UPM annual report 2014

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-

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

icantly during the last few years. The importance of patent registration highlights the progress made in new businesses.

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.

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-

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UPM Annual Report 2014

UPM Annual Report 2014