A N N U A L R E P O R T UPM ANNUAL REPOR T Kannet2004.indd 1 Kannet2004.indd :09:

Transcription

1 ANNUAL REPORT 2004

2 FINANCIAL INFORMATION IN 2005 During the 2005 financial period, UPM-Kymmene Corporation will publish the following financial information in Finnish, Swedish and English: 1 February Financial Review April Interim Report for January March July Interim Report for January June November Interim Report for January September 2005 These reports are available from the company s Internet pages, address The publications can also be ordered from UPM s Head Office, address P.O. Box 380, FI Helsinki, tel , fax STOCK EXCHANGE LISTINGS UPM s shares are listed on the Helsinki and New York stock exchanges. On the New York Stock Exchange, trading is in American Depository Receipts (ADR). One UPM ADR is equivalent to one share in the company. Helsinki Stock Exchange: Trading code UPM1V New York Stock Exchange: Trading code UPM CORPORATE RESPONSIBILITY UPM will publish a separate Corporate Responsibility Report for UPM Investor Relations Tel Fax ir@upm-kymmene.com UPM Corporate Communications Tel Fax info@upm-kymmene.com

3 CONTENTS ANNUAL GENERAL MEETING UPM-Kymmene Corporation will hold its Annual General Meeting on Thursday 31 March 2005 beginning at 2.30 pm in the Congress Wing of Helsinki Fair Centre, address Messu aukio 1, Helsinki. Instructions for participation will be given in the summons to the meeting and can also be found on the company s Internet pages at DIVIDEND The Board of Directors has decided to propose to the Annual General Meeting that a dividend of 0.75 per share be paid in respect of the 2004 financial year. To receive dividend, shareholders must be registered in the list of shareholders kept by Finnish Central Securities Ltd. at 5 April 2005, the record date for dividend payment. The Board of Directors will propose to the Annual General Meeting that dividend be paid on 12 April Key financial information The year in brief 3 Review by the President 4 UPM Group profile Business operations 6 The company s strengths 10 Goals 11 Sensitivity analysis and risk factors 12 Divisional reviews Paper markets 14 Magazine papers 18 Newsprint 20 Fine and speciality papers 22 Converting 24 Wood products 28 Other operations 31 Resources and support functions Fibre supply 32 Wood procurement 34 Energy 36 Capital expenditure 38 Research and development 40 Environment 42 Personnel 44 Events in Accounts for 2004 Report of the Board of Directors 49 Board s proposal for the distribution of profits 52 Consolidated financial statements (IFRS) Income statement 53 Balance sheet 54 Statement of changes in shareholders equity 55 Cash fl ow statement 56 Notes to the consolidated financial statements 57 Parent company financial statements (FAS) Profit and loss account 86 Funds statement 86 Balance sheet 87 Notes to the parent company financial statements 88 Auditor s report 92 Information on shares 93 Calculation of key indicators 99 Adjusted share-related indicators Key figures Quarterly figures Corporate governance 103 Board of Directors 106 Executive Team 108 Glossary of terms 110 Production plants and sales network 112 Organizational structure 114 Addresses 115 UPM ANNUAL REPORT

4 UPM KEY FINANCIAL INFORMATION Figures for are reported in accordance with International Financial Reporting Standards (IFRS), while figures for previous years are based on Finnish Accounting Standards (FAS). The effect of the changeover to IFRS on the balance sheet and income statement is explained in a press release dated 24 March The press release is available on UPM s Internet pages at Formulae for the calculation of key indicators can be found on page UPM ANNUAL REPORT 2004

5 UPM THE YEAR IN BRIEF Growth in delivery volumes kept the financial result the same as the previous year despite a further fall in sales prices and the stronger euro. The targets set for the 200 million cost-cutting programme were achieved earlier than envisaged Sales, m 9,820 9,787 10,417 Operating profit, m excl. non-recurring items, m Profit before tax, million Earnings per share, excl. non-recurring items, Cash fl ow from operating activities per share, Return on equity, % Dividend per share (2004: Board s proposal) Shareholders equity per share at end of period, Gearing ratio at end of period, % Capital expenditure and acquisitions, m UPM ANNUAL REPORT

6 REVIEW BY THE PRESIDENT REVIEW BY THE PRESIDENT Dear Reader, World paper markets showed a marked improvement in 2004 thanks to stronger demand. The fall in prices came to an end. Despite this, our financial result was well short of the target. The result was affected by low average prices for paper and by higher costs. The trend in exchange rates for our export currencies also had an adverse impact on the result. Our cash flow and balance sheet were strong. Excluding non-recurring items, return on equity was 3.7% (2003: 3.7%). Including non-recurring items, earnings per share were 1.83 (0.61). The Board of Directors proposes that the dividend remain unchanged. UPM succeeded in improving both costeffectiveness and production efficiency during the year. This helped to ease the effects of the downturn, which has been going on for quite some time. There has been a firm commitment to improving cost-effectiveness throughout the Group, and for this I want to thank all our employees. The fact that we began our cost-cutting programmes in good time meant that they made a substantial impact on last year s results. These programmes are continuing, and we therefore expect the rise in costs in 2005 to be modest. Our high self-sufficiency in both energy and fibre raw material will help us to achieve this goal. Demand for paper showed a positive trend throughout the year, and the market improved considerably. There was a clear increase in print media advertising, with direct mail advertising showing especially strong growth. Good demand allowed us to raise contract prices for newsprint and magazine paper in all our main markets early in The markets for our converted products and plywood also developed well, but the market for sawn timber continued to be affected by over-supply. Customer satisfaction ratings were up in all our business areas. Relations with customers have become closer and more diversified as a result of long-term collaboration. For the past three years feedback from our regular customer satisfaction surveys has been used in developing customerships. UPM s primary goal at present is to bring profitability up to an acceptable level. During the year we introduced numerous internal measures that will influence our profitability and future competitiveness. In the paper industry, our business concept is based on large and efficient production units, the industry s strongest production machinery, and products and working practices that meet customers needs and expectations. We also conducted certain restructurings and made investments aimed at improving our business prospects in the long term. Some of the results of this will already be visible this year. The most rigorous restructuring concerned the Wood Products Division in Finland and the Miramichi mill in Canada. These were difficult, but vital, decisions. This restructuring will give us better prospects for competitive business both at these units and throughout the UPM Group. Our business strategy was given a sharper cutting edge during the year. We are aiming to grow faster than the industry on average. UPM currently has footholds in all the most important markets and thus good prospects for future development. Our mills are close either to their customers or to their sources of raw material. UPM will grow either organically or through acquisitions. In rapidly expanding markets our growth will be primarily organic. The completion this summer of our second paper machine at the Changshu mill in China is a good example of an investment in growth markets. In developed markets, where growth is slower, we shall achieve growth largely by modernizing existing machines or through potential acquisitions. 4 UPM ANNUAL REPORT 2004

7 REVIEW BY THE PRESIDENT Innovations in our pressure-sensitive labels business and the development of our Wood Products Division are also opening up new opportunities for growth. UPM attaches great importance to good corporate governance, clear decision-making, and good corporate citizenship. The way in which we take responsibility for the environmental impacts of our activities is one area in which we have won recognition. By working responsibly, we believe we will gain a competitive advantage, as UPM is seen as an attractive and reliable business partner, employer and investment. At the end of my first year as President and CEO, UPM is both competitive and well positioned for future growth. We have a clear strategy, an integrated management concept, a wealth of knowhow and a skilled workforce. We also have the resources and the desire for growth. The outlook for the current year is positive. A further rise in deliveries of paper is expected this year. The price rises introduced early this year form a basis for better profitability in Jussi Pesonen President & CEO UPM ANNUAL REPORT

8 UPM A STRONG AND DYNAMIC PAPER AND FOREST PRODUCTS COMPANY UPM is one of the world s leading manufacturers of printing papers. In magazine papers it is the clear market leader. In 2004, UPM s sales were 9.8 billion. UPM s target is to be the best and UPM s businesses Capital employed and personnel at 31 Dec Share of Group most attractive company in its sector of industry. Magazine Papers Sales, m 3,285 32% Capital employed, m 4,485 33% Personnel 8,825 26% Newsprint Sales, m 1,295 13% Capital employed, m 1,905 14% Personnel 3,451 10% Fine and Speciality Papers Sales, m 2,275 22% Capital employed, m 2,674 20% Personnel 6,831 20% Converting Sales, m 1,409 14% Capital employed, m 621 4% Personnel 4,594 14% Wood Products Sales, m 1,486 14% Capital employed, m 647 5% Personnel 6,851 21% Other Operations Sales, m 552 5% Capital employed, m 3,351 24% Personnel 2,881 9%

9 UPM BUSINESS ON A GLOBAL SCALE UPM s mission is to promote both social and economic well-being through its innovative products: papers, converting materials and wood products. UPM has production plants in 16 countries, and its products are sold on markets throughout the world. The company s most important markets the EU countries and North America account for 85% of sales. On the most important markets the company sells its products through its own sales organization. Market positions of UPM s main products PAPERS UPM s paper mills are situated in Finland, Germany, Great Britain, France, Austria, the United States, Canada and China. The total papermaking capacity is 12.5 million tonnes a year. UPM manufactures a comprehensive range of different papers. Products and services are constantly being further developed together with customers. Papers are produced from a varied raw material base, and roughly a quarter of production is based on recycled fibre. MAGAZINE PAPER is used to produce magazines, newspaper supplements, printed advertising material and sales catalogues. UPM produces both coated and uncoated magazine papers. Most of this magazine paper is supplied to buyers in Europe. The next most important market is the United States. With an annual capacity of 5.7 million tonnes, UPM is the world s leading manufacturer of magazine papers. The company has more than one-fifth of the global market for magazine paper. NEWSPRINT is used for newspapers as well as for telephone directories and mail order catalogues. Most of UPM s newsprint is sold on the markets of Europe, where the company has a share of just under one-fifth. FINE PAPER is supplied mainly to paper merchants, office supplies wholesalers, printers and converters. Uncoated fine paper is used for products such as copier paper and Papers Machines no. Capacity (1,000 t/a) European position Global position Magazine papers LWC 15 3,820 SC 8 1,840 Magazine papers, total 23 5, Newsprint 12 2, Fine papers 1) uncoated 10 1,650 coated 1,610 Fine papers, total 10 3, Printing papers, total 11,720 Label papers Packaging papers Speciality papers, total Total 53 12, ) Including the second paper machine of Changshu mill with a capacity of 450,000 t/a due for start-up in summer Converting European position Global position Pressure-sensitive labelstock 2 2 Siliconized papers 1 1 Industrial wrappings 1 Wood products Capacity (1,000 m 3 /a) European position Plywood 1,100 1 Sawn timber 2,250 3 UPM ANNUAL REPORT

10 UPM non-impact printing paper, while coated fine paper is used for direct advertising, specialinterest magazines and high-quality printed products. The main markets for UPM s fine papers are in Europe and Asia. In Asia, the focus is on the growing Chinese market. UPM enjoys a good position in fine paper markets both in Europe and worldwide. UPM s SPECIALITY PAPERS comprise face and release papers for pressure-sensitive labels, and white and brown sack and kraft papers. UPM is the world s largest producer of label papers. The company is also one of Europe s biggest suppliers of packaging papers. WALKI WISA produces wrapping materials for manufacturers of paper, wood and steel products. As a manufacturer of industrial wrappings the company is the European market leader. It also manufactures composite materials for the packaging industry and for technical purposes. Its production plants are in Finland, Germany, Great Britain and China. The main markets for UPM s converting business are Europe and the United States. WOOD PRODUCTS UPM is the largest PLYWOODS producer in Europe and one of the world leaders in the manufacture of high-quality plywoods. It is also Europe s third biggest producer of SAWN TIMBER. In plywood production, UPM s strengths include both standard grade plywoods as well as highly processed special plywoods and veneers. The main customer segments are the building and transport vehicle industries. Also part of the division is the Puukeskus chain of builders merchants in Finland. CONVERTED PRODUCTS UPM s Converting Division comprises two business areas: Pressure-sensitive labelstock (Raflatac and UPM Rafsec) and Special coatings (Loparex and Walki Wisa). All UPM s converting units are market leaders in their product segments. RAFLATAC is Europe s leading supplier of pressure-sensitive labelstock for product and information labelling. Raflatac has production plants in four countries in Europe, and in the United States, Australia, Malaysia, China and South Africa. UPM Rafsec is one of the world leaders in the development and manufacture of transponders based on radio frequency identification (RFID) technology. RFID systems are used for product identification and in stock control. The unit s manufacturing operations are centred in Finland. LOPAREX manufactures siliconized release materials for hygiene products, self-adhesive labels and industrial uses. Loparex is the world s biggest producer of siliconized papers, and has production in Finland, Great Britain, the Netherlands, the United States and China. The main markets for UPM s plywood and sawn timber are in Europe. SUBSTANTIAL RESOURCES UPM owns over one million hectares of FOREST, of which some 920,000 hectares are in Finland. UPM is Finland s biggest private forest owner. The company also owns forest in the United States and Canada and, through a joint venture, also in Uruguay. In Canada, UPM has licences to use 942,000 hectares of forest. On average, one-tenth of the wood used annually by UPM comes from UPM s own forests or other forests where the company has felling rights. The PULP MILLS operated by UPM and its associated company supply some 90% of the 8 UPM ANNUAL REPORT 2004

11 chemical pulp needed by UPM s paper mills. In printing paper manufacture, UPM is the world s leading consumer of recovered paper. Most of the recovered paper used is secured under long-term purchasing agreements. In ELECTRICAL ENERGY including its interests in power generating companies UPM is about 70% self-sufficient. In Finland, the company is fully self-sufficient. Elsewhere, most of the electricity used by the company s mills is purchased locally through long-term agreements. SKILLED EMPLOYEES The UPM Group employs around 33,400 people. The aim of the human resources policy is to encourage employees to achieve results by stressing initiative and the continuous development of knowledge and skills. Particular emphasis is placed on equality and on the company s core values, which are openness, trust and initiative. The company has a single set of unified management principles. It provides training for its employees, and it operates incentive schemes that are based on productivity, financial results and individual performance. RESPONSIBILITY IN BUSINESS OPERATIONS UPM works in an ethically acceptable way in fulfilling its financial, social and environmental obligations. The company seeks to operate profitably and to generate added value for its stakeholders in the long term. Securing future competitiveness is another important responsibility. UPM regards meeting its responsibilities as a key factor in securing quality and as part of its everyday work. In 2004, the company s shares were rated the best in the industry in the Dow Jones sustainability indexes. By acting responsibly, UPM seeks to gain a competitive advantage so that it is seen as a desirable business partner, employer and investment. INTERNATIONAL OWNERSHIP UPM s shares are quoted on the Helsinki (UPM1V) and New York (UPM) stock exchanges. At the end of 2004, the company had 72,861 registered shareholders. UPM ANNUAL REPORT

12 UPM THE COMPANY S STRENGTHS UPM is committed to the future and seeks continuous improvement in all its activities. Solutions that serve the customer s business, together with costeffectiveness and profitable growth, are the cornerstones on which UPM seeks to develop its own business. GLOBAL ACTIVITIES UPM has production plants in 16 countries. The most important of these are in Finland, Germany, France, Great Britain, Austria, the United States, Canada and China. LONG-TERM CUSTOMER RELATIONS The company enjoys close and lasting relations with its customers, both local and global. Continuous development of operations, combined with a long-term commitment, make UPM a reliable and attractive partner. SKILLED PERSONNEL One of UPM s key competitive advantages is its skilled, highly motivated employees. It is people who lay the foundations for quality, continuous learning and renewal. MODERN MACHINES The company s production facilities rank with the world s best in terms of production capacity and competitiveness. A high level of technical expertise forms the basis for cost leadership and reliability as a supplier. COMPREHENSIVE LOGISTICS NETWORK UPM operates a highly efficient worldwide logistics network. The high proportion of shipments made by sea ensures competitive deliveries, which are backed up by modern IT management systems. STRONG BUSINESS FOCUS AND MARKET SHARES UPM has focused its activities by investing in its core businesses and by divesting noncore assets and activities. In all its main product segments, UPM is among the leading manufacturers in the most important markets. STRONG VERTICAL INTEGRATION UPM s activities are based on close integration of raw materials, energy and production. The company is largely self-sufficient in terms of chemical pulp and electrical power. Wood raw material supplies are secured partly by the company s own forests. UPM s production plants make proper and efficient use of their wood raw material. UPM s converting business is based to a large extent on raw material from its own paper mills and on in-house specialist knowhow. 10 UPM ANNUAL REPORT 2004

13 UPM GOALS UPM s goal is to be the best and most attractive company in the industry. UPM seeks to achieve profitable growth and to be one of the leading companies in the global paper industry. The company s businesses focus on printing and writing papers, speciality papers for the converting industry, converted paper products and wood products. In seeking to achieve these goals, the key factors are good customer relations, skilled employees, cost-effectiveness and global market positions in the company s main product segments. Well known as a reliable supplier, UPM ensures the satisfaction of its customers in many ways. These include a competitive product portfolio and customer-oriented product development work and service. For its employees, UPM offers work that inspires initiative and the desire to produce results. Professional expertise is promoted through job rotation and continuous inservice training. The company seeks to achieve costeffectiveness by continuously raising efficiency levels and by focusing on products in which its production resources and knowhow can be utilized to maximum advantage. To achieve leading market positions, the company will continue to grow both organically and through acquisitions. In investments, special emphasis is placed on product development and new technology. UPM seeks to maintain a strong financial position, which provides the foundation for long-term development and effective use of capital markets. The financial goal is to increase shareholder value. The company wants to reach this goal in a socially and ecologically sustainable way. FINANCIAL OBJECTIVES UPM s objective is to be more profitable than its main competitors. The long-range objective is a return on equity of at least five percentage points above the yield of a risk-free investment such as the Finnish government s 10-year euro-denominated bonds. At the end of 2004, the minimum target for return on equity, as defined above, was 8.7%. The aim is to keep the gearing ratio under 100%. DIVIDEND POLICY It is UPM s policy to distribute a dividend averaging over one-third of the profit for the financial period. The aim is to provide shareholders with a steady, growing annual dividend. Meeting financial targets Return on equity, % Min. target Return on equity, % Achieved excluding non-recurring items Achieved Target Achieved Gearing ratio, % < Dividend per share, Steady, growing 1) Dividend to earnings ratio, % > ) Board s proposal for UPM ANNUAL REPORT

14 UPM SENSITIVITY ANALYSIS AND RISK FACTORS While UPM has carefully studied, and is prepared to deal with, factors that could pose a risk to its operations, changes in the business environment do affect the company s financial results. Forest products markets are influenced by swings in the business cycle. Changes in sales prices and variations in delivery volumes resulting from cyclical swings have a major impact on UPM s financial results. SENSITIVITY ANALYSIS PRICE CHANGES The biggest factor affecting UPM s financial results is the sales price of its paper. A change in the volume delivered has about half the effect on financial results as the same percentage change in product prices. Effect of a 10% change in prices on operating profit for the year (based on 2004 sales) m Magazine paper 310 Newsprint 130 Fine paper 160 Plywood 60 Sawn timber 50 EXCHANGE RATE RISK Prolonged changes in exchange rates also have a marked impact on financial results. Around half of the Group s net foreign currency exposure is in US dollars and about a third is in sterling. For example, a 10% change in the value of the euro against the US dollar has a profound effect on pre-tax profit: an increase/decrease of around 45 million in the short term and around 90 million in the long term. It is the company s policy to hedge an average of 50% of net currency exposure for 12 months ahead. COST STRUCTURE The company s biggest cost items are its personnel expenses and the cost of its fibre raw material. Delivering products to customers worldwide is also a major cost factor. Costs, excluding depreciation % Personnel expenses Logs and pulpwood Delivery of own products Fillers, coating pigments and other chemicals Energy 9 8 Recovered paper 3 3 Other raw materials Other costs Total Costs totalled 8.5 billion (excluding refunds on Finnish pension expenses) in 2004 and 8.4 billion in Crude oil prices, the most important of all world market prices, have little direct impact on the company. The effect on financial results of a change of $ 5/barrel in the price of oil is less than 10 million over 12 months. The indirect effects, for example on freight and oil-based raw materials, are greater but difficult to predict. 12 UPM ANNUAL REPORT 2004

15 UPM RISK FACTORS Below are the main risk factors that can affect the company s business and financial results. COMPETITION AND BUSINESS CYCLE FLUCTUATIONS Forest products markets are highly competitive, and there is little individual suppliers can do to influence prices for their products. The markets are also susceptible to swings in the business cycle. CHANGES IN CONSUMER HABITS Demand for paper is influenced by the use of information technology and by consumer expectations. RISKS ASSOCIATED WITH CORPORATE RESPONSIBILITY The company seeks to manage those risks associated with its corporate responsibility, primarily risks concerning the environment and its products. However, changes in legislation and unforeseen events can affect the company s reputation and financial results. INSURANCE COVER UPM is extensively insured against material damage and against statutory liability for damages. This insurance is not necessarily sufficient to cover unforeseen catastrophes. FOREST INDUSTRY CONSOLIDATION AND POSSIBLE ACQUISITIONS UPM, in common with the forest industry in general, has undergone numerous restructurings. These can involve risks. SIGNIFICANCE OF BIGGEST CUSTOMERS While the company s dependence on any particular customer is limited, the loss of one or several important customers is possible. CHANGES IN EXCHANGE RATES Most of UPM s business is conducted in the euro-zone. Nevertheless, the company is still vulnerable to changes in exchange rates. The risk mainly concerns exports to the extent that product prices are in currencies other than the currency in which production costs are incurred. CUSTOMER CREDIT RISKS To reduce credit losses, the company has insured most of its trade receivables. Credit and payment times are monitored closely. AVAILABILITY AND PRICE OF MAJOR PRODUCTION INPUTS The rise in prices for the company s main production inputs has previously been fairly modest. Availability has been good. In some areas or in some activities there may nevertheless be disruptions in the prices and/or availability of production inputs. POLITICAL RISK Although the political situation is currently quite stable in those countries where the company has business activities, unexpected political developments may occur in some areas. AVAILABILITY OF MANPOWER Every effort is made to predict the risks associated with the availability of manpower and with the change of generation through career planning and by stepping up job rotation. STRATEGIC RISKS The company s present product portfolio and the wide geographic spread of its businesses help to even out business risks. However, this does not necessarily form the best basis for profitable business in the future. UPM ANNUAL REPORT

16 PAPER MARKETS Brisk economic growth coupled with a recovery in printed media advertising boosted global demand for paper. Prices in markets outside Europe rose during In Europe, prices for publication papers and for certain fine papers were raised at the turn of the year.

17 MARKETS THE MARKET Global economic growth in 2004 was the strongest seen for several years. This, combined with a feeling of optimism, boosted printed advertising, in particular direct mail advertising. In the most important markets, demand for UPM s main papers rose strongly and faster than the average. The fastest growth was in demand for coated grades. Deliveries by the paper industry to markets outside Europe remained strong in response to good demand. Prices embarked on a rise UPM paper divisions: Sales by market in 2004 m Magazine papers % Newsprint % Fine and speciality papers % Europe 2, , , USA and Canada Rest of world Total 3, , , Global demand for printing papers in 2004 Magazine papers in North America and Asia, but in Europe the rise in prices was deferred until the turn of the year because of contract arrangements and over-supply. Only a limited amount of new capacity came on stream in the main markets. MAGAZINE PAPER MARKETS in Europe and the United States grew at roughly the same rate, though in the United States demand for coated magazine paper rose at the expense of uncoated. In Europe, on the other hand, the market for uncoated magazine paper grew at Newsprint Fine papers million t/a Europe USA and Canada Rest of world Total kg per capita/a Europe USA and Canada Rest of world Total a slower pace than for coated grades. Magazine advertising recovered and the growth in volumes, notably in direct mail advertising, bolstered demand. With little new capacity coming on stream in the United States, the market was constrained almost all year, and price rises were introduced in stages. In Europe, no rise in prices was possible until the turn of The NEWSPRINT MARKET in Europe showed clear growth after several lacklustre years. Newspaper advertising developed in a positive direction. In the United States, demand for standard newsprint declined for the fourth year in succession, though this time only marginally. By contrast, demand for speciality newsprint was extremely strong on both continents. In Europe, newsprint prices fell slightly early in the year, but due to longterm contracts remained unchanged for the rest of the year. In the United States and other markets outside Europe prices rose in steps throughout the year. The MARKET FOR FINE PAPERS recovered in Europe, with demand rising faster than the average. Demand for coated fine paper was especially strong, but there was also brisk growth in demand for uncoated grades, including copier papers. Large investments, however, have resulted in over-capacity, and prices fell further during the year. Some price rises for coated grades were introduced in the second half of the year, but more substantial rises were targeted for the start of In Asia, demand continued to grow strongly despite changes in competition and raw material prices. The MARKET FOR SPECIALITY PAPERS developed positively. Demand for label papers exceeded supply and the market was good throughout the year. Prices rose appreciably, particularly during the second half of the year. The market for packaging papers showed a steady improvement and prices were raised during the year. UPM ANNUAL REPORT

18 MARKETS CUSTOMER SEGMENTS MAGAZINE PUBLISHERS There was a recovery in magazine advertising, particularly in North America but also in Europe. Advertising is being directed at new reader groups, and publishers have brought new lifestyle magazines onto the market. This trend is likely to continue in Retailers magazines and celebrity magazines have become extremely popular both in the United States and in Europe. In Russia, the range of magazines available has widened, a trend sustained by socioeconomic development and growth in advertising. The big international magazine publishers have further expanded their activities in Russia. Both these and Russian publishers have brought more new titles onto the market. In China, magazine advertising is booming, providing opportunities for both Chinese and international publishers. Magazine publishers are producing electronic web versions of their magazines. The aims are to provide readers with added value and to stimulate more interest in the printed publications. RETAILERS AND SALES CATALOGUES Both retail sales and advertising made positive progress during Consolidation and globalization continued among the leading retail chains. The biggest chains strengthened their market positions in central and eastern Europe and also in Asia. Several companies improved the efficiency of their purchasing and distribution logistics. Increasing interest is being shown in supply chain control systems based on radio frequency identification (RFID) technology. The use of several sales channels in parallel continued to become more common. Retailers are seeking to reach customers through their own stores as well as through sales catalogues and the Internet. The Internet offers new ways to present products, and this promotes both in-store sales and catalogue sales. PRINTERS Optimism among printers increased towards the end of the year in both Europe and North America. Many printers invested in new presses in order to raise efficiency levels and meet customers new requirements. Plans to build new printing plants were also announced during the year, notably in Great Britain. In Russia, printers are starting to invest in gravure printing. Continuing consolidation in the printing industry in both Europe and North America is providing a platform for success in the face of increasing competition. The development of printing technology is being driven by the need for shorter print 16 UPM ANNUAL REPORT 2004

19 MARKETS runs and by the growth in on-demand production. Some offset printing jobs are likely to go to digital printers. NEWSPAPER PUBLISHERS Following three years of consolidation, newspaper publishers turned their attention back to expanding their business and investing in new projects. Publishers bought new, high-capacity presses and brought onto the market new supplements and free-sheets. Plans to build new printing plants were also announced. To entice younger readers, many publishers experimented with tabloid formats instead of broadsheets. New sources of income were sought through the sale of books, CDs and DVDs in an attempt to improve profitability. Circulation figures continued to decline and the trend in advertising was unsatisfactory. Substantial cost-cutting helped some publishers to record improved financial results, in some cases quite considerably better. DIRECTORY PUBLISHERS Telephone directory publishers employ CDs, the Internet and mobile phone links in addition to traditional printed products. Growth in printed media was modest during Yellow pages represent the biggest growth area and main source of income for telephone directory publishers. Directory publishers retained their good level of profitability. This was particularly the case in Europe, where in most countries telephone directory publishing is dominated by one major player. Restructuring was again a feature in Europe, with national telephone companies the traditional owners con tinuing to sell off companies to capital investors and to seek stock exchange listings. In North America, the biggest market, the year was marked by continuing consolidations and intense competition between publishers. MERCHANTS The business environment last year was a challenging one for merchants. The traditional approach to business was affected by restructuring and by measures introduced to improve competitiveness. The primary goals continued to be improving profitability and preserving market shares. However, the drive for greater profitability was hampered by growth in the indent business and intensified competition. An increase in printers orderstocks and a general improvement in the market gave merchants the opportunity to meet their business goals. Growth in direct mail advertising laid the foundation for volume growth. UPM ANNUAL REPORT

20 MAGAZINE PAPERS MAGAZINE PAPERS Demand for magazine paper showed clear growth in Paper for direct mail advertising was in particularly good demand. PROFITABILITY Sales of the Magazine Papers Division were practically unchanged on the previous year. Deliveries increased by 2%. Profitability declined further from Although deliveries increased and operations became more efficient, operating profit was reduced by lower average prices in Europe and the effects of the weakened U.S. dollar. During the second half of the year profitability also suffered from rises in world market prices for certain oil-based raw materials such as latex, and from energy price increases in continental Europe and North America. Demand for coated magazine paper grew by 6% in Europe and by 8% in the United States. Magazine advertising recovered and 2004 was in many markets a record year for new magazine launches. Demand for uncoated magazine paper grew by 3% in Europe but declined by 3% in the United States as customers substituted some of their consumption with coated grades. The strong growth in direct mail advertising and the catalogue and insert markets continued to fuel magazine paper markets. Average sales prices for magazine papers fell by 3% in Europe. In the United States prices rose by 5% on average. CAPITAL EXPENDITURE AND RESTRUCTURING The rebuild of Rauma s paper machine no. 2 was completed in March at a cost of around 30 million. A second major investment a rebuild of Jämsänkoski s SC paper machine no. 6 will cost roughly 24 million. The work is due for completion in the first quarter of Miramichi pulp mill in Canada, which was part of the division, was closed down in December Magazine papers, key figures Sales, m 3,285 3,280 3,570 EBITDA, m % of sales Operating profit, m Amortization of goodwill, m Non-recurring items, m 1) Operating profi t excl. amortization of goodwill and non-recurring items, m % of sales Capital employed (average), m 4,754 5,089 5,396 Return on capital employed, % excl. non-recurring items, % Capital expenditure and acquisitions, m Personnel at 31 Dec. 8,825 8,887 9,325 Deliveries, 1,000 t 4,940 4,822 4,618 Capacity utilization rate, % ) Non-recurring items in 2004: Costs of 110 million from the closure of Miramichi pulp mill and gains of 6 million arising from the change in Finland s employment pension scheme. Non-recurring costs in are due to the closure of Blandin s two paper machines. The division comprises the Group s magazine paper machines, Kaukas and Miramichi pulp mills, and Miramichi s sawmills (see Fibre Supply, p. 33). 18 UPM ANNUAL REPORT 2004

21 MAGAZINE PAPERS For end-uses ranging from magazines, catalogues, magazine covers, advertising material, annual reports, brochures, direct mail advertising, inserts and supplements to manuals and books. UPM Finesse UPM Star UPM Ultra UPM Cote UPM Satin UPM Matt UPM Cat UPM Lux UPM Max UPM Eco

22 NEWSPRINT Demand for newsprint recovered in Europe. UPM further increased its use of recovered paper in newsprint production. NEWSPRINT AND MECHANICAL SPECIALITY PAPERS For a variety of end uses: newspapers, inserts, supplements, directories and advertising material. UPM Matt UPM Brite UPM Opalite UPM Color UPM News

23 NEWSPRINT PROFITABILITY Sales for the Newsprint Division were up by 2% on the previous year. Deliveries were up by 5%. Average prices in Europe were slightly lower than in Operating profit remained unsatisfactory. Although cost efficiency continued to improve, the recent price level has been too low for profitable operations. The price of the division s main raw material recovered paper was similar to the year before. On the other hand, energy costs have risen, especially at the mills in continental Europe. Newsprint demand grew by 5% in Europe as a result of the growth in newspaper advertising and classified ads. In the United States, despite strong economic growth demand for newsprint fell by 1%. Average sales prices for newsprint in Europe were 2% lower than in Prices in markets outside Europe, however, showed a clear rise. CAPITAL EXPENDITURE AND RESTRUCTURING UPM decided to invest 18 million in its Kaipola paper mill in Finland. The investment will increase the use of recovered paper in the mill s newsprint production. The project is scheduled for completion in the second quarter of The 100,000 t/a book paper machine (no. 17) and the old groundwood mill at Voikkaa paper mill in Finland were closed down on 1 May At Shotton paper mill in Great Britain, UPM is building a boiler plant to raise the mill s energy self-sufficiency. The cost of the investment is 60 million. Newsprint, key figures Sales, m 1,295 1,273 1,379 EBITDA, m % of sales Operating profit, m Amortization of goodwill, m Non-recurring items, m 1) Operating profit excl. amortization of goodwill and non-recurring items, m % of sales Capital employed (average), m 2,002 2,134 2,393 Return on capital employed, % excl. non-recurring items, % Capital expenditure and acquisitions, m Personnel at 31 Dec. 3,451 3,785 3,826 Deliveries, 1,000 t 2,719 2,587 2,467 Capacity utilization rate, % ) Non-recurring items in 2004 relate to changes in the Finnish pension scheme and in 2003 to the shutdown of Voikkaa PM 17. The division comprises the Group s newsprint machines. UPM ANNUAL REPORT

24 FINE AND SPECIALITY PAPERS FINE AND SPECIALITY PAPERS The most important growth area for the division is China, where UPM will start up a new paper machine in The machine will raise the mill s production capacity to 800,000 t/a. PROFITABILITY Sales for the division were 1% up on the previous year. Paper de liveries grew by 7%. Although increases in both deliveries and speciality paper prices improved profit ability, much lower fine paper prices and higher pulp costs resulted in lower operating profit. Demand for fine papers was strong in Europe. The growth was 8% in coated grades and 7% in uncoated grades. The Chinese market for fine paper continued to show robust growth. Average prices in Europe for coated fine papers were down by 4% and for uncoated fine papers by 6% compared with In China, prices fluctuated along with changes both in the competitive situation and in pulp prices. Label paper demand was strong throughout the year and prices were raised, especially towards the end of the year. The market for packaging papers was relatively stable, allowing prices to be raised. CAPITAL EXPENDITURE AND RESTRUCTURING UPM s biggest ongoing investment is the 450,000 t/a paper machine being built at Changshu near Shanghai in China. The cost of the project is roughly $ 470 million. The project has progressed well, and the new machine is due to start up in summer Modernization work at Pietarsaari pulp mill was completed in April 2004, raising capacity by 180,000 t/a to 800,000 t/a. The cost of the project was around 280 million. During the second quarter, UPM decided to invest about 60 million in developing production of release papers at its Tervasaari mill in Finland. The rebuild of paper machine no. 8 will raise production capacity by 45,000 t/a to 175,000 t/a. The project will be completed in summer Fine and speciality papers, key figures Sales, m 2,275 2,244 2,446 EBITDA, m % of sales Operating profit, m Amortization of goodwill, m Non-recurring items, m 1) 3 Operating profit excl. amortization of goodwill and non-recurring items, m % of sales Capital employed (average), m 2,640 2,621 2,657 Return on capital employed, % excl. non-recurring items, % Capital expenditure and acquisitions, m Personnel at 31 Dec. 6,831 6,654 6,611 Deliveries, 1,000 t 3,074 2,879 2,774 Capacity utilization rate, % ) Non-recurring gains in 2004 arise in the change in Finland s employment pension scheme. The division comprises the Group s paper machines producing fine and speciality papers, and Kymi, Wisaforest and Tervasaari pulp mills (see Fibre supply, p. 33). 22 UPM ANNUAL REPORT 2004

25 FINE PAPERS Coated and uncoated graphic papers for advertising material, annual reports, direct mail, brochures, magazines and maps. Offi ce papers for copying and printing, papers for digital and preprint applications, and a wide range of envelope papers. UPM Finesse UPM Fine UPM Offi ce Yes Future UPM Preprint UPM DIGI UPM Mail SPECIALITY PAPERS PACKAGING PAPERS Packaging papers for several end-uses e.g. fl our and sugar bags, high-performance sacks, fashion and carrier bags, envelopes, industrial converting for various heavy duty and technical applications, fl exible packaging. LABEL PAPERS For pressure-sensitive labelstock, both face papers and base papers.

26 CONVERTING The market for converted products, in particular for pressure-sensitive labelstock, was strong. The division recorded much better profitability.

27 CONVERTING Sales for the division increased by 3% compared with Deliveries increased and prices for certain converted products rose during the year. Profitability was much better than in Profitability benefited from stronger demand and price increases, as well as from internal rationalization measures. The strengthening of the euro against the U.S. dollar and the rise in prices for certain raw materials in turn weakened profitability. Projects aimed at achieving growth concerned the pressure-sensitive labelstock business and the production of siliconized papers. RAFLATAC Raflatac s sales grew by 6%. Growth in delivery volumes, more efficient production and higher sales prices for some products lifted operating profit. Results achieved from earlier efficiency measures also boosted profit. It was decided to invest $ 40 million in a new coating and finishing line at Raflatac s plant in Fletcher, North Carolina. The US market for pressure-sensitive labelstock is estimated to be growing at 4 6% a year. The investment will strengthen Raflatac s market position and diversify its product portfolio. The new capacity will go into production in the final quarter of Converting, key figures Sales by business unit m Sales, m 1,409 1,370 1,539 EBITDA, m % of sales Operating profit, m Amortization of goodwill, m Non-recurring items, m 1) 2 Operating profit excl. amortization of goodwill and non-recurring items, m % of sales Capital employed (average), m Return on capital employed, % excl. non-recurring items, % Capital expenditure and acquisitions, m Personnel at 31 Dec. 4,594 4,558 4,694 Paper production, 1,000 t Rafl atac Loparex Walki Wisa Units sold and other Internal sales ,409 1,374 1,541 1) Non-recurring income relating to changes in Finland s employment pension scheme. UPM ANNUAL REPORT

28 CONVERTING LOPAREX Sales by Loparex showed marginal growth. The demand for siliconized papers improved in North America, while in Europe the market stabilized. Asian markets moved in a positive direction. Loparex recorded clearly better profitability. Raw material prices rose during the second half of the year, adversely affecting financial results. Loparex started up a new production line at Guangzhou, China, in the third quarter of The new capacity will meet the growing demand in Asia. WALKI WISA Walki Wisa s sales decreased somewhat. The market for industrial wrappings in Europe improved. Delivery volumes were the same as during the previous year. There was little change in profitability. Walki Wisa s plant in Great Britain underwent a reorganization in The unit s printing plant in the United States was closed down because of its poor profitability. Other internal measures to improve financial results are continuing. TWO BUSINESS AREAS FROM START OF 2005 UPM s Converting Division comprises two business areas: Labelstock (Raflatac and UPM Rafsec) and Speciality Coatings (Loparex and Walki Wisa). 26 UPM ANNUAL REPORT 2004

29 CONVERTING CONVERTING UNITS AND MAIN PRODUCTS RAFLATAC Pressure-sensitive labelstock for product and information labelling. Production plants in Finland, Spain, Great Britain, France, the United States, Australia, Malaysia, China and South Africa. UPM Rafsec from 1 January Production based in Finland. LOPAREX Siliconized release materials for hygiene products, labels and industrial applications. Production plants in Finland, Great Britain, the Netherlands, the United States and China. WALKI WISA Wrappings for the paper, steel and wood products industries. Composite materials for the packaging industry and technical purposes. Production plants in Finland, Germany, Great Britain and China. UPM ANNUAL REPORT

30 WOOD PRODUCTS Plywood markets strengthened, but sawn timber markets continued to be over-supplied. 28 UPM ANNUAL REPORT 2004

31 WOOD PRODUCTS THE MARKET Spruce plywood, which is used mainly in construction, was in good demand all year. Demand for birch plywood began to rise during the second half of the year. With sawn timber markets over-supplied, prices were low all year. The market for processed goods was better. Demand for building supplies in Finland remained good thanks to brisk activity in both new building and repairs to existing buildings. PROFITABILITY The division s profitability was better than the previous year but was still unsatisfactory. Sales were 4% down on the previous year due to the sale of the two wood-based building supplies businesses Brooks Group and Anco Træ. The profitability of the plywood business began to improve during the second half of the year. Sawmilling profitability declined further and operations showed a substantial loss. The reasons were oversupply and, most significantly, high log prices. The availability of domestic wood in the second half of the year was affected by adverse weather conditions, and production had to be curtailed. Sales of wood-based building supplies were 519 million (608 million). Comparable profitability remained unchanged. Wood products, key figures Sales, m EBITDA, m % of sales 5,1 4,7 5,6 Operating profit, m % of sales 7,2 1,4 2,2 Amortization of goodwill, m Non-recurring items, m 1) 83 Operating profit excl. amortization of goodwill and non-recurring items, m % of sales 1,6 1,4 2,2 Capital employed (average), m Return on capital employed, % 14,3 2,7 4,3 excl. non-recurring items, % 3,2 2,7 4,3 Capital expenditure and acquisitions, m Personnel at 31 Dec Production, 1,000 m 3 Plywood Sawn timber ) Non-recurring items in 2004: Gains of 110 million from the sale of Brooks Group, costs of 34 million from restructuring of sawmilling and plywood production in Finland, and gains of 7 million arising from the change in Finland s employment pension scheme. UPM ANNUAL REPORT

32 WOOD PRODUCTS CAPITAL EXPENDITURE AND RESTRUCTURING Pestovo sawmill in Russia started production in spring The sawmill has an annual capacity of approximately 300,000 cubic metres. UPM sold the wood-based building supplies chains Anco Træ in April and Brooks Group in August. The two companies had combined sales of 265 million in 2003 and employed 620 people. In autumn 2004, UPM decided to make adjustments to its production in Finland. Aureskoski sawmill and Viiala plywood mill were closed down at the end of the year. It was also decided to close down Kuopio plywood mill by the end of August Production at both Alholma and Kajaani sawmills will be cut by about a third. This will reduce annual plywood production capacity by 70,000 cubic metres and the annual output of sawn timber by almost 400,000 cubic metres. Roughly 670 jobs will be shed by the end of In view of this, UPM launched an extensive relocation programme in WOOD PRODUCTS PLYWOODS AND VENEERS High-quality WISA plywoods and veneers, mainly for building, interiors and transport equipment 13 production plants in Finland, 1 in France, 1 in Estonia and 2 Russia SAWN TIMBER Wide selection of WISA products ranging from standard products to complete components and mouldings, mainly for the building and joinery industries 7 sawmills and 6 processing facilities in Finland, 1 sawmill in Austria and 1 in Russia WOOD-BASED BUILDING SUPPLIES TRADE Puukeskus, Finland Sales by business area Sales by market m m 2004 % Plywood Sawmilling Building supplies trade Other and internal sales ,486 1,549 1,487 Finland Other EU countries Other European countries 41 2 North America 14 1 Rest of world , UPM ANNUAL REPORT 2004

33 OTHER OPERATIONS OTHER OPERATIONS OTHER OPERATIONS The biggest units of UPM s Other Operations are the forestry and energy departments in Finland. Approximately 75% of these units sales are within the Group. The biggest of the logistics companies responsible for the forwarding, storage and export transport of UPM s products are Rauma Stevedoring Oy, UPM-Kymmene Seaways Oy and Interot Speditions GmbH. The New Ventures unit develops new products and services that are expected to support the company s future business operations. The Real Estate unit comprises business and residential premises in Finland. Other Operations also includes Group staff functions, shares in the results of associated companies and joint ventures, and shareholdings. The results of associated companies are reported after operating profit. The most important associated companies are Metsä-Botnia and Pohjolan Voima. The forestry department returned a better operating profit than the year before. Wood procurement volumes rose, while average prices for wood fell slightly. The energy department also recorded a better operating profit. The company used its own energy resources as well as the plentiful supply of hydropower. The result of the hedging of cash flows in foreign currencies is reported under Other Operations. The impact of this hedging in 2004 was 26 million positive. Other operations, key figures Sales, m 1) Operating profit, M 2) of which Forestry department, Finland Energy department, Finland Other and eliminations Operating profit excl. non-recurring items, m Capital employed at end of period, m 3,351 3,187 3,329 Capital expenditure and acquisitions, m Personnel at 31 Dec. 2,881 2,887 3,546 Associated companies and joint ventures in Other Operations Share of results before tax, M 3) Metsä-Botnia Pohjolan Voima Other Total ) Includes sales outside the Group. 2) Operating profit for 2004 includes the following non-recurring items: income of 249 million arising from the change in Finland s employment pension scheme and provisions totalling 30 million relating to the Group s restructuring and wood procurement contracts. Non-recurring items in 2003: costs of 19 million arising from the cancelled MACtac deal, losses of 6 million on the sale of the Rosenlew business, and costs of 5 million arising from restructuring of the forestry department in Finland. 3) The 2004 figure includes income of 10 million arising from the change in Finland s employment pension scheme, of which 6 million from Metsä-Botnia, 3 million from Pohjolan Voima and 1 million from other companies. UPM ANNUAL REPORT

34 FIBRE SUPPLY UPM s pulp production capacity rose by 180,000 t/a following the modernization at Wisaforest s Pietarsaari mill. 32 UPM ANNUAL REPORT 2004

35 FIBRE SUPPLY CHEMICAL PULP UPM is about 90% self-sufficient in chemical pulp. Fluctuations in market pulp prices therefore have only a small impact on profits. Global market pulp capacity increased during the year. Prices rose during the first half of the year, but fell rapidly during the summer months. During the latter part of the year demand recovered and prices rose. The price differential between short and longfibre pulps remained high as a result of increased supplies of short-fibre pulp. The average price of bleached long-fibre pulp in Europe was $615/t (525), while that of short-fibre pulp was 419/t (446). High capacity utilization rates at paper mills raised pulp consumption. The pulp mills operated at 92% of capacity compared with 87% in The new cooking chemicals line at Pietarsaari pulp mill came on stream at the end of April, raising production capacity by 180,000 t/a. At the year-end, UPM s own pulp production capacity totalled 2.3 million t/a. The associated company Metsä-Botnia had a capacity of 2.7 million t/a, of which UPM s entitlement was almost 1.1 million tonnes. At the end of September UPM announced a reorganization for its Miramichi mill. This included closing down the pulp mill. This was effected in December, reducing pulp production capacity by 240,000 t/a. The chemical pulp needed by Miramichi paper mill is now supplied partly from UPM s own mills in Finland and partly through increased purchases of market pulp. RECOVERED PAPER UPM is one of the world s leading consumers of recovered paper: in 2004 the company used 2.8 million tonnes of this fibre raw material. About half of this paper is purchased under long-term contracts, usually for a year at a time. The market for recycled fibre was stable all year. On average, prices were marginally lower than the year before. Availability was good. METSÄ-BOTNIA UPM owns 47% of Oy Metsä-Botnia Ab, one of Europe s biggest pulp producers with a capacity of 2.7 million t/a. The other owners are the Metsäliitto Group company M-real Corporation (47%) and Metsäliitto Cooperative (6%). Metsä-Botnia produces softwood and birch pulps at five mills in Finland. Most of this pulp is supplied to the company s owners. Sales in 2004 were 1,063 million, and at the end of the year the company had 1,359 employees. UPM purchased 568,000 tonnes of pulp from Metsä-Botnia in Metsä-Botnia has investigated the possibility of building a pulp mill, capacity around 1 million t/a, in Uruguay. A final decision will be taken in the first months of Pulp production and consumption Pulp production capacity 1,000 t/a ,000 t/a January 2005 Pulp production Chemical pulp own production 2,241 2,027 2,102 from associated company Mechanical pulp 2,902 2,952 2,951 Recycled fibre pulp 2,257 1,875 1,735 Total 7,968 7,459 7,382 Pulp consumption Chemical pulp 3,290 3,139 3,161 Mechanical pulp 2,948 3,002 2,988 Recycled fibre pulp 2,259 1,877 1,737 Total 8,497 8,018 7,886 Kaukas 730 Wisaforest 800 Kymi 525 Tervasaari 240 Own production capacity, total 2,295 Entitlement to associated company s capacity corresponding to UPM s shareholding 1,100 Total 3,395 The Kaukas pulp mill is part of the Magazine Papers division, and the Kymi, Wisaforest and Tervasaari pulp mills belong to the Fine and Speciality Papers division. UPM ANNUAL REPORT

36 WOOD PROCUREMENT WOOD PROCUREMENT UPM carefully verifies the origins of its wood raw material. Consumption of wood raw material by the UPM Group totalled 26.7 million m 3 (26.3). To secure supplies of wood to its own mills, UPM also procures and supplies wood to outside customers. In Finland, 71% of wood raw material was used for papermaking (69) and 29% in the manufacture of wood products (31). Besides supplying UPM s own mills, the forestry department supplied 4.4 million m 3 of wood to associated companies and other outside customers (4.6). Wood trading followed the usual course during the year, and purchases from private forests were 6% up on the year before. The exceptionally wet weather and the resulting heavy demand for stands readily accessible for harvesting pushed stumpage prices up, in particular those for logs, during the second half of the year. However, wood prices at the mills were on average slightly lower than the year before. In mainland Europe, UPM s paper mills in Germany, France and Austria used 69% of the wood raw material (68) and the Wood Products Division principally the sawmill in Austria used 31% (32). UPM stepped up its wood procurement operations in Germany by acquiring an interest in a private wood procurement company there. Competition for wood increased, although an inventory of Germany s forests has shown that utilization of wood raw material can be increased. UPM s wood consumption in Great Britain has fallen as Shotton paper mill s production is now based entirely on recycled fibre. The British forest products industry operated at high capacity and this, coupled with increased wood exports, boosted demand for wood and put pressure on prices. In Russia, UPM is setting up a company to procure wood for its production plants there as well as wood for export to Finland. Imports of wood to Finland totalled 3.2 million m 3 (4.0). As in Finland, wood procurement was hampered by bad weather. In Estonia, the company responsible for supplying wood to Otepää plywood mill also supplied a total of 0.6 million m 3 to Finland (0.1). In North America, the closure of Miramichi pulp mill will reduce UPM s wood consumption in Canada. Competition was fierce for pulpwood in the USA and for sawmill UPM s wood consumption Forests owned or managed by UPM m Finland 21,480 20,910 20,960 Austria Germany France Russia Great Britain Estonia Canada 2,140 2,080 2,140 United States Total 26,710 26,310 26,340 1,000 hectares Own forests Managed/ leased forests Finland Great Britain United States 79 Canada Uruguay (joint venture) UPM ANNUAL REPORT 2004

37 logs in Canada. Supply and demand for pulpwood were in balance in Canada, and there was even an over-supply of some species. Forest wood for energy production equivalent to 1,262 GWh was supplied to the company s power plants in Finland (994) and 121 GWh to outside customers (111). UPM procures energy wood in other areas where it has its own wood procurement operations. FOREST CERTIFICATION AND WOOD ORIGINS Issues of particular interest to customers were forest certification, the legality and origins of wood, and imported wood. UPM keeps close track of the origins of all the wood it uses and continues to further develop chain of custody schemes. Forest certification and a chain of custody for wood together ensure that the wood used comes from sustainably managed forests. At the same time the legality of the wood can be confirmed. All forests owned by UPM are certified. In summer 2004, UPM began a study to compare forest certification systems in three countries. The purpose is to promote the use of forest certification, improve the company s own forestry work, to increase mutual recognition of different forest certification schemes and to further develop their content. UPM ANNUAL REPORT

38 ENERGY ENERGY The rising cost of energy had no material impact on UPM s profitability as the company is largely self-sufficient in electrical energy. In 2004, UPM procured 21.0 TWh of electricity (19.9), of which 18.5 TWh was consumed by the Group s own mills (18.1) and 2.5 TWh was sold (1.8). Because the Group is largely self-sufficient in electric power, the price of electricity purchased for the Group s own use in Finland has remained fairly stable. Changes in spot prices on the Nordic electricity exchange had no significant impact on energy costs. The Group s own generating capacity, plus that leased and available through interests in associated companies, totalled around 2,196 MW at the end of the year. The most important associated company in terms of energy is Pohjolan Voima Oy (PVO). UPM also owns 19.0% of Kemijoki Oy s hydropower shares. Heat generated from fuel procured by the Group, plus purchased heat and heat generated by thermomechanical pulping totalled 39.2 TWh (36.6). The energy generated from forest-based fuel exceeded 1.25 TWh in 2004 and the figure is still rising. Biofuels accounted for 58% of total fuel procurement (56). UPM and PVO have continued their programme to build power plants designed to burn biofuels. The world s largest and most modern pulping chemicals recovery plant went into operation at the Pietarsaari mill in The steam generated by this plant is used to produce both electricity and heat for the mill. Plentiful rainfall during the year boosted UPM s own generation of hydropower as well as that leased and available through associated power companies. Hydropower accounted for a record 15% of total electricity procurement. Making greater use of biofuels and nuclear power reduces carbon dioxide emissions from fossil fuels. UPM has made preparations for the start of emissions trading in the EU from 1 January Applications for emission allowances and emission permits for the Group s mills were made during autumn POHJOLAN VOIMA (PVO) UPM owns 41% of the industry-owned Finnish power company PVO, which generates and procures some 20,000 GWh of electricity and heat annually for its shareholders. Energy supplied by PVO covers about 40% of UPM s total electricity requirement. Most of this amount is hydropower and nuclear power. In 2004, PVO had sales of 565 million, and employed, at year-end, 177 people. Teollisuuden Voima Oy, which is owned 57.2% by PVO, has started to build a 1,630 MW nuclear power plant at Olkiluoto in Finland. The work is going ahead on schedule and the start-up is planned for UPM has reserved, through PVO, a 468 MW share in the plant s output. The aim is to secure supplies of electric power at a stable, favourable price for UPM s mills in Finland and mainland Europe well into the future. UPM invested 40 million in buying this share of the output at the end of the year. 36 UPM ANNUAL REPORT 2004

39 Electricity procurement and consumption TWh Procurement Hydropower shares Back-pressure power Nuclear power shares Thermal energy shares Purchased electricity Total Consumption Mills in Finland Mills outside Finland Sales Total Sources of thermal energy TWh Black liquor Bark and other biofuels Heat recovered from TMP production Peat Purchased heat Natural gas Oil Coal Total

40 CAPITAL EXPENDITURE Capital expenditure focused on rebuilds and new production units.

41 CAPITAL EXPENDITURE Capital expenditure, excluding company acquisitions, was 645 million, 6.6% of sales (2003: 703 million and 7.2%). A total of 41 million was used for company acquisitions (17 million). Maintenance and repair investments in existing production machinery totalled 253 million (278). 392 million was invested in machine conversions and in new production units and lines (425). Sales of shares and other fixed assets totalled 311 million (255). The biggest was the sale of the Brooks Group buildings supplies chain in Ireland for 213 million. Also during the year, UPM sold Anco Træ, its wood-based buildings supplies retail chain in Denmark. The most important projects completed during the year concerned modernizations to Wisaforest s pulp mill and to Rauma s paper machine no. 2. In both cases, start-up was actually earlier than planned. Installation work on Changshu s new fine paper production line has progressed on schedule. The new paper machine is due to start up in summer In the United States, Raflatac began construction of a new laminating line in September. The additional capacity, which will come on stream in the second half of 2005, will strengthen Raflatac s position in the North American market. Capital expenditure and acquisitions by country, m Finland Germany , Great Britain Canada ,011 United States China Austria Russia Other European countries Rest of world Total ,850 2,175 Main ongoing investment projects Cost in 2004, m Total cost Due for completion Changshu paper machine project (2003: 45) /2005 New power plant, Shotton 60 11/2006 Tervasaari PM 8, additional capacity /2005 New coater line, Rafl atac, Fletcher /2005 New power plant, Rauma 20 12/2006 UPM ANNUAL REPORT

42 RESEARCH AND DEVELOPMENT RESEARCH AND DEVELOPMENT UPM s research work helps the company and customers to succeed by providing better quality products more cost-effectively. UPM s research and development work is divided between its own product and process development and work conducted with universities, research institutes and suppliers of materials. In 2004, the company spent roughly 47 million on research and development projects (48), which corresponds to 0.5% of sales (0.5). Important development work is also carried out in conjunction with production line modernizations. COLLABORATION WITH UNIVERSITIES AND RESEARCH INSTITUTES UPM owns 39% of the Finnish Pulp and Paper Research Institute, which is owned collectively by the pulp and paper industry in Finland. Other research institutes with which UPM works include Papiertechnische Stiftung (PTS) in Germany, Centre Technique du Papier (CTP) in France, and Paprican (Paper Research Institute) Canada. The company also works closely together with universities and every year sponsors numerous postgraduate research projects connected with the company s products and manufacturing technologies. PRODUCT AND PROCESS DEVELOPMENT UPM s own research projects are aimed at developing the company s products and manufacturing processes. Development work conducted by the PAPER DIVISIONS is aimed at providing customers with tailor-made papers that are competitive and have the right quality for each end use. Improving cost-effectiveness means reducing raw material costs and energy consumption. Work is constantly being done to expand the range of fibre raw materials and to manage energy consumption more efficiently. The manufacture of publication papers has been made more cost-effective by making increasing use of recycled fibre and of minerals costing less than wood fibre, and by using less of the more expensive chemical pulp. In fine paper manufacture, the proportions of short-fibre birch pulp and minerals have been increased. Process research by the paper divisions is aimed at achieving more consistent quality and at reducing specific consumptions and wastes. Testing and introduction of new technical solutions together with machinery and equipment manufacturers continued. This has led to better product quality and more efficient production. The range of fibre raw materials has been extended in order to support growth, particularly in the fine papers business. Work is also being done to modify the properties of fibres from different wood raw materials for optimum end-use suitability. UPM s own softwood pulps have been developed to provide even better raw material for the manufacture of magazine papers. The properties of the fibres present in wood from forest thinning have been used to develop a new type of pulp that is particularly suitable for the production of speciality papers. In CONVERTING, Raflatac has upgraded its filmic products using new adhesives and top coats. At the end of the year, Raflatac also conducted the first successful commercial tests with freshness indicator labels for food packages. UPM Rafsec has been playing an active role in standardization work for the air interface protocol for UHF frequency, which is fundamental to the further development of this technology. UPM Rafsec has also made commercially available its own UHF tags, which are now being used by several major retail companies. Development work conducted by Loparex has been aimed at direct customer applications notably in the USA. New applications for solventless coating have been developed at all factories. The Lohja factory has devel- 40 UPM ANNUAL REPORT 2004

43 RESEARCH AND DEVELOPMENT oped new products that will strengthen its competitiveness. The focus of development by Walki Wisa has been on new composite materials for the manufacture of packagings and insulation materials. Product development work by the WOOD PRODUCTS DIVISION mainly concerned new coating techniques. Good examples of these are the range of WISA-Multi products designed for the transport vehicle and building industries, and WISA-Form Elephant, a product specially designed for concrete formwork. Other focal points in product development included more effective management of wood raw material properties with the aim of responding better to the demands imposed by end-product applications. NEW VENTURES New Ventures develops products and processes based largely on new technology, and thus seeks to support UPM s future business operations. Special attention is being given to coating, wood and fibre-based materials, waste utilization, and new technologies and products for reel-to-reel production. Ideas and innovations are sought both internally and from outside partners. UPM ANNUAL REPORT

44 ENVIRONMENT UPM s aim is to handle its environmental affairs in an exemplary manner. UPM seeks to deal with all environmentrelated issues in compliance with ISO standard Since August 2004, all UPM s pulp and paper mills, as well as the Wood Products Division s production plants in Finland, have had environmental management systems approved by a third party. Four of the Converting Division s plants also have certified systems. All UPM s pulp and paper mills in Finland, and most of those elsewhere in Europe have also received approval for their systems under the EU s EMAS scheme. UPM s Finnish pulp and paper mills published a joint EMAS report for WASTE MANAGEMENT THE FOCUS OF DEVELOPMENT Ways to reduce waste volumes and to make use of waste are under constant development. The amount of waste taken to landfill sites still needs to be reduced, especially in Finland. UPM is actively involved in several projects aimed at promoting the use of waste. 42 UPM ANNUAL REPORT 2004

45 ENVIRONMENT Most of the solid waste from pulp and paper mills is ash from power plants. In the Converting Division, mixed waste is used for landfill. The potential for using waste varies from one country to another and depends on local legislation and practices. In Finland, for example, ash is usually taken to landfill sites, whereas in Germany and China almost all ash is used as raw material for cement production. Reducing water consumption is the aim at all pulp and paper mills. Cutting water consumption lowers the mill s environmental loading and improves energy economy. During 2004, water consumption was reduced at the Augsburg, Stracel, Shotton and Changshu mills. The Changshu mill also succeeded in cutting the chemical oxygen demand (COD) of its treated wastewater by 25%. Closure of Miramichi s old pulp mill in December 2004 will considerably improve the Group s environmental balance sheet. Bringing the mill into line with UPM s requirements for environmental protection would have necessitated substantial investment. NO SERIOUS EFFLUENT DISCHARGES IN 2004 The abnormally high effluent discharge that occurred at Kaukas pulp mill in summer 2003 led to a reappraisal of risks throughout the Group and to improvements in communications in crisis situations. Action plans were drawn up based on the risks associated with pulp production in particular. FUTURE CHALLENGES: CLIMATE CHANGE AND CHEMICALS LEGISLATION The EU s emissions trading scheme took effect at the beginning of UPM has been reducing carbon dioxide emissions from fossil fuels by using more wood-based fuels in its energy production. Where woodbased fuels cannot be used, UPM has replaced fossil fuels with natural gas. The use of energy has been made more efficient at all mills. The challenge now is to find ways to reduce carbon dioxide emissions still further. Fuel availability varies greatly from one country to another. In the United States, Scotland and China, for example, coal is still the main fuel. The EU is revising its legislation on chemicals by introducing a new registration system for chemicals known as REACH. This will harmonize practices for the registration, evaluation and authorization of chemicals. The new regulations will apply to all branches of industry where chemicals are either produced or used. UPM has prepared for the introduction of REACH and has examined its possible impacts on operations and costs. The new regulations are due to come into effect in 2007 at the latest. ENVIRONMENT-RELATED INVESTMENT AND OPERATING COSTS The most important project in terms of its environmental impact was modernization work at Pietarsaari pulp mill, which was completed in spring Specific emissions from the mill have fallen as planned. UPM s use of recovered paper continues to rise. The Kaipola mill is raising its deinking capacity to 210,000 t/a. The expansion will be complete in summer Investments in measures to reduce environmental loadings or reduce environmentrelated risks totalled 55 million in 2004 (37). Operating expenditure on environmental protection, including depreciation, was 112 million (109). Figures for 2000 do not include Changshu and Miramichi; figures for 2001 do not include Haindl. 1) Figures for Augsburg, Blandin and Caledonian not included. COD is not measured at Blandin. Wastewater at Augsburg and Caledonian is treated in municipal treatment plants. 2) Waste also includes building and demolition waste. UPM ANNUAL REPORT

46 PERSONNEL Special emphasis in 2004 was given to occupational health and safety. 44 UPM ANNUAL REPORT 2004

47 PERSONNEL The number of UPM s employees was 34,482 at the start of the year and 33,433 at the end. This represents a decrease of 1,049, of which about 600 resulted from business disposals. Other reductions were achieved largely through natural attrition. The closure of Miramichi pulp mill in Canada and the restructuring of wood products production in Finland affected a large number of workers. Special programmes were instigated to assist those who are losing of will lose their jobs. In Finland, this mainly involved relocations and re-training. WORK SATISFACTION An opinion survey covering all employees within the Group was conducted in autumn The aim was to assess the present situation and identify the main areas for further development. The results showed a fairly good level of satisfaction among the personnel. The company s main strengths were considered to be its corporate image and reputation, the way work is organized, customer focus, and cooperation and teamwork. Areas chosen for further development were the work of superiors, cooperation and teamwork. OCCUPATIONAL HEALTH AND SAFETY New occupational safety arrangements have now been almost completed at the largest units. One of the main aims was to reduce the number of accidents, and this was achieved. Overall, absenteeism through illness increased, although figures at several units actually fell. A new occupational health and safety network encompassing the entire Group was set up to assist the units to achieve their occupational health and safety targets. Personnel by country at end of year Key indicators Sales per person, 282, , ,000 Value added per person, 124, , ,000 Remunerations based on financial performance, m Training costs, m Average no. of days spent in training Personnel turnover, % No. of man-days lost through strikes 14,700 6, Calculation of key indicators: Sales per person = Sales / average no. of employees Value added per person = Sales materials and services / average number of employees Training costs = Training costs incl. salaries and indirect employee costs Average no. of days spent in training = No. of days of training / average no. of employees Personnel turnover, % = No. of persons leaving / average no. of employees x 100 Finland 18,720 19,401 19,873 Germany 4,311 4,333 4,385 Great Britain 1,852 1,960 2,001 France 1,712 1,771 2,032 Russia Austria Spain Estonia The Netherlands Italy Belgium Sweden Hungary Poland Denmark Ireland Other Europe United States 1,571 1,526 1,968 Canada 1,296 1,414 1,449 China 1, Malaysia Australia South Africa Rest of world Total 33,433 34,482 35,579 UPM ANNUAL REPORT

48 PERSONNEL INCENTIVE SCHEMES Rewards paid to employees are based on the return on capital employed. Rewards are paid if the return on capital employed exceeds a pre-set minimum target. Rewards paid under the profit-sharing scheme for 2004 totalled 9 million (6). The company also operates incentive schemes based on achievement of personal targets and increased productivity. LEARNING AND JOB ROTATION A new training course was started for those just embarking on their careers. The idea is to develop participants management skills and prepare them for demanding duties. During the first year 50 persons took part. For those graduating from university UPM offers an international development programme. The vocational training arranged in conjunction with the Changshu paper mill project in China is a good example of what can be achieved. By working together, UPM s vocational training school and its local counterpart in China have provided 170 students at the Changshu school with basic knowledge of papermaking and equipped them with the basic skills needed for work in a paper mill. UPM encourages its employees to take advantage of job rotation opportunities. Job rotation promotes the exchange of information, improves networking and helps individuals to develop themselves. In 2004, 123 employees were involved in job rotation internationally. HUMAN RESOURCES POLICY UPM s human resources policy is based on equality in job applications and career advancement. Rules have been produced for equality to support the human resources policy and to clarify definitions. PENSION SCHEMES The company s pension schemes are specific to each country and unit. In Finland, the pensions of 93% of UPM s employees are arranged through pension insurance companies, and the remaining 7% through UPM s own pension funds. Outside Finland, about 40% of employees are members of defined contribution plans and about 60% are covered by defined benefit plans. 46 UPM ANNUAL REPORT 2004

49 EVENTS IN 2004 EVENTS IN 2004 JANUARY 29 The Board of Directors accepted Juha Niemelä s resignation from the position of President and CEO. Mr Niemelä also announced his resignation from the Board of Directors. At the same meeting, the Board of Directors appointed Senior Executive Vice President and COO Jussi Pesonen as the Group s new President and CEO. MARCH 24 The Annual General Meeting approved the Board of Directors proposal to buy back a minimum of 100 and a maximum of 26,178,900 of the company s own shares. The meeting authorized the Board of Directors to decide on an increase in the share capital through the issuance of new shares and/or convertible bonds in one or more issues. The number of new shares issued or subscribable through bond conversions may not exceed an aggregate maximum of 104,715,000 new shares, each with an equivalent value of 1.70, and the resulting increase in the company s share capital may not exceed 178,015, UPM announced it would double the manufacturing capacity for Radio Frequency Identification (RFID) smart labels and cards at the UPM Rafsec plant in Jyväskylä. APRIL 1 UPM sold Anco Træ, its chain of wood-based building supplies outlets in Denmark. 27 UPM announced its intention to invest in developing the production of release paper for pressure-sensitive label stock at its Tervasaari mill in Valkeakoski. The investment will raise the paper machine s capacity by 45,000 t/a. 28 UPM announced it would increase the use of recovered paper by raising deinking capacity at its Kaipola paper mill to over 210,000 t/a. MAY 1 Paper machine no. 17 and the old groundwood mill at Voikkaa paper mill were closed. 4 UPM received a statement of objection from the European Commission concerning alleged antitrust activities in the market for plastic industrial sacks. The company manufactured plastic industrial sacks until December UPM Pestovo sawmill in Russia was officially opened. 25 UPM announced that the European Commission s competition authorities had carried out inspections at several of the company s premises. The inspections were connected with the competition authorities investigations into alleged antitrust activities. The European Union, several of its member states and the Canadian authorities informed UPM that it has received conditional full immunity with respect to certain conduct disclosed to the authorities. UPM ANNUAL REPORT

50 EVENTS IN 2004 JUNE 23 UPM announced that during the summer it would begin field testing to compare forest certification schemes in three countries: Finland, Great Britain and Canada. The study will compare national forest certification schemes with the international PEFC and FSC schemes in forests owned or managed by UPM. WWF is acting as an observer for the study. JULY 1 UPM announced it was launching a feasibility study concerning the building of a new printing paper machine at its Blandin paper mill in Minnesota. 30 UPM announced it was to sell the Brooks Group Limited building supplies chain in Ireland to Wolseley plc for 213 million. The sale took effect on 1 September AUGUST 19 UPM acquired a minority interest in the German timber harvesting company Lignis GmbH & Co. KG. 24 The new chemicals recovery line at UPM s Wisaforest pulp mill in Pietarsaari was officially inaugurated. 25 UPM announced that all its pulp and paper mills have ISO environmental management systems verified by a third party. The last such certificate was granted to UPM s Miramichi mill in Canada in July The first mill to receive certification was Kymi in UPM started negotiations with employees at three of its sawmills and two plywood mills in Finland and at the Wood Products Division s head office. As a result of these negotiations, production at Viiala plywood mill and Aureskoski sawmill ceased at the end of Kuopio plywood mill will close at the end of August Production at the Alholma and Kajaani sawmills has been greatly reduced. On conclusion of the talks, UPM launched a wide-ranging relocation and re-training programme. SEPTEMBER 6 UPM received its first-ever recognition as the sector leader in the forest products industry in the Dow Jones Sustainability World Indexes (DJSI World). 14 UPM announced it would increase coating capacity for pressure-sensitive labelstock at Raflatac s plant at Fletcher, North Carolina, USA. The investment features a second coating line designed for the production of synthetic labelstock. 24 UPM announced an investment to improve paper quality at its Caledonian Paper mill in Scotland. 29 UPM announced a major restructuring of its Miramichi mill in Canada with the aim of securing the mill s longterm profitability. As part of this, UPM decided to close down Miramichi s old pulp mill. The mill was closed on 10 December OCTOBER 25 UPM strengthened its wood procurement operations in Russia by acquiring the Russian wood procurement business of Aranna Oy. NOVEMBER 15 UPM announced it was withdrawing from a planned joint venture in Zhanjiang in the Guangdong province of China. 19 Loparex, a member of UPM s Converting Division, officially opened its mill in Guangzhou, China. The mill produces siliconized release materials. DECEMBER 8 UPM announced a 4.5 million investment for its Kaukas plywood mill. 10 UPM announced that, as of 1 January 2005, its Converting Division would consist of two businesses. Heikki Pikkarainen was appointed President of the Labelstock business and a member of UPM s Executive Team. Matti J. Lindahl was appointed President of the Speciality Coatings business. He continues as a member of UPM s Executive Team. 16 UPM announced it was to build a boiler plant at its Shotton paper mill in North Wales, Great Britain. The main fuel for the new boiler will be deinking sludge, with biomass as cofuel. 17 UPM announced the construction at Rauma paper mill of a power plant as a joint venture with Rauman Energia Oy. The new power plant will use forest energy in the form of bark, logging waste and peat, with biosludge as auxiliary fuel. 31 The state prosecutor in Finland informed UPM that no prosecutions would result from the discharge of effluent from Kaukas pulp mill in summer UPM ANNUAL REPORT 2004

51 GROUP REPORT OF THE BOARD OF DIRECTORS THE MARKET IN 2004 Demand for paper grew faster than general economic growth in Europe, the company s main market. There was a sharp rise in printed advertising, boosting demand for coated papers in particular but also for newsprint. The same trend was visible for coated papers in North America. In Asia, demand continued to grow strongly, especially in China. Global paper manufacturing capacity increased more slowly than demand, thus improving the balance between supply and demand. Average prices for magazine papers in Europe were somewhat lower compared with the previous year. In the United States average prices rose. Newsprint prices in Europe fell slightly but increased in the United States and Asia. Fine paper prices in Europe fell as a result of plentiful supply. In China, prices fluctuated during the year. Prices for label and packaging papers were raised. The markets served by the Converting Division showed an improvement on Demand for self-adhesive labelstock grew in all markets. Raflatac enjoyed robust growth, especially in North America. Demand for siliconized papers developed well in North America and the situation in Europe also strengthened during the year. Demand for industrial wrappings grew. The markets for plywood improved and prices were raised during the second half of the year. The oversupply in sawn timber continued and prices remained low. Trading conditions for wood-based building supplies in Finland remained good. EARNINGS FOURTH QUARTER OF 2004 COMPARED WITH THIRD QUARTER Sales for the fourth quarter were 2,423 million, compared with 2,449 million for the third quarter. Operating profit was 197 million (250 million for the third quarter). Operating profit includes net 95 million in non-recurring income. Following changes to Finland s employees pension scheme (TEL), the disability pensions arranged with insurance companies has been treated in the books as a defined contribution plan instead of the previous defined benefit plan. This resulted in a decrease in pension liability of 246 million and a corresponding amount as non-recurring income. A further 23 million in non-recurring income was booked in respect of other changes to the Finnish pension scheme. The closure of Miramichi pulp mill in Canada caused 110 million of non-recurring charges and the restructuring of wood products operations in Finland 34 million. In addition, a provision of 11 million was made for changes in group structure and a 19 million provision for long-term wood supply agreements in the UK. Third-quarter operating profit includes a capital gain of 110 million on the sale of the wood-based building supplies chain Brooks Group in Ireland. As a result of mandatory downtime around Christmas at Finnish pulp and paper mills and the one-day strike in November in Finland, operating profit excluding non-recurring items decreased to 102 million, 4.2% of sales, compared with the previous quarter s 140 million and 5.7% of sales. Profitability was also negatively affected by the stronger euro. Operating profit for the Converting Division was down on the previous quarter. The market, however, remained good. The profitability of the Wood Products Division improved on the third quarter for seasonal reasons. Profit before tax was 211 million (243 million), and excluding non-recurring items 80 million (133 million). In addition to nonrecurring items included in operating profit, profit includes a reversal of the impairment charge made in 2003 on listed company shares of 26 million and income of 10 million related to changes in pension system (TEL) concerning associated companies. Taxes booked for the fourth quarter were 234 million positive (75 million negative). Taxes include non-recurring income of 284 million. In connection with the Haindl acquisition in 2001, new tax bases were set for the net assets acquired. As the uncertainty regarding taxation has now been removed, the reduction in deferred tax liability and income tax credit of 284 million mentioned above was booked. Including the portion of tax-deductible goodwill, the positive cash effect will be approximately 400 million in the next ten years or so. Earnings per share were 0.85 (0.32). Excluding non-recurring items, earnings per share were 0.12 (0.19), return on equity 3.3% (5.6) and return on capital employed 4.0% (6.0) COMPARED WITH 2003 Sales for 2004 were 9,820 million, slightly higher than in 2003 (9,787 million). Although paper deliveries increased by 4%, the continued fall in paper prices in Europe and the stronger euro reduced sales. Restructuring within the Wood Products Division also negatively affected sales. Operating profit was 639 million (352 million), which includes net non-recurring income of 205 million (charges of 61 million). Non-recurring income amounted to 379 million and nonrecurring charges to 174 million. Excluding non-recurring items, operating profit was 434 million (413 million), 4.4% (4.2) of sales. Operating profit for the paper divisions fell due to lower sales prices in Europe and the stronger euro. Profitability was enhanced by higher deliveries and the cost savings made. Operating profit for the Converting Division improved markedly, as demand strengthened and prices for some products were raised. The Wood Products Division also improved its operating profit, in particular from its plywood operations. In Other Operations, joint resources clearly improved their operating profits. Profit before tax was 600 million (438 million), and excluding non-recurring items 359 million (363 million). Interest and other finance costs net were 178 million (177 million). Interest expenses were lower, but dividend income fell by 11 million. Gains of 48 million were booked on exchange rate differences and changes in fair values (107 million). The Group s share of results of associated companies before tax was 64 million (29 million). Taxes were 359 million positive (121 million negative). Taxes for 2004 include non-recurring gains of 235 million relating to the change in Finnish tax laws and 284 million relating to the decrease in deferred tax liability in Germany. The effective tax rate, excluding non-recurring tax gains, was 26.7% (27.6). Profit for the year was 958 million (319 million). UPM ANNUAL REPORT

52 ACCOUNTS FOR 2004 Earnings per share were 1.83 (0.61), return on equity 13.1% (4.4) and return on capital employed 6.3% (5.2). Excluding nonrecurring items, earnings per share were 0.52 (0.50), return on equity 3.7% (3.7) and return on capital employed 4.5% (4.7). DELIVERIES UPM s paper deliveries increased by 4% and were 10,792 million tonnes in 2004 (10,342 million tonnes). Magazine paper deliveries were 4,940 million tonnes (4,822 million), newsprint deliveries 2,719 million tonnes (2,587 million), and fine and speciality paper deliveries 3,074 million tonnes (2,879 million). Plywood production was 969,000 cubic metres (936,000). The output of sawn timber was 2,409 million cubic metres (2,408 million). FINANCING At 31 December 2004, the gearing ratio was 61% (69% at 31 December 2003). Net cash provided by operating activities was 997 million (1,258 million). The increase of 114 million in working capital was due to the termination of the asset securitization programme in respect of trade receivables of 179 million. Net interest-bearing liabilities at the end of the year were 4,617 million (4,874 million). The average maturity of borrowings at the year-end was 7.6 years (8.1). UPM s credit ratings for its bonds at the year-end were unchanged at Baa1 (Moody s negative) and BBB (S&P stable). PERSONNEL The average number of employees was 34,815 (35,751). At the end of the year the Group had 33,433 employees (34,482). The decrease was mainly due to divestments and closures of units. CAPITAL EXPENDITURE Capital expenditure, excluding acquisitions, was 645 million (703 million), 6.6% (7.2) of sales. Including acquisitions, capital expenditure was 686 million (720 million). The rebuild of Wisaforest pulp mill in Finland, which increased its capacity by 180,000 tonnes, was started up during spring. The rebuild of paper machine 2 at the Rauma mill in Finland was completed in March. The new sawmill, annual capacity 300,000 cubic metres, at Pestovo in Russia was inaugurated in May. UPM s largest on-going investment, the 450,000 t/a paper machine project near Shanghai in China, is going according to plan and the machine is expected to start up in summer During the second quarter, UPM decided to invest 60 million in developing release paper production at its Tervasaari mill in Finland. The rebuild planned for PM 8 will increase production capacity by 45,000 t/a to 175,000 t/a. The work is due for completion in summer Also during the second quarter, the company announced a 18 million investment for its Kaipola mill in Finland. The investment will increase the use of recycled fibre. In September, UPM decided to invest USD 40 million in raising the coating and converting capacity of Raflatac s self-adhesive labelstock factory in Fletcher, North Carolina. The new line will start up during the last quarter of In December, the company decided on two power plant investments. Together with Rauman Energia Oy and Pohjolan Voima Oy, it was decided that 75 million would be spent on increasing power generating capacity at Rauma paper mill in Finland by the end of UPM s share of the investment is about 20 million. A new power boiler using renewable fuel will be built at Shotton paper mill in Wales for a late 2006 start-up. The cost of the investment is 60 million. UPM has reserved, through its associated company Pohjolan Voima Oy, approximately 470 MW of the output from the new Finnish nuclear power plant being built in southwest Finland. UPM invested 40 million in the project at the end of the year. RESTRUCTURING In April, UPM sold the Danish building materials retail chain Anco Træ. The operations in question had annual sales of 70 million and employed 190 people. The Irish building supplies chain Brooks Group Limited was sold during the third quarter. Brooks Group had annual sales of 195 million and 430 employees. At the end of September, UPM announced its intention to close the 240,000 t/a kraft pulp mill at Miramichi in Canada. The mill was closed at the beginning of December. The reorganization of Miramichi will also affect the paper mill and wood procurement. Measures to restructure the Wood Products Division s businesses in Finland were decided in October. As a result, UPM s annual sawmilling production will decrease by about 400,000 cubic metres and birch plywood production by 70,000 cubic metres. Personnel reductions will be about 670. Aureskoski sawmill and Viiala plywood mill were closed at the end of 2004, and Kuopio plywood mill will be closed during the latter half of Sawmilling at Alholma and Kajaani will be reduced by about one third. Staff functions will be adjusted accordingly. In November, the company announced its withdrawal from a planned wood procurement and possible pulp mill project in Zhanjiang, Guandong province in China. COST-CUTTING PROGRAMME In April 2003, UPM announced a programme aiming at annual cost savings of 200 million by the beginning of The target was achieved about half a year ahead of schedule. SHARES UPM share turnover on the Helsinki Exchanges in 2004 was 9,731 million (9,117 million). The highest quotation was in November and the lowest in January. The value of the company s shares traded on the New York Stock Exchange was USD 311 million (191 million). The Annual General Meeting of 24 March 2004 approved a proposal to buy back a minimum of 100 and a maximum of 26,178,900 own shares. The meeting authorized the Board to decide on the disposal of shares so purchased. The company did not buy back any of its own shares under the authorization during the year. The same meeting authorized the Board of Directors to decide to increase the share capital by issuing new shares or convertible bonds in one or more issues. The increase in the number of shares 50 UPM ANNUAL REPORT 2004

53 GROUP may amount to an aggregate maximum of 104,715,000. This authorization has not been used. Options were exercised to subscribe 871,342 shares during Together with the authorization and share options, the number of shares, which stood at 524,450,272 at the end of December, may increase to a maximum of 651,493,930. The number of shares entered in the Trade Register at 31 December 2004 was 524,320,252. Apart from the above, the Board of Directors has no current authorization to issue shares, convertible bonds or share options. COMPANY DIRECTORS The Annual General Meeting elected two new Board members: Karl Grotenfelt, Chairman of the Board of Famigro, and Françoise Sampermans, Director of the French media distribution chain NMPP. The following persons were re-elected members of the Board of Directors: Martti Ahtisaari, ex-president of the Republic of Finland, Michael C. Bottenheim, ex-director of Lazard Brothers, Berndt Brunow, Managing Director of Oy Karl Fazer Ab, Georg Holzhey, former director of Haindl and UPM-Kymmene, Jorma Ollila, Chairman and Chief Executive Officer of Nokia Corporation, Gustaf Serlachius, and Vesa Vainio. At its first meeting the Board of Directors elected Vesa Vainio to serve as its chairman and Jorma Ollila and Gustaf Serlachius as vice chairmen. The Board of Directors elected from its members an Audit Committee with Michael C. Bottenheim as chairman and Martti Ahtisaari and Françoise Sampermans as members. Vesa Vainio was elected chairman of the Human Resources Committee, and Berndt Brunow and Georg Holzhey as members. Gustaf Serlachius was elected chairman of the Nomination Committee, and Karl Grotenfelt and Jorma Ollila as members. LITIGATION In August 2003, UPM received a grand jury subpoena in connection with the US Department of Justice Antitrust Division s investigation into the US labelstock industry. The company has responded, and is continuing to respond, to the subpoena as required. Following internal investigations into competitive practices, UPM decided on 15 January 2004 to approach the competition authorities in the European Union, the United States and Canada. The competition authorities have started investigations into alleged antitrust activities and consequently the EU, several of its member states, and the Canadian authorities have informed UPM that it has received conditional full immunity with respect to certain conduct disclosed to the authorities. The US Department of Justice has not decided on immunity, which is pending and available. UPM has also been named as a defendant in several class-action lawsuits against labelstock and magazine paper manufacturers in the United States. In May 2004, UPM received a European Commission Statement of Objection concerning alleged antitrust activities in the market for plastic industrial sacks. UPM manufactured plastic industrial sacks until December The annual sales of the operations under investigation amounted to 11 million. UPM has responded to the Statement of Objection. All of the above litigation matters may last several years. No provisions have been made in relation to these investigations. RESEARCH AND DEVELOPMENT UPM s research and development work is divided between its own product and process development and work conducted with universities, research institutes and suppliers of materials. In 2004, the company spent roughly 47 million (48 million) on research and development projects, which corresponds to 0.5% of turnover (0.5). Important development work is also carried out in conjunction with production line modernizations. The manufacture of newsprint and magazine papers has been made more cost-effective by making increasing use of recycled fibre and of minerals costing less than wood fibre, and by using less of the more expensive chemical pulp. In fine paper manufacture, the proportions of short-fibre birch pulp and minerals have been increased. In the converting business, Raflatac has upgraded its filmic products using new adhesives and top coats. Loparex has developed several applications for solventless coating. The focus of development by Walki Wisa has been on new composite materials for the manufacture of packagings and insulation materials. Product development work by the Wood Products Division mainly concerned new coating techniques. THE ENVIRONMENT Environment-related capital expenditure was 55 million (37 million) and the corresponding operating expenses, including depreciation, were 112 million (109 million). Certified environmental management systems covered roughly 97% of production in 2004 (85%). OUTLOOK FOR 2005 Paper deliveries are forecast to increase. Sales prices will be higher than at the end of last year. In export markets, price increases will exceed losses caused by the recent weakening of invoicing currencies. Demand for converted products is estimated to grow in all markets. In wood products, demand for plywood and sawn timber will remain good, but the markets for sawn timber will continue to be over-supplied. The cost-cutting programmes will continue, and costs for the current year are therefore likely to show only a modest rise. Profitability is expected to be better than last year. Capital expenditure will be somewhat higher than in 2004 but remain below depreciation. UPM ANNUAL REPORT

54 ACCOUNTS FOR 2004 BOARD OF DIRECTORS PROPOSAL FOR THE DISTRIBUTION OF PROFITS The distributable funds of the Group and the parent company are 4,372 million and 3,419,394, respectively. The Board of Directors proposes to the Annual General Meeting that a dividend of 0.75 per share be paid on the shares outstanding at the record date, the remainder being retained. On 1 February 2005, there are 524,450,272 outstanding shares and the corresponding amount to be paid in dividends is million. Helsinki, 1 February 2005 Vesa Vainio Jorma Ollila Gustaf Serlachius Martti Ahtisaari Chairman Michael C. Bottenheim Berndt Brunow Karl Grotenfelt Georg Holzhey Françoise Sampermans Jussi Pesonen President & CEO 52 UPM ANNUAL REPORT 2004

55 GROUP CONSOLIDATED INCOME STATEMENT Year ended 31 December m Note Sales 4 9,820 9,787 10,417 Other operating income Costs and expenses 7 8,227 8,445 8,580 Depreciation, amortization and impairment charges 8 1,122 1,048 1,125 Operating profit Share of results of associated companies and joint ventures Gains on available-for-sale investments, net Exchange rate and fair value gains and losses Finance costs, net Profit before tax Income taxes Profit after tax Minority interest Net profit for the period Earnings per share Basic earnings per share, Diluted earnings per share, The notes are an integral part of these financial statements. UPM ANNUAL REPORT

56 ACCOUNTS FOR 2004 CONSOLIDATED BALANCE SHEET 31 December m Note ASSETS Non current assets Goodwill 15 1,560 1,663 Other intangible assets Property, plant and equipment 17 7,621 8,125 Investment property Biological assets 19 1,143 1,127 Investments in associated companies and joint ventures 20 1,047 1,012 Available-for-sale investments Non-current receivables Deferred tax assets Other non-current assets ,802 13,509 Current assets Inventories 24 1,138 1,144 Trade and other receivables 25 1,587 1,439 Accrued income tax receivables Available-for-sale investments Cash and cash equivalents ,025 3,082 Total assets 15,827 16, December m Note EQUITY AND LIABILITIES Capital and reserves Share capital Share issue 1 Share premium reserve Translation differences Fair value and other reserves Retained earnings 5,720 5,154 7,586 6,997 Minority interest Non current liabilities Deferred tax liabilities ,579 Retirement benefit obligations Provisions Interest-bearing liabilities 31 4,424 4,911 Other liabilities ,966 7,322 Current liabilities Current interest-bearing liabilities Trade and other payables 33 1,256 1,269 Accrued income tax payables ,249 2,240 Total liabilities 8,215 9,562 Total equity and liabilities 15,827 16,591 The notes are an integral part of these financial statements. 54 UPM ANNUAL REPORT 2004

57 GROUP CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS EQUITY m Share capital Share issue Share premium Translation reserve differences Fair value and other reserves Retained earnings Total Balance at 1 January ,229 7,204 Share issue Convertible bond loan Translation differences Other items 4 4 Cash fl ow hedges recorded in shareholders equity, net of tax transferred to income statement, net of tax Available-for-sale investments gains/losses arising from fair valuation, net of tax 2 2 transferred to income statement, net of tax Dividend paid Net profit for the period Balance at 31 December ,154 6,997 Balance at 1 January ,154 6,997 Share options exercised Translation differences Other items Cash fl ow hedges recorded in shareholders equity, net of tax transferred to income statement, net of tax Available-for-sale investments gains/losses arising from fair valuation, net of tax transferred to income statement, net of tax Dividend paid Net profit for the period Balance at 31 December ,720 7,586 The notes are an integral part of these financial statements UPM ANNUAL REPORT

58 ACCOUNTS FOR 2004 CONSOLIDATED CASH FLOW STATEMENT Year ended 31 December m Cash flow from operating activities Net profit for the period Adjustments to net profit 1) 381 1,081 1,392 Interest received Interest paid, net of amounts capitalized Dividends received Other financial items, net Income taxes paid Change in working capital 2) Net cash provided by operating activities 997 1,258 1,418 Cash flow from investing activities Acquisition of subsidiary shares, net of cash (Note 5) Acquisition of shares in associated companies Acquisition of available-for-sale investments 1 5 Capital expenditure Proceeds from disposal of subsidiary shares, net of cash (Note 5) Proceeds from disposal of shares in associated companies Proceeds from disposal of available-for-sale investments Proceeds from sale of fi xed assets Proceeds from long-term receivables Increase in long-term receivables Other investing cash fl ow 7 Net cash used in investing activities Cash flow from financing activities Proceeds from long-term liabilities 579 1,050 Payments of long-term liabilities 224 1, Proceeds from (payment of) short-term borrowings, net Proceeds from share options exercised 10 Dividends paid Other financing cash fl ow Net cash used in financing activities ,032 Change in cash and cash equivalents Cash and cash equivalents at the beginning of year Foreign exchange effect on cash Change in cash and cash equivalents Cash and cash equivalents at year-end Notes to the consolidated cash flow statement 1) Adjustments to net profit Minority interest Taxes Depreciation, amortization and impairment charges 1,122 1,048 1,125 Share of results in associated companies and joint ventures Profits and losses on sale of fixed assets and investments Gains on available-for-sale investments, net Finance costs, net Change in the Finnish pension system 269 Other adjustments ,081 1,392 2) Change in working capital Inventories Current receivables 3) Current non-interest bearing liabilities ) 2004 includes 179 million arising from termination of the securitization programme for trade receivables. 56 UPM ANNUAL REPORT 2004

59 GROUP NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (In the notes all amounts are shown in millions of euros unless otherwise stated.) 1 ACCOUNTING POLICIES The principal accounting policies to be adopted in the preparation of the consolidated financial statements are set out below: TRANSITION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) UPM has adopted International Financial Reporting Standards (IFRS). The Group s first financial statements under IFRS for 2003 and 2002 were published on 23 November PRINCIPAL ACTIVITIES UPM is a global paper and forest products company engaged in the production of paper, with an emphasis on the manufacture and sale of printing and writing papers. The Group is vertically integrated with operations that are organized through five divisions: Magazine Papers, Newsprint, Fine and Speciality Papers, Converting and Wood Products. The biggest units of UPM s Other operations are in the forestry and energy departments in Finland. The Group s activities are centred in the European Union countries and North America, with production facilities in 16 countries. BASIS OF PREPARATION These consolidated financial statements of UPM-Kymmene Corporation, a Finnish limited liability company, domiciled in Helsinki in the Republic of Finland, are prepared in accordance with International Financial Reporting Standards (IFRS). The financial statements have been prepared under the historical cost convention as modified by the revaluation of biological assets, available-for-sale investment securities and certain other financial assets and financial liabilities. USE OF ESTIMATES The preparation of financial statements requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting periods. Accounting estimates are employed in the financial statements to determine reported amounts, including the realizability of certain assets, the useful lives of tangible and intangible assets, income taxes and others. Although these estimates are based on management s best knowledge of current events and actions, actual results may ultimately differ from those estimates. CONSOLIDATION PRINCIPLES SUBSIDIARIES The consolidated financial statements of UPM include the financial statements of the parent company, UPM-Kymmene Corporation, and its subsidiaries. Subsidiaries are those entities in which UPM-Kymmene Corporation either owns, directly or indirectly, over fifty per cent of the voting rights, or otherwise has the power to govern their operating and financial policies. Acquisitions of subsidiaries are accounted for using the purchase method of accounting. The cost of an acquisition is measured as the fair value of the assets given up, shares issued or liabilities undertaken at the date of acquisition plus costs directly attributable to the acquisition. The excess cost of acquisition over the fair value of the net assets of the subsidiary acquired is recorded as goodwill (see Intangible Assets for the accounting policy on goodwill). Subsidiaries acquired during the year are included in the consolidated financial statements from the date on which control is transferred to the Group, and subsidiaries sold are included up to the date that control is relinquished. Where necessary, the accounting policies of subsidiaries have been adjusted to ensure consistency with the policies adopted by the Group. All intercompany transactions, receivables, liabilities and unrealized profits, as well as intragroup profit distributions, are eliminated. The Group adopted the transition provisions of IFRS 3, Business Combinations, with effect from 1 April As a result, goodwill relating to acquisitions for which the agreement date was on or after 31 March 2004, is no longer subject to amortization. Goodwill arising in business combinations completed before 31 March 2004 will continue to be amortized until the standard is fully adopted as of 1 January ASSOCIATED COMPANIES AND JOINT VENTURES Associated companies are entities over which the Group generally holds between 20% and 50% of the voting rights, or over which the Group has significant influence but not overall control. Joint ventures are entities over which the Group has contractually agreed to share the power to govern the financial and operating policies of that entity with another venturer or venturers. Interests in associated companies and joint ventures are accounted for using the equity method of accounting. Under this method the Group s share of the associated com pany s and joint venture s profit or loss for the year less any amortized goodwill is recognized on the income statement. The Group s interest in an associated company and joint venture is carried on the balance sheet at an amount that reflects its share of the net assets of the associated company and joint venture together with goodwill on acquisition, as amortized, less any impairment. Gains and losses on transactions between the Group and its associated companies and joint ventures are eliminated to the extent of the Group s interest in the associated company and joint venture. Equity accounting is discontinued when the carrying amount of the investment in an associated company or interest in a joint venture reaches zero, unless the Group has incurred or guaranteed obligations in respect of the associated company or joint venture. MINORITY INTERESTS Minority interests have been disclosed separately from the consolidated shareholders equity and are recorded as a separate deduction on the consolidated income statement. FOREIGN CURRENCY TRANSACTIONS Items included in the financial statements of each subsidiary in the Group are measured using the currency that best reflects the economic substance of the underlying events and circumstances relevant to that subsidiary ( the measurement currency ). The consolidated financial statements are presented in euros, which is the measurement currency of the parent company. UPM ANNUAL REPORT

60 ACCOUNTS FOR 2004 Foreign currency transactions are translated into euros using the exchange rates prevailing at the dates of the transactions. Receivables and liabilities in foreign currencies are translated into euros at the exchange rates ruling on the balance sheet date. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognized in the income statement, except when deferred in equity as qualifying cash flow hedges. Foreign exchange differences arising in respect of operating business items are included in operating profit in the appropriate income statement account, and those arising in respect of financial assets and liabilities are included as a net amount in finance costs. The income statements and cash flows of subsidiaries, whose measurement and reporting currencies are not euros, are translated into euros at quarterly average exchange rates. Their balance sheets are translated at the exchange rates ruling on the balance sheet date and the translation differences are taken to shareholders equity. When a foreign entity is sold or liquidated, such translation differences are recognized in the income statement as part of the gain or loss on sale. DERIVATIVE FINANCIAL INSTRUMENTS Derivative financial instruments are initially recognized on the balance sheet at cost and thereafter revalued at their fair value. The method of recognizing the resulting gain or loss is dependent on the nature of the item being hedged. On the date a derivative contract is entered into, the Group designates certain derivatives as either a hedge of the fair value of a recognized asset or liability (fair value hedge), or a hedge of a forecasted transaction or of a firm commitment (cash flow hedge). Changes in the fair value of derivatives that are designated and qualify as fair value hedges and that are highly effective both prospectively and retrospectively are recorded in the income statement under finance costs, along with any changes in the fair value of the hedged asset or liability that is attributable to the hedged risk. Changes in the fair value of derivatives that are designated and qualify as cash flow hedges and that are highly effective both prospectively and retrospectively are recognized in equity (at the spot rate difference). Amounts deferred in equity are transferred to the income statement and classified as revenue or an expense in the same period during which the hedged firm commitment or forecasted transaction affects the income statement (for example, when the forecasted external sale to the Group takes place). The period when the hedging reserve is released to sales after each derivative has matured varies between 1 3 months. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting under IAS 39, any cumulative gain or loss existing in equity at that time remains in equity and is recognized when the committed or forecasted transaction ultimately is recognized on the income statement. However, if a committed or forecasted transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement. Certain derivative transactions, while providing effective economic hedges under the Group Financial Policy, do not qualify for hedge accounting under the specific rules in IAS 39. Changes in the fair value of any derivative instruments that do not qualify for hedge accounting under IAS 39 are recognized immediately in the income statement under finance costs. The Group documents at the inception of the transaction the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives designated as hedges to specific assets and liabilities or to specific firm commitments or forecast transactions. The Group also documents its assessment, both at the hedge inception and on an ongoing basis, as to whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Fair values of derivative financial instruments have been estimated as follows: Interest forward rate agreements and futures contracts are fair valued based on quoted market rates as at the balance sheet date; forward foreign exchange contracts are fair valued based on the contract forward rates in effect as at the balance sheet date; foreign currency options are fair valued based on quoted market rates as at the balance sheet date; interest and currency swap agreements are fair valued based on discounted cash flow analyses; and commodity derivatives are fair valued based on quoted market rates as at the balance sheet date. In assessing the fair value of non-traded derivatives such as embedded derivatives and other financial instruments, the Group uses a variety of methods and makes assumptions that are based on market conditions existing at each balance sheet date. Other valuation techniques, such as option pricing models and estimated discounted value of future cash flows, are used to determine fair value for the remaining financial instruments. Embedded derivatives that are identified and are monitored by the Group and the fair value changes are reported in financial income and expenses on the income statement. SEGMENT REPORTING Business segments provide products or services that are subject to risks and returns that are different from those of other business segments. Geographical segments provide products or services within a particular economic environment that is subject to risks and returns that are different from those of components operating in other economic environments. The accounting policies of the segments and Other Operations are the same as those of the Group. The costs and revenues as well as assets and liabilities of the segments are allocated on symmetrical basis. All inter-segment sales are based on market prices, and all inter-segment sales are eliminated in consolidation. DISCONTINUING OPERATIONS A discontinuing operation results from a decision, pursuant to a single disposal plan, to divest an operation comprising a separate major line of business for which the assets less liabilities and net financial results may be distinguished physically, operationally and for financial reporting purposes. The pre-tax gain or loss on disposal of discontinuing operation is shown as a separate item on the consolidated income statement. REVENUE RECOGNITION Sales are recognized after the transfer of the decisive risks and rewards that are connected with the ownership of the goods sold to the buyer and the Group retains neither a continuing right to dispose of the goods, nor effective control of those goods. Revenues from services are recorded when the service has been performed. Sales are shown net of indirect sales taxes, discounts and exchange differences on sales in foreign currency. The costs of distributing products sold are included in costs and expenses. INCOME TAXES The Group s income taxes include income taxes of Group companies based on taxable profit for the financial period, together with tax adjustments for previous periods and the change of deferred income taxes. Tax credits arising from subsidiaries distribution of dividends are deducted 58 UPM ANNUAL REPORT 2004

61 GROUP from income taxes. Deferred income tax is provided in full, using the liability method, on temporary differences arising between the tax bases of assets and liabilities and their carrying amounts in the financial statements. Currently enacted tax rates are used in the determination of deferred income tax. Deferred income tax is also provided on temporary differences arising on investments in subsidiaries, associated companies and joint ventures, except where the timing of the reversal of the temporary difference can be controlled and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax assets are recognized to the extent that it is probable that future taxable profit will be available against which the temporary differences can be utilized. INTANGIBLE ASSETS Amortization of intangible assets is based on the following expected useful lives: Goodwill Computer software Other intangible assets 5 20 years 3 5 years 5 10 years GOODWILL Goodwill represents the excess of the cost of acquisition over the fair value of assets less liabilities of the acquired subsidiary, associated company or joint venture at the date of acquisition. Goodwill and fair value adjustments arising on the acquisition of a foreign entity have been treated as assets of the reporting entity, and reported using the exchange rate at the time the transaction took place. Goodwill is amortized on a straight-line basis over its expected useful life. Expected useful lives vary between 5 and 20 years, depending upon the nature of the acquisition. At each balance sheet date the expected useful lives are reviewed and, where they differ significantly from previous estimates, amortization periods are changed prospectively. At each balance sheet date the Group evaluates the carrying value of goodwill. An impairment is charged to the income statement when the expected future operating cash flows derived from the cash generating units are less than the carrying value of the cash-generating unit. The gain or loss on disposal of an entity includes the unamortized balance of goodwill. RESEARCH AND DEVELOPMENT Research and development costs are expensed as incurred, except for certain development costs, which are capitalised when it is probable that a development project will be successful considering its commercial and technological feasibility, and only if the cost can be measured reliably. Capitalised development costs are amortised on a systematic basis over their expected useful future lives, not exceeding five years. COMPUTER SOFTWARE Costs associated with maintaining computer software programs and costs related to the research phase of computer software development projects are recognized as an expense as incurred. However, development costs that are directly associated with identifiable and unique software products controlled by the Group and have a probable economic benefit exceeding the cost beyond one year are recognized as intangible assets. Direct costs include staff costs of the software development team and an appropriate portion of relevant overhead. Computer software development costs recognized as assets are amortized using the straight-line method over their useful lives. OTHER INTANGIBLE ASSETS Expenditure on acquired patents, trademarks and licences is capitalized and amortized using the straight-line method over their useful lives. Intangible assets are not revalued. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment acquired by Group companies are stated at historical cost. Assets of acquired subsidiaries are stated at the fair values at the date of acquisition. Depreciation is calculated on a straightline basis and the carrying value is adjusted for impairment charges, if any. The carrying value of the property, plant and equipment on the balance sheet represents the cost less accumulated depreciation and any impairment charges. Interest costs on borrowings to finance the construction of property, plant and equipment are capitalized during the period of time that is required to complete and prepare the asset for its intended use. Other borrowing costs are expensed. Land is not depreciated, but otherwise depreciation is based on the following expected useful lives: Buildings Heavy machinery Light machinery and equipment years years 5 15 years Expected useful lives of long-lived assets are reviewed at each balance sheet date and, where they differ significantly from pre vious estimates, depreciation periods are changed prospectively. Ordinary repairs and maintenance costs are charged to the income statement during the financial period in which they are incurred. The cost of major renovations is included in the asset s carrying amount when it is probable that the Group will derive future economic benefits in excess of the originally assessed standard of performance of the existing asset. Major renovations are depreciated over the remaining useful lives of the related assets. Gains and losses on disposals are determined by comparing the disposal proceeds with the carrying amount and are included in operating profit. Assets to be disposed of are reported at the lower of the carrying amount and the fair value less selling costs. GOVERNMENT GRANTS Government grants relating to the purchase of property, plant and equipment are deducted from the acquisition cost of the asset and recognized as income by reducing the depreciation charge of the asset they relate to. Other government grants are deferred and recognized on the income statement over the period necessary to match them with the costs they are intended to compensate. INVESTMENT PROPERTY Investment property includes real estate investments such as flats and other premises occupied by third parties. Investment property is treated as a long-term investment and is stated at historical cost. Depreciation is calculated on a straight-line basis and the carrying value is adjusted for impairment charges, if any. Useful lives are the same as for property, plant and equipment. The balance sheet value of investment property reflects the cost less accumulated depreciation and any impairment charges. UPM ANNUAL REPORT

62 ACCOUNTS FOR 2004 BIOLOGICAL ASSETS Biological assets (i.e. living trees) are measured at their fair value less estimated point-of-sale costs. The fair value of biological assets other than young seedling stands is based on discounted cash flows from continuous operations. The fair value of young seedling stands is the actual reforestation cost of those stands. Continuous operations, the maintenance of currently existing seedling stands and the felling of forests during one rotation, are based on the Company s forest management guidelines. The calculation takes into account the growth potential and environmental restrictions and other reservations of the forests. Felling revenues and maintenance costs are calculated on the basis of actual costs and prices, taking into account the projection of future price development. Periodic changes resulting from growth, felling, prices, costs and other premise changes are included in operating profit in the income statement. FINANCIAL ASSETS Financial investments have been classified into trading, held-tomaturity and available-for-sale categories. The classification is dependent on the purpose for which the investments were acquired. All investments are currently classified as available-for-sale investments and are included in non-current assets. Purchases and sales of financial investments are recognized on the settlement date, which is the date that the asset is delivered to or by the Group. The cost of purchase includes transaction costs. Available-for-sale investments are subsequently carried at fair value. The fair values of listed investments are based on quoted closing prices. Unlisted equity securities, for which fair values cannot be measured reliably, are recognized at cost less impairment. Unrealized gains and losses arising from changes in the fair value of securities classified as available-for-sale are recognized in equity. When securities classified as available-for-sale are sold or impaired, the accumulated fair value adjustments in equity are included in the income statement as gains and losses from investment securities. Loans receivable originated by the Company that have a fixed maturity are measured at amortized cost using the effective interest method and those that do not have a fixed maturity are measured at cost. Loans receivable are impaired if the carrying amount is greater than the estimated recoverable amount. The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity securities classified as available for sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the securities are impaired. If any such evidence exists for available-forsale financial assets, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognized in profit or loss is removed from equity and recognized in the income statement. A previously recognized impairment loss is reversed when the impairment loss was caused by a specific external event of an exceptional nature that is not expected to recur and subsequent external events have occurred which reverse the effect of that event. IMPAIRMENTS Property, plant and equipment and other non-current assets, including goodwill and intangible assets, are reviewed for potential impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. For the purposes of assessing impairment, assets are grouped at the lowest levels for which there are separately identifiable, mainly independent, cash inflows. An impairment loss is the amount by which the carrying amount of the assets exceeds the recoverable amount. The recoverable amount is the higher of the asset s net selling price and its value in use. The value in use is determined by reference to discounted future net cash flows expected to be generated by the asset. A previously recognized impairment loss on property, plant and equipment is reversed only if there has been a change in the estimates used to determine the recoverable amount, however not to an extent higher than the carrying amount that would have been determined had no impairment loss been recognized in prior years. A previously recognized impairment loss on goodwill is reversed when the impairment loss was caused by a specific external event of an exceptional nature that is not expected to recur and subsequent external events have occurred which reverse the effect of that event. LEASES Leases of property, plant and equipment where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalized at the inception of the lease at the lower of the fair value of the leased property or the present value of the minimum lease payments. Each lease payment is apportioned between the liability and finance charges. The corresponding rental obligations, net of finance charges, are included in other long-term interest-bearing liabilities. The interest element of the finance cost is charged to the income statement over the lease period so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period. Property, plant and equipment acquired under finance leases are depreciated over the shorter of the useful life of the asset or the lease term. Leases where a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease. INVENTORIES Inventories are stated at the lower of cost or net realizable value. Cost is determined by the first-in, first-out (FIFO) method. The cost of finished goods and work in progress comprises raw materials, direct labour, other direct costs and related production overheads (based on normal operating capacity) but excludes borrowing costs. Net realizable value is the estimated selling price in the ordinary course of business, less the costs of completion and selling expenses. TRADE RECEIVABLES Trade receivables are carried at their anticipated realizable value, which is the original invoice amount less an allowance for doubtful accounts. An allowance for doubful accounts is made when there is objective evidence that the Group will not be able to collect all amounts due according to the original terms of the receivables. 60 UPM ANNUAL REPORT 2004

63 GROUP CASH AND CASH EQUIVALENTS Cash and cash equivalents comprise cash on hand, deposits held at call with banks and other short-term highly liquid investments with original maturities of three months or less. Bank overdrafts are included within borrowings in current liabilities on the balance sheet. TREASURY SHARES Where the Company or its subsidiaries purchases the Company s own equity share capital, the consideration paid including any attributable transaction costs net of income taxes is deducted from total shareholders equity as treasury shares until they are cancelled. Where such shares are subsequently sold or reissued, any consideration received is included in shareholders equity. INTEREST-BEARING LIABILITIES Interest-bearing liabilities are classified as originated loans and are recognized initially at the amount of proceeds received, net of transaction costs incurred. In subsequent periods, interest-bearing liabilities are stated at amortized cost using the effective yield method; any difference between proceeds (net of transaction costs) and the redemption value is recognized in the income statement over the period of the interestbearing liabilities. Most long-term interest-bearing liabilities are designated as hedged items in a fair value hedge relationship. Fair value variations resulting from the hedged interest rate risk are recorded to adjust the carrying amount of the hedged item and reported in the income statement under finance costs. If the hedge accounting is discontinued, the carrying amount of the hedged item is no longer adjusted for fair value changes attribut able to the hedged risk and the cumulative fair value adjustment recorded during the hedge relationship is amortized based on a new effective yield recalculation through the income statement under finance costs. EMPLOYEE BENEFITS PENSION OBLIGATIONS The Group operates a mixture of pension schemes in accordance with the local conditions and practices in the countries in which it operates. Such benefit plans vary according to the customary benefit plans prevailing in the country concerned. Most of these programs are defined benefit pension schemes with retirement, disability and termination income benefits. The retirement income benefits are generally a function of years of employment and final salary with the Company. Generally, the schemes are either funded through payments to insurance companies or to trustee-administered funds as determined by periodic actuarial calculations. In addition, the Group also operates defined contribution pension arrangements. For defined benefit plans, the liability in respect of defined benefit pension plans is the present value of the defined benefit obligation at the balance sheet date minus the fair value of plan assets, together with adjustments for actuarial gains/losses and past service cost. The defined benefit obligation is calculated by independent actuaries using the projected unit credit method and is measured as the present value of the estimated future cash outflows using interest rates of government securities that have terms to maturity approximating the terms of the related liability. The cost of providing pensions is charged to the income statement so as to spread the regular cost over the service lives of the employees. Actuarial gains and losses outside the corridor are recognized over the average remaining service lives of the employees concerned. For defined contribution plans, contributions are paid to pension insurance plans. Once the contributions have been paid, there are no further payment obligations. Contributions to defined contribution plans are charged to the income statement in the period to which the contributions relate. OTHER POST-RETIREMENT OBLIGATIONS Some Group companies provide post-retirement healthcare benefits to their retirees. The entitlement to these benefits is usually based on the employee remaining in service up to retirement age and the completion of a minimum service period. The expected costs of these benefits are accrued over the period of employment, using an accounting methodology similar to that for defined benefit pension plans. Valuations of these obligations are carried out by independent qualified actuaries. EQUITY COMPENSATION BENEFITS Share options are granted to key personnel. Holders of options have the right to subscribe shares at a price that is based on the weighted average share prices on the Helsinki Exchanges during the periods defined in the share option plans. The fixed subscription prices will be reduced, on the respective record dates for dividend payments, by the amount of dividend declared after the period for determining the subscription price has expired and before the shares are subscribed. When the options are exercised, the proceeds received, net of any transaction costs, are credited to share capital and the share premium reserve. PROVISIONS Provisions are recognized when the Group has a present legal or constructive obligation as a result of past events, and it is probable that an outflow of resources will be required to settle the obligation, and a reliable estimate of the amount can be made. Where the Group expects a provision to be reimbursed, for example under an insurance contract, the reimbursement is recognized as a separate asset but only when the reimbursement is virtually certain. RESTRUCTURING PROVISIONS Restructuring provisions are recognized in the period in which the Group becomes legally or constructively committed to payment. Employee termination benefits are recognized only after either an agreement has been made with the appropriate employee representatives on the terms of redundancy and the numbers of employees affected, or after employees have been advised of the specific terms. Costs related to the ongoing activities of the Group are not provisioned in advance. ENVIRONMENTAL REMEDIATION PROVISIONS Expenditures that result from remediation of an existing condition caused by past operations and do not contribute to current or future revenues is expensed. Environmental remediation provisions are recognized based on current interpretations of environmental laws and regulations when it is likely that the liability has been incurred and the amount of such liability can be reasonably estimated. Amounts provisioned do not include third-party recoveries. DIVIDENDS Dividends are recorded in the Group s financial statements in the period in which they are approved by the Group s shareholders. UPM ANNUAL REPORT

64 ACCOUNTS FOR 2004 COMPARATIVES Where necessary, comparative figures have been reclassified to conform to changes in presentation in the current year. EARNINGS PER SHARE The basic earnings per share is computed using the weighted average number of shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of shares outstanding during the period plus the dilutive effect of convertible bonds, treasury shares and share options. 2 CHANGE IN THE COMPARATIVE FIGURES CASH AND CASH EQUIVALENTS As a part of the Group s cash management strategy the Group uses highly liquid, low risk instruments that have been classified as cash equivalents in previous years. Those instruments such as certificates of deposits that have original maturities of more than three months have been separated from cash and cash equivalents during 2004 and reported in the balance sheet as available for sale investments to reflect the characteristic of those instruments. The amounts in the cash flow statement have been changed to reflect the current classification of cash and cash equivalents and current available for sale investments. Comparative information has been changed in the balance sheet and cash flow statement accordingly. 3 FINANCIAL RISK MANAGEMENT FINANCIAL RISKS The objective of financial risk management is to protect the Group against unfavorable changes in financial markets and thus help to secure profitability. The objectives and limits for financing activities are defined in the Group Treasury Policy approved by the company s Board of Directors. In financial risk management, various financial instruments are used within the limits specified in the Group Treasury Policy. Only such instruments whose market value and risk profile can be continuously and reliably monitored are used for this purpose. FOREIGN CURRENCY RISKS Management of foreign currency exposure is divided into two parts: that relating to foreign currency flows and that relating to balance sheet items denominated in foreign currency. The first concerns the 12-month forecasted commercial foreign currency flows, contracts longer than 12 months and their related hedging. Hedging of 50% of the net foreign currency flow for the 12 months ahead is considered neutral. The overall hedging rate may vary between 25 and 100%, and the hedging rates for individual currencies between 0 and 100%. Most of the forwards made to hedge foreign currency flows meet the IFRS hedge accounting requirements. The table below shows the nominal values of the hedging instruments at 31 December Nominal values of hedging instruments Currency m USD 565 GBP 399 CAD 56 SEK 74 DKK 49 JPY 76 NOK 32 CHF 27 Others 47 Total 1,213 The Group s financial results and competitiveness are also affected indirectly by changes in the values of the domestic currencies of its main competitors, principally the US dollar, the Canadian dollar, and the Swedish krona. Exposure to these risks is not hedged. However, the company s own production in the United States and Canada reduces this risk. The balance sheet position comprises foreign currency denominated debts and receivables. According to the Group Treasury Policy, the aim is a fully hedged position. At 31 December 2004 the balance sheet position was EUR 25 million. ( : EUR 5 million). Also the net of accounts receivable and accounts payable is hedged. Foreign currency risks associated with the shareholder s equity of foreign subsidiaries are not hedged. INTEREST RATE RISKS The Group s net debt per currency corresponds to the parent company s and subsidiaries loan portfolios in their home currencies. The nominal values of the Group s interest-bearing net debts (including derivatives) by currency were at 31 December 2004 as follows: Currency Amount bn EUR 3.4 USD 0.5 CAD 0.6 CNY 0.2 Others 0.1 Total 4.8 Management of interest rate risks is based on the 12-month average duration of the net debt portfolio as defined in the Group Treasury Policy. This relatively short duration is based on the assumption that, on average, yield curves will be positive. This approach thus reduces interest costs in the long term. The duration may deviate from the 12-month norm by +/ 6 months. At 31 December 2004, the average duration of the net debt portfolio was 10 months. ( months). Most of the long term loans and the interest rate derivatives related to them meet the IFRS hedge accounting requirements. Changes in the fair value of any derivative instruments that do not qualify for hedge accounting are recognized immediately in the income statement. 62 UPM ANNUAL REPORT 2004

65 GROUP LIQUIDITY AND REFINANCING RISKS The Group seeks to maintain adequate liquidity under all circumstances by means of efficient cash management and restricting investments to those that can be cashed in quickly. In addition to cash funds of 142 million, at 31 December 2004 the Group had unused committed credit facilities amounting to 3.3 billion. Refinancing risks are minimized by ensuring that the loan portfolio has a balanced maturity schedule and that loans have sufficiently long maturities. The average loan maturity at 31 December 2004 was 7.6 years (8.1 years at 31 December 2003). The most important financial programs in use at present are: Domestic commercial paper program, 1.0 billion Euro commercial paper program, USD 500 million Belgian commercial paper program, 400 million Medium Term Note program, 5.0 billion Revolving credit facility, 2.0 billion (matures 2006) Revolving credit facility, 1.2 billion (matures 2008) CREDIT RISK Potential concentrations of credit risk with respect to trade and other receivables are limited due to the large number and geographic dispersion of companies that comprise the Group s customer base. Customer credit limits are established and monitored, and on-going evaluations of customers financial condition are performed. Most of the receivables are covered by credit risk insurances. COUNTERPARTY RISK Counterparty risk is defined as the risk that a counterparty will be unable to fulfill its contractual obligations. According to the Group Treasury Policy, derivative instruments and investments of cash funds may be made only with a counterparty who meets a certain standard of creditworthiness. DERIVATIVES RELATED TO COMMODITY PRICE RISK MANAGEMENT The Group s manufacturing process requires a significant amount of electricity and recycled fiber. The Group manages the procurement and sales of electricity mainly to its own mills. The Group uses electricity forward contracts to manage price risks associated with the Group s electricity exposure, which is the difference between the Group s electricity consumption and production. Recycled paper price risk management includes the use of recycled fiber derivatives. 4 SEGMENT INFORMATION The Group is organised on a worldwide basis into the following primary business segments: Magazine Papers division Newsprint division Fine and Speciality Papers division Converting division Wood Products division Activities outside the segments are reported under Other operations. MAGAZINE PAPERS Magazine papers have high mechanical pulp content and are generally used in magazines, newspaper supplements, catalogues and direct mailings. The division manufactures both coated and uncoated papers. Coated magazine papers are mainly used in the manufacture of highquality, multi-coated printed products including magazines, catalogues, brochures, direct mail advertising and other advertising materials. Uncoated papers are mainly used for magazines, weekend newspaper supplements, catalogues, and flyers. NEWSPRINT This division produces standard newsprint and machine-finished uncoated papers. The end-uses include daily newspapers, direct mail, telephone catalogues and books. FINE AND SPECIALITY PAPERS This division produces a complete range of coated and uncoated woodfree papers for graphic use and office communication. Fine papers are used for copying, non-impact printing, facsimile, direct mail advertising, brochures, and special interest magazines, while speciality papers include label papers, envelopes and packaging papers. CONVERTING DIVISION This division produces self-adhesive labelstock, siliconized release materials and industrial wrappings. WOOD PRODUCTS DIVISION This division includes plywood manufacturing, sawmilling and the building supplies trade. OTHER OPERATIONS This includes forest and energy resources in Finland, logistics operations and real estate units, as well as the new ventures business unit. It also includes the share of net earnings of associated companies (mainly the chemical pulp company Metsä-Botnia) and the central administrative functions for the Group. The sales of Other operations comprises only sales outside the Group. UPM ANNUAL REPORT

66 ACCOUNTS FOR 2004 Primary reporting format Segment data for the year ended 31 December 2004 m Magazine Papers Newsprint Fine and Speciality Papers Converting Wood Products Other operations 1) Eliminations Group External sales 3,209 1,293 2,000 1,367 1, ,820 Internal sales Total sales 3,285 1,295 2,275 1,409 1, ,820 Operating profit 2) Share of results of associates and joint ventures Gains on available-for-sale investments, net 27 Finance costs, net 130 Income taxes 3) 359 Minority interest 1 Net profit 958 Assets 4) 4,683 2,016 2, , ,398 Associates and joint ventures 1,047 1,047 Unallocated assets 1,382 Total assets 4,683 2, ,579 15,827 Liabilities 5) Unallocated liabilities 7,453 Total liabilities 8,215 Other items Depreciation and amortization ,024 Impairment charge Capital expenditure Capital employed, 31 December 6) 4,485 1,905 2, , ,953 Capital employed, average 4,754 2,002 2, ,882 Return on capital employed, % 7) ) Sales include only sales outside the Group. Internal sales to segments amount to 1,506 million, consisting mainly of Forestry and Energy Departments in Finland. 2) The operating profit of the Magazine Papers segment includes expenses of 110 million relating to the closure of Miramichi pulp mill as well as income of 6 million from a change in the Finnish pension system. The change in the pension system resulted in income of 2 million being booked to Newsprint, 3 million to Fine and Speciality Papers, and 2 million to Converting. The operating profit of the Wood Products segment includes a capital gain of 110 million from the sale of Brooks Group, expenses totalling 34 million from restructuring arrangements made at Finnish sawmills and plywood mills, and income of 7 million from the change in the pension system. Other Operations includes income of 249 million stemming from the change in Finland s TEL employment pension scheme, an 11 million provision for group restructuring expenses and a 19 million provision for long-term wood procurement agreements in Great Britain 3) Taxes include a tax benefit of 235 million due to a change in Finnish tax legislation and a benefit of 284 million resulting from a decrease in the German tax liability. 4) Segment assets include goodwill, other intangible assets, property, plant and equipment, investment property, biological assets and investments in associated companies and joint ventures, investments in energy shares under available-for-sale investments, inventories and trade receivables. 5) Segment liabilities include trade payables and advances received. 6) Capital employed is segment assets less segment liabilities. Other operations include the Forestry Department in Finland: 1,392 million and the Energy Department in Finland: 1,011 million. Eliminations include unallocated assets and unallocated non-interest bearing liabilities. 7) The formula for calculation return on capital employed; segments: Operating profit/capital employed (average) x 100, the Group: Profit before tax + interest expenses and other finance costs/balance sheet total non-interest-bearing liabilities (average) x UPM ANNUAL REPORT 2004

67 GROUP Primary reporting format Segment data for the year ended 31 December 2003 m Magazine Papers Newsprint Fine and Speciality Papers Converting Wood Products Other operations 1) Eliminations Group External sales 3,209 1,271 2,000 1,331 1, ,787 Internal sales Total sales 3,280 1,273 2,244 1,370 1, ,787 Operating profit 2) Share of results of associates and joint ventures Gains on available-for-sale investments, net 127 Finance costs, net 70 Income taxes 121 Minority interest 2 Net profit 319 Assets 3) 5,041 2,186 2, , ,808 Associates and joint ventures 1,012 1,012 Unallocated assets 1,771 Total assets 5,041 2,186 2, ,417 16,591 Liabilities 4) Unallocated liabilities 8,790 Total liabilities 9,562 Other items Depreciation and amortization ,048 Impairment charge Capital expenditure Capital employed, 31 December 5) 4,847 2,071 2, ,187 1,237 12,811 Capital employed, average 5,089 2,134 2, ,250 Return on capital employed, % 6) ) Sales include only sales outside the Group. Internal sales to segments amount to 1,436 million consisting, mainly of the Forestry and Energy Departments in Finland. 2) Operating profit includes charges of 22 million related to the shutdown of Blandin s two paper machines in the Magazine Papers segment and charges of 9 million related to the shutdown of Voikkaa PM 17 in the Newsprint segment. Additionally, Other operations include charges related to the unrealized MACtac acquisition of 19 million, a loss of 6 million related to the disposal of the operations of Rosenlew, and charges of 5 million related to the restructuring of forestry operations in Finland. 3) Segment assets include goodwill, other intangible assets, property, plant and equipment, investment property, biological assets and investments in associated companies and joint ventures, investments in energy shares under available-for-sale investments, inventories and trade receivables. 4) Segment liabilities include trade payables and advances received. 5) Capital employed is segment assets less segment liabilities. Other operations include the Forestry Department in Finland: 1,377 million and the Energy Department in Finland: 962 million. Eliminations include unallocated assets and unallocated non-interest bearing liabilities. 6) The formula for calculation return on capital employed; segments: Operating profit/capital employed (average) x 100, the Group: Profit before tax + interest expenses and other finance costs/balance sheet total non-interest-bearing liabilities (average) x 100. UPM ANNUAL REPORT

68 ACCOUNTS FOR 2004 Primary reporting format Segment data for the year ended 31 December 2002 m Magazine Papers Newsprint Fine and Speciality Papers Converting Wood Products Other operations 1) Eliminations Group External sales 3,472 1,377 2,138 1,497 1, ,417 Internal sales Total sales 3,570 1,379 2,446 1,539 1, ,417 Operating profit 2) Share of results of associates and joint ventures Gains on available-for-sale investments, net 72 Finance costs, net 245 Income taxes 212 Minority interest 2 Net profit 500 Assets 3) 5,303 2,406 2, , ,422 Associates and joint ventures 1,095 1,095 Unallocated assets 2,107 Total assets 5,303 2,406 2, ,473 17,624 Liabilities 4) Unallocated liabilities 9,636 Total liabilities 10,387 Other items Depreciation and amortization ,042 Impairment charge Capital expenditure Capital employed, 31 December 5) 5,107 2,306 2, ,329 1,077 13,689 Capital employed, average 5,396 2,393 2, ,076 Return on capital employed, % 6) ) Sales include only sales outside the Group. Internal sales to segments amount to 1,460 million, consisting mainly of the Forestry and Energy Departments in Finland. 2) Operating profit includes charges of 108 million related to the shutdown of Blandin s two paper machines in the Magazine Papers segment, charges of 8 million related to the rebuild of the Shotton RCF plant in the Newsprint segment, and a capital gain of 14 million on the sale of Walki Films unit in Other operations. 3) Segment assets include goodwill, other intangible assets, property, plant and equipment, investment property, biological assets and investments in associated companies and joint ventures, investments in energy shares under available-for-sale investments, inventories and trade receivables. 4) Segment liabilities include trade payables and advances received. 5) Segments capital employed is segment assets less segment liabilities. Other operations include the Forestry Department in Finland: 1,366 million, and the Energy Department in Finland: 955 million. Eliminations include unallocated assets and unallocated non-interest bearing liabilities. 6) The formula for calculation return on capital employed; segments: Operating profit/capital employed (average) x 100, the Group: Profit before tax + interest expenses and other finance costs/balance sheet total non-interest-bearing liabilities (average) x UPM ANNUAL REPORT 2004

69 GROUP Personnel (average) by segment Year ended 31 December Magazine Papers 9,125 9,180 9,635 Newsprint 3,631 3,843 3,914 Fine and Speciality Papers 6,933 6,827 6,816 Converting 4,675 4,755 4,979 Wood Products 7,503 7,803 7,862 Other operations 2,948 3,343 3,660 Total 34,815 35,751 36,866 Personnel at year end 33,433 34,482 35,579 Secondary reporting format External sales by destination Year ended 31 December m Germany 1,543 1,550 1,803 Great Britain 1,295 1,216 1,369 Finland 1,029 1, France Other EU countries 1) 2,291 2,041 2,151 Other European countries United States 1,323 1,209 1,269 Canada Rest of world 1,064 1,068 1,020 Total 9,820 9,787 10,417 1) 21 countries in 2004, 11 countries in 2003 and Total external assets by country As at 31 December m Germany 2,958 3,153 3,349 Great Britain Finland 8,088 8,492 8,860 France Other EU countries 1) 940 1,072 1,189 Other European countries United States Canada Rest of world Total 15,827 16,591 17,624 1) 21 countries in 2004, 11 countries in 2003 and Capital expenditure by country Year ended 31 December m Germany Great Britain Finland France Russia Other European countries China North America Rest of world Total ACQUISITIONS AND DISPOSALS In 2004, 2003 and 2002, the Group made only some minor aquisitions. The total consideration paid was 10 million in 2004, 14 million in 2003 and 12 million in In August 2004, UPM sold Brooks Group Limited, the Irish building material merchant, for 213 million. The capital gain from the sale amounted to 110 million. In September 2003, UPM sold the Rosenlew flexible intermediate bulk container (FIBC) operations with an after-tax loss of 4 million. In October 2002, the Group sold its Walki Films packaging films business. The pre-tax gain on disposal was 14 million. None of these disposals are classified as discontinued operations. Assets and liabilities arising from the acquisition Year ended 31 December m Cash and cash equivalents 9 2 Other intangible assets 1 4 Property, plant and equipment 3 37 Inventories 8 2 Receivables 14 2 Borrowings Fair value of net assets acquired Goodwill 8 1 Total purchase price Less: Cash and cash equivalents in subsidiary acquired 9 2 Cashfl ow on acquisition Net assets and liabilities of disposals Year ended 31 December m Cash and cash equivalents Property, plant and equipment Inventories Receivables Payables Borrowings Gain/loss on disposal Total consideration Satisfied by cash and cash equivalents Cash and cash equivalents in subsidiary disposed Net cash infl ow arising on disposals OTHER OPERATING INCOME Year ended 31 December m Gains on sale of non-current assets 1) Rental income, investment property Rental income, other Other ) Year 2004 includes capital gains of 110 million from the sale of Brooks Group. UPM ANNUAL REPORT

70 ACCOUNTS FOR COSTS AND EXPENSES Year ended 31 December m Change in inventories of finished goods and work in progress Production for own use Materials and services Raw materials, consumables and goods Purchased during the period 4,737 4,472 4,531 Change in inventories Biological assets harvested during the period Fair value change of biological assets External services 1) ,513 5,405 5,366 Personnel expenses Salaries and fees Salaries of board of directors and managing directors Other salaries 1,310 1,285 1,349 1,325 1,302 1,369 Indirect employee costs Pension costs-defined benefit plans (Note 29) Change in the Finnish pension system 2) 269 Pension costs-defined contribution plans Other post-employment benefits (Note 29) Other indirect employee costs 3) Other operating costs and expenses Rents and lease expenses Losses on sale of non-current assets Other operating expenses 4) 1,281 1,308 1,447 1,347 1,361 1,520 Costs and expenses, total 8,227 8,445 8,580 1) External services comprise mainly distribution costs of products sold. 2) Changes were made to Finland s TEL employment pension scheme in This resulted in a decrease of 269 million in the pension liability. 3) Other indirect employee costs include primarily other statutory social costs, excluding pension costs. 4) Other operating expenses include, among others, energy and maintenance costs, costs paid for services and for administration. The research and development costs included in costs and expenses were 47 million (2003: 48 million and 2002: 46 million). Remuneration paid to the members of the Board of Directors and the Executive Team During 2004 the 9 members of the Board of Directors were paid fees totalling 918,000, of which 356,000 was paid in the form of UPM shares. The 13 members of the Executive Team were paid salaries and fringe benefits totalling about 4.6 million, of which 8 % were bonuses. According to the Company s performance-related and incentive pay scheme, executives can be paid a performance-related reward amounting to not more than twelve months salary. The combined value of President and CEO Jussi Pesonen s salary, fringe benefits and other remuneration in 2004 was 665,000 (in 2003 the corresponding total for Juha Niemelä was 1,089,000). On 29 January 2004 the Company s Board of Directors appointed Senior Executive Vice President and COO Jussi Pesonen as the Group s new President and CEO. Mr. Pesonen s monthly salary is 45,000, which includes housing and telephone benefits. In addition, he has a company car as a fringe benefit. Besides salaries and bonuses the members of the Executive team are also entitled to participate in the Company s stock option plans. The managing Director s agreed retirement age is 60 years. The retirement age of the members of the Executive Team is years, depending on agreements. The costs of lowering the retirement age or supplementing statutory pension security are generally covered by voluntary pension insurance. In 2004 the total amount of pension expenses relating to the pension plans of the members of the Executive Team was 1.2 million ( 2.3 million in 2003). Members of the Executive Team have negotiated certain benefits upon the termination of their service contracts prior to the stated expiration date of such service contracts. If UPM-Kymmene Corporation gives notice of termination to Jussi Pesonen, the President and CEO, a severance compensation of 24 months fixed salary will be paid, in addition to the six months salary required to be paid during the notice period for his termination. For other members of the Executive Team, the period for additional severance compensation is 12 months in addition to the six months salary for the notice period. If there is a change of control in UPM-Kymmene Corporation (as defined in the Key Personnel Stock Options Terms and Conditions, authorized by the annual general shareholder s meeting of 19 March 2002), each member of the Executive Team may terminate such executive s service contracts within one month or, in the case of Jussi Pesonen, within three months, of the closing of the trigger event for the change of control and receive compensation equivalent to such executive s 24 months fixed salary. 8 DEPRECIATION, AMORTIZATION AND IMPAIRMENT CHARGES Year ended 31 December m Depreciation on property, plant and equipment Buildings Machinery and equipment Other tangible assets Depreciation on investment property Buildings Amortization of intangible assets Intangible rights Goodwill Other capitalized expenditure Impairment charges of property, plant and equipment Land areas 8 Buildings Machinery and equipment Other tangible assets Impairment of intangible assets Other capitalized expenditure 4 Depreciation, amortization and impairment charges total 1,122 1,048 1,125 In 2004, the impairments of tangible fixed assets includes 75 million relating to the closure of the Miramichi pulp mill in Canada and UPM ANNUAL REPORT 2004

71 GROUP million relating to restructuring of the wood product industry in Finland. No further impairments are expected related to the restructurings. The impairment charge in 2002 for property, plant and equipment includes 71 million related to the shut-down of two paper machines at the Blandin mill in the U.S. and 5 million related to the rebuild of the RCF plant at the Shotton mill in the U.K. 9 SHARE OF RESULTS OF ASSOCIATED COMPANIES AND JOINT VENTURES BEFORE TAXES Year ended 31 December m Oy Metsä-Botnia Ab Pohjolan Voima Oy Others GAINS ON AVAILABLE-FOR-SALE INVESTMENTS, NET Year ended 31 December m Fair value gains and losses on disposals Impairment reversal/loss Total FINANCE COSTS Year ended 31 December m Interest expenses Interest income Dividend income from available-for-sale investments Exchange gains and losses Fair value gains and losses on derivative financial instruments 1) Gains and losses on sale of associated companies and joint ventures shares Other financial income Other financial expenses Total ) The fair value hedge ineffectiveness, net was 12, 22 and 13 million in 2004, 2003 and 2002, respectively. The aggregate foreign exchange gains and losses included in the consolidated income statement Year ended 31 December m Sales Costs and expenses Net financial items Total INCOME TAXES Year ended 31 December m Major components of tax expenses Current tax expense Change in deferred taxes (Note 28) Share of tax of associates Income tax reconciliation Profit before tax Computed tax at Finnish statutory rate of 29% Difference between Finnish and foreign rates Non-deductible expenses and tax exempt income Non-deductible purchase price difference Tax loss with no tax benefit Undistributed profits of associated companies 11 1 Change in tax legislation 1) Other 1) Income tax expense Effective tax rate 1) 26.7% 27.6% 29.9% 1) Taxes for 2004 include a non-recurring tax benefit of 235 million stemming from a change in Finnish tax legislation and a non-recurring tax benefit of 284 million owing to a decrease in the German tax liability. These amounts have been excluded in computing the effective tax rate for EARNINGS PER SHARE Year ended 31 December Net profit attributable to shareholders ( m) Average weighted number of shares (1000) 523, , ,935 Basic earnings per share, For the diluted earnings per share the number of shares is adjusted by the effect of convertible bond loan and share options. Net profit attributable to shareholders Adjustments to the net profit 2 Net profit used to determine diluted earnings per share Average weighted number of shares (1000) 523, , ,935 Effect of convertible bond loan 449 4,980 Effect of options 2, ,867 Average weighted number of shares for diluted earnings per share (1000) 526, , ,782 Diluted earnings per share, UPM ANNUAL REPORT

72 ACCOUNTS FOR DIVIDEND PER SHARE At the Annual General Meeting on 24 March 2004, a dividend in respect of 2003 of 0.75 per share, amounting to a total dividend of 393 million, was approved. After giving effect to the bonus issue in 2003, the dividends declared in respect of 2002 were 0.75 per share, totalling 390 million. 15 GOODWILL As at 31 December m Acquisition cost at 1 Jan. 2,031 2,014 Additions 20 Disposals 7 3 Acquisition cost at 31 Dec. 2,024 2,031 Accumulated amortization and impairment at 1 Jan Amortization Disposals 4 3 Accumulated amortization and impairment at 31 Dec Carrying value at 1 Jan. 1,663 1,745 Carrying value at 31 Dec. 1,560 1, OTHER INTANGIBLE ASSETS As at 31 December m Intangible rights Acquisition cost at 1 Jan Additions 8 12 Disposals 2 2 Reclassifications Translation differences 2 4 Acquisition cost at 31 Dec Accumulated amortization and impairment at 1 Jan Amortization Disposals 2 1 Reclassifications 9 Accumulated amortization and impairment at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Other capitalized expenditure Acquisition cost at 1 Jan Additions Disposals Reclassifications 8 25 Acquisitions through business combinations 1 Translation differences 1 5 Acquisition cost at 31 Dec Accumulated amortization and impairment at 1 Jan Amortization Impairment charges 4 Disposals 7 28 Reclassifications 3 9 Translation differences 1 3 Accumulated amortization and impairment at 31 Dec As at 31 December m Advance payments and construction in progress Acquisition cost at 1 Jan Additions 5 5 Disposals Reclassifications 7 8 Acquisition cost at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Total other intangible assets Intangible rights include 123 million in respect of the water rights of power plants acquired under finance lease agreements (2003: 168 million). 17 PROPERTY, PLANT AND EQUIPMENT As at 31 December m Land and water areas Acquisition cost at 1 Jan Additions 4 7 Disposals Reclassifications 3 Translation differences 2 Acquisition cost at 31 Dec Accumulated depreciation and impairment at 1 Jan Disposals 2 Impairment 8 Accumulated depreciation and impairment at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Buildings Acquisition cost at 1 Jan. 3,052 3,036 Additions Acquisitions through business combinations 2 2 Disposals Reclassifications Translation differences Acquisition cost at 31 Dec. 3,092 3,052 Accumulated depreciation and impairment at 1 Jan. 1,219 1,158 Depreciation Impairment 18 1 Disposals Reclassifications 1 2 Translation differences 3 14 Accumulated depreciation and impairment at 31 Dec. 1,316 1,219 Carrying value at 1 Jan. 1,833 1,878 Carrying value at 31 Dec. 1,776 1,833 Carrying value at 1 Jan Carrying value at 31 Dec UPM ANNUAL REPORT 2004

73 GROUP As at 31 December m Machinery and equipment Acquisition cost at 1 Jan. 12,669 12,636 Additions Acquisitions through business combinations 3 2 Disposals Reclassifications Translation differences Acquisition cost at 31 Dec. 12,856 12,669 Accumulated depreciation and impairment at 1 Jan. 7,323 6,966 Depreciation Impairment 77 3 Disposals Reclassifications 4 5 Translation differences Accumulated depreciation and impairment at 31 Dec. 7,840 7,323 Carrying value at 1 Jan. 5,346 5,670 Carrying value at 31 Dec. 5,016 5,346 Other tangible assets Acquisition cost at 1 Jan Additions Disposals Reclassifications 12 3 Translation differences 2 6 Acquisition cost at 31 Dec Accumulated depreciation and impairment at 1 Jan Depreciation Disposals Reclassifications 1 3 Impairment 1 Translation differences 2 3 Accumulated depreciation and impairment at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Advance payments and construction in progress Acquisition cost at 1 Jan Additions Disposals 6 47 Reclassifications Translation differences 4 5 Acquisition cost at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Total property, plant and equipment 7,621 8,125 In 2004, additions included assets of 8 million acquired under finance lease arrangements (2003: 85 million). Finance lease arrangements Property, plant and equipment includes property that is acquired under finance lease and sale and leaseback contracts: As at 31 December m Land and water areas Acquisition cost 1 1 Accumulated depreciation Carrying value at 31 Dec. 1 1 Buildings Acquisition cost Accumulated depreciation 9 15 Carrying value at 31 Dec Machinery and equipment Acquisition cost Accumulated depreciation Carrying value at 31 Dec Advance payments and construction in progress Acquisition cost 85 Carrying value at 31 Dec. 85 Total leased assets There is no property, plant and equipment leased to third parties under operating lease. Capitalized borrowing costs The borrowing costs capitalized amounted to 7 million in 2004 (2003: 5 million). The 2.6 % (2003: 3.0) average interest rate used represents the costs of the loan used to finance the projects. 18 INVESTMENT PROPERTY As at 31 December m Acquisition cost at 1 Jan Additions 6 4 Disposals 9 12 Reclassifications 5 4 Acquisition cost at 31 Dec Accumulated depreciation and impairment at 1 Jan Depreciation 1 2 Disposals 1 2 Reclassifications 4 4 Accumulated depreciation and impairment at 31 Dec Carrying value at 1 Jan Carrying value at 31 Dec Investment property includes real estate investments such as flats and other premises occupied by third parties. The fair value of these flats at 31 December 2004 was 30 million (2003: 38 million). At 31 December 2004 approximately 84 % (2003: 77) of flats were state-subsidized buildings, for which certain restrictions exist for sale. The fair value of other premises at 31 December 2004 was 9 million (2003: 12 million). UPM ANNUAL REPORT

74 ACCOUNTS FOR 2004 The amounts recognized in the income statement: Year ended 31 December m Rental income Direct operating expenses arising from investment properties that generate rental income 8 11 All lease contracts can be cancelled during a normal period of time. Rent increase is possible once a year and is based mainly on the cost-ofliving index or the real estate maintenance index. There were no contractual obligations for future repair and maintenance or purchase of investment property. All assets under investment property are leased to third parties under operating lease contracts. 19 BIOLOGICAL ASSETS As at 31 December m At 1 Jan. 1,127 1,129 Purchases during the period 11 2 Sales during the period 9 8 Harvested during the period Gains and losses arising from changes in fair values Translation differences 1 9 At 31 Dec. 1,143 1, INVESTMENTS IN ASSOCIATES AND JOINT VENTURES As at 31 December m At 1 Jan. 1,012 1,095 Increases 40 2 Decreases 26 2 Share of results before tax Income taxes 6 7 Dividend received Subsidiary transfers 1 43 Translation differences 3 9 At 31 Dec. 1,047 1,012 Investments in associated companies at 31 December 2004 include goodwill of 39 million of which 37 million relates to Pohjolan Voima Oy s shares (2003: 35 million of which 32 million relates to Pohjolan Voima Oy s shares). As at 31 December m Sales and lease back agreements included in investments in associated companies Acquisition cost at 1 Jan Accumulated increases 6 5 Carrying value at 31 Dec Associated companies and joint ventures Group holding percentage Carrying value Associated companies Austria Papier Recycling Ges.m.b.H., AT Circel Grundstücks- und Vermögensverwaltung AG, DE Corenso United Oy Ltd, FI Oy Finnish Peroxides Ab, FI Kaygee Papers Private Limited, IN Oy Keskuslaboratorio-Centrallaboratorium Ab, FI Oy Metsä-Botnia Ab, FI Paperinkeräys Oy, FI Pohjolan Voima Oy, FI 1) Powest Oy, FI RETS Timber Oy Ltd, FI Steveco Oy, FI Oy Transfennica Ab, FI Other 9 At 31 Dec. 1,022 1) The Group holding percentage has been calculated excluding D2 and D7 share series (Wisa Power Oy, Jämsäkosken Voima Oy) which have been consolidated as subsidiaries. Pohjolan Voima Oy ( PVO ) holds a 57.2 percent shareholding in Teollisuuden Voima Oy ( TVO ), which owns and operates nuclear powers plants in Olkiluoto, Finland. The operation of a nuclear power plant involves potential costs and liabilities related to decommissioning and dismantling of the nuclear power plant and storage and disposal of spent fuel, and is governed by international, European Union and local nuclear regulatory regimes. Pursuant to the Nuclear Liability Act, the operator of a nuclear facility is strictly liable for damage resulting from a nuclear incident at the operator s installation or occurring in the course of transporting nuclear fuels. Shareholders of power companies that own and operate nuclear power plants are not subject to liability under the Nuclear Liability Act. In Finland, the future costs of conditioning, storage and final disposal of spent fuel, management of low and intermediate-level radioactive waste and nuclear power plant decommissioning are the responsibility of the operator. Reimbursements of the operators costs related to decommissioning and dismantling of the power plant and storage and disposal of spent fuel are provided for by state-established funds funded by annual contributions from nuclear power plant operators. Pursuant to PVO and TVO shareholders agreements, the Group bears its proportionate share of the costs related to decommissioning and dismantling of the nuclear power plant and storage and disposal of spent fuel through the price of electricity acquired from PVO. The contributions to such funds are intended to be sufficient to cover estimated future costs. If the actual costs deviate from fund provisions, the Group would be affected accordingly. Group holding percentage Carrying value Joint ventures Compania Forestal Oriental S.A., UA Kainuun Voima Oy, FI Associated companies and joint ventures at 31 Dec. 1, UPM ANNUAL REPORT 2004

75 GROUP The amounts representing the Group s share of the assets and liabilities and sales and results of the joint ventures that have been accounted for using the equity method are presented in the table below. Year ended 31 December m The amount of assets and liabilities related to investments in joint ventures Non-current assets Current assets 7 7 Non-current liabilities Current liabilities Net assets The income and expenses related to investments in joint ventures Sales Expenses Net profit 1 The average number of employees in the joint ventures Transactions and balances with associates and joint ventures Year ended 31 December m Sales to associates and joint ventures Purchases from associates and joint ventures Non-current receivables from associates and joint ventures Receivables from associates and joint ventures Payables to associates and joint ventures Loan receivables from associates and joint ventures 1) At 1 Jan Withdrawals 1 4 Repayments 1 6 At 31 Dec ) Loans to associated companies and joint ventures include current and non-current loan receivables. The interest rates of the associated company receivables are based on market rates. As at 31 December million of the loans mature by the end of 2007, and 2 million by the end of AVAILABLE-FOR-SALE INVESTMENTS Year ended 31 December m At 1 Jan Increases Decreases Changes in fair values 1) 39 2 Impairments 26 Other changes 3 2 At 31 Dec ) Changes in fair values include 26 million due to reversal of impairments. Available-for-sale investments, comprising principally of equity securities in listed companies and investments in unlisted equity shares, are fair valued, except in the case of certain unlisted equities, where the fair value cannot be measured reliably. Such unlisted equities are carried at cost, less impairment. The fair value of the shares in Kemijoki Oy cannot be reliably measured as the majority of the shares is owned by the state of Finland and some municipal institutions. There is not an active market for these shares. Fair value of equity investments traded in active markets is 233 million in 2004 and 197 million in Fair value for equity investments traded in active markets is determined by using exchange quoted closing prices. Principal available-for-sale investments Number of shares Group holding percentage Carrying value Kemijoki Oy 100, Metso Corporation (listed company) 19,922, Other 28 Carrying value of available-for-sale investments at 31 Dec NON-CURRENT RECEIVABLES As at 31 December m Loans to associates and joint ventures Other loans receivables Derivative financial instruments At 31 Dec The carrying value is considered to approximate the fair value. There were no loans granted to the Executive Team or managing director at 31 December 2004 or OTHER NON-CURRENT ASSETS As at 31 December m Defined benefit plans (Note 29) Other non-current assets 1 At 31 Dec INVENTORIES As at 31 December m Raw materials and consumables Work in progress Finished products and goods Advance payments At 31 Dec. 1,138 1,144 UPM ANNUAL REPORT

76 ACCOUNTS FOR TRADE AND OTHER RECEIVABLES As at 31 December m Trade receivables 1,261 1,065 Loan receivables Other receivables Derivative financial instruments Trading investments 1 Prepayments and accrued income At 31 Dec. 1,587 1,439 Doubtful accounts receivable Trade receivables are recorded net of the following allowances for doubtful accounts: As at 31 December m At 1 January 4 10 Additions 5 7 Deductions 7 13 At 31 Dec. 2 4 Asset securitization In January March 2004, the Group terminated its asset securitization programmes. Some Group companies in Great Britain, France, Italy and Germany had made agreements with third parties concerning their receivables (asset securitization). The Group companies in question had agreed to sell the ownership right to specified trade receivables on a continuous and irrevocable basis. The value of the receivables sold on the basis of the asset securitization agreement at 31 December 2003 was 179 million and it is presented on the consolidated balance sheet as a decrease in trade receivables. Increases and decreases in trade receivables are reported on the consolidated cash flow statement as cash generated from operations. 26 AVAILABLE-FOR-SALE INVESTMENTS The available-for-sale investments comprise of certificates of deposits with original maturities over three months. Main items included in prepayments and accrued income As at 31 December m Personnel expenses 5 7 Interest income 2 13 Indirect taxes 5 23 Other items At 31 Dec The carrying value is considered to approximate the fair value. 27 SHARE CAPITAL, SHARE PREMIUM RESERVE AND FAIR VALUE AND OTHER RESERVES Share capital and share premium reserve m Number of shares (1000) Share capital Share premium At 1 Jan , ,146 Share issue 261, Convertible bond loan 1, At 31 Dec , ,627 Exercise of share options At 31 Dec , ,636 Total Under the articles of association of the Company, the authorized share capital may not be less than 750,000,000 or more than 3,000,000,000. As of 31 December 2004 the issued share capital was 891,344, consisting of 524,320,252 fully-paid shares. The counter value of each share is 1.70 and each of the shares entitles its holder to one vote. The shares are in book-entry format. Authorizations to increase share capital On 24 March 2004, the Annual General Meeting authorized the Board of Directors to decide to increase the company s share capital by issuing new shares and/or convertible bonds in one or more issues. The number of shares carrying an equivalent value of 1.70 per share available for subscription under this authorization may not exceed 104,715,000 and the share capital may be increased by a maximum total amount of 178,015, Under the same authorization, the number of shares may rise by 20.00%. The authorization was not used during In 2004, class A share options and B share options were exercised to subscribe 871,342 shares, of which 741,322 were recorded in the Trade Registry before the end of If all 7,128,658 shares are subscribed under the 3,564,329 share options issued in 1998, together with all 15,200,000 shares that can be subscribed under the 7,600,000 share options issued in 2002, the number of the company s shares will increase by a total of 22,328,658 shares, i.e. by 4.26%. The shares available for subscription under the Board s authorization and through the exercise of options may increase the total number of the company s shares by 24.22%, i.e. by 127,043,658 shares, to 651,493,930 shares, and the share capital by 215,974, to 1,107,539, UPM ANNUAL REPORT 2004

77 GROUP Bonus issue On 19 March 2003, the annual general meeting of shareholders resolved to increase the share capital by a bonus issue of the amount of 445,042, from 445,042, to 890,084, In the bonus issue, the shareholders of the Company were, free of charge, given one new share for one old share. A total of 261,789,465 new shares were issued. An amount corresponding to the increase of the share capital was transferred from the legal reserve to the share capital. The new shares are entitled to any further dividends paid by the Company. The terms and conditions of the Company s year 1998 and 2002 stock options have been amended in a way that the proportional amount of the shares to be subscribed with the stock options will remain unchanged in respect of the share capital. Converting bond loan In December 2002, the Company announced that it would redeem all unconverted subordinated convertible bonds of the issue of 161 million, launched in 1994 outstanding. Between 2 January 2003 and 18 February 2003 (the last day a holder could have converted such convertible bonds into shares) approximately 36 million in principal amount of such convertible bonds were converted into 3,346,980 of the shares, adjusted by the bonus issue of March The redemption date was 28 February A total of 3,627, in principal amount of the convertible bonds was redeemed. Treasure shares As of 31 December 2004 and as of 31 December 2003, none of the shares were held as treasury shares. Redemption clause Under 12 of UPM-Kymmene Corporation s Articles of Association, a shareholder who alone or jointly with another shareholder owns 33 1/3 per cent or 50 per cent or more of all the company s shares or their associated voting rights shall, at the request of other shareholders, be liable to redeem in the manner prescribed in 12 their shares and any securities that, under the Companies Act, carry the right to such shares. Fair value and other reserves As at 31 December m Fair value reserve of available-for-sale investments 13 Hedging reserve Legal reserve At 31 Dec Distributable funds M 2004 Retained earnings 4,762 Net profit for the period 958 Translation differences 55 Portion of accumulated depreciation and voluntary provisions recorded in shareholders equity 1) 1,293 4,372 1) Under the Finnish legislation the calculated equity part of untaxed reserves and accumulated depreciation difference is not distributable to shareholders. 28 DEFERRED INCOME TAXES Reconciliation of the movements of deferred tax assets and liabilities balances during the period m As at 1 Jan Charged in income statement Charged in shareholders equity Translation differences As at 31 Dec Deferred tax assets Retirement benefit and other provisions Book over tax depreciation Tax losses and tax credits carried forward Other temporary differences Total deferred tax assets Offset against deferred tax liabilities 1) Net deferred tax assets Deferred tax liabilities Tax over book depreciation Undistributed profits of associated companies Fair value adjustments of net assets acquired and biological assets Fair valuation of available-for-sale investments and derivative financial instruments Other temporary differences Total deferred tax liability 1, ,177 Offset against deferred tax assets 1) Net deferred tax liabilities 1, Deferred tax liabilities, net 1, UPM ANNUAL REPORT

78 ACCOUNTS FOR 2004 Reconciliation of the movements of deferred tax assets and liabilities balances during the period m As at 1 Jan Charged in income statement Charged in shareholders equity Translation differences As at 31 Dec Deferred tax assets Retirement benefit and other provisions Book over tax depreciation Tax losses and tax credits carried forward Other temporary differences Total deferred tax assets Offset against deferred tax liabilities 1) Net deferred tax assets Deferred tax liabilities Tax over book depreciation Undistributed profits of associated companies Fair value adjustments of net assets acquired and biological assets Fair valuation of available-for-sale investments and derivative financial instruments Other temporary differences Total deferred tax liability 1, ,804 Offset against deferred tax assets 1) Net deferred tax liabilities 1, ,579 Deferred tax liabilities, net 1, ,176 1) Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same fiscal authority. The deferred income tax charged to equity during the years: m Cash fl ow hedges 2 13 Available-for-sale investments 39 Total 2 26 At 31 December 2004, the net operating loss carry-forwards for which the Group has recorded a deferred tax asset amounted to 548 million (of which 244 million and 145 million were attributable to the German and French subsidiaries, respectively) and at 31 December 2003 it was 529 million (of which 164 million and 193 million were attributable to the German and French subsidiaries, respectively). In France net operating loss carry-forwards do not expire. In other countries net operating loss carry-forwards expire at various dates and in varying amounts. The operating loss carry-forwards for which no deferred tax asset is recognized due to uncertainty of the utilization of these loss carry-forwards amounted to 175 million in 2004 ( 145 million in 2003). These operating loss carry-forwards are mainly attributable to Canadian subsidiaries. The Group has recognized deferred tax asset of 110 million in 2004 ( 96 million in 2003) relating to book over tax depreciation in Canada. The Group has considered projected future taxable income in making this assessment. These deferred tax assets do not expire. The book over tax depreciation for which no deferred tax asset is recognized amounted to 54 million in This relates to fixed assets impairment in 2004 in Canada. In connection with the acquisition of Haindl in 2001, a new tax basis was determined for acquired net assets. In 2003 the Group had a contingent tax benefit, which was not recorded due to the uncertainty of the tax treatment in Germany. As the uncertainty regarding the tax treatment has now been removed, the Group has recorded in million as a reduction of deferred tax liability. In addition, the Group has recorded in million as a reduction in deferred tax liabilities net of deferred tax assets resulting from the change in capital gains taxation and, effective as of the beginning of 2005, from the decrease of Finnish corporate tax rate from 29% to 26%. No deferred tax liability has been recognized for the undistributed profits of Finnish subsidiaries and associated companies as, such earnings are transferred to the Group without any tax consequences. In addition the Group does not provide for deferred tax liability on undistributed earnings of non-finnish subsidiaries to the extent that such earnings are intended to be permanently reinvested in those operations. 76 UPM ANNUAL REPORT 2004

79 GROUP 29 RETIREMENT BENEFIT OBLIGATIONS The Group operates a number of defined benefit and contribution plans throughout the world. The most significant pension plan in Finland is the statutory Finnish employee pension scheme (TEL) according to which benefits are directly linked to the employee s earnings. The TEL pension scheme is mainly arranged with insurance companies. Less than ten percent of the TEL scheme is arranged through the Company s own funds. The disability portion of the Finnish TEL scheme has been accounted for as a defined plan. Following changes in the Finnish TEL scheme, the disability pensions arranged with insurance companies will change from a defined benefit to a defined contribution plan beginning from 1 January As the change was enacted in 2004 the Company s pension liability decreased by 246 million in The pension liability also decreased by 23 million due to other changes in the TEL pension scheme effective from 1 January The foreign plans include both defined contribution and defined benefit plans. The Group also funds certain other post-employment benefits in North America relating to retirement medical and life incurance programmes. Pensions and other post-employment benefit provisions As at 31 December m Defined benefit pension plans Other post-employment benefits Other long-term employee benefits 23 9 Overfunded plan shown as asset (Note 23) Total liability in balance sheet DEFINED BENEFIT PLANS The amounts recognized in the balance sheet As at 31 December m Present value of funded obligations Present value of unfunded obligations Fair value of plan assets Unrecognized actuarial gains and losses Total liability Balance sheet reconciliation As at 31 December m Net liability at 1 Jan Translation differences 1 1 Net expenses recognized in the income statement Contributions paid Net liability at 31 Dec OTHER POST-EMPLOYMENT BENEFITS The amounts recognized in the balance sheet As at 31 December m Present value of unfunded obligations Unrecognized actuarial gains and losses 4 6 Liability in the balance sheet The amounts recognized in the income statement Year ended 31 December m Current service cost 1 1 Interest cost 1 2 Past service cost 8 Curtailment 1 Total included in personnel expenses 2 4 Balance sheet reconciliation As at 31 December m Net liability at 1 Jan Translation differences 1 6 Net expenses recognized in the income statement 2 4 Contributions paid 2 2 Net liability at 31 Dec The amounts recognized in the income statement Year ended 31 December m Current service cost Interest cost Expected return on plan assets Net actuarial gains and losses recognized during the year 4 1 Past service cost 26 Settlements 8 2 Curtailment 249 Total included in personnel expenses The actual return on plan assets was 40 million in 2004 (2003: 42 million). UPM ANNUAL REPORT

80 ACCOUNTS FOR 2004 Defined benefit plans: the principal actuarial assumptions used as at 31 December Finland Canada Germany USA Great Britain Other Discount rate % Expected return on plan assets % Future salary increases % Future pension increases % N/A N/A Expected average remaining working years of staff The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit obligation for U.S. plans was 11.0% in 2004, 12,0% in 2003, declining to 5.0% by the year 2011 and remaining at that level thereafter. The amounts of pension and other post-employment benefit plans recognized in the balance sheet as at 31 December 2004 m Finland Canada Germany USA Great Britain Other Total Present value of funded obligations Present value of unfunded obligations Fair value of plan assets Unrecognized actuarial gains and losses Liability in the balance sheet In Finland, the plan assets include a loan receivable of 174 million issued (2003: 167 million) by the company s own fund. The amounts of pension and other post-employment benefit plans recognized in the balance sheet as at 31 December 2003 m Finland Canada Germany USA Great Britain Other Total Present value of funded obligations Present value of unfunded obligations Fair value of plan assets Unrecognized actuarial gains and losses Liability in the balance sheet PROVISIONS m Closure and restructuring Reforestation Environmental obligations obligations Termination provisions Tax provisions Other Total At 1 Jan Translation difference Additional provisions and increases to existing provisions Utilized during year Unused amounts reversed At 31 Dec At 1 Jan Translation difference Additional provisions and increases to existing provisions Utilized during year Unused amounts reversed At 31 Dec UPM ANNUAL REPORT 2004

81 GROUP Provisions In September 2004 the Company announced the closure of the old and uncompetitive 240,000 tonne capacity Miramichi pulp mill. The pulp mill was closed down in December The arrangements made at the mill also included rationalization of paper production and wood procurement. Due to the arrangements, personnel costs of 14 million were booked under termination provisions, and costs of 9 million, mainly relating to the dismantling of the pulp mill, were entered in closure and restructuring provisions. In October 2004 a decision was made on restructuring arrangements in the Finnish wood products industry. As a consequence of these arrangements, UPM s production of sawn timber will fall by about 400,000 cubic metres and its birch plywood production by about cubic metres a year. The number of employees will fall by about 670 as a result of the production cutbacks. Aureskoski sawmill and Viiala plywood mill were closed at the end of 2004, and Kuopio plywood mill is scheduled for closure in the second half of The production of sawn timber at Alholma and Kajaani will fall by about a third. Staff functions are also adjusted. Relating to the restructuring, pension costs of 4 million were recorded under termination provisions, and other charges of 5 million primarily relating to the dismantling of the mill closures were recognized in closure and restructuring provisions. Additionally, charges of 19 million relating to long-term wood supply contracts in the U.K. and charges of 11 million relating to changes in group structure were recorded in other provisions. Environmental obligations include charges relating to idled production and land fill sites. Other termination provisions include mainly unemployment and disability provisions in several units.. 31 INTEREST-BEARING LIABILITIES m Non-current Interest-bearing liabilities Bond loans 2,648 2,893 Loans from financial institutions Pension loans Trade payables Finance lease liabilities Derivative financial instruments Accrued expenses and deferred income 1 3 Other liabilities ,424 4,911 Current Interest-bearing liabilities Current portion of long-term debt (repayments) Short-term loans Bills of exchange payable 1 9 Accruals Other liabilities 1) Total interest-bearing liabilities 5,341 5,781 1) Includes issued commercial papers of 226 million in 2004 (2003: 153 million). Maturity of non-current interest-bearing liabilities m Total Bond loans ,792 Loans from financial institutions Pension loans Trade payables Finance lease liabilities Derivative financial instruments Accrued expenses and deferred income 1 1 Other liabilities ,647 4,827 Current portion of long-term debt 403 Non-current interest-bearing liabilities 4,424 UPM ANNUAL REPORT

82 ACCOUNTS FOR 2004 Bond loans in interest-bearing liabilities Interest rate % Currency Nominal of value issued bond m As at 31 Dec m 2003 m Fixed rate USD USD EUR USD EUR JPY 10, JPY 2, USD EUR JPY 2, EUR USD GBP USD ,608 2,709 Floating-rate EUR EUR EUR EUR EUR Bond loans, total 2,792 2,893 - current portion 144 Bond loans, long-term portion 2,648 2,893 Fair value hedge of the long-term interest-bearing liabilities Fair value hedge accounting in accordance with IAS 39 results in a cumulative fair value adjustment totalling 89 million (2003: 114 million), which has increased the carrying amounts of the liabilities. Accordingly, the positive fair value of the hedging instruments excluding accrued interest amount to 174 million (2003: 162 million) in assets and negative fair value of 64 million in liabilities (2003: 38 million). The carrying amounts of the hedged liabilities and the fair values of the hedging instruments are included in the net interest bearing liabilities. The effect of the fair value hedge ineffectiveness on the income statement was 12 million (2003: 22 million). The interest rate ranges of interest-bearing liabilities As at 31 December % Loans from financial institutions Pension loans Finance lease liabilities Interest rate swaps The Group uses interest rate swap agreement to hedge the interest rate risk relating to long-term loans. At 31 December, 2004 the fixed interest rates varied from 0.1% to 8.0% (0.1% to 9.12% in 2003) and the floating rates varied from 1.08% to 6.18% (1.0% to 5.17% in 2003). NET INTEREST-BEARING LIABILITIES As at 31 December m Interest-bearing liabilities, total 5,341 5,781 Interest-bearing receivables Non-current Loans receivable Available-for-sale investments (listed shares) Derivatives Other receivables Current Loans receivable Trade receivables 9 20 Available-for-sale investments Cash and cash equivalents Interest-bearing receivables, total Net interest-bearing liabilities 4,617 4,874 The convertible bond loan The subordinated convertible bond issue was launched on 25 February 1994 in the amount of 161 million. The bonds had a maturity of 10 years and carried a coupon of 6.5 percent. The Company had the right to terminate the issue from 25 March 1998 onwards and to repay the loan, with accrued interest, in full. Bondholders had the right to convert their bonds during the period 1 April 1994 to 25 March 2004, and each 1,682 bond entitled the holder to subscribe to 78 shares of the Company, before the bonus issue adjustment in The calculated conversion share price was and the maximum potential increase in the share capital due to conversion of the bonds was 12.7 million (7,488,000 shares). As of 31 December 2002, a total of 5,646,264 shares had been subscribed through conversion under the issue, of which 1,398,150 shares were subscribed during In December 2002, the Company decided to exercise its right, under the terms and conditions of the issue, to redeem all unconverted bonds with a value of 40 million. By the redemption, on 28 February 2003 the total number of conversions during the years 1994 to 2003 was 157,832, and the number of shares converted 7,319,754 corresponding to 14,639,508 shares after the bonus issue. The remaining amount of the bonds ( 3,627,815.16) was redeemed on the redemption date. According to the terms of the bonds, holders of new shares subscribed under the issue in 2003 are entitled to receive dividends for the first time for the 2003 financial period. Finance lease liabilities The company has sold and then leased back certain power plants and certain tangible assets under long-term agreements and uses the electrical power generated by these plants in its own production. These leases contain renewal and/or purchase options. Payments are generally made over 10 to 20 years and, as of 31 December 2004, are due through In December 2004, UPM exercised its option and redeemed two of its leased power plants and the lease liability decreased by 65 million. In addition the Group leases certain tangible assets, including buildings, machinery and equipment, under long-term arrangement. 80 UPM ANNUAL REPORT 2004

83 GROUP Finance lease liabilities minimum lease payments As at 31 December m Not later than 1 year years years years years Later than 5 years Future finance charges Finance lease liabilities the present value of minimum lease payments Finance lease liabilities the present value of minimum lease payments As at 31 December m Not later than 1 year years years years years Later than 5 years OTHER LIABILITIES As at 31 December m Derivative financial instruments 59 Other TRADE AND OTHER PAYABLES As at 31 December m Advances received Trade payables Amounts due to associates and joint ventures Accrued expenses and deferred income Derivative financial instruments Other current liabilities ,256 1,269 Main items included in accrued expenses and deferred income As at 31 December m Personnel expenses Interest expenses Indirect taxes 8 9 Other items DERIVATIVE FINANCIAL INSTRUMENTS Derivative Financial Instruments are recorded on the balance sheet at their fair values, defined as the amount at which the instruments could be exchanged between willing parties in a current transaction, other than in a liquidation or forced sale. The fair values of such financial items have been estimated on the following basis: Interest forward rate agreements and futures contracts are fair valued based on quoted market rates as at the balance sheet date. Forward foreign exchange contracts are fair valued based on the contract forward rates in effect as at the balance sheet date. Foreign currency options are fair valued based on quoted market rates as at the balance sheet date. Interest and currency swap agreements are fair valued based on discounted cash flow analyses. Commodity derivatives are fair valued based on quoted market rates as at the balance sheet date. Net fair values of derivative financial instruments As at 31 December m Positive Negative fair fair values values Net fair values Net fair values Interest rate swaps 1) Forward contracts 2) Interest rate options Cross currency swaps 3) Commodity contracts ) Out of the interest rate swaps, fair value of 232 million was designated for fair value hedges of long-term borrowings as at 31 December 2004 ( 221 million as at 31 December 2003). 2) Out of the foreign exchange forward contracts, fair value of 58 million was designated for cash flow hedges as at 31 December 2004 ( 45 million as at 31 December 2003) and reported in fair value and other reserves, net of tax 44 million ( 32 million as at 31 December 2003). The qualification for cash-flow hedge accounting according to IAS 39 were met for agreements made in February 2003 or later. 3) Out of the cross currency swaps, fair value of 119 million was designated for fair value hedges of long-term borrowings as at 31 December 2004 ( 74 million as at 31 December 2003). Positive and negative fair values of financial instruments are shown under other non-current receivables, trade and other receivables, interest-bearing liabilities and trade and other payables. The carrying value is considered to approximate the fair value. UPM ANNUAL REPORT

84 ACCOUNTS FOR PRINCIPAL SUBSIDIARIES AS AT 31 DECEMBER 2004 Name of the subsidiary, country of incorporation Group holding % Name of the subsidiary, country of incorporation Group holding % Blandin Paper Company, US Oy Botnia Shipping Ab, FI ZAO Chudovo-RWS, RU Jämsänkosken Voima Oy, FI 1) Lignis GmbH & Co. KG, DE ) Lohja Papierprodukte GmbH, DE Loparex B.V., NL Loparex Hong Kong Ltd, CN Loparex Inc., US Loparex Ltd, GB Loparex Oy, FI Nordland Papier GmbH, DE Norfolk House Management Ltd, GB NorService GmbH, DE Nortrans Speditions GmbH, DE ZAO Pestovo Novo, RU AS Puukeskus, EE Puukeskus Oy, FI Rafl atac AB, SE Rafl atac Canada Inc., CA Rafl atac CZ s.r.o., CZ Rafl atac GmbH, DE Rafl atac Handels GmbH, AT Rafl atac Iberica S.A., ES Rafl atac Inc., US Rafl atac Italia s.r.l., IT Rafl atac Ltd, GB Rafl atac Mexico S.A. de C.V., ME Rafl atac Oy, FI Rafl atac Papirfeldolgozo Kft, HU Rafl atac Polska Sp. z o.o., PL Rafl atac Shanghai Co. Ltd, CN Rafl atac South Africa (Pty) Ltd, ZA Rafl atac S.A., FR Rafl atac (M) SDN BHD, MY Rafl atac (Oceania) Pty Ltd, AU Rafl atac (S) Pte Ltd, SG Rafl atac (Thailand) Co., Ltd, TH Oy Rauma Stevedoring Ltd, FI STAG-SCA Frischholz GmbH, AT Steyrermühl Sägewerksgesellschaft m.b.h. Nfg KG, AT Stracel S.A.S., FR Tilhill Forestry Ltd, GB UPM-Asunnot Oy, FI UPM Rafsec Oy, FI UPM Sähkönsiirto Oy, FI UPM Tehdasmittaus Oy, FI UPM-Kymmene AB, SE UPM-Kymmene AG, CH UPM-Kymmene AS, NO UPM-Kymmene Asia Pacific Pte Ltd., SG UPM-Kymmene Austria GmbH, AT UPM-Kymmene A/S, DK UPM-Kymmene B.V., NL UPM-Kymmene Comercializacao de Papel, Lda, PT UPM-Kymmene Forest AS, EE UPM-Kymmene France S.A.S., FR UPM-Kymmene Inc., US UPM-Kymmene Japan K.K., JP UPM-Kymmene Loulay S.A., FR UPM-Kymmene Miramichi Inc., CA UPM-Kymmene NV/SA, BE UPM-Kymmene Otepää AS, EE UPM-Kymmene Papier GmbH & Co. KG, DE UPM-Kymmene Pty. Ltd, AU UPM-Kymmene Sales GmbH, DE UPM-Kymmene Sp. z o.o., PL UPM-Kymmene Srl., IT UPM-Kymmene S.A., ES UPM-Kymmene Wood Ab, SE UPM-Kymmene Wood A/S, DK UPM-Kymmene Wood B.V., NL UPM-Kymmene Wood GmbH, DE UPM-Kymmene Wood Ltd, GB UPM-Kymmene Wood Oy, FI UPM-Kymmene Wood S.A., ES 100,00 UPM-Kymmene Wood S.A., FR UPM-Kymmene Wood S.r.l., IT, UPM-Kymmene (Changshu) Paper Industry Co., Ltd, CN UPM-Kymmene (Shanghai) Trading Co., CN UPM-Kymmene (UK) Ltd, GB Walki Wisa Converfl ex Ab, SE Walki Wisa GmbH, DE Walki Wisa Ltd, GB Walki Wisa Oy, FI Werla Insurance Company Ltd, GB Wisapower Oy, FI 1) The table presents subsidiaries with sales exceeding 2 million. 1) Jämsänkosken Voima Oy and Wisapower Oy are owned by Pohjolan Voima Oy, in which UPM has a controlling interest. UPM also has a controlling interest in Lignis GmbH & Co. KG 36 EQUITY COMPENSATION BENEFITS Share options granted to key personnel The Class A and Class B share options were issued pursuant to the management incentive program approved by the annual general meeting of shareholders in 1998 and the Class D share options and Class E share options were issued pursuant to a management incentive program approved by the annual general meeting of shareholders in Each share option is exercisable for two shares. On 25 March 1998, the shareholders approved the issuance to key personnel worldwide of 6,000,000 share options, each option conferring a right to subscribe for two shares. The share options comprised three classes with 2,000,000 share options in each class. In March 2002, the two million Class C share options were cancelled. Class A share options have been exercisable since 1 April 2001 and will be exercisable through 30 April 2005 at an exercise price of per share, without giving effect to the bonus issue, and per two shares, after giving effect to the bonus issue. Class B share options are exercisable from 1 April 2003 through 30 April 2005 at an exercise price of per share, without giving effect to the bonus issue, and per two shares, after giving effect to the bonus issue. The exercise price for the share options is reduced by the amount of dividends distributed (without any 82 UPM ANNUAL REPORT 2004

85 GROUP corporate tax credit) after 1 May 1998 and before the date of the share subscription. As a result of the share subscriptions with the 1998 share options, the share capital may be increased by a maximum of 13,600,000. On 19 March 2002, the shareholders authorized the issuance of 7,600,000 share options to key personnel. Each share option entitles its holder to subscribe for two shares of UPM-Kymmene share. Half of the share options are marked with the symbol 2002D, while the other half are marked 2002E. Those share options marked 2002D may be exercised between 1 April 2004 and 30 April 2007 while those share options marked 2002E may be exercised between 1 April 2005 and 30 April The share subscription price for the share options marked 2002D is per two shares and the share subscription price for the share options marked 2002E is per share. The share subscription price of share options 2002D and 2002E will, as per the dividend record date be reduced by the amount of the dividend decided after the end of the period for determination of the subscription price but before share subscription. As a result of the share subscriptions with the 2002 share options, the share capital may be increased by a maximum of 25,840,000. On 19 March 2003, the annual general meeting of shareholders resolved to increase the Company s share capital by a bonus issue. The shareholders of the Company were, free of charge, given one new share for one old share. A total of 261,789,465 new shares were issued. The terms and conditions of the Company s year 1998 and 2002 share options have been amended in a way that the proportional amount of the shares to be subscribed with the share options will remain unchanged in respect of the share capital. The Group has accrued the social security expenses relating to these option programmes. Movements in the number of share options granted As at 31 December m At 1 Jan. 11,071,700 7,582,000 Granted 330,200 3,591,000 Returned 174,200 Exercised 1) 435, ,300 At 31 Dec. 10,792,029 11,071,700 1) During 17 September to 30 December 2004, 336,271 class A share options and 99,400 B share options were exercised to subscribe 871,342 shares. Outstanding share options as at 31 December 2004 Plan/ year of launch Type Exercise price 1) No. of options 1 January 31 December issued outstanding Exercise period Vesting schedule 2002/2003 E ,800,000 3,758, /2002 D ,800,000 3,629, vested 1998/1998 B ,000,000 1,843, vested 1998/1998 A ,000,000 1,561, vested 11,600,000 10,792,029 1) The exercise prices for A, B and D options are per two shares and the exercise price for E options is per one share. 37 RELATED PARTY TRANSACTIONS The Group holds a 47 percent interest in Oy Metsä-Botnia Ab ( Metsä- Botnia ), a joint venture between M-real Oyj ( M-real ) and Metsäliitto Group. M-real is a Finnish paper producer, and Metsäliitto Group is a co-operative organization of Finnish forest owners. Metsäliitto Group is also the controlling shareholder of M-real. Chemical pulp produced by Metsä-Botnia is sold to the Group and to M-real at the market price less certain transportation and other costs. In 2004 and 2003, the Group s chemical pulp entitlement with respect to the production of Metsä- Botnia was 1.1 million tons per year. Total purchases of chemical pulp from Metsä-Botnia amounted to 238 million in 2004 and 226 million in The Group obtains most of the energy for its production units in Finland through the Group s owned and leased power plants, as well as through ownership in power companies which entitle it to receive electricity and heat from those companies. A significant volume of the Group s electricity procurement comes from Pohjolan Voima Oy, a Finnish power producer in which the Group holds a percent equity interest and Kemijoki Oy, a Finnish hydropower producer in which the Group holds a 4.13 percent equity interest. Pohjolan Voima Oy is also a majority shareholder in Teollisuuden Voima Oy, one of Finland s two nuclear power companies. Such purchases of electricity totalled 198 million in 2004 and 181 million in In accordance with the power companies respective articles of association and related shareholder agreements, the prices paid by the Group to the power companies are based on production costs, which are generally lower than market prices. Internal sales to the Group s segments are priced at the prevailing market price. Approximately 10 to 15 percent of the Group s research and development activities is conducted by Oy Keskuslaboratorio-Centrallaboratorium Ab (the Finnish Pulp and Paper Research Institute or FPPRI ), in which the Group is one of four corporate owners with a percent interest. The ownership in FPPRI provides the Group with fundamental research information regarding the Group s main raw materials, major manufacturing processes and key product attributes. In addition to joint research at FPPRI, the Group also utilizes the institute for contract research in connection with product and process development. These services are provided on an arm s-length basis and upon terms that the Group believes to be customary within the industry and generally no less favourable than would be available from unrelated third parties. The Group purchases logistics and transport services from certain associated companies, the most significant of which is Oy Transfennica Ab, in which the Group holds percent interest. Oy Transfennica Ab is a Finnish shipping company engaged in the transport of cargo, primarily paper and other forest products, between Finland and the main European trading ports. Such purchases amounted to 20 million in 2004 and 19 million in These purchases were made on an arm slength basis and upon terms that the Group believes to be customary within the industry and generally no less favourable than would be available from unrelated third parties. The Group purchases raw materials from certain associated compa- UPM ANNUAL REPORT

86 ACCOUNTS FOR 2004 nies, the most significant of which is Paperinkeräys Oy, a Finnish company in which the Group has a percent interest engaged in the procurement, processing and transport of recovered paper. Aggregate raw material purchases from associated companies amounted to 15 million in 2004 and 14 million in Recovered paper is sold to the Group and other shareholders of Paperinkeräys Oy at a price which is determined using a contractual formula that takes into account the world market prices for recovered paper and the prices of other fibre raw materials, as well as costs relating to paper recovery. In Austria, the Group has a similar arrangement concerning recovered paper which is purchased from Austria Paper Recycling G.m.b.H., a company in which the Group owns a percent equity interest. The aggregate recovered paper purchases amounted to 12 million in 2004 and 11 million in In Finland, UPM has a pension foundation (Kymin Eläkesäätiö) which is a separate legal entity. The pensions of about seven percent of the Group s Finnish employees have been arranged by the foundation. The contributions paid by UPM to the foundation amounted to 19 million in 2004, and 15 million in The foundation manages and invests the contributions for the employee benefit plans. At 31 December 2004, UPM had borrowings of 174 million ( 167 million at 31 December 2003) from the foundation. 38 COMMITMENTS AND CONTINGENCIES Contingent liabilities The Group is a defendant or plaintiff in a number of legal proceedings incidental to its operations. These lawsuits primarily involve claims arising out of commercial law issues. In August 2003, the Company received a grand jury subpoena in connection with the U.S. Department of Justice Antitrust Division s investigation into the U.S. labelstock industry. The company is responding to the subpoena as required. Following internal investigations into competitive practices, UPM decided on 15 January 2004 to approach the competition authorities in the European Union, the United States and Canada. The competition authorities have started investigations into alleged antitrust activities and consequently the EU, several of its member states, and the Canadian authorities have informed UPM that it has received conditional full immunity with respect to certain conduct disclosed to the authorities. The US Department of Justice has not decided on immunity, which is pending and available. The company has also been named as a defendant in several classaction lawsuits against labelstock and magazine paper manufacturers in the United States. In May 2004 UPM received a European Commission Statement of Objection concerning alleged antitrust activities in the market for plastic industrial sacks. The company manufactured plastic industrial sacks until December The annual sales of the operations under investigation amounted to 11 million. UPM has responded and will respond to the Statement of Objection as requested by the Commission. All of the above litigation matters may last several years. No provisions have been made in relation to these investigations. Except for the proceedings described above, the Group has not been involved in any legal, administrative or arbitration proceedings which management would expect to have a material adverse effect on the financial condition or results of operations of the Group, nor, so far as management is aware, are any such legal, administrative or arbitration proceedings either pending or threatened. Commitments In the normal course of business, UPM-Kymmene Corporation and certain of its subsidiaries enter into various agreements providing financial or performance assurance to third parties on behalf of those subsidiaries. These agreements are entered into primarily to support or enhance the creditworthiness otherwise achieved by a subsidiary on a standalone basis, thereby facilitating the availability of sufficient credit to accomplish the subsidiaries intended business purposes. The maximum amount of future payments by UPM-Kymmene Corporation on behalf of its subsidiaries under these guarantees are disclosed in the table below under guarantees of on own behalf caption. The Group has also entered into various agreements to provide financial or performance assurance to third parties on behalf of certain affiliates and other third parties. These agreements are entered into primarily to support or enhance the creditworthiness otherwise achieved by these related parties and entities on a stand-alone basis. The Group has no collateral or other recourse provisions related to these guarantees. The maximum amounts of future payments by UPM-Kymmene Corporation on behalf of its associated companies under these guarantees are disclosed in the table below under guarantees on behalf of associated companies caption. In the normal course of business, certain subsidiaries of UPM- Kymmene Corporation mainly in Germany grant commercial guarantees to their customers to facilitate the customers to finance purchases of goods from the subsidiary. The Group has no collateral but these commercial guarantees are covered by the Group s credit risk insurance. These guarantees mature within one year. The maximum potential amount of future payments under these guarantees amounted to 11 million and 8 million as at 31 December 2004 and 2003, respectively, and they are included in the amounts disclosed in Other Commitments in the table. Commitments As at 31 December m On own behalf Pledges given Mortgages Guarantees On behalf of associated companies and joint ventures Pledges given Mortgages Guarantees On behalf of others Pledges given Mortgages Guarantees 10 7 Other commitments, own Operating leases, due within 12 months Operating leases, due after 12 months Other commitments Total UPM ANNUAL REPORT 2004

87 GROUP As at 31 December m Mortgages Guarantees Operating leases Other commitments Total Property under mortgages given as collateral for own commitments include industrial estates and forest land. Operating lease commitments where a Group company is the lessee The Group leases office, manufacturing and warehouse space under various non-cancellable operating leases. Certain contracts contain renewal options for various periods of time The future costs for contracts exceeding one year and for non-cancellable operating leasing contracts As at 31 December m less than 1 year years years years years 10 9 over 5 years EVENTS AFTER THE BALANCE SHEET DATE On 1 February 2005, UPM decided to buy back its own shares. The aim is to purchase a maximum of ten million shares by 21 March Additionally on 1 February 2005, UPM made decisions on significant investments in Germany and France. UPM will rebuild two paper machines at its Nordland and Docelles paper mills. At Nordland paper mill in Germany, UPM will invest approximately 82 million in rebuilding paper machine 3. After the investment, the production capacity will be 340,000 tonnes. At Docelles paper mill in France, UPM will invest approximately 26 million in rebuilding paper machine 1. After the investment, the production capacity will be 155,000 tonnes. The rebuilds will be completed in the third quarter of UPM will also build a power plant at its Chapelle Darblay mill in France, to annually combust 160,000 tonnes of energy wood available in the region and all the sludge produced in its recovered paper recycling process. The total investment cost is 75 million. The power plant will start-up in the first quarter of Joint ventures As at 31 December m Proportionate interest in joint ventures commitments Contingent liabilities relating to the Group s interest in the joint ventures Capital commitments at the balance sheet date but not recognized in the financial statements; major commitments listed below Commitment as at 31 December m Total cost Changshu paper machine project New power plant, Shotton Tervasaari PM 8, additional capacity New coater line, Rafl atac, Fletcher New power plant, Rauma UPM ANNUAL REPORT

88 ACCOUNTS FOR 2004 PARENT COMPANY ACCOUNTS (FINNISH ACCOUNTING PRINCIPLES, FAS) PROFIT AND LOSS ACCOUNT , m Note FUNDS STATEMENT m Turnover (1) 4,417 4,403 Increase (+) or decrease ( ) in finished goods Production for own use Other operating income (2) Raw materials and services Raw materials and consumables Purchases during the financial period 2,252 2,070 Increase ( ) or decrease (+) in stocks 1 13 External services ,532 2,394 Personnel expenses Wages and salaries (3) Social security expenses Pension expenses Other social security expenses Depreciation and value adjustments (4) Depreciation according to plan Value adjustments to goods held as non-current assets Other operating costs and expenses Operating profit Financial income and expenses Income from investments held as non-current assets Income from Group companies Income from participating interest companies Income from other shares and holdings 7 23 Interest income from Group companies Interest income from other companies 3 5 Other interest and financial income Other interest income from Group companies Other interest income from other companies 18 7 Other financial income from Group companies 3 Other financial income from other companies Interest and other financial expenses Interest expenses paid to Group companies Interest expenses paid to other companies Other financial expenses paid to Group companies Other financial expenses paid to other companies Profit before extraordinary items Extraordinary items (5) Extraordinary income Extraordinary expenses Profit before appropriations and taxes Appropriations Increase ( ) or decrease (+) in accumulated depreciation difference Income taxes (6) Profit for the financial period Business operations Operating profit Adjustments to operating profit a) Change in net working capital b) Interest Dividends received Other financial items Taxes c) Net cash flow from operations Investments Purchase of shares Purchase of other fixed assets Sale of shares Sale of other fixed assets Increase in other non-current investments Decrease in other non-current investments Total cash used in investments Cash flow before financing Financing Increase in non-current liabilities 565 Decrease in non-current liabilities Increase ( ) or decrease (+) in interest-bearing receivables Increase (+) or decrease ( ) in interest-bearing current liabilities 15 8 Dividends paid Group contributions, received and paid Share issue and share conversions 10 Total financing Increase (+) or decrease ( ) in liquid funds Liquid funds at 1 Jan Liquid funds at 31 Dec a) Adjustments to operating profit Depreciation Gains (+) or losses ( ) on sale of fixed assets Value adjustments on non-current assets 2 4 Total b) Change in net working capital Increase ( ) or decrease (+) in stocks Increase ( ) or decrease (+) in non-interestbearing receivables Increase (+) or decrease ( ) in non-interestbearing current liabilities ( ) Total c) Taxes due to extraordinary items and the sale of fixed assets are presented on a net basis. 86 UPM ANNUAL REPORT 2004

89 PARENT COMPANY BALANCE SHEET m Note ASSETS Non-current assets Intangible assets (7) Intangible rights 5 5 Other capitalized expenditure Advance payments Tangible assets (8) Land and water areas 1,033 1,034 Buildings Machinery and equipment 1,940 2,045 Other tangible assets Advance payments and construction in progress ,677 3,811 Investments (9) Holdings in Group companies 3,688 3,617 Receivables from Group companies 1,753 2,458 Holdings in participating interest companies Receivables from participating interest companies Other shares and holdings Other receivables ,479 7,117 10,356 11,082 Current assets Stocks Raw materials and consumables Work in progress 1 Finished products and goods Advance payments Receivables Current (10) Trade receivables Receivables from Group companies 1,412 1,007 Receivables from participating interest companies 6 9 Loan receivables 1 Other receivables Prepayments and accrued income ,652 1,283 m Note EQUITY AND LIABILITIES Shareholders equity (11) Share capital Share issue 1 Share premium reserve Revaluation reserve Legal reserve Retained earnings 2,670 2,786 Profit for the financial period ,748 5,381 Appropriations Accumulated depreciation difference 1,529 1,603 Provisions (12) Provisions for pensions Other provisions Liabilities Non-current (13) Bond loans 2,480 2,714 Loans from financial institutions Pension loans Payables to Group companies Other liabilities ,379 3,727 Current (14) Bond loans 144 Loans from financial institutions Pension loans Advances received Trade payables Payables to Group companies 689 1,435 Payables to participating interest companies Other liabilities Accruals and deferred income ,877 2,309 5,256 6,036 Cash and cash equivalents ,231 1,982 Total assets 12,587 13,064 Total equity and liabilities 12,587 13,064 UPM ANNUAL REPORT

90 ACCOUNTS FOR 2004 NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS (All amounts in millions of euros unless otherwise stated.) 1 TURNOVER Owing to the corporate structure of the Group, the turnover of the parent company has not been broken down by division and market. 2 OTHER OPERATING INCOME m Capital gains on disposal of fixed assets Income from rents Other PERSONNEL EXPENSES m Wages and salaries Salaries of the Managing Director, Deputy Managing Director and members of the Board of Directors 1) 2 2 Other wages and salaries ) See notes to the consolidated accounts, note 6. Loans to company directors At 31 December 2004, the company s Managing Director and members of the Board of Directors had no loans out stand ing from the company or its subsidiaries 4 DEPRECIATION ACCORDING TO PLAN AND VALUE ADJUSTMENTS m Depreciation according to plan Intangible rights 1 1 Other capitalized expenditure Buildings Machinery and equipment Other tangible assets Value adjustments Value adjustments on non-current assets EXTRAORDINARY ITEMS m Extraordinary income Group contributions Other INCOME TAXES m Taxes on business income for the financial period Income taxes from previous periods Deferred tax liabilities and assets Deferred tax liabilities and receivables for the parent company are not re cord ed in the balance sheet. Deferred tax liability comprises mainly depreciation differences, for which the deferred tax liability at 31 December 2004 was 397 million (465 million). Deferred tax liability is not stated separately for revaluations. Applying a tax rate of 26%/29 % to the amount of the revaluations, the potential tax li a bil i ty arising from the sale of revalued assets is 185 million (207 million). 7 INTANGIBLE ASSETS m Intangible rights Acquisition cost at 1 Jan Increases 1 Acquisition cost at 31 Dec Accumulated depreciation at 1 Jan. 5 4 Depreciation for the period 1 1 Accumulated depreciation at 31 Dec. 6 5 Book value at 31 Dec. 5 5 Other capitalized expenditure Acquisition cost at 1 Jan Increases Decreases 1 Transfers between balance sheet items 9 2 Acquisition cost at 31 Dec Accumulated depreciation at 1 Jan Accumulated depreciation on decreases and transfers 3 12 Depreciation for the period Value adjustments and their cancellations 4 Accumulated depreciation at 31 Dec Book value at 31 Dec Advance payments Acquisition cost at 1 Jan Increases 2 1 Decreases 14 7 Transfers between balance sheet items 11 7 Book value at 31 Dec Extraordinary expenses Group contributions 1 14 Other UPM ANNUAL REPORT 2004

91 PARENT COMPANY 8 TANGIBLE ASSETS m Land and water areas Acquisition cost at 1 Jan Increases 1 2 Decreases 2 2 Transfers between balance sheet items 1 Acquisition cost at 31 Dec Revaluations at 1 Jan Reversal of revaluation Revaluations at 31 Dec Book value at 31 Dec. 1,033 1,034 Buildings Acquisition cost at 1 Jan. 1,070 1,048 Increases Decreases 1 1 Transfers between balance sheet items 7 9 Acquisition cost at 31 Dec. 1,100 1,070 Accumulated depreciation at 1 Jan Accumulated depreciation on decreases and transfers 3 6 Depreciation for the period Accumulated depreciation at 31 Dec Book value at 31 Dec Machinery and equipment Acquisition cost at 1 Jan. 5,498 5,316 Increases Decreases 3 7 Transfers between balance sheet items Acquisition cost at 31 Dec. 5,672 5,498 Accumulated depreciation at 1 Jan. 3,453 3,217 Accumulated depreciation on decreases and transfers Depreciation for the period Value adjustments and their cancellations 2 Accumulated depreciation at 31 Dec. 3,732 3,453 Book value at 31 Dec. 1,940 2,045 Other tangible assets Acquisition cost at 1 Jan Increases 4 2 Decreases Transfers between balance sheet items 3 2 Acquisition cost at 31 Dec Accumulated depreciation at 1 Jan Accumulated depreciation on decreases and transfers 3 Depreciation for the period 6 6 Accumulated depreciation at 31 Dec Book value at 31 Dec INVESTMENTS HELD AS NON-CURRENT ASSETS m Holdings in Group companies Acquisition cost at 1 Jan. 3,896 3,765 Increases Decreases Transfers between balance sheet items Acquisition cost at 31 Dec. 3,967 3,896 Accumulated depreciation at 1 Jan Accumulated depreciation on decreases and transfers 25 Value adjustments and their cancellations 204 Accumulated depreciation at 31 Dec Revaluations at 1 Jan. 2 2 Revaluations at 31 Dec. 2 2 Book value at 31 Dec. 3,688 3,617 Receivables from Group companies Acquisition cost at 1 Jan. 2,458 2,590 Increases Decreases Transfers between balance sheet items Acquisition cost at 31 Dec. 1,753 2,458 Book value at 31 Dec. 1,753 2,458 Holdings in participating interest companies Acquisition cost at 1 Jan Increases 49 2 Decreases 10 1 Transfers between balance sheet items 7 Acquisition cost at 31 Dec Accumulated depreciation at 1 Jan. Value adjustments and their cancellations 6 Value adjustments and their cancellations 6 Accumulated depreciation at 31 Dec. Revaluations at 1 Jan Revaluations at 31 Dec Book value at 31 Dec Receivables from participating interest companies Acquisition cost at 1 Jan Increases 2 Decreases 3 9 Transfers between balance sheet items 3 Acquisition cost at 31 Dec Book value at 31 Dec Advance payments and construction in progress Acquisition cost at 1 Jan Increases Decreases 36 Transfers between balance sheet items Book value at 31 Dec UPM ANNUAL REPORT

92 ACCOUNTS FOR 2004 m Other shares and holdings Acquisition cost at 1 Jan Increases 1 Decreases Transfers between balance sheet items 11 Acquisition cost at 31 Dec Accumulated depreciation at 1 Jan. 12 Accumulated depreciation on decreases and transfers 12 Accumulated depreciation at 31 Dec. Revaluations at 1 Jan Revaluations at 31 Dec Book value at 31 Dec Other receivables Acquisition cost at 1 Jan Decreases Transfers between balance sheet items 4 10 Acquisition cost at 31 Dec Book value at 31 Dec CURRENT RECEIVABLES m Trade receivables Loan receivables 1, Other receivables Prepayments and accrued income ,652 1,283 Main items included in current prepayments and accrued income Personnel expenses 3 4 Interest income Interest expenses 7 Income taxes Others Receivables from Group companies Trade receivables Loan receivables 1, Other receivables 8 Prepayments and accrued income 7 8 1,412 1,007 Receivables from participating interest companies Trade receivables SHAREHOLDERS EQUITY m Share capital Share issue Share premium reserve Revaluation reserve Legal reserve Retained earnings Share hold ers equity, total Shareholders equity at 1 Jan ,176 5,459 Convertible bond loan Share issue Dividends paid Profit for the period Shareholders equity at 31 Dec ,062 5,381 Share options Cancellation of revaluations 1 1 Dividends paid Profit for the financial period Other changes 1 1 Shareholders equity at 31 Dec ,420 5,748 m Distributable funds at 31 Dec. Retained earnings 2,670 2,786 Profit for the fiancial period Distributable funds at 31 Dec. 3,420 3, PROVISIONS M Provisions for pensions Environmental provisions 15 5 Other provisions UPM ANNUAL REPORT 2004

93 PARENT COMPANY 13 NON-CURRENT LIABILITIES m Bond loans 2,480 2,714 Loans from financial institutions Pension loans Other liabilities ,379 3,727 Payables to Group companies Other liabilities Long-term loans and their repayment schedule In / Bonds Loans from financial institutions Pension loans Payables to Group companies Other liabilities 1 2 1,015 1,243 In 2010 / 2009 or later Bonds 1,947 2,264 Loans from financial institutions Pension loans 202 Other liabilities ,364 2,484 Total at 31 Dec. 3,379 3,727 Bonds Interest, % Initial amount million Fixed-rate USD USD USD EUR JPY 10, JPY 2, USD EUR JPY 2, EUR USD GBP USD ,440 2,530 Floating-rate EUR EUR EUR EUR EUR Bonds, total 2,624 2,714 current portion 144 Bonds, long-term portion 2,480 2, CURRENT LIABILITIES m Bond loans 144 Loans from financial institutions Pension loans Advances received Trade payables Other liabilities 887 1,463 Accruals and deferred income ,877 2,309 Main items included in current accruals and deferred income Personnel expenses Interest expenses Income tax Currency derivatives Others Payables to Group companies Trade payables Other liabilities Accruals and deferred income ,435 Payables to associated and participating interest companies Advances received 1 1 Trade payables Other liabilities CONTINGENT LIABILITIES m Mortgages 1) As security against own debts Guarantees Guarantees for loans On behalf of Group companies On behalf of associated and participating interest companies On behalf of others 1 1 Other guarantees On behalf of Group companies On behalf of others 2 3 Leasing commitments 2) Commitments for 2005/ Commitments for subsequent years 6 1) The mortgages given relate mainly to reborrowing of statutory employment pension contributions. 2) UPM-Kymmene Corporation has also leased certain power plants under long-term agreements and uses the electrical power generated by these plants in its production. The company has the right, but not the obligation, to purchase these power plants or shares therein. Leasing commitments are 15 million in 2005 and subsequently 48 million up to UPM-Kymmene estimates that the market value of these agreements exceeds the above commitments. Directors pension commitments The Managing Director s agreed retirement age is 60 years. UPM ANNUAL REPORT

94 ACCOUNTS FOR 2004 AUDITOR S REPORT To the Shareholders of UPM-Kymmene Corporation We have audited the accounting records, the financial statements and the administration of UPM-Kymmene Corporation for the period The financial statements prepared by the Board of Directors and the Chief Executive Officer include the report of the Board of Directors, consolidated financial statements of UPM- Kymmene Group prepared in accordance with International Financial Reporting Standards (IFRS), and parent company s financial statements prepared in accordance with prevailing rules and regulations in Finland. Based on our audit we express an opinion on these financial statements and on the parent company s administration. We have conducted the audit in accordance with Finnish Standards on Auditing. Those standards require that we perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by the management as well as evaluating the overall financial statement presentation. The purpose of our audit of administration has been to examine that the members of the Board of Directors and the Chief Executive Officer of the parent company have legally complied with the rules of the Finnish Companies Act. In our opinion the consolidated financial statements prepared in accordance with International Financial Reporting Standards give a true and fair view of the consolidated result of operations, as well as of the financial position of UPM-Kymmene Group. The consolidated financial statements have been prepared in accordance with prevailing rules and regulations in Finland and can be adopted. The parent company s financial statements have been prepared in accordance with the Finnish Accounting Act and other rules and regulations governing the preparation of financial statements. The parent company s financial statements give a true and fair view, as defined in the Finnish Accounting Act, of the company s result of operations and of the financial position. The parent company s financial statements can be adopted and the members of the Board of Directors and the Chief Executive Officer of the parent company can be discharged from liability for the period audited by us. The proposal by the Board of Directors regarding the distributable funds is in compliance with the Finnish Companies Act. Helsinki, 24 February 2005 PricewaterhouseCoopers Oy Authorised Public Accountants Merja Lindh Authorised Public Accountant 92 UPM ANNUAL REPORT 2004

95 INFORMATION ON SHARES INFORMATION ON SHARES SHARE CAPITAL Under UPM-Kymmene Corporation s Articles of Association, the company s issued share capital may be not less than 750,000,000 and not more than 3,000,000,000. The issued share capital may be increased or decreased between these limits without amendment to the Articles of Association. The minimum number of shares is 500,000,000 and the maximum 2,000,000,000. The equivalent value of the company s share is At 31 December 2004, the company s fully paid-in share capital stood at 891,344, and the number of shares at 524,320,252. OWN SHARES The Annual General Meeting held on 24 March 2004 approved a proposal to buy back a minimum of 100 and a maximum of 26,178,900 own shares using funds available for the distribution of profit. The AGM authorized the Board of Directors to decide on the disposal of shares so purchased. The company did not purchase any of its own shares during AUTHORIZATIONS TO INCREASE SHARE CAPITAL The Annual General Meeting held on 24 March 2004 authorized the Board of Directors to decide to increase the company s share capital by issuing new shares and/or convertible bonds in one or more issues. The number of the company s new shares carrying the equivalent value of 1.70 per share made available for subscription under this authorization may not exceed 104,715,000 and the share capital may be increased by a maximum total amount of 178,015, Under the same share issue authorization, the number of shares may rise by 20.00%. The share issue authorization was not used during In 2004, 336,271 of the company s A options and 99,400 of the company s B options were exercised to subscribe 871,342 shares, of which 741,322 were entered in the Trade Register during the year. If all 7,128,658 shares are subscribed under the remaining 3,564,329 share options issued to the company s management in 1998, together with all 15,200,000 shares that can be subscribed under the 7,600,000 share options issued in 2002, the number of the company s shares will increase by a total of 22,328,658 shares, i.e. by 4.26%. The shares available for subscription under the Board s share issue authorization and through the exercise of options may increase the total number of the company s shares by 24.22%, i.e. by 127,043,658 shares, to 651,493,930 shares, and the share capital by 215,974, to 1,107,539, REDEMPTION CLAUSE Under 12 of UPM-Kymmene Corporation s Articles of Association, a shareholder who alone or jointly with another shareholder owns 33 1/3 per cent or 50 per cent or more of all the company s shares or their associated voting rights shall, at the request of other shareholders, be liable to redeem in the manner prescribed in 12 their shares and any securities that, under the Companies Act, carry the right to such shares. UPM ANNUAL REPORT

96 INFORMATION ON SHARES Changes in number of shares and share capital, 1 January December 2004 Number of shares Share capital, 1999 Share capital at 31 Dec ,568, ,336, Own shares declared void 7,538,000 12,678,011 Exchanged under convertible bond issue (1994) 942,162 1,584,603 Share capital at 31 Dec ,973, ,243, Increase through bonus issue 4,710, Own shares declared void 12,900,000 21,930, Exchanged under convertible bond issue (1994) 520, , Rights issue 12,300,000 20,910, Share capital at 31 Dec ,893, ,818, Own shares declared void 1,175,398 1,998, Exchanged under convertible bond issue (1994) 1,398,150 2,376, Share capital at 31 Dec ,115, ,197, Exchanged under convertible bond issue (1994) 1,673,490 2,844, Bonus share issue (1:1) 261,789, ,042, Share capital at 31 Dec ,578, ,084, Options exercised 741,322 1,260, Share capital at 31 Dec ,320, ,344, Shareholder breakdown by sector at 31 December, % Companies Financial institutions and insurance companies Public bodies Non-profitmaking organizations Households Non-Finnish nationals Total UPM ANNUAL REPORT 2004

97 INFORMATION ON SHARES Biggest registered shareholders at 31 December 2004 Shares at 31 Dec % of shares % of votes Holzhey/Bischoff group (representing 10 shareholders) 17,515, IImarinen Mutual Pension Insurance Company 1) 10,600, Gustaf Serlachius (representing 5 shareholders) 6,338, The State Pension Fund 4,900, Merita plc Pension Fund 905, Merita plc Pension Foundation 2,073, Nordea Life Assurance Finland Ltd 1,661, Nordea Group 4,639, Svenska litteratursällskapet i Finland 3,487, Palkkiyhtymä Oy 1,700, Oy Premiere Holding Ab 1,000, Palcmills Oy 200, Palkki Group 2,900, OP-Delta Investment Fund 2,285, Varma Mutual Pension Insurance Company 2,403, The Finnish Cultural Foundation 2,091, Nominees & registered foreign owners 320,346, (including Holzhey/Bischoff) (337,861,855) (64.44) (64.44) Others 146,812, Total 524,320, ) Includes 1,832,777 lent shares. Lent shares have no voting rights. UPM ANNUAL REPORT

98 INFORMATION ON SHARES 1) Figures for 2004, 2003 and 2002 are reported in accordance with International Financial Reporting Standards (IFRS) and for in accordance with Finnish Accounting Standards (FAS). 96 UPM ANNUAL REPORT 2004

99 INFORMATION ON SHARES STOCK EXCHANGE TRADING The company s shares are listed on the Helsinki and New York stock exchanges. A total of million UPM-Kymmene Corporation shares were traded on the Helsinki Stock Exchange in 2004 (646.0 million in 2003). This represents 119.5% (123.4%) of the total number of shares. The highest quotation during the financial period was (in November) and the lowest (in January). UPM-Kymmene Corporation shares with a total value of 9,731 million were traded on the Helsinki Stock Exchange in 2004 ( 9,117 million in 2003). During the year, 1,140,000 A options issued in 1998 were traded for 11.1 million (457,950 and 3.9 million in 2003) and 1,489,600 B options for 8.8 million (72,700 and 0.4 million). From 1 April 2004, 98,400 D options issued in 2002 were traded for 0.16 million. Trading in the company s shares on the New York Stock Exchange was USD 311 million (16.1 million shares). The corresponding figures for 2003 were USD 191 million and 11.8 million shares. The company s shares are also traded on SEAQ International in London, and in Germany on the Freier Markt in Frankfurt, Berlin and Munich. TAXATION VALUE OF SHARES IN FINLAND For Finnish taxation purposes, the company s share was given a value of in SHAREHOLDER AGREEMENTS UPM-Kymmene Corporation is not aware of any shareholder agreements concerning either the ownership of the company s shares or the exercise of the associated voting rights. Distribution of shareholders at 31 December 2004 Size of shareholding Number of shareholders % of shareholders Number of shares, million % of shares , ,000 41, ,001 10,000 15, , ,000 1, ,001 1,000, ,000, Total 72, Nominee-registered Not registered as book entry units Total DIRECTORS INTEREST AT 31 DECEMBER 2004 At the end of the year, the members of the Board of Directors and the President and CEO owned a total of 2,765,655 (2003: 2,359,129) UPM-Kymmene Corporation shares (including those held by under-age children and by organizations or foundations of which the person has control). These represent 0.53% of the share capital (0.45%) and 0.53% of the voting rights (0.45%). At the end of the year, President and CEO Jussi Pesonen owned 120,000 share options. Exercise of these options would increase the company s share capital by 408,000 and the number of shares by 240,000, which at 31 December 2004 would have represented 0.05% of the company s share capital and voting rights. SHARE OPTIONS TO KEY PERSONNEL A and B options have been issued under the management incentive scheme approved by the 1998 Annual General Meeting and D and E options under the management incentive scheme approved by the 2002 Annual General Meeting. Each option can be exercised to subscribe two company shares. The Annual General Meeting held on 25 March 1998 approved the issue of 6,000,000 share options to the Group s key personnel worldwide. Each option can be exercised to subscribe two shares. They were divided into three series, with 2,000,000 of each. In March 2002, all C options were declared void. Since 1 April 2001, holders of A options have had the right to subscribe shares at each before the bonus UPM s option programmes Options Number of options Number of shares Redemption price at date of issue * Redemption price at * Subscription period Options exercised in A 2,000,000 4,000, , B 2,000,000 4,000, , D 3,800,000 7,600, E 3,800,000 7,600, * corrected for 2003 bonus issue UPM ANNUAL REPORT

100 INFORMATION ON SHARES Directors shareholdings and options Name Shares Options A B D E Board of Directors, 31 December 2004 Vesa Vainio 10,161 Gustaf Serlachius 1,772,782 Françoise Sampermans * 2,689 Martti Ahtisaari 5,712 Michael C. Bottenheim 5,712 Berndt Brunow 261,924 Georg Holzhey ** 646,468 Jorma Ollila 31,504 Karl Grotenfelt 8,689 Total 2,745,641 Executive Team, 1 January 2005 Jussi Pesonen 20,014 50,000 70,000 Harald Finne ,000 37,000 Pirkko Harrela 4,142 7,929 10,000 13,200 37,000 Pauli Hänninen 60 22,000 37,000 Matti Lievonen 5,000 33,000 37,000 Matti J. Lindahl 33,000 37,000 Jyrki Ovaska 3,300 8,000 33,000 37,000 Heikki Pikkarainen 7,400 7,800 12,200 Riitta Savonlahti 37,000 Heikki Sara 10,800 33,000 37,000 Hans Sohlström 1,492 5,000 5,000 26,400 37,000 Kari Toikka 4,156 35,100 35,000 33,000 37,000 Markku Tynkkynen 3,600 33,000 37,000 Hartmut Wurster 33,000 37,000 Total 55,440 48,029 63, , ,200 * of which 500 in nominee register, ** in nominee register Share ownership also includes shares held by under-age children and by organizations or foundations of which the person has control. share issue and at per two shares after the bonus issue. The subscription period ends on 30 April The subscription period for B options is 1 April April 2005 and the subscription price per share before the bonus share issue and per two shares after the bonus issue. The subscription price will be reduced by the total amount of dividends paid, excluding corporate tax credit, during the period between 1 May 1998 and the date on which the shares are subscribed. Share subscriptions based on options issued in 1998 may raise the share capital by a maximum of 13,600,000. The Annual General Meeting held on 19 March 2002 authorized the company to issue a total of 7,600,000 options to the company s key personnel. Each option entitles the holder to subscribe two UPM- Kymmene shares. Half of the options are designated 2002D and half 2002E. The subscription period for 2002D options is 1 April April 2007 and for 2002E options 1 April April The share subscription price is per two shares for 2002D options and per share for 2002E options. The subscription prices for 2002D and 2002E options will be reduced by the amount of dividend confirmed after the end of the subscription price determination period and before the date of share subscription, in each case on the record date of dividend distribution. Share subscriptions based on options issued in 2002 may raise the share capital by a maximum of 25,840, UPM ANNUAL REPORT 2004

101 CALCULATION OF KEY INDICATORS CALCULATION OF KEY INDICATORS FORMULAE FOR CALCULATION OF FINANCIAL INDICATORS FORMULAE FOR CALCULATION OF ADJUSTED SHARE-RELATED INDICATORS Return on equity, %: Profit before tax 2) income taxes Shareholders equity + minority interest (average) x 100 Earnings per share: Profit for the period 3) Adjusted average number of shares during the period excluding own shares Return on capital employed, %: Profit before tax 2) + interest expenses and other financial expenses Balance sheet total non-interest-bearing liabilities (average) Equity to assets ratio, %: Shareholders equity + minority interest own shares 1) Balance sheet total advances received own shares 1) Net interest-bearing liabilities: x 100 x 100 Interest-bearing liabilities interest-bearing assets listed shares Gearing ratio, %: Net interest-bearing liabilities Shareholders equity + minority interest own shares 1) x 100 Shareholders equity per share: Shareholders equity Adjusted number of shares at end of period Dividend per share: Dividend distribution Adjusted number of shares at end of period Dividend to earnings ratio, %: Dividend per share Earnings per share Effective dividend yield, %: Adjusted dividend per share Adjusted share price at P/E ratio: Adjusted share price at Earnings per share x 100 x 100 EBITDA: Operating profit + depreciation + amortization of goodwill + impairment non-recurring items Return on capital employed (ROCE) for the divisions (operating cap i tal), %: Operating profit Non-current assets + stocks + trade receivables trade payables (average) x 100 Market capitalization: Total number of shares x striking price at end of period Adjusted share price at end of period: Share price at end of period Share issue coefficient Adjusted average share price: Total value of shares traded Adjusted number of shares traded during period Cash from operating activities per share: Cash from operating activities Adjusted average number of shares during the period excluding own shares 1) Own shares were shown in the balance sheet in ) : Profit/loss before extraordinary items and tax. 3) : Profit/loss before extraordinary items and tax income tax +/ minority interest. Key exchange rates for the euro at end of period USD CAD JPY GBP SEK UPM ANNUAL REPORT

102 ADJUSTED SHARE-RELATED INDICATORS ADJUSTED SHARE-RELATED INDICATORS ) 2) 7) Earnings per share, (diluted 2004: 1.82) Shareholders equity per share, Dividend per share, 5) 4) Dividend to earnings ratio, % 5) Effective dividend yield, % 5) P/E ratio Cash fl ow from operations per share, Dividend distribution, m 5) 4) Share price at 31 Dec., Market capitalization, m 8,578 7,917 7,960 9,681 9,502 10,663 6,630 4,957 4,340 3,690 Shares traded, m 6) 9,731 9,117 10,827 7,645 6,157 4,834 3,374 3,125 1,162 Shares traded (1,000s) 625, , , , , , , , ,374 Shares traded, % of all shares Lowest quotation, Highest quotation, Average quotation for the period, Number of shares, average (1,000s) 523, , , , , , , , , ,558 Number of shares at end of period (1,000s) * 524, , , , , , , , , ,753 * Number of shares entered in the Trade Register at was 524,320,252. Share prices and shares traded are based on trading on the Helsinki Stock Exchange. Notes to the tables on pages ) Figures for are reported in accordance with International Financial Reporting Standards (IFRS) and for in accordance with Finnish Accounting Standards (FAS). More information on the effects of the transition on the balance sheet and income statement is given in the bulletin released on The bulletin is available on UPM s Internet pages at 2) The financial and share-related indicators for 1995 are based on the combined consolidated financial statements of Kymmene and Repola. The share-related indicators are based on the share exchange ratios for the two companies shares on amalgamation merger at 30 April ) Includes the Rauma engineering group and Simpele s board and packaging unit. 4) Proposal. 5) The 1999 figure includes an extra dividend payment of ) Trading on the Helsinki Stock Exchange. Own shares bought by the company are included in shares traded. Shares traded and share prices for 1996 are for the period 1 May 31 December. 7) Figures reported in Finnish markka for the years have been converted into euro using the official conversion rate, 1 euro = markka. 100 UPM ANNUAL REPORT 2004

103 KEY FIGURES KEY FIGURES ) 2) 7) m Sales 9,820 9,787 10,417 9,918 9,583 8,261 8,365 7,776 6,921 7,452 Sales, businesses disposed of 3) 702 1,784 1,754 Sales, total 9,820 9,787 10,417 9,918 9,583 8,261 8,365 8,478 8,705 9,206 Operating profit, excluding non-recurring items ,394 1, , ,370 % of sales Operating profit, total ,614 1,860 1,573 1,620 1, ,430 % of sales Profit before tax ,333 1,859 1,398 1, % of sales Profit for the period , , % of sales Exports from Finland and foreign operations 8,791 8,697 9,475 8,948 8,563 7,165 7,219 6,522 7,361 8,029 Exports from Finland 4,301 4,539 4,759 4,635 5,216 4,873 4,571 4,152 4,209 4,710 Non-current assets 12,802 13,509 14,336 12,874 10,163 8,741 8,802 8,530 8,124 7,691 Inventories 1,138 1,144 1,224 1,289 1,184 1,008 1,054 1,047 1,368 1,600 Other current assets 1,887 1,938 2,064 2,268 1,766 1,831 1,593 1,827 1,899 1,912 Assets, total 15,827 16,591 17,624 16,431 13,113 11,580 11,449 11,404 11,391 11,203 Shareholders equity 7,586 6,997 7,204 6,810 6,156 5,536 5,311 4,538 4,007 3,753 Minority interest Non-current liabilities 5,943 7,322 8,104 5,992 4,564 3,830 3,731 3,872 3,665 3,907 Current liabilities 2,272 2,240 2,283 3,601 2,374 2,192 2,383 2,967 3,570 3,415 Equity and liabilities, total 15,827 16,591 17,624 16,431 13,113 11,580 11,449 11,404 11,391 11,203 Capital employed at year end 12,953 12,811 13,689 13,519 10,448 9,004 9,319 9,371 9,147 8,879 Return on equity, % Return on capital employed, % Equity to assets ratio, % Gearing ratio, %, % Net interest-bearing liabilities 4,617 4,874 5,135 6,041 4,071 2,940 3,739 4,252 4,320 4,358 Gross capital expenditure ,850 2, ,418 1, % of sales Gross capital expenditure excluding acquisitions % of sales Personnel at year end 33,433 34,482 35,579 36,298 32,755 30,963 32,351 33,814 32,826 33,308 Personnel at year end, businesses disposed of 3) 10,810 11,363 Personnel at year end, total 33,433 34,482 35,579 36,298 32,755 30,963 32,351 33,814 43,636 44,671 Production figures Papers, total (1,000 t) 10,886 10,232 10,046 8,298 8,285 7,494 7,499 7,198 6,134 6,733 Plywood (1,000 m 3 ) Sawn timber (1,000 m 3 ) 2,409 2,408 2,201 2,035 2,117 1,911 2,104 2,050 1,857 1,939 Chemical pulp (1,000 t) 2,243 2,027 2,102 2,038 1,965 1,846 1,913 1,963 1,874 2,000 Formulae for calculating indicators are given on page 99. UPM ANNUAL REPORT

104 QUARTERLY INFORMATION QUARTERLY INFORMATION m 10 12/04 7 9/04 4 6/04 1 3/ /03 7 9/03 4 6/03 1 3/ / / /02 Sales by segment Magazine Papers ,285 3,280 3,570 Newsprint ,295 1,273 1,379 Fine and Speciality Papers ,275 2,244 2,446 Converting ,409 1,370 1,539 Wood Products ,486 1,548 1,487 Other Operations Internal sales Sales, total 2,423 2,449 2,497 2,451 2,511 2,400 2,453 2,423 9,820 9,787 10,417 Operating profit by segment * Magazine Papers Newsprint Fine and Speciality Papers Converting Wood Products Other Operations Operating profit, total % of sales Share of results of associated companies and joint ventures Gains on available-for-sale investments, net Exchange rate and fair value gains and losses Interest and other fi nance costs, net Profit before tax Income taxes Profit before minority interest Minority interest Net profit for the period Basic earnings per share, Diluted earnings per share, Average number of shares, basic (1,000) 523, , , , , , , , , , ,935 Average number of shares, diluted (1,000) 526, , , , , , , , , , ,782 * Non-recurring items included in operating profit (Non-recurring items in operating profit are specified in the divisional reviews on pages 18, 21, 22, 25, 29 and 31.) Magazine papers Newsprint Fine and Speciality papers 3 3 Converting 2 2 Wood Products Other Operations Non-recurring items in operating profit, total Non-recurring items reported after operating profit 1) Non-recurring items reported in taxes 2) Non-recurring items, total Operating profit, excl. non-recurring items % of sales Profit before tax, excl. non-recurring items % of sales Earnings per share, excl. non-recurring items, ROE, excl. non-recurring items, % ROCE, excl. non-recurring items, % ) Non-recurring items include net gains of 26 million on sales of listed shares and income of 10 million relating to changes in the Finnish employees pension scheme (TEL) in associated companies. 2) Non-recurring items for 2004 consist of a reduction of 235 million in deferred tax liabilities in Finland and 284 million in Germany. 102 UPM ANNUAL REPORT 2004

105 CORPORATE GOVERNANCE CORPORATE GOVERNANCE UPM-Kymmene Corporation complies with the recommendations of the Helsinki Stock Exchange concerning the governance of publicly listed companies. Furthermore, as a company listed on the New York Stock Exchange (NYSE), UPM complies with the Sarbanes-Oxley Act and the NYSE s regulations for foreign companies insofar as Finnish legislation allows. The corporate governance practices adopted by the company do not differ materially from those laid down by the NYSE for publicly listed companies in the United States, with the exception that UPM s Human Resources Committee includes one non-independent member of the Board of Directors. Under Finnish regulations, a human resources committee does not have to consist solely of independent members. Pursuant to the provisions of Finland s Companies Act and the company s Articles of Association, the company s control and governance is divided among the shareholders represented at the general meeting of shareholders, the Board of Directors and the President and CEO. The President and CEO is assisted by the company s Executive Team. GENERAL MEETING OF SHAREHOLDERS The Annual General Meeting is held annually by the end of June. The general meeting of shareholders is the company s supreme decision-making body. Under the Companies Act, the following issues, among others, are decided at a general meeting of shareholders: amendment of the Articles of Association adoption of the accounts the distribution of dividend the granting of freedom from responsibility to the President and CEO and the Board of Directors raising and lowering the share capital the procurement and disposal of own shares option programmes election of members of the Board of Directors and the fees to be paid to them election of auditors, and the audit fees. A shareholder is entitled to have any matter put before a general meeting of shareholders provided that he/she requests it in writing from the Board of Directors in good time so that the matter can be included in the summons to the meeting. The right to attend a general meeting of shareholders shall apply to any shareholder who is registered as a shareholder of the company ten days prior to the meeting. BOARD OF DIRECTORS DUTIES OF THE BOARD OF DIRECTORS The Board of Directors is responsible for the governance of the company and for the proper organization of its activities in accordance with the legislation and the Articles of Association. The Board of Directors establishes the principles of the strategy, organization, accounting and financial control of the company, and appoints the President and CEO, who acts in accordance with the orders and instructions of the Board of Directors. The Board of Directors other duties include: defining the company s dividend policy and making a proposal to the general meeting of shareholders for the annual payment of dividend determining the main lines of the company s strategy approving the company s plans of activities and budget annually deciding on large and strategically significant investments, corporate acquisitions and asset divestments appointing the Executive Team based on the President and CEO s proposal scrutinizing the annual financial statements and the Report of the Board of Directors setting up committees and defining the scope of their work assessing the performance of management. The Board of Directors makes an annual assessment of its own activities and working practices. COMPOSITION OF THE BOARD OF DIRECTORS The Annual General Meeting elects at least five but not more than 12 members to sit on the Board of Directors. At the Annual General Meeting held on 24 March 2004, nine members were elected to the Board of Directors. Members of the Board of Directors are elected for a term of one year that begins at the end of the general meeting of shareholders at which they are elected and ends at the conclusion of the next Annual General Meeting. UPM ANNUAL REPORT

106 CORPORATE GOVERNANCEI According to a recommendation concerning Finnish listed companies that was released in December 2003, the following members of the Board of Directors have been independent of the company in 2004: Vesa Vainio, Gustaf Serlachius, Martti Ahtisaari, Michael C. Bottenheim, Berndt Brunow, Karl Grotenfelt, Jorma Ollila and Françoise Sampermans. Georg Holzhey, a director at UPM until 2002, is not independent. Under regulations, he will be regarded as independent only after three years have elapsed from the end of his employment contract. A member of the Board of Directors is not independent of the company if, amongst other reasons, he or she has been employed by the company within three years of becoming a member of the Board or if the member belongs to the operative management of another company with which UPM has a significant collaborative relationship. The Board of Directors elects from among its members a Chairman and two Vice Chairmen for a term of one year. The Board of Directors has a quorum when more than half of its members are present and one of them is either the Chairman or a Vice Chairman. The Board of Directors met on 11 occasions during On average, the members attended 98 per cent of the meetings. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors has set up committees composed of its members and has elected chairmen for them. The Audit Committee was chaired by Michael C. Bottenheim and its members were Martti Ahtisaari and Françoise Sampermans. The members of the committee must have adequate knowledge of business accounting as the committee deals with matters relating to the company s financial reporting and control. Michael C. Bottenheim is an accountancy expert recognized under SOX regulations. The committee s tasks include scrutinizing the contents of the annual financial statements and interim reports as well as the company s internal control systems and auditing. The committee works in line with pre-approval policy, according to which it must approve auditing fees and fees for other services rendered by public accountants. Those represented at the committee s meetings also include the company s external auditor, the head of internal auditing, the President and CEO, the Chief Financial Officer, the Senior Vice President, Financial Control, and other management representatives as and when necessary. The Audit Committee met seven times during the year. Matters pertaining to the appointment, assessment, salaries, fees and other remuneration or benefits of senior management are handled by the Human Resources Committee, which has comprised Vesa Vainio (Chairman) and members Georg Holzhey and Berndt Brunow. The Human Resources Committee met five times during the year. Meetings of the aforementioned committees may be attended by all members of the Board of Directors. Final decisions on proposals made by these committees are made by the Board of Directors. The Board of Directors has also elected from among its members a Nomination Committee, which has comprised Gustaf Serlachius (Chairman) and members Karl Grotenfelt and Jorma Ollila. The task of the committee is to prepare nominations for membership of the Board of Directors for consideration by the general meeting of shareholders. The Nomination Committee met three times during the year. PRESIDENT AND CEO The Board of Directors elects a President and CEO for the company in accordance with the Companies Act. The President and CEO is responsible for the day-to-day management of the company s affairs. The President and CEO ensures that the company s bookkeeping conforms with the law and that the company s financial administration and management is reliably organized. Measures which are not within the ordinary course of the company s business may be taken by the President and CEO only if approved by the Board of Directors, unless the time required to obtain such approval would cause the company to suffer a substantial disadvantage. In the latter case, the Board of Directors must be informed as soon as practicable of the measures which have been taken. A Service Contract has been drawn up for the company s President and CEO. The Board of Directors prepares a written assessment of the work of the President and CEO once a year. EXECUTIVE TEAM AND OTHER MANAGEMENT GROUPS The Executive Team assists the President and CEO in running the company. It prepares matters that are to be put before the Board of Directors for decision-making. Examples of such matters include the Group s strategies, budgets and policies, as well as significant investments and acquisitions. The Executive Team also handles matters relating to reporting, corporate image, personnel rewards and the management of investor relations. The members of the Executive Team are the President and CEO, the presidents of the business divisions, and executive vice presidents responsible for different corporate functions. The divisions have their own management groups, the purpose of which is to assist the presidents of their respective divisions. In addition, there are local management groups in which the company s personnel are represented. SALARIES, FEES AND OTHER BENE- FITS OF THE BOARD OF DIRECTORS AND SENIOR MANAGEMENT In accordance with a decision made by the 2004 Annual General Meeting, the Chairman of the Board of Directors received a fee of 160,000 for the year, the vice chairmen 110,000, and the members 85,000. Of this fee, 60 per cent was paid in cash and 40 per cent in the form of company shares purchased on the members behalf. The cash component of the fees paid to the nine members of the Board of Directors in 2004 totalled 918,000. The additional equity component of their fees amounted to 22,921 UPM shares. President and CEO Jussi Pesonen s monthly salary is 45,000, which includes a company house and telephone. He also has the use of a company car. Under the company s profit-sharing and incentive scheme for top management, an amount equivalent of up to 12 months salary may be paid to the President and CEO as profit-sharing based on his overall performance. The retirement age of the President and CEO, as stated in the Service Contract, is 60. In the event that the President and CEO is dismissed, or in situations where control of the company changes, he has the right to receive compensation corresponding to 24 months salary. The period of notice is 6 months. The retirement age for other members of the Executive Team is The shares and options held by the members of the Board of Directors and the Exec- 104 UPM ANNUAL REPORT 2004

107 CORPORATE GOVERNANCE utive Team are detailed on page 98. At 31 December 2004, the company s President and CEO, the members of the Executive Team and the members of the Board of Directors had no loans outstanding from the company or its subsidiaries. INSIDER GUIDELINES Helsinki Stock Exchange, the Central Chamber of Commerce and the Confederation of Finnish Industry and Employers published insider guidelines on 28 October 1999 (see On 14 December 1999, the company s Board of Directors decided to observe these guidelines. When necessary, registers of project-specific insiders are established. The company s permanent insiders are the members of the Board of Directors and the Executive Team, and those persons who, in the course of their duties, regularly receive information having a significant bearing on the value of the company s listed securities. Each year the company decides on closed windows, i.e. specific periods of time during which insiders are barred from trading in shares and options issued by the company as well as warrants related to the company. In 2004 the closed windows were 1 30 January (relating to the 2003 financial review) and 1 28 April, 1 28 July and 1 27 October (relating to the 2004 interim reports). In 2005 the corresponding periods are 1 January 2 February (relating to the 2004 financial review) and 1 27 April, 1 29 July and 1 October 2 November (relating to the 2005 interim reports). AUDITORS The Annual General Meeting elects an auditor to scrutinize the company s governance and accounts. The elected auditor must be a public accountant or firm of public accountants authorized by the Central Chamber of Commerce. The AGM elected PricewaterhouseCoopers Oy to act as the company s auditor. The total amount of fees paid for auditing and other related work in 2004 was 4.9 million (4.8 million). The auditor s term of office ends at the conclusion of the first AGM after the election. Breakdown of fees M Auditor s fees Other audit-related fees Fees for tax advice Total INTERNAL CONTROL, RISK MANAGEMENT AND INTERNAL AUDIT The company s Board of Directors is responsible for internal control. The company s Executive Team has approved internal control guidelines. In accordance with these guidelines, the director of each unit or function must organize the internal control of his or her unit or organization. The Executive Team has confirmed the risk management guidelines drawn up according to principles approved by the Board of Directors. The company s business units are responsible for the identification of risks as well as their management in practice. The Executive Team monitors the development of risks and risk concentrations. The Group s internal audit function assists the Board of Directors to discharge its supervisory responsibility by ensuring that the Group s control is planned appropriately and effectively. The internal audit function is administratively subordinate to the President and CEO but reports to the Audit Committee on the adequacy and effectiveness of the company s internal control systems. ETHICAL PRINCIPLES The company s ethical principles are set out in its policies regarding corporate social responsibility, occupational health and safety, the environment, human resources and fraud, which have been ratified by the Board of Directors. These policies are presented on the Group s Internet pages at: BOARD OF DIRECTORS CHAIRMAN Vesa Vainio VICE CHAIRMEN Jorma Ollila (Vice Chairman from ) Gustaf Serlachius Carl H. Amon III (to ) MEMBERS Martti Ahtisaari Michael C. Bottenheim Berndt Brunow Karl Grotenfelt (from ) Georg Holzhey Juha Niemelä (to ) Françoise Sampermans (from ) Donna Soble Kaufman (to ) AUDITORS PricewaterhouseCoopers Oy (Authorised Public Accountants) Responsible for the audit Merja Lindh (APA) EXECUTIVE TEAM Juha Niemelä (to ) Jussi Pesonen Harald Finne Pirkko Harrela Pauli Hänninen Matti Lievonen Matti J. Lindahl Jyrki Ovaska Heikki Pikkarainen (from ) Heikki Sara Riitta Savonlahti (from ) Hannu Schildt (to ) Hans Sohlström (from ) Kari Toikka Markku Tynkkynen Hartmut Wurster SECRETARY TO THE BOARD OF DIRECTORS Reko Aalto-Setälä UPM ANNUAL REPORT

108 BOARD OF DIRECTORS BOARD OF DIRECTORS VESA VAINIO Chairman Chairman of the Human Resources Committee Independent member of the Board JORMA OLLILA Vice Chairman Member of the Nomination Committee Independent member of the Board GUSTAF SERLACHIUS Vice Chairman Chairman of the Nomination Committee Independent member of the Board MARTTI AHTISAARI Member of the Audit Committee Independent member of the Board MICHAEL C. BOTTENHEIM Chairman of the Audit Committee Independent member of the Board BERNDT BRUNOW Member of the Human Resources Committee Independent member of the Board KARL GROTENFELT Member of the Nomination Committee Independent member of the Board GEORG HOLZHEY Member of the Human Resources Committee Non-independent member of the Board FRANÇOISE SAMPERMANS Member of the Audit Committee Independent member of the Board 106 UPM ANNUAL REPORT 2004