DOMTAR CORPORATION
This Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") should be read in conjunction with Domtar Corporation's
unaudited interim financial statements and notes thereto included in this
Quarterly Report on Form 10-Q. This MD&A should also be read in conjunction with
the historical financial information contained in our Annual Report on Form 10-K
for the year ended December 31, 2020 , filed with the Securities and Exchange
Commission ("SEC") on March 1, 2021 . This discussion contains forward-looking
statements that involve risks and uncertainties. Our actual results may differ
materially from those discussed in forward-looking statements. Factors that
might cause a difference include, but are not limited to, those discussed below
under "outlook", "Forward-looking statements", as well as in Item 1A, Risk
Factors, in Part II, of this report. Throughout this MD&A, unless otherwise
specified, "Domtar Corporation ," "the Company," "Domtar ," "we," "us" and "our"
refers to Domtar Corporation and its subsidiaries. Domtar Corporation's common
stock is listed on the New York Stock Exchange and the Toronto Stock
Exchange . Except where otherwise indicated, all financial information reflected
herein is determined on the basis of accounting principles generally accepted in
the United States .
The information contained on our website, www.domtar.com, is not incorporated by
reference into this Form 10-Q and should in no way be construed as a part of
this or any other report that we file with or furnish to the SEC .
In accordance with industry practice, in this report, the term "ton" or the
symbol "ST" refers to a short ton, an imperial unit of measurement equal to
0.9072 metric tons. The term "metric ton" or the symbol "ADMT" refers to an air
dry metric ton. In this report, unless otherwise indicated, all dollar amounts
are expressed in U.S. dollars, and the term "dollars" and the symbol "$" refer
to U.S. dollars. In the following discussion, unless otherwise noted, references
to increases or decreases in income and expense items, prices, contribution to
net earnings (loss), and shipment volumes are based on the three and six months
ended June 30, 2021 and June 30, 2020 . The three month and six month periods are
also referred to as the second quarter and first half of 2021 and 2020.
Reference to notes refers to footnotes to the consolidated financial statements
and notes thereto included in Item 1 in this Form 10-Q.
This MD&A is intended to provide investors with an understanding of our recent performance, financial condition and outlook. Topics discussed and analyzed include:
• Overview
• Highlights for the three month and six month periods ended
• COVID-19 Update and Outlook • Cost Reduction Program • Review of Continuing Operations • Discontinued Operations of our Personal Care Business • Liquidity and Capital Resources
Paper Excellence to
OnMay 10, 2021 ,Domtar and Paper Excellence, a global diversified manufacturer of pulp and specialty, printing, writing, and packaging papers, entered into a business combination transaction (the "Paper Excellence transaction" or "transaction") under which the Paper Excellence group of companies will acquire all of the issued and outstanding shares ofDomtar common stock for$55.50 per share, in cash. The all-cash transaction represents an enterprise value of approximately$3 billion . After the transaction closes, Paper Excellence intends to continue the operations ofDomtar as a stand-alone business entity. As such,Domtar will continue to be led by its management team and Paper Excellence plans to retain its corporate and production locations. The transaction is expected to close in the second half of 2021, subject to receipt of the required regulatory approvals and other customary closing conditions. OnJuly 29, 2021 ,Domtar's shareholders approved the transaction. During the second quarter of 2021, we recorded$18 million of transaction fees under Closure and restructuring costs on the Consolidated Statement of Earnings and Comprehensive Income (Loss).
Restart of the paper machine at our
OnJuly 15, 2021 , we announced our intention to restart the paper machine at ourAshdown, Arkansas mill to add an additional 185,000 tons per year of uncoated freesheet production capacity to our manufacturing network. The increase is necessary to meet growing customer demand as the economy recovers from the COVID-19 pandemic. The additional paper capacity will also result in a capacity reduction of 185,000 ADMT per year of baled SBSK pulp at the mill. However, it will not impactAshdown's fluff pulp production capacity, or our commitment to serving our key hygiene customers around the world. Additionally, we have a dedicated team developing a kraft linerboard project for ourAshdown mill, and the decision to restart the paper machine will not impact our 49
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intention to produce containerboard and other packaging products at the
facility. The machine is expected to resume full operation in
Sale of Personal Care Business
OnMarch 1, 2021 , we completed the previously announced sale of our Personal Care business toAmerican Industrial Partners ("AIP") for a purchase price of$920 million in cash, including elements of working capital estimated at$130 million , subject to customary adjustments. We received a net amount of$897 million , which represents the selling price minus the estimated settlements of the net indebtedness and other elements of working capital adjustments. For financial reporting purposes, our former Personal Care business is presented as a discontinued operation. For more information, refer to Item 1, Financial Statements and Supplemental Data, under Note 3, "Discontinued Operations".
OVERVIEW
We design, manufacture, market and distribute a wide variety of fiber-based products including communication papers, specialty and packaging papers. The foundation of our business is a network of wood fiber converting assets that produce paper grade, fluff and specialty pulp. Approximately 40% of our pulp production is consumed internally to manufacture paper, with the balance sold as market pulp. We are the largest integrated marketer of uncoated freesheet paper inNorth America serving a variety of customers, including merchants, retail outlets, stationers, printers, publishers, converters and end-users. To learn more, visit www.domtar.com.
We operate as a single reportable segment as described below, which also represents our only operating segment.
Pulp and Paper: Consists of the design, manufacturing, marketing and distribution of communication, specialty and packaging papers, as well as softwood, hardwood and fluff pulp and high quality airlaid and ultrathin laminated cores.
Our segment measure of profit (operating income (loss) from continuing operations) is used by management to evaluate performance and make operational decisions. Management believes that this measure allows for a better understanding of cost trends, operating efficiencies, prices and volume. Business segment operating income (loss) is defined as earnings (loss) from continuing operations before income taxes and equity losses, excluding corporate items, interest expense, net, and non-service components of net periodic benefit cost. Corporate expenses are allocated to our segment with the exception of certain discretionary charges and credits, which we present under "Corporate" and do not allocate to the segment.
Conversion of our
We plan to enter the linerboard market with the conversion of our
We estimate the conversion cost to be approximately$350 million . Once fully operational, the mill is expected to be a low-cost, first quartile recycled linerboard facility inNorth America . The converted mill is expected to directly employ approximately 160 employees.
HIGHLIGHTS FOR THE THREE MONTH PERIOD ENDED
• Operating income and net earnings increased by 1800% and 95%, respectively,
from the second quarter of 2020
• We reported earnings from continuing operations of
a loss from continuing operations of
2020
• Sales increased by 26% from the second quarter of 2020. Our net average
selling prices for pulp and paper were up from the second quarter of 2020.
Our manufacturing paper volumes were up, while our pulp volumes were
slightly down, when compared to the second quarter of 2020
• Recognition of closure and restructuring charges and asset conversion costs
of
Excellence transaction, our cost reduction program and our previously
announced decision to repurpose assets at our
• Repaid
including make-whole premium of $11 million
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HIGHLIGHTS FOR THE SIX MONTH PERIOD ENDED
• Operating income increased by 1500% while net earnings decreased by 67%,
respectively, from the first half of 2020
• We reported earnings from continuing operations of
a loss from continuing operations of
• Loss from discontinued operations, net of taxes amounted to
the first half of 2021, including a net loss on disposition from
discontinued operations of $33 million • Sales increased by 7% from the first half of 2020. Our net average selling
prices for pulp and paper and our pulp volumes were up while our
manufacturing paper volumes were down from the first half of 2020
• Recognition of closure and restructuring charges and asset conversion costs
of
Excellence transaction, our cost reduction program and our previously
announced decision to repurpose assets at our
• Repaid
Term Loan Agreement, including make-whole premium of $11 million and
repurchased $223 million of our common stock
Three months ended Six months ended
Variance Variance
FINANCIAL HIGHLIGHTS June 30, 2021 June 30, 2020 $ % June 30, 2021 June 30, 2020 $ %
(In millions of dollars,
unless otherwise noted)
Sales $ 1,010 $ 802 $ 208 26 % $ 1,954 $ 1,833 $ 121 7 %
Operating income (loss)
Pulp and Paper 95 3 92 3067 % 107 7 100 1429 %
Corporate (27 ) (7 ) (20 ) (286 %) (37 ) (12 ) (25 ) (208 %)
Operating income (loss) 68 (4 ) 72 1800 % 70 (5 ) 75 1500 %
Earnings (loss) from
continuing operations 38 (3 ) 41 1367 % 31 (18 ) 49 (272 %)
(Loss) earnings from
discontinued operations,
net of taxes (1 ) 22 (23 ) (105 %) (23 ) 42 (65 ) (155 %)
Net earnings 37 19 18 95 % 8 24 (16 ) (67 %)
Basic net earnings per
common share (in dollars)
(a):
Earnings (loss) from
continuing operations $ 0.76 $ (0.05 ) $ 0.81 0.59 (0.32 ) $ 0.91
(Loss) earnings from
discontinued operations $ (0.02 ) $ 0.39 $ (0.41 ) (0.44 ) 0.75 $ (1.19 )
Basic net earnings $ 0.74 $ 0.34 $ 0.40 0.15 0.43 $ (0.28 )
Diluted net earnings per
common share (in dollars)
(a):
Earnings (loss) from
continuing operations $ 0.75 $ (0.05 ) $ 0.80 0.59 (0.32 ) $ 0.91
(Loss) earnings from
discontinued operations $ (0.02 ) $ 0.39 $ (0.41 ) (0.44 ) 0.75 $ (1.19 )
Diluted net earnings $ 0.73 $ 0.34 $ 0.39 0.15 0.43 $ (0.28 )
At June 30, At December 31,
2021 2020
Total assets $ 3,922 $ 4,856
Total long-term debt,
including current portion $ 504 $ 1,097
(a) See Note 6 "Earnings per Common Share" of the financial statements in this
Quarterly Report on Form 10-Q for more
information on the calculation of net earnings per common share.
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COVID-19 UPATE First identified in people in late 2019, COVID-19 spread rapidly throughout the world and, inMarch 2020 , theWorld Health Organization characterized COVID-19 as a pandemic. With the unprecedented and rapid spread of COVID-19 and social distancing measures implemented throughout the world due to the pandemic, this virus has had a profound impact on human health, the global economy and society in general. We are actively monitoring the impact of COVID-19 on all aspects of our business, including our employees, operations, customers, suppliers, liquidity and capital resources. We took a variety of actions during 2020 and 2021 to help mitigate the financial impact, including a cost reduction program, reducing our capital spending, suspended our regular quarterly dividend, and proactively managing our working capital. Our focus has been on the health and safety of our employees throughout the pandemic and we will continue to maintain the safety protocols we established. As guidance from authorities such as theU.S. Centers for Disease Control evolves, we will update our practices accordingly, as we have done throughout the pandemic. Our operations are essential services in the jurisdictions where we operate. Certain of our paper products are used in the testing for COVID-19 as well as for personal protection medical gowns. Beginning inApril 2020 , we saw a significant decline in demand for our paper, largely due to work-from-home rules and the overall economic slowdown. In the second quarter of 2021, there has been an increase in demand for our paper as the economy recovers from the effects of the COVID-19 pandemic. In response to the increase, onJuly 15, 2021 , we announced the restart of the paper machine at ourAshdown, Arkansas mill, discussed above. For the second quarter of 2021, our paper shipments were higher by approximately 20% when compared to the second quarter of 2020. TheGovernment of Canada created theCanada Emergency Wage Subsidy ("CEWS") to provide financial support for businesses during the COVID-19 pandemic and prevent large layoffs. For the six months endedJune 30, 2021 , we recognized$6 million as a reduction of costs related to this program (CDN$8 million ) ($5 million in Cost of sales (CDN$6 million ) and$1 million in Selling, general and administrative (CDN$2 million)).
OUTLOOK
Paper demand will remain dependent upon recovery from COVID-19, but demand is expected to accelerate as people return to offices and schools. We expect to sell all paper production for the balance of the year. Near-term pulp markets should remain balanced due to steady demand growth and limited new supply. Paper prices are expected to continue to increase following recently announced price increases while pulp prices are expected to see some seasonal volatility. Overall raw material costs are expected to remain stable while freight costs will increase. COST REDUCTION PROGRAM OnAugust 7, 2020 , we announced the implementation of a cost reduction program, targeting$200 million in annual run-rate cost savings to be realized by the end of 2021. As ofJune 30, 2021 , we have achieved and closed our cost reduction program. The goal of the program was to build a stronger business operation, enhance our cost efficiency, improve operating margins and maximize productivity and cash flow. The costs saving initiatives included capacity reduction and asset closures, mill-level cost savings and rightsizing support functions. Our cost reduction program included the permanent closure of the uncoated freesheet manufacturing at ourKingsport, Tennessee andPort Huron, Michigan mills, the remaining paper machine at ourAshdown, Arkansas mill and the converting center in Ridgefields,Tennessee . Additionally, onMay 7, 2021 , we announced the closure of our converting center inDallas, Texas . These actions reduced our annual uncoated freesheet paper capacity by approximately 721,000 short tons and resulted in a workforce reduction of approximately 750 employees. Our Ridgefields converting center ceased operations at the end of the third quarter of 2020, ourPort Huron mill ceased operations in the first quarter of 2021 and ourDallas converting center ceased operations at the beginning ofJuly 2021 . For the three and six months endedJune 30, 2021 , we recorded$1 million and$7 million , respectively, of accelerated depreciation under Impairment of long-lived assets,$1 million and$4 million , respectively, of severance and termination costs,$1 million and$1 million , respectively, of pension settlement loss and$5 million and$5 million , respectively, of other costs under Closure and restructuring costs on the Consolidated Statement of Earnings and Comprehensive Income (Loss). Additionally, we recorded$5 million and$13 million , respectively, under Asset Conversion Costs on the Consolidated Statement of Earnings and Comprehensive Income (Loss) as part of the conversion of ourKingsport, Tennessee mill to a linerboard facility. 52
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REVIEW OF OPERATIONS
This section presents a discussion and analysis of our second quarter and first half of 2021 and 2020 sales, operating income (loss) and other information relevant to the understanding of our results of operations.
ANALYSIS OFNET SALES Three months ended Six months ended Variance Variance June 30, 2021 June 30, 2020 $ % June 30, 2021 June 30, 2020 $ % Sales 1,010 802 208 26% 1,954 1,833 121 7% Shipments Paper - manufactured (in thousands of ST) 549 459 90 20% 1,095 1,138 (43 ) (4%) Communication Papers 454 366 88 24% 907 935 (28 ) (3%)Specialty and Packaging papers 95 93 2 2% 188 203 (15 ) (7%) Paper - sourced from third parties (in thousands of ST) 18 12 6 50% 36 34 2 6% Paper - total (in thousands of ST) 567 471 96 20% 1,131 1,172 (41 ) (3%) Pulp (in thousands of ADMT) 454 459 (5 ) (1%) 935 881 54 6%
ANALYSIS OF CHANGES IN SALES
Second quarter of 2021 versus Second quarter of 2020 First half of 2021 versus First half of 2020
% Change in Sales due to % Change in Sales due to
Net Price Volume / Mix Total Net Price Volume / Mix Total
Sales 13 % 13 % 26 % 8 % (1 %) 7 %
Sales in the second quarter of 2021 increased by $208 million , or 26%, when
compared to sales in the second quarter of 2020. This increase in sales is
mostly due to an increase in our net average selling prices for pulp and paper
and an increase in our paper sales volume as the economy recovers from the
effects of the pandemic. This increase was partially offset by a decrease in our
pulp sales volumes.
Sales in the first half of 2021 increased by $121 million , or 7% when compared
to sales in the first half of 2020. This increase in sales is mostly due to an
increase in our net average selling prices for pulp and paper and our pulp sales
volumes. This increase was partially offset by a decrease in our paper sales
volumes as a result of work-from-home rules and the overall economic slowdown
due to the pandemic in the early 2021.
ANALYSIS OF CHANGES IN OPERATING INCOME (LOSS)
Second quarter of 2021 versus
Second quarter of 2020
$ Change in Operating Income (Loss) due to
Operating Depreciation/ Restructuring/ Other Income/
Volume/Mix Net Price Input Costs (a) Expenses (b) Currency Impairment (c) Conversion (d) Expense (e) Total
Pulp and Paper 18 107 4 (21 ) (2 ) 4 (12 ) (6 ) 92
Corporate - - - (3 ) - - (17 ) - (20 )
Operating income (loss) 18 107 4 (24 ) (2 ) 4 (29 ) (6 ) 72
(a) Includes raw materials (such as fiber and chemicals) and energy costs.
(b) Includes maintenance, freight costs, selling, general and administrative
("SG&A") expenses and other costs.
(c) Depreciation charges were lower by
excluding foreign currency impact and we recorded
depreciation under Impairment of long-lived assets, related to our cost
reduction program. There were no accelerated depreciation charges in the
second quarter of 2020.
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(d) We recorded
2021 related to transaction fees for the Paper Excellence transaction and our
cost reduction program, compared to
We also recorded
as part of the conversion to a linerboard facility.
(e)Second quarter of 2021 other Second quarter of 2020 other operating
operating
income/expense includes: income/expense includes:
- Foreign currency loss on working - Income from termination of
capital items non-production agreement
($1 million ) ($7 million )
- Bad debt expense ($1 million )
- Foreign currency loss on working
capital items
($1 million )
Commentary - Second quarter of 2021 compared to Second quarter of 2020
Operating income in our Pulp and Paper segment amounted to$95 million in the second quarter of 2021, an increase of$92 million , when compared to operating income of$3 million in the second quarter of 2020. Our results were positively impacted by: • Higher net average selling prices for pulp and paper ($107 million ) • Higher volume and mix ($18 million )
• Lower input costs (
for fiber
• Lower depreciation/impairment charges (
were lower by
recorded
long-lived assets, related to our cost reduction program in the second
quarter of 2021 and there were no accelerated depreciation charges in the
second quarter of 2020
These increases were partially offset by:
• Higher operating expenses (
recognized from the CEWS in the second quarter of 2021, higher maintenance
in part due to the timing of some major maintenance and higher freight
costs. This increase was partially offset by higher production
• Higher restructuring and conversion charges (
quarter of 2021 mostly related to our cost reduction program including the
conversion of our
million of restructuring charges or conversion costs in the second quarter
of 2020.
• Lower other income ($6 million )
• Negative impact of a stronger Canadian dollar on our Canadian dollar
denominated expenses, net of our hedging program ($2 million )
OTHER FACTORS
Corporate
We incurred $27 million of corporate charges in the second quarter of 2021, an
increase of $20 million compared to corporate charges of $7 million in the
second quarter of 2020. This increase was mostly due to transaction fees for the
Paper Excellence transaction. There were no restructuring charges in the second
quarter of 2020. SG&A expenses were higher in the second quarter of 2021 mostly
due to higher variable compensation when compared to the second quarter of 2020.
Interest Expense, net
We incurred$20 million of net interest expense in the second quarter of 2021, an increase of$5 million compared to net interest expense of$15 million in the second quarter of 2020. We paid$11 million in make-whole premium fees related to the early retirement of the 4.4% Notes originally dueMarch 2022 , in the second quarter of 2021. This was partially offset by lower interest on the 4.4% Notes due to the early retirement inApril 2021 as well as lower interest on the Term loan due to the early repayment in theMarch 2021 .
Income Taxes
For the second quarter of 2021, our income tax expense was$16 million , consisting of a current income tax expense of$16 million and no deferred income tax expense. This compares to an income tax benefit of$11 million in the second quarter of 2020, consisting of a current income tax benefit of$2 million and a deferred income tax benefit of$9 million . We made income tax payments, net of refunds, of$8 million during the second quarter of 2021. The effective tax rate for the second quarter of 2021 was 30% compared with an effective tax rate of 79% in the second quarter of 2020. The effective tax rate for the second quarter of 2021 was impacted by certain transaction costs incurred during the quarter related to our potential acquisition by Paper Excellence which provided no tax benefit. Our tax provision for interim periods is determined using an estimate of the annual effective tax rate and then adjusting for 54
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discrete items arising in that quarter. In each interim quarter we update the estimate of the annual effective tax rate and, if the estimated annual tax rate changes, make a cumulative adjustment in that quarter. The effective tax rate for the second quarter of 2020 was significantly impacted by such an adjustment. The effective tax rate for the second quarter of 2020 was also favorably impacted by our recognition of additional tax credits in various jurisdictions, as well as by the CARES Act, which granted the ability to carry back tax losses generated in theU.S. in 2020 to a tax year with a higher statutory tax rate. First half of 2021 versus First half of 2020 By Business Segment $ Change in Segmented Operating Income (Loss) due to Input Costs Operating Depreciation/
Restructuring/ Other Income/
Volume/Mix Net Price (a) Expenses (b) Currency Impairment (c) Conversion (d) Expense (e) Total
Pulp and Paper (10 ) 134 (11 ) 10 1 2 (22 ) (4 ) 100
Corporate - - - (6 ) (3 ) - (18 ) 2 (25 )
Operating income (loss) (10 ) 134 (11 ) 4 (2 ) 2 (40 ) (2 ) 75
(a) Includes raw materials (such as fiber and chemicals) and energy costs.
(b) Includes maintenance, freight costs, SG&A expenses and other costs.
(c) Depreciation charges were lower by
excluding foreign currency impact and we recorded
depreciation under Impairment of long-lived assets, related to our cost
reduction program. There were no accelerated depreciation charges in the
first half of 2020.
(d) We recorded
related to transaction fees for the Paper Excellence transaction and our cost
reduction program. We recorded
first half of 2020. We also recorded
our
first half of 2021.
(e) First half of 2021 other operating First half of 2020 other operating income/
income/
expense includes: expense includes:
- Bad debt recovery ($2 million ) - Income from termination of
- Foreign currency loss on working capital non-production agreement
items (
($7 million )
- Environmental provision ($1 million ) - Foreign currency gain on working
- Other income ($2 million ) capital items ($1 million )
- Bad debt expense ($5 million )
- Environmental provision ($1 million )
- Other income ($1 million )
Commentary - First half of 2021 compared to first half of 2020
Operating income in our Pulp and Paper segment amounted to
• Higher net average selling prices for pulp and paper (
• Lower operating expenses (
costs in part due to the timing of some major maintenance, and lower costs
due to our 2020 cost reduction program, including lower salaries and wages.
Partially offset by higher freight costs
• Lower depreciation/impairment charges (
were lower by
recorded
long-lived assets, related to our cost reduction program in the first half
of 2021 and there were no accelerated depreciation charges in the first half
of 2020.
• Positive impact of our foreign currency hedging program partially offset by
a stronger Canadian dollar on our Canadian dollar denominated expenses
(
These increases were partially offset by:
• Higher restructuring and conversion charges (
of 2021 mostly related to our cost reduction program including the
conversion of our
million of restructuring charges or conversion costs in the first half of
2020
• Higher input costs (
due to a business acquisition in the second quarter of 2020, unfavorable
market conditions as well as higher energy costs mostly due to severe
weather issues in the first quarter of 2021
• Lower volume and mix ($10 million )
• Lower other income ($4 million )
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OTHER FACTORS Corporate We incurred$37 million of corporate charges in the first half of 2021, an increase of$25 million compared to corporate charges of$12 million in the first half of 2020. This increase was mostly due to transaction fees incurred for the Paper Excellence transaction. There were no restructuring charges in the first half of 2020. SG&A expenses were higher in the first half of 2021 mostly due to higher variable compensation when compared to the first half of 2020.
Interest Expense, net
We incurred$35 million of net interest expense in the first half of 2021, an increase of$6 million compared to net interest expense of$29 million in the first half of 2020. We paid$11 million in make-whole premium fees related to the early retirement of the 4.4% Notes originally dueMarch 2022 and wrote-off$2 million of unamortized debt issuance costs related to the repayment of the Term Loan in the second quarter of 2021. This was partially offset by lower interest on the 4.4% Notes due to the early retirement.
Income Taxes
For the first six months of 2021, our income tax expense was$16 million , consisting of a current income tax expense of$15 million and a deferred income tax expense of$1 million . This compares to an income tax benefit of$8 million in the first six months of 2020, consisting of a current income tax benefit of$5 million and a deferred income tax benefit of$3 million . We made income tax payments, net of refunds, of$1 million during the first six months of 2021. The effective tax rate was 34% compared to an effective tax rate of 32% in the first six months of 2020. The effective tax rate for the first six months of 2021 was significantly impacted by certain transaction costs incurred during the period related to our potential acquisition by Paper Excellence which provide no tax benefit. The effective tax rate for the first six months of 2020 was significantly impacted by our mix of earnings or loss in our major jurisdictions, by our recognition of additional tax credits in various jurisdictions, and by our ability to carry backU.S. tax losses generated in 2020 to a tax year with a higher statutory tax rate. These favorable impacts were partially offset by an increase in the valuation allowance related to the expected realization of certainU.S. state tax credits.
Economic conditions and uncertainties
The markets in which our pulp and paper business operate are highly competitive with well-established domestic and foreign manufacturers. Most of our products are commodities that are widely available from other producers as well. Because commodity products have few distinguishing qualities from producer to producer, competition for these products is based primarily on price, which is determined by supply relative to demand. We also compete on the basis of product quality, breadth of offering and service solutions. Further, we compete against electronic transmission and document storage alternatives. As a result of such competition, we are experiencing ongoing decreasing demand for most of our existing paper products. In addition, current global economic conditions are highly volatile due to the COVID-19 pandemic, resulting in both market size contractions in certain countries due to economic slowdowns and government restrictions on movement.
The pulp market is highly fragmented with many manufacturers competing worldwide. Competition is primarily on the basis of access to low-cost wood fiber, product quality and pricing of other pulp products.
The high degree of uncertainty and volatility day-to-day and the longer-term potential impacts of the economic slowdown remain unclear. Paper demand will remain dependent upon recovery from COVID-19, but demand is expected to continue to rebound through the year as people return to schools and offices. We expect to sell all paper production for the balance of the year. Near-term pulp markets should remain balanced due to steady demand growth and limited new supply. Paper prices are expected to continue to increase following recently announced price increases while pulp prices are expected to see some seasonal volatility. Overall raw material costs are expected to remain stable while freight costs will increase. DISCONTINUED OPERATION OnMarch 1, 2021 , we completed the sale of our Personal Care business. Its results of operations are reported as discontinued operations for all periods presented. For the first half of 2021, we reported a loss from discontinued operations, net of taxes, of$23 million (first half of 2020 - earnings from discontinued operations, net of taxes of$42 million ). For more information, refer to Item 1, Financial Statements and Supplemental Data, under Note 3, "Discontinued Operations". 56
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STOCK-BASED COMPENSATION EXPENSE
For the first half of 2021, stock-based compensation expense recognized in our results from continuing and discontinued operations was$6 million for all outstanding awards which includes the mark-to-market recovery, net of hedging, related to liability awards of$1 million . This compares to a stock-based compensation expense of nil from continuing and discontinued operations for all outstanding awards which includes the mark-to-market recovery, net of hedging, related to liability awards of$9 million in the first half of 2020. Compensation costs for performance awards are based on management's best estimate of the final performance measurement.
LIQUIDITY AND CAPITAL RESOURCES
Our principal cash requirements are for ongoing operating costs, pension contributions, working capital and capital expenditures, as well as principal and interest payments on our debt and income tax payments. We expect to fund our liquidity needs primarily with internally generated funds from our operations and, to the extent necessary, through borrowings under our$700 million credit facility, of which$672 million is currently undrawn and available, or through our$150 million receivables securitization facility, of which$111 million is currently undrawn and available. Under adverse market conditions, there can be no assurance that these agreements would be available or sufficient. See "Capital Resources" below. Our ability to make payments on the requirements mentioned above will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our credit and receivable securitization facilities and debt indentures impose various restrictions and covenants on us that could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities. A portion of our cash is held outside theU.S. by foreign subsidiaries. The earnings of the foreign subsidiaries reflect full provision for local income taxes. We remain indefinitely reinvested in the outside basis differences of our foreign subsidiaries. Operating Activities Our operating cash flow requirements are primarily for salaries and benefits, the purchase of raw materials, including fiber and energy, and other expenses such as income tax and property taxes. Cash flows from operating activities, including discontinued operations, totaled$90 million in the first half of 2021, a$65 million decrease compared to cash flows from operating activities of$155 million in the first half of 2020. This decrease in cash flows from operating activities is primarily due to an increase in working capital requirements as well as a decrease in profitability. We made income tax payments, net of refunds, of$1 million during the first half of 2021 compared to income tax refunds, net of payments, of$24 million in the first half of 2020. Investing Activities
Cash flows provided from investing activities, including discontinued operations
in the first half of 2021 amounted to
The source of cash provided from investing activities in the first half of 2021 was attributable to the proceeds from the sale of our Personal Care business ($897 million ) and was partially offset by the additions to property, plant and equipment of$122 million .
The use of cash in the first half of 2020 was attributable to additions to
property, plant and equipment of
Our annual capital expenditures for 2021 should increase mostly due to our
Financing Activities Cash flows used for financing activities, including discontinued operations, totaled$829 million in the first half of 2021 compared to cash flows provided from financing activities of$41 million in the first half of 2020. The use of cash flows for financing activities in the first half of 2021, was mostly due from the early repayment of the Term Loan and 4.4% Notes, including the make-whole premium ($605 million ) as well as for the repurchase of our common stock ($223 million ) of which a$200 million payment was made under the ASR agreement. 57
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The primary source of cash flows provided from financing activities in the first half of 2020, was from proceeds of the Term Loan in the first half of 2020 ($300 million ). This was partially offset by the decrease in borrowings under our credit facilities (revolver and receivables securitization) ($135 million ), the repurchase of our common stock ($59 million ), dividend payments ($51 million ) and a decrease in bank indebtedness ($10 million ).
Capital Resources
Net indebtedness, consisting of bank indebtedness and long-term debt, net of cash and cash equivalents, was$158 million as ofJune 30, 2021 compared to$788 million as ofDecember 31, 2020 .
Use of proceeds from the sale of our Personal Care business
OnApril 8, 2021 , we redeemed the 4.4% Notes, originally due inMarch 2022 , at a redemption price of 100% of the principal amount of$300 million , plus accrued and unpaid interest, as well as a make-whole premium of$11 million . The debt extinguishment as well as the related loss on debt extinguishment was recognized in the second quarter of 2021. OnMarch 11, 2021 , we repaid$294 million remaining under our Term Loan Agreement that had an original maturity inMay 2025 . A write-off of$2 million of unamortized debt issuance costs is included in the Interest Expense line item on the Consolidated Statement of Earnings.
Revolving Credit Facility
We have an unsecured
Borrowings by the Company under the Credit Agreement are guaranteed by our significant domestic subsidiaries. Borrowings by certain foreign subsidiaries under the Credit Agreement are guaranteed by the Company, our significant domestic subsidiaries and certain of our significant foreign subsidiaries.
Borrowings under the Credit Agreement bear interest at LIBOR, EURIBOR, Canadian bankers' acceptance or prime rate, as applicable, plus a margin linked to our credit rating. In addition, we pay facility fees quarterly at rates dependent on our credit ratings.The Financial Conduct Authority in theUnited Kingdom plans to phase out LIBOR by the end of 2021. We do not anticipate a significant impact to our financial position from the planned phase out of LIBOR. The Credit Agreement contains customary covenants and events of default for transactions of this type, including two financial covenants: (i) an interest coverage ratio, as defined in the Credit Agreement, that must be maintained at a level of not less than 3 to 1 and (ii) a leverage ratio, as defined in the Credit Agreement, that must be maintained at a level of not greater than 3.75 to 1 (or 4.00 to 1 upon the occurrence of certain qualifying material acquisitions). AtJune 30, 2021 andJune 30, 2020 , we were in compliance with these financial covenants, and had no borrowings under the Credit Agreement (June 30, 2020 - nil). AtJune 30, 2021 andJune 30, 2020 , we had$28 million and$49 million , respectively, of outstanding letters of credit, leaving$672 million unused and available under this facility (June 30, 2020 -$651 million ).
This agreement will terminate upon completion of the Paper Excellence transaction, to be replaced by other financing arrangements.
Receivables Securitization
We have a
AtJune 30, 2021 , we had no borrowings under the receivables securitization facility and$28 million of outstanding letters of credit under the program (June 30, 2020 - nil and nil, respectively). The program contains certain termination events, which include, but are not limited to, matters related to receivable performance, certain defaults occurring under the Credit Agreement or our failure to repay or satisfy material obligations. AtJune 30, 2021 , we had$111 million unused and available under the receivable securitization facility.
This agreement will terminate upon completion of the Paper Excellence transaction, to be replaced by another financing arrangement.
Common Stock
OnMay 5, 2020 , due to the unprecedented market conditions cause by COVID-19, we suspended the payment of our regular quarterly dividend and stock repurchase program in order to preserve cash and provide additional flexibility in the current environment.
On
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Due to the Paper Excellence transaction, we have discontinued further share repurchases.
OnMarch 2, 2021 , we entered into an ASR agreement under which we paid an aggregate of$200 million and received an aggregate initial share delivery of 4,430,906 shares of our common stock, which were immediately retired. The final number of shares to be repurchased under the ASR agreement and the average price paid per share will be determined upon settlement of the agreement during the third quarter of 2021. Based upon the current share price, we expect to make an additional payment of approximately$16 million , with no additional shares being delivered. For more information, refer to item 1, Financial Statements and Supplemental Data, under Note 15, "Shareholders' Equity". During 2020, we declared one quarterly dividend of$0.455 per share, to holders of our common stock. Total dividends aggregating$25 million were paid onApril 15, 2020 to shareholders of record as ofApril 2, 2020 .
GUARANTEES
Indemnifications
In the normal course of business, we offer indemnifications relating to the sale of our businesses and real estate. In general, these indemnifications may relate to claims from past business operations, compliance with laws, the failure to abide by covenants and the breach of representations and warranties included in sales agreements. Typically, such representations and warranties relate to taxation, environmental, product and employee matters. The terms of these indemnification agreements are generally for an unlimited period of time. AtJune 30, 2021 , we were unable to estimate the potential maximum liabilities for these types of indemnification guarantees as the amounts are contingent upon the outcome of future events, the nature and likelihood of which cannot be reasonably estimated at this time. Accordingly, no provision has been recorded. These indemnifications have not yielded significant expenses in the past.
Pension Plans
We have indemnified and held harmless the trustees of our pension funds, and the respective officers, directors, employees and agents of such trustees, from any and all costs and expenses arising out of the performance of their obligations under the relevant trust agreements, including in respect of their reliance on authorized instructions from us or for failing to act in the absence of authorized instructions. These indemnifications survive the termination of such agreements. AtJune 30, 2021 , we have not recorded a liability associated with these indemnifications, as we do not expect to make any payments pertaining to these indemnifications.
RECENT ACCOUNTING PRONOUNCEMENTS
Refer to Note 2 "Recent Accounting Pronouncements," of the financial statements in this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING ESTIMATES AND POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted inthe United States of America requires management to make estimates, assumptions and choices amongst acceptable accounting methods that affect our reported results of operations and financial position. Critical accounting estimates pertain to matters that contain a significant level of management estimates about future events, encompass the most complex and subjective judgments and are subject to a fair degree of measurement uncertainty. On an ongoing basis, management reviews its estimates, including those related to environmental matters and asset retirement obligations, impairment and useful lives of long-lived assets, closure and restructuring costs, intangible assets impairment, pension and other post-retirement benefit plans, income taxes and contingencies related to legal claims. These critical accounting estimates and policies have been reviewed with the Audit Committee of our Board of Directors. We believe these accounting policies, and others, should be reviewed as they are essential to understanding our results of operations, cash flows and financial condition. Actual results could differ from those estimates.
For more details on critical accounting policies, refer to our Annual Report on
Form 10-K for the year ended
There has not been any material change to our policies since
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FORWARD-LOOKING STATEMENTS The information included in this Quarterly Report on Form 10-Q contains forward-looking statements relating to trends in, or representing management's beliefs about,Domtar Corporation's future growth, results of operations, performance, liquidity and business prospects and opportunities. These forward-looking statements are generally denoted by the use of words such as "anticipate", "believe", "expect", "intend", "aim", "target", "plan", "continue", "estimate", "project", "may", "will", "should" and similar expressions. These statements reflect management's current beliefs and are based on information currently available to management. Forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by management, are inherently subject to known and unknown risks and uncertainties and other factors that could cause actual results to differ materially from historical results or those anticipated. Accordingly, no assurances can be given that any of the events anticipated by the forward-looking statements will occur, or if any occur, what effect they will have on our results of operations or financial condition. These factors include, but are not limited to:
• continued decline in usage of fine paper products in our core North
American market;
• our ability to implement our business diversification initiatives,
including repurposing of assets and strategic acquisitions or
divestitures, including facility closures;
• conversion costs in excess of our expectations and demand for linerboard;
• product selling prices; • raw material prices, including wood fiber, chemical and energy;
• conditions in the global capital and credit markets, and the general
economy, particularly in the
• performance of our manufacturing operations, including unexpected
maintenance requirements;
• the level of competition from domestic and foreign producers;
• cyberattacks or other security breaches;
• the effect of, or change in, forestry, land use, environmental and other
governmental regulations and accounting regulations;
• the effect of weather and the risk of loss from fires, floods,
windstorms, hurricanes and other natural disasters;
• transportation costs;
• the loss of current customers or the inability to obtain new customers;
• legal proceedings;
• changes in asset valuations, including impairment of long-lived assets,
inventory, accounts receivable or other assets or other reasons;
• changes in currency exchange rates, particularly the relative value of
the
• the effect of timing of retirements and changes in the market price of
Domtar Corporation's common stock on charges for stock-based compensation;
• performance of pension fund investments and related derivatives, if any;
• a material disruption in our supply chain, manufacturing, distribution
operations or customer demand such as public health crises that impact
trade or the general economy, including COVID-19 and other viruses,
diseases or illnesses; and
• the other factors described under "Risk Factors", in item 1A of our
Annual Report on Form 10-K, for the year ended December 31, 2020 .
You are cautioned not to unduly rely on such forward-looking statements, which
speak only as of the date made, when evaluating the information presented in
this Quarterly Report on Form 10-Q. Unless specifically required by law, Domtar
Corporation disclaims any obligation to update or revise these forward-looking
statements to reflect new events or circumstances.
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