Analytical income statement

SSO present its income statement by the nature of expense method, which directly discloses

information of each major type of expense, including depreciation, amortization and impairment. The main objective of reformulating the income statement is to identify items that are linked to the core business activities and the strategic value drivers of SSO prior to net operating profit after tax (NOPAT), as well as non-operating items after NOPAT. This yields the NOPAT that represents the profits from the core operating activities themselves. In addition, calculations of EBITDA and EBIT will be conducted based on the adjustment. Accordingly, non-recurring costs and revenue shall be removed from the income statement as per Petersen & Plenborg (2012). By doing this, we get the analytical income statement, which is an income statement that displays the contribution from

operating and financing activities separately and omits non-recurring costs & revenues. The following items will be emphasized further in detail;

48 Net gain/ (loss) from sale of project assets

The classification is up for discussion, and is determined by the type of industry the company operates in. SSO recognizes gains and losses from sale of projects under operating income. Even though the adjustments are recurring, they fluctuate from approximately NOK -1m to NOK 375m, making it difficult to do a reliable forecast later on. It is too volatile for SSO to speculate on income or losses from project assets. Furthermore, by looking at the chosen peer group it is clear that the companies in the industry do not recognize such activity in their income statement. Hence, this post will be excluded from core operation and allocated to financial income as a non-recurring activity. The exclusion will give less noise in calculating key ratios estimates compared to competitors for valuation purposes.

Net income/ (loss) from associated companies

Investments in associated companies are related to core business activities, and accordingly considered as core operation for both SSO and the peer group. For SSO net income and losses from associated companies are recurring in all quarterly reports, besides Q4 2015. Similarly, the relevant balance sheet items will be classified as operational and are included in the invested capital according to Petersen and Plenborg (2012).

Net personnel expenses

Net personnel expenses are adjusted, as pension cost and share-based payment are deducted from the operating expenses and added as a financing activity to interest and other financial expenses, see figure 14. The rationale behind this is Petersen and Plenborg’s (2012) way of defining pension cost as an interest-bearing item, and share-based payment as a financial decision.

Operational leasing

Like other items, the classification for operational leasing is up for discussion, both because of the little literature on how to capitalize operating lease and the new IFRS 16 that was issued by IASB in 2016.

The standard is effective from 1 January 2019 and requires all leases to be recognized in the financial statement with subsequent depreciation (Scatec Solar ASA, 2017b).

49 Koller, et. al (2010) highlights the importance of capitalizing operational leases to perform a reliable benchmarking in comparing companies. The use of operating leases can bias and lead to a boost in return on invested capital, as reduction in operating profit by rental expense is smaller than the

reduction in invested capital by leaving out assets (Koller et al., 2010). Following Koller, et. al (2010), the financial statements will be adjusted to reflect the correct economic picture. By calculating the cost of secured debt, estimated asset life and rental expense it is possible to capitalize the value of leased assets on the balance sheet, and correspondingly adjust long-term debt. Accordingly, both sources and uses of invested capital are increased. Proportionately, NOPAT is adjusted upward as the implicit interest in rental expense is removed. Table 3 shows the calculation.

Table 3: Operating Lease Calculations

Source: Scatec Solar ASA 2015-2017b / Own creation

The risk-free rate is calculated by estimating a term-structure, which is better explained in section 11.

Together with the AA-rated 10-year bond spread (Appendix 27), as recommended by Koller, et. al (2010) it estimates the cost of debt to be 3,06%. For the estimation of asset life property, plant, and equipment (PP&E) is divided by annual depreciation. To compensate the lessor correctly, the rental expense of financing the asset has to be included. Rental expense is expressed as;

𝑅𝑒𝑛𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑠𝑒 = 𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒₀₁₂ 𝑘₄+ 1 𝐴𝑠𝑠𝑒𝑡 𝐿𝑖𝑓𝑒

50 To estimate the asset´s value, the equation above has to be rearranged as follows;

𝐴𝑠𝑠𝑒𝑡 𝑉𝑎𝑙𝑢𝑒₀₁₂ = 𝑅𝑒𝑛𝑡𝑎𝑙 𝐸𝑥𝑝𝑒𝑛𝑠𝑒₀ 𝑘₄+ 1

𝐴𝑠𝑠𝑒𝑡 𝐿𝑖𝑓𝑒

Looking at the analytical income statement at the bottom of this section in combination with the calculation of operating lease above, one can get a clearer picture of how all of this is linked together.

Rental and lease interest are eliminated from operating profit. The implicit rental and lease interest expense is calculated as the value of operating leases multiplied by the cost of secured debt. Lease depreciation remains as an operating expense since depreciation is not relevant to capital structure.

Income tax

Tax is an accounting item that both relates to operating and financing items. As accounting practices do not separate these, there is necessary for analytical purposes to distinguish and allocate tax accordingly.

SSO states in its annual reports that they use effective tax. The logical reason behind the choice of effective tax rate, and not marginal tax rate can be that SSO have numerous operations abroad.

Obtaining information about each local corporate tax can be difficult. The effective tax rate is calculated according to Petersen & Plenborg (2012) as;

𝑇𝑎𝑥 𝑟𝑎𝑡𝑒 = 𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑖𝑜𝑛 𝑡𝑎𝑥 ∗ 100 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥

As stated above it is necessary to divide the income tax into operations and financing, as adding back the tax shield that the net financial expenses offer should be reflected. The tax benefit is calculated as;

𝑇𝑎𝑥 𝑏𝑒𝑛𝑒𝑓𝑖𝑡𝑠 𝑠ℎ𝑖𝑒𝑙𝑑 = 𝑁𝑒𝑡 𝑓𝑖𝑛𝑎𝑛𝑐𝑖𝑎𝑙 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑎 ∗ 𝐶𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒

The effective tax rate expresses the average tax rate imposed and reflects different tax rates within the firm. Therefore, it is assumed that operating income, as well as financial income, are taxed at the same rate (Petersen & Plenborg, 2012).

51 Restructuring cost

In 2014 and 2016 SSO had respectively NOK 15m and NOK 4m related to restructuring costs. These costs are mainly related to operations in Germany and Japan, as well as discontinuing project

development activities in the US (Scatec Solar ASA, 2016c). Since SSO does not target the markets in Germany and Japan any longer, and the restructuring costs in the US is related to a specific project, the item is classified as non-recurring and deducted from operating expenses. The reason for this is that net income can be manipulated if a large restructuring expense is reported so that the firm takes a big hit in the current year to make future year earnings look more profitable. In addition, no footnotes, neither in the annual reports or quarterly reports suggest that SSO often does major changes related to plants IPO cost

The item is classified as non-recurring activity due to its one-time appearance. The cost is deducted from operating expenses and spread to financial expenses in Q3 2014 and Q4 2014 accordingly to SSO (Scatec Solar ASA, 2014a). See figure 14 for a short version of the reformulated income statement, and appendix 2 for a comprehensive overview of the reformulated income statement.

52 Figure 14: Analytical Income Statement 2014Q1-Q4 & 2017Q1-Q4

Source: Scatec Solar ASA 2014abc & 2015-2017acde & 2018b / Own creation