more of these shares. The table also sets out the number of shares of each class beneficially owned by the members of our Supervisory Board and our Board of Management.

Title of class

Identity of person or group

At February 28, 2006

At December 31, 2005

At December 31, 2004

At December 31, 2003

Ordinary shares

The State of The Netherlands

166,966,893 (7.8%)

166,966,893 (7.8%)

481,966,893

(20.7%)

481,966,893 (19.3%)

Ordinary shares

Capital Group International, Inc.

February 1: 255,941,080 (11.9%)

November 4: 239,155,060 (10.3%)

Unknown

Unknown

Ordinary shares

Capital Research and Management Company

February 6: 279,884,010 (13.0%)

November 10: 250,588,270 (10.7%)

Unknown

Unknown

Ordinary shares

Current members of our Board of Management and our Supervisory Board

Less than 0.01%

Less than 0.01%

Less than 0.01%

Less than 0.01%

Special share

The State of The Netherlands

-

-

1

1

As of December 31, 2005, 57 ADR record holders held 11,528,996 ordinary shares in the form of American Depository Shares representing 0.54% of our outstanding ordinary shares.

As of December 31, 2005, 21% of our outstanding ordinary shares was held by Dutch investors, including the State of the Netherlands (14% of the free float, i.e. disregarding the shares held by the State of the Netherlands).

THE STATE OF THE NETHERLANDS

The State of the Netherlands, referred to hereinafter as the State, represented by the Ministry of Finance, is a large shareholder in our Company. On December 7, 2005, the State announced the sale of 105 million shares in a block trade to ABN AMRO Rothschild and 60 million shares to the Company thereby reducing its shareholding in the Company to 7.8%. Following the sale of a large part of its shareholding the State announced the disposal of the special share and on December 16, 2005, we repurchased this special share for its nominal value of 48 eurocents, as provided for in the articles of association. At the same time the Heads of Agreement with the State, under which agreement the relation with the State as shareholder in our Company was co-ordinated, was terminated. At the Annual General Meeting of Shareholders on April 11, 2006, we will propose an amendment to the articles of association to cancel the special share. In the mean time, KPN will not sell or otherwise use the special share. The State has announced that it intends to sell the remainder of its KPN shares, subject to market conditions.

The State is a major customer and purchases our services on normal market terms and conditions. The State may further require us by law to provide certain services in connection with national security or the investigation of criminal offences. The services include tapping telephone lines and providing and maintaining a special secure network for emergencies.

THE FOUNDATION FOR THE PROTECTION OF KPN (STICHTING BESCHERMING KPN)

The Foundation for the Protection of KPN (the 'Foundation') was organized to protect our interests and those of other stakeholders, such as shareholders and employees, by, among other things, protecting us from influences that may threaten our continuity, independence and identity. The independent members of the Board of the Foundation are Professor S.C.J.J. Kortmann (Chairman), Professor P. Bouw, Mr. H. Zwarts MBA and Mr. J. den Hoed RA (vice-Chairman). The Chairman of our Supervisory Board, Mr. A.H.J. Risseeuw, is also a member of the Board of the Foundation. Our Board of Management and the members of the Board of the Foundation share the view that the Foundation is independent from us in accordance with Appendix X to the Listing and Issuing Rules of the Stock Exchange of Amsterdam (Euronext).

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We have a put option to place with the Foundation a number of our Class B preference shares, which have the same voting rights as ordinary shares, not exceeding the total issued share capital before such issue, or, subject to prior approval by the General Meeting of Shareholders, such larger number as the parties may agree. In addition, the Foundation has a call option to acquire a number of Class B preference shares from us not exceeding the total issued amount of ordinary shares and the special share, minus one share and minus any shares already issued to the Foundation. Upon exercise of the option, only 25% of the nominal value of EUR 0.24 per Class B preference share needs to be paid. The remainder, amounting to EUR 0.18, is payable on call by resolution of our Board of Management, subject to the approval of the Supervisory Board. We anticipate not exercising our put option other than to temporarily protect our Company against a hostile take-over bid. We believe that the put option is a useful instrument to enable our management to carefully consider any such offer and potential alternatives. We intend to discuss the offer and potential alternatives with the general meeting of shareholders in order to fully comprehend the considerations of the shareholders. We also intend to submit the offer and/or the potential alternatives for approval to the general meeting as we believe that management alone should not decide on the future of our Company.

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REMUNERATION REPORT

Introduction

The Remuneration & Organization Development Committee (‘the Committee’) of the Supervisory Board ensures that Koninklijke KPN’s (‘the Company’) remuneration policy and practices are competitive and reflect the long-term interests of KPN shareholders. The Company’s remuneration policy is consistent with the Dutch Corporate Governance Code (‘the Code’), legal requirements, and best practices in The Netherlands.

The Committee meets several times each year to review KPN’s remuneration policy. The existing remuneration policy was adopted by the Annual General Meeting of Shareholders (‘AGM’) in 2004 and confirmed in 2005. No changes are foreseen for 2006, with the exception of the introduction of a share plan, replacing the current performance stock option plan. As the Board of Management is eligible to participate in this share plan, it is subject to the approval of the Annual General Meeting of Shareholders in line with the Dutch Corporate Governance Code. The 2004 AGM approval continues to be in effect for all policy elements, except for the Share Plan.

Any changes to the remuneration of the (individual) Board members in 2006 will be either in line with the remuneration policy, or will be put up for adoption or approval in accordance with the Dutch Corporate Governance Code, or any other relevant legislation.

This report describes the Company’s remuneration policy as applied in 2005 and provides an overview of the remuneration policy planned for the next financial year and consecutive years.

The report contains three sections:

  • a summary of KPN’s 2005 remuneration policy and structure for the Board of Management, along with audited tables that provide details on all remuneration received per individual;

  • a summary of remuneration received by the Supervisory Board; and

  • an overview of KPN remuneration policy elements that may be reviewed in 2006.

Remuneration Policy 2005

The Company’s remuneration policy is designed to ensure that KPN can attract, motivate and retain highly qualified executives who are critical to the Company’s long-term success. The goals, principles and practices outlined in this report are the same for all members of KPN's top management. The policy is based on three simple principles: pay competitively, pay for performance, and align remuneration with individual responsibility, experience and performance.

Pay competitively. We benchmark remuneration levels against a peer group that includes European telecom operators and IT companies as well as AEX-listed companies. The complexity and size of the benchmark companies are taken into account and made comparable to KPN’s size and complexity through a methodology commonly used by independent remuneration experts (the list of companies is included below under ‘Employment market peer group’);

Pay for performance. We place emphasis on incentives designed to the Company’s long-term value-creation strategy.

To align remuneration with individual responsibility, experience and performance. Individual remuneration packages are designed for each member of the Board of Management.

Executive remuneration

The executive remuneration of the current members of the Board of Management is provided below.

 

 

Annual compensation

Options granted 3

 

 

Salary

Bonus paid 2

Total

 

A.J. Scheepbouwer 1

 

 

 

 

 

Chairman of the Board

2005

1,001,397

1,001,900

2,003,297

297,177

 

2004

1,003,236

637,500

1,640,736

310,078

M.H.M. Smits 1

 

 

 

 

 

CFO

2005

423,828

104,761

528,589

115,330

 

2004

169,372

-

169,372

42,708

G.J.M.Demuynck 1

 

 

 

 

 

Member

2005

453,828

348,255

802,083

123,568

 

2004

455,555

450,000

905,555

110,635

 

 

 

 

 

 

Total current members

2005

1,879,053

1,454,916

3,333,969

536,075

 

2004

1,628,163

1,087,500

2,715,663

463,421

  1. According to IFRS accounting principles service costs related to pension benefits amounted for Mr. Scheepbouwer EUR 0 in 2005 (EUR 0 in 2004), for Mr. Smits EUR

    80


    84,700 in 2005 (EUR 22,500 in 2004) and for Mr. Demuynck EUR 174,200 in 2005 (EUR 174,100 in 2004). Costs recognized for options under IFRS amounted EUR 828,898 in 2005 (EUR 882,396 in 2004) for Mr. Scheepbouwer, EUR 117,053 in 2005 (EUR 16,681 in 2004) for Mr. Smits and EUR 395,498 in 2005 (EUR 281,542 in 2004) for Mr. Demuynck. Costs according to IFRS accounting principles do not reflect actual cash payments.

  2. Bonuses paid relate to the performance of the previous year.

  3. Number of options granted in a year.

Former Members of the Board of Management:

Name and position

Year

Annual Compensation

Severance payments

Total

Options granted 5

 

 

Salary

Bonus paid 4

 

 

 

J.M. Henderson 1

 

 

 

 

 

 

CFO

2005

-

177,560

-

177,560

-

 

2004

412,236

337,500

409,000

1,158,736

-

E. Blok 2

 

 

 

 

 

 

Member

2005

-

182,280

-

182,280

-

 

2004

280,140

79,700

-

359,840

98,342

L. Roobol 3

 

 

 

 

 

 

Member

2005

-

-

-

-

-

 

2004

379,984

262,500

-

642,484

-

 

 

 

 

 

 

 

Total former members

2005

-

359,840

-

359,840

-

 

2004

1,072,360

679,700

409,000

2,161,060

98,342

  1. Mr. Henderson was CFO up to September 11, 2004, his employment contract ended December 31, 2004 and he was succeeded by Mr. Smits. According to IFRS accounting principles costs related to pension benefits amounted to EUR 154,800 in 2004, and costs related to options to EUR 153,754 in 2004.

  2. Mr. Blok joined the Board of Management on April 15, 2004 and resigned from the Board on December 23, 2004. According to IFRS accounting principles costs related to pension benefits amounted to EUR 39,600 in 2004, and costs related to options EUR 157,569 in 2004.

  3. Mr. Roobol resigned from the Board of Management on November 10, 2003 for health reasons. His employment contract ended November 30, 2004. According to IFRS accounting principles costs related to pension benefits amounted to EUR 109,100 in 2004, and costs related to options to EUR 260,492 in 2004.

  4. Bonuses paid relate to the performance of the previous year.

  5. Number of options granted in a year.

81


Base salary 2005

There were no base salary increases in 2005.

Short-term incentives: Bonus 2005

The CEO receives a target bonus opportunity equal to 100% of base salary, and at maximum performance, 150% of base salary. For the other members of the Board of Management, the target bonus is equal to 60% of base salary, and the maximum bonus is 100% of base salary. If performance is below a certain minimum threshold, there is, in principle, no pay-out. However, the Supervisory Board has discretion in establishing the final bonus payment, e.g. by taking into account achievements of management that created value for the company, but which were not reflected in the bonus items. Performance targets are ambitious and in line with company strategy. Target pay-out will be achieved at target performance. Performance between target and maximum level or between target and the minimum threshold level will result in a pay-out that is determined according to linear formulas. The maximum pay-out is pre-defined.

The short-term bonus is linked to a combination of performance measures at corporate and divisional level. At the corporate level, revenues and net income before tax is used. At divisional level, customer satisfaction is used for the Fixed Division and revenue market share is used for the Mobile Division in combination with operating result for the respective divisions. The applicable divisional performance measure depends on each Board member’s specific responsibilities, typically on a 50/50 basis of division versus corporate results, as determined each year by the Supervisory Board.

Performance is determined as follows:

  • revenues, operating result and net income before tax are derived from the audited Consolidated Financial Statements;

  • customer satisfaction is based on independent surveys; and

  • revenue market share is based on publicly available information together with the Company’s own records and calculations.

KPN considers these measures and targets to be adequate, as they are solid indicators of the Company’s financial health and consistent performance, and they are in line with KPN’s strategy and may be considered a strong indication for the Company’s future success.

For the bonus over 2005, which is to be paid-out in 2006, performance on revenues at corporate level was close to the minimum threshold level while performance on net income before tax well exceeded the maximum level. The performance on revenue market share for the Mobile division is expected to be close to the maximum level. The final calculation can only be made if all relevant competitors in The Netherlands, Germany and Belgium have published their results. For the Fixed Division, customer satisfaction was between the target level and the minimum threshold. Provisionally, bonuses over 2005 would amount to approximately EUR 1,000,000 for Mr. Scheepbouwer, EUR 275,000 for Mr. Smits and EUR 365,000 for Mr. Demuynck and will be reported on in our Annual Report and Form 20-F over 2006.

The Supervisory Board ensures each year that the targets set are quantifiable and stretching but realistic. Specific quantitative performance targets cannot be disclosed due to their commercially sensitive nature.

Long-term incentives: stock options 2005

KPN shareholders approved the Company’s stock option plan at the Annual General Meeting on April 15, 2004. The conditional long-term incentive stock option plan reflects the Company’s focus on long-term sustainable value creation and meets the requirements of the Dutch Corporate Governance Code, among others by linking the right to exercise the options to attaining a pre-set and measurable performance target.

The relative importance of the long-term incentive, as a part of the total remuneration package, did not change in 2005.

The option grant in 2005 was based on a target grant level equaling 60% of base salary for members of the Board of Management, and 106% of base salary for the CEO. These levels were established using the binomial valuation method. Options vest in three years and expire in eight years, except for the options of the CEO, which expire after 5 years. The use of the binomial valuation method is in line with the requirements of IFRS 2. The use of the binomial valuation method instead of the Black Scholes valuation method (which was used in 2004) does not constitute a material change in value, and was therefore not put up for approval to the AGM.