UPM annual report 2014

UPM Annual Report 2014

CONTENTS

ACCOUNTS

The main earnings sensitivities and the Group’s cost structure are pre-

sented in the Annual Report of 2014, on page 13.

Availability and price of major inputs.

In 2014, third-party suppliers

accounted for approximately 83% of UPM’s wood requirements. Other

production inputs, such as chemicals, fillers and recovered paper, are

obtained from third-party suppliers. Disruptions in the supply of key

inputs would impact upon manufacturing operations, for example, by

interrupting or resulting in the downscaling of production or a change in

the product mix. They could also cause price increases for critical inputs

or shifts in the availability and price of wood. It is also uncertain how

the EU energy policies may impact upon the availability and costs of

fibre and energy.

Project execution.

Investment projects in UPM businesses such as

energy, pulp, paper or biofuels are often large and take one or more

years to complete. UPM has experience in such projects in various busi-

nesses and locations around the world, and applies vigorous planning,

project management and follow-up processes. Participation in large proj-

ects involves risks such as cost overruns or delays, as well as achievement

of the economic targets set for the investment.

Partnerships.

UPM currently works together with many partners

without control over strategic direction and operational output. The

highly competitive market situation and, for example, new developments

in biofuels or bioenergy are likely to increase the importance of partner-

ships in the search for higher efficiency or new products and businesses.

Partnerships, however, may create risks to the profitability, for example,

through changes occurring within the partner entity or changes in how

the partnership operates.

Ability to recruit and retain skilled employees.

To meet the challenges

of sustaining growth and improving the effectiveness of operations, a

skilled workforce is necessary. UPM is continuously evaluating its

recruitment, compensation and career development policies and taking

measures to attract and retain skilled personnel, thereby seeking to avoid

shortages of appropriately skilled personnel in the future.

Availability of information systems.

UPM business operations are

depending on the availability of supporting information system and net-

work services. Unplanned interruptions in critical information services

can potentially cause a major interruption of UPM business areas. UPM

has implemented numerous technical, physical and process improve-

ments to mitigate the availability risk and to reduce the service interrup-

tion related recovery time to acceptable level.

Financial risks

Changes in exchange and interest rates.

Exchange rate exposure primarily

affects export operations when sales are denominated in currencies other

than those in which manufacturing costs are incurred. Part of UPM’s

sales and purchases are denominated in currencies other than the euro

(primarily the US dollar and the British pound sterling). To manage

exposure to such exchange rate fluctuations, close monitoring of the

exposure to currency risks is carried out simultaneously with the hedging

of such risks, using financial instruments including forward foreign

exchange agreements and currency swaps. Furthermore, changes in

interest rates may have a considerable impact on the values of the com-

pany’s assets (e.g. biological assets or available-for-sale investments, such

as energy assets), which are valued on a discounted cash flow model.

Availability of capital and liquidity.

Availability of capital to UPM is

dependent on conditions of the financial markets and the Group's finan-

cial health. If either or both of these factors were to change dramatically

for the worse, the cost and availability of capital would be at risk. To

mitigate possible materialisation of these risks, the UPM has liquidity

reserves in the form of committed multi-year loan facilities. UPM’s avail-

able-for-sale investments are recognised at fair value in the balance sheet.

Changes in the assumptions used (e.g. electricity price estimate and start-

up schedule of the Olkiluoto 3 nuclear power plant) might have a signifi-

cant impact on UPM’s financial position.

Payment defaults.

There is a risk of non-payment or non-perfor-

mance by the Group's customers in connection with the sale of products.

UPM has various programmes in place to monitor and mitigate cus-

tomer credit risk, and insurance policies cover most of the trade receiv-

ables.

Additional information about financial risks and the maturity of

long term debt is disclosed in the consolidated financial statements

(Notes 3 and 31).

Hazard risks

UPM operates a significant number of manufacturing facilities globally,

mostly UPM-owned, and is also the largest private owner of forestland

in Finland. UPM is exposed to risks in areas such as occupational health

and safety, environment, fire, natural events and site security. These risks

are managed through established management procedures and loss

prevention programmes. UPM’s insurance programme also provides

coverage for insurable hazard risks, subject to terms and conditions.

Research and development

The objective of UPM’s research and development programmes and

business development is to create new technologies and products, pro-

vide support to and ensure the competitiveness of its core businesses.

The share of R&D work increased in new technologies and growth

businesses like developing biofuels, biocomposites, biochemicals, biofi-

brils, pulp and CO2-neutral energy in 2014.

In 2014, UPM’s direct expenditure on research and development was

approximately EUR 35 million (38 million), or 0.4% (0.4%) of the

Group’s sales. In total, UPM spent approximately EUR 112 million (155

million) on research and development for existing and developing busi-

nesses including negative operating cash flow and capital expenditures in

developing businesses, corresponding 9.0% (21.1%) of UPM’s operating

cash flow.

Versatile use of wood biomass

UPM’s Biofore strategy is based on the versatile use of renewable wood

biomass, combined with innovation, resource efficiency and sustainabili-

ty. The purpose is to replace non-renewable materials with renewable,

recyclable and low-impact alternatives - the main drivers for bioecono-

my.

Improvements in material efficiency make it possible to consume

fewer resources and raw materials in production processes. Therefore,

UPM R&D work has increased its focus on more efficient use and reuse

of side streams. The most recent examples are UPM’s construction

products Elurit and Cinerit that are made of fly ash from the thermal

recovery of the biogenic waste materials.

UPM has a global network of research centres to support the busi-

nesses and their business development goals. UPM’s all businesses and

R&D have adopted ecodesign in their product development processes.

This means that environmental aspects are systematically integrated into

product design at an early stage.

Wide-scale collaboration in new businesses

UPM is a shareholder in the Finnish Bioeconomy Cluster (FIBIC). The

Cluster’s research programmes focus on the bioeconomy and products

based on renewable materials, thus supporting UPM’s internal R&D

activities. Moreover, UPM is a shareholder in the Finnish CLEEN Ltd

research company that is focusing on energy and environmental re-

search.

The research clusters support the Finnish bioeconomy and cleantech

strategies with the aim of increasing sustainable businesses in Finland.

The clusters’ research projects are in line with the research and imple-

mentation activities of UPM’s Biofore strategy.

In July 2014, EU and industry leaders launched a new European

Joint Undertaking on Bio-based Industries (BBI) in which UPM acted

as one of the founding members in industrial consortium part.

This Public Private Partnership (PPP) aims to trigger investments

and create competitive market for bio-based products and materials that

are sourced locally. For UPM, the PPP is an important funding element

for speeding up the implementation of future investments in new areas

such as biochemicals, biocomposites and biofuels.

In 2014, UPM received approximately EUR 2.1 million (3.8 million)

from Tekes (the Finnish Funding Agency for Technology and Innova-

tion) for its research projects. These projects were carried out in co-oper-

ation with research institutes, universities and other companies.

UPM’s intellectual property rights applications have increased signif-

icantly during the last few years. The importance of patent registration

highlights the progress made in new businesses.

UPM's Biocomposites combine natural fibres and plastic

UPM Biocomposites business unit develops, manufactures, markets and

sells high quality composite products and granulates for a wide range of

consumer and industrial applications.

UPM ProFi and UPM Formi composites combine the best charac-

teristics of natural fibres and plastic. Their principal ingredients are

cellulose fibres and polymers, which can be either virgin or recycled. The

non-toxic composites can be recycled.

UPM ProFi products are used for decking and other outdoor end

uses. They are made mainly from the surplus paper and plastic left over

from the production of self-adhesive label materials.

UPM Formi composite is used to replace plastic in many applica-

tions, from furniture to consumer electronics. UPM Formi is manufac-

tured from cellulose fibre and plastics. Around half of the oil-based

plastic is replaced with cellulose fibres in the biocomposite.

Products manufactured from UPM Formi comply with food con-

tact material requirements stipulated in EU and US Food and Drug

Administration (FDA) regulations.

The composite also complies with EU toy safety regulations.

UPM Biochemicals has profound know-how in lignin-based

products

UPM Biochemicals unit develops wood-based chemical building blocks,

performance chemicals and biofibrils.

Chemical building blocks are a cost competitive replacement for

fossil-based monomers and chemicals such as intermediates to bioplas-

tics. Performance chemicals utilise the basic structure of the natural

biopolymers of wood, such as lignin and hemicellulose.

Biofibrils™ products and lignin, the binding agent of wood, are

examples of UPM’s performance chemicals. Biofibrils are cellulose

micro and nanofibril products that can be used for shaping materials

and giving them new characteristics. Lignin can be used in e.g. various

resin mixtures and adhesives.

In 2014, UPM Biochemicals worked with Renmatix to test the com-

pany’s water-based Plantrose™ process. The goal of the initiative is to

convert woody biomass into intermediates for subsequent downstream

processing into biochemical.

In addition, UPM Biochemicals signed a lignin supply contract

with Domtar Inc. to develop the market and offer sustainable, value

added products for a growing variety of end uses.

UPM Biochemicals has developed profound know-how and intel-

lectual property in the area of lignin based products, e.g. resins, which

are typically used as binders in wood based products. UPM BioPiva™

lignin for resin formulations, based on UPMs proprietary activation

technology, is one example of this kind of products.

Product development of UPM Biochemicals is at the pre-commer-

cial phase. The purpose of the work is to develop and test industrial

applications with UPM's partners in order to create mill-scale industrial

concepts.

Businesses

UPM Biorefining

UPM has reduced process water consumption significantly in its pulp

mills. In UPM’s newest mill, UPM Fray Bentos, Uruguay, the consump-

tion of process water is among the lowest in the industry. Recently

special focus has been in significant reduction of phosphor emissions.

In plantations operations, development work focuses on the tree

breeding programme and developing new frost-tolerant eucalyptus

clones in order to create more value and improve productivity.

UPM Pulp continued to focus on joint development activities with

customers, mainly in Europe and China, in 2014.

In Biofuels, UPM focused strongly for the market entry of the

UPM BioVerno renewable diesel.

As a product, UPM BioVerno has been extensively tested in engine

tests and fleet tests, and has been found to function like any regular die-

sel. The comprehensive emission, performance and wear tests were car-

ried out with the Technical Research Centre of Finland (VTT). Due to

the high quality, there are no technical blending limits. After the start-up

of the biorefinery, the emphasis will be on optimising and increasing the

efficiency of the production processes.

In the long term, research work aims to extend biofuel production to

new processes and raw materials, such as pyrolysis oils and solid bio-

mass. In technology development, UPM joined a five-year project called

LignoCat (lignocellulosic fuels by catalytic pyrolysis) to produce

advanced high value lignocellulosic fuels for transportation.

UPM Energy

UPM Energy focuses on improving the efficiency and cost competitive-

ness of biomass-based energy technologies.

To reach its target, UPM Energy participates in several research

programmes. These programmes are looking for new innovative solu-

tions to improve the design and operation of large-scale energy conver-

sion systems using biomass fuel mixtures.

UPM Raflatac

In the specialty business, UPM Raflatac focused on developing new high

added value products to its end-use range as well as tailored solutions

for specific customer needs.

In the standard products the re-engineering of paper-based products

for greater cost efficiency and improved performance continued.

New thin film products have been developed both for the rigid and

squeezable package applications. For the rigid packages UPM Raflatac

launched a new VANISH™ range of ultra-thin, invisible clear film label

stocks. A new thin squeezable film has also been developed mainly for

labelling of personal care products. The squeezable film is based on

UPM Raflatac’s proprietary film technology.

UPM Paper Asia

UPM R&D centre based in Changshu concentrates to support UPM’s

production units in China and in the Asia Pacific region, with main

focus being R&D work for paper and label products.

UPM Paper ENA

The R&D work focuses on improving cost efficiency by implementing

various research results and launching new material efficient paper

grades. UPM Valor is a prime example of how UPM’s papers add value

for customers by providing savings in mailing and delivery costs without

the need to compromise on quality. UPM Valor matches the quality and

the properties of the reference paper grades but is up to 15% lighter in

basis weight.

One key target is to reduce water consumption at the paper mills.

UPM is also studying ways to exploit deinking process waste and recycle

surplus materials coming from paper mills to use waste streams more

efficiently.

UPM Plywood

UPM Plywood’s product management and development work focused

on creating new customer-based solutions in addition to commercialis-

ing and piloting applications developed previously.

One of the key areas was to improve the properties of plywood for

end-uses such as the LNG containment systems.

For concrete forming end uses, R&D work concentrated on creating

new customer-focused products that are more economic with better

functional properties.

For vehicle industries a more economical fire retardant plywood

solution was developed.

Development of rigid structures for vehicle flooring continued with

pilot installations for customers selected earlier. Piloting of the rigid

structure solution was also agreed with new customers. Plywood with

high friction surface was in the development pipeline.

In addition to product development, high effort was put in raw

material testing and process development.