UPM Annual Report 2018

UPM AT A GLANCE

STRATEGY

BUSINESSES

SOCIETY AND ENVIRONMENT

GOVERNANCE AND COMPLIANCE

REPORT OF THE BOARD OF DIRECTORS

FINANCIAL STATEMENTS

AUDITOR’S REPORT

OTHER FINANCIAL INFORMATION

10. Other notes 10.1 Forthcoming new standards, amendments and accounting policy changes UPM will adopt in 2019 IFRS 16 Leases standard and IFRIC 23 Uncertainty over income tax treatments interpretation. In addition, the group will change accounting policy of forest renewal costs on 1 January 2019. Description of effects of implementation is presented below. The new leasing standard IFRS 16 Leases is effective for annual reporting periods beginning on or after 1 January 2019 and it replaces the current IAS 17 standard. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases. As a result, lessees will recognise most of leases on the balance sheet and there will be no distinction between operating and finance leases anymore. Under IFRS 16, a lease asset (i.e. right-of-use asset), representing right to use the underlying item, and a lease liability, representing obligation to make lease payments, will be recognised. The new standard introduces certain exemptions what comes to the short-term leases and leases of low-value items. Lessor accounting remains similar compared to the current IAS 17 standard. IFRS 16 implementation project The group is about to finalise the IFRS 16 implementation project and related documentation. The project was carried out in several streams including determination of accounting policies, collecting and assessing lease contract data, selecting and implementing of lease software, determining lease process related workflows and controls, and calculating quantitative impact analyses. Representatives from several departments have been involved in the project including Finance, Sourcing, Real Estate, production units, Treasury, Tax, IT, Investment Management and Investor Relations. Several trainings and communication sessions were arranged for end-users and stakeholders. Impact analysis As described above, the adoption of the new standard will have an impact on the group’s financial statements as most of the future operating lease payments will be recognised as right-of-use assets and interest-bearing liabilities in the balance sheet. On adoption of IFRS 16 as of 1 January 2019, UPM expects to recognise right-of-use assets of approximately EUR 490 million and lease liabilities approximately EUR 490 million from current operating leases. The most significant lease agreements that will be capitalised consist of the following leased assets - Land areas (~32%) - Power plants (~30%) - Real estate (~27%) Real estate contracts include offices, factories, terminals and warehouses. In addition, the group has a significant number of company cars. The disclosed non-cancellable operating lease commitments under IAS 17 cover the major part of the lease agreements that will be recognised as right-of-use asset and lease liabilities. The reported undiscounted lease commitments amounted to EUR 554 million as of 31 December 2018. » Refer Note 5.2 Net debt. IFRS 16 Leases

Accounting policy change of forest renewal costs From 1 January 2019, UPM will change its accounting policy relating to forest assets by capitalising forestry renewal costs on the balance sheet during the growth cycle and reclassifying forest assets-related cash flows from operating cash flow to investing cash flow. Currently UPM recognises forestry renewal costs in income statement and reports forest assets-related cash flows, including forest renewal costs, forest asset purchases and sales, in operating cash flow. UPM has consistently increased the weight of the Southern hemisphere plantations in its forest asset portfolio, where the growth cycle is significantly shorter and significance of forestry renewal cost substantially higher compared to the Northern hemisphere. Majority of UPM's forest renewal costs are related to Southern hemisphere plantations. Thus, the change of accounting policy results in more relevant information on group's financial performance and cash flows. The change will impact the following key figures in UPM group, UPM Biorefining Business Area and Other operations: EBITDA, EBITDA margin, operating and investing cash flows, operating cash flow per share and net debt to EBITDA ratio. There will be no impact on operating profit, comparable EBIT and balance sheet. The comparative years will be restated according to the new reporting principles.

The turnkey principle of the OL3 plant contract and the joint and several liability of the supplier consortium companies remain in full force. The agreement also noted the plant Supplier’s schedule at the time the agreement was signed, according to which regular electricity production in the unit would have commenced in May 2019. The ICC arbitration concerning the costs and losses caused by the delay of the OL3 project is settled by financial compensation of EUR 450 million to be paid to TVO in two installments by the Supplier. The parties withdraw all on-going legal actions related to OL3, including the ICC Arbitration and appeals in the General Court of the European Union. The supplier consortium companies are entitled to receive an incentive payment, in a maximum amount of EUR 150 million, upon timely completion of the OL3 project. In the event that the supplier consortium companies fail to complete the OL3 project by the end of 2019, the supplier consortium companies will pay a penalty to TVO for such delay in an amount which will depend on the actual time of completion of the OL3 project and may not exceed EUR 400 million. According to TVO, TVO received the first payment of EUR 328 million of the settlement amount in March at the entry into force of the settlement agreement. The second payment of EUR 122 million is payable upon completion of the OL3 project or, in any event, on 31 December 2019 at the latest. TVO had made in the first quarter of 2018, a provision of EUR 150 million reflecting the maximum amount of the incentive payment payable to the Supplier for timely completion of the OL3 project. According to the updated schedule for the commissioning of OL3 received by TVO from the Supplier in June 2018, the regular electricity generation at OL3 will start in September 2019, so in the second quarter of 2018, the provision was withdrawn by EUR 50 million. According to the announcement by TVO in accordance with the updated schedule for the commissioning of OL3 received in November 2018 the regular electricity generation at OL3 will start in January 2020. These settlement payments to TVO, any incentive payment by TVO and any penalty payable to TVO due to any additional project delay have all been taken into account by TVO in calculating the final cost of the OL3 project. TVO announced that based on the current OL3 project schedule provided by the Supplier, TVO’s current capital expenditure assumptions and the effect of the settlement agreement, TVO estimates its total investment in OL3 EPR to be approximately EUR 5.5 billion. 9.3 Events after the balance sheet date On 9 January, UPM announced it is taking part in the international public tendering process in the port of Montevideo organised by the National Ports Administration (ANP) of Uruguay. The scope of the concession tender is the building and operation of a port terminal specialising in the storage and shipping of pulp, chemicals and other inputs related to pulp production, with the capacity to handle approximately 2 million tonnes of pulp annually. The tender includes the design, financing, engineering, construction, operation and maintenance of the pulp terminal. The tenure of the concession would be for 50 years. If awarded a concession in the Montevideo port, UPM’s financial commitment in the form of a performance bond would be USD 20 million at this stage. At the time of the potential investment decision on the pulp mill project described in the report of Board of Directors, UPM would proceed with the port investment decision and start of the construction of the port facilities. The preliminary UPM investment estimate for the port facilities would be approximately USD 260 million. On 31 January, UPM announced it will invest in the refurbishment of Kuusankoski hydropower plant in Finland. The average annual production of the Kuusankoski plant is expected to increase from the current 180 GWh to 195 GWh. The investment will be completed by the end of 2022.

The new standard will also influence the group’s income statement as operating lease expense will be replaced by anticipated similar levels of depreciation and interest expense. For lease contracts that will be recognised on the balance sheet as of 1 January 2019, the annual operating lease expense, which would have been recognised under IAS 17, approximates to EUR 80 million. Additionally, IFRS 16 will influence cash flow statement. The principal payment will be recognised under financing activities and interest portion of lease payments will be recognised under operating activities. As a result, the operating cash flow will increase, and financing cash flow will correspondingly decrease by approximately EUR 70 million. Transition policy UPM will apply IFRS 16 using modified retrospective application method without restatement of comparatives. Under modified retrospective approach, UPM measures right-of-use assets and lease liabilities at the application date as of 1 January 2019 and respectively recognises an adjustment to the opening balance of retained earnings. UPM estimates the remaining lease term as of 1 January 2019 and measures the remaining lease payments accordingly. The group measures its lease liability at the present value of the remaining lease payments discounted using incremental borrowing rate at the date of application 1 January 2019. Lease payments relating to an optional renewal period in the lease liability are included only if it is reasonably certain that the group will exercise that option. UPM applies short-term leases exemption consistently on transition and subsequently for all asset classes. The lease contracts with a duration of less than 12 months are considered short-term and will not be capitalised. As a practical expedient UPM will not reassess previous decisions about existing contracts whether they are or contain a lease. Additionally, the group will not identify initial direct costs of leases previously classified as operating leases. What comes to the leases previously classified as finance leases, UPM is not making any adjustments to its IAS 17 balances on transition. Subsequently, the group accounts for the right-of-use asset and lease liability in accordance with the general requirements of IFRS 16. UPM has not identified any significant lease agreement where it is a lessor. IFRIC 23 Uncertainty over income tax treatments IFRIC 23 explains how to recognise and measure deferred and current income tax assets and liabilities where there is uncertainty over a tax treatment. The interpretation is effective for annual reporting periods beginning on or after 1 January 2019. The group is subject to income taxes in numerous jurisdictions and the calculation of the group’s tax expense and income tax liabilities involves a degree of estimation and judgement. Tax balances reflect the current understanding and interpretation of existing tax laws and the latest information available about the positions expected to be taken by tax authorities. Tax matters at UPM are managed by UPM’s own tax function, which is complemented by third-party tax services in order to comply with local tax reporting, filings and other duties. Management periodically evaluates positions taken in tax returns with respect of situations in which applicable tax regulation is subject to interpretation and adjusts income tax liabilities where appropriate using the most likely amount expected to be paid. The group will apply IFRIC 23 retrospectively with the cumulative effect recognised to retained earnings and without adjusting comparative information. At the end of 2018, the group has reviewed its uncertain tax positions and concluded that there are appropriate tax liabilities recognised for periods which are open for reviews and audits by tax authorities. Thus, the adoption of IFRIC 23 on 1 January 2019 will not have any impact on the group’s financial statement on transition.

As published

2018

2017

EBITDA, EURm

1,823 1,631

% of sales

17.4

16.3

Operating cash flow, EURm

1,391 1,558

Operating cash flow per share, EUR Investing cash flow, EURm Net debt to EBITDA (last 12 m.)

2.61

2.92 –222

–260 –0.17

0.11

Restated

2018

2017

EBITDA, EURm

1,868 1,677

% of sales

17.8

16.8

Operating cash flow, EURm

1,330 1,460

Operating cash flow per share, EUR Investing cash flow, EURm Net debt to EBITDA (last 12 m.)

2.49 –199 –0.17

2.74 –124 0.10

172

173

CONTENTS

ACCOUNTS

UPM ANNUAL REPORT 2018

UPM ANNUAL REPORT 2018