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Domtar 10-Q 2014
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from________to_______

COMMISSION FILE NUMBER 001-33164

 

 

DOMTAR CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

DELAWARE   20-5901152
(State of Incorporation)   (I.R.S. Employer Identification No.)

395 de Maisonneuve West, Montreal, Quebec H3A 1L6 Canada

(Address of principal executive offices) (zip code)

(514) 848-5555

(Registrant’s telephone number)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation ST (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

At October 28, 2014, 64,470,324 shares of the issuer’s voting common stock were outstanding.

 

 

 


Table of Contents

DOMTAR CORPORATION

FORM 10-Q

For the Quarterly Period Ended September 30, 2014

INDEX

 

PART I.

   FINANCIAL INFORMATION      3   

ITEM 1.

   FINANCIAL STATEMENTS (UNAUDITED)      3   
   CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME      3   
   CONSOLIDATED BALANCE SHEETS      4   
   CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY      5   
   CONSOLIDATED STATEMENTS OF CASH FLOWS      6   
   INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      7   
   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS      8   

ITEM 2.

   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      49   

ITEM 3.

   QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK      65   

ITEM 4.

   CONTROLS AND PROCEDURES      65   

PART II

   OTHER INFORMATION      65   

ITEM 1.

   LEGAL PROCEEDINGS      65   

ITEM 1A.

   RISK FACTORS      66   

ITEM 2.

   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS      66   

ITEM 3.

   DEFAULT UPON SENIOR SECURITIES      66   

ITEM 4.

   MINE SAFETY DISCLOSURES      66   

ITEM 5.

   OTHER INFORMATION      66   

ITEM 6.

   EXHIBITS      67   


Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS (UNAUDITED)

DOMTAR CORPORATION

CONSOLIDATED STATEMENTS OF EARNINGS AND COMPREHENSIVE INCOME

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

 

    For the three months ended      For the nine months ended  
    September 30,
2014
    September 30,
2013
     September 30,
2014
    September 30,
2013
 
    (Unaudited)  
    $     $      $     $  

Sales

    1,405        1,375         4,184        4,032   

Operating expenses

        

Cost of sales, excluding depreciation and amortization

    1,105        1,116         3,316        3,280   

Depreciation and amortization

    96        93         291        281   

Selling, general and administrative

    99        95         313        281   

Impairment and write-down of property, plant and equipment (NOTE 12)

    —          —           —          15   

Closure and restructuring costs (NOTE 12)

    2                3        18   

Other operating (income) loss, net (NOTE 7)

    (17     22         (17     89   
 

 

 

   

 

 

    

 

 

   

 

 

 
    1,285        1,326         3,906        3,964   
 

 

 

   

 

 

    

 

 

   

 

 

 

Operating income

    120        49         278        68   

Interest expense, net

    25        21         76        67   
 

 

 

   

 

 

    

 

 

   

 

 

 

Earnings before income taxes and equity loss

    95        28         202        1   

Income tax (benefit) expense

    (186     1         (158     (26

Equity loss, net of taxes

    —          —           —          1   
 

 

 

   

 

 

    

 

 

   

 

 

 

Net earnings

    281        27         360        26   
 

 

 

   

 

 

    

 

 

   

 

 

 

Per common share (in dollars) (NOTE 5)

        

Net earnings

        

Basic

    4.34        0.41         5.55        0.39   

Diluted

    4.33        0.41         5.54        0.39   

Weighted average number of common and exchangeable shares outstanding (millions)

        

Basic

    64.8        65.3         64.9        67.2   

Diluted

    64.9        65.4         65.0        67.3   

Net earnings

    281        27         360        26   

Other comprehensive (loss) income (NOTE 13):

        

Net derivative (losses) gains on cash flow hedges:

        

Net (losses) gains arising during the period, net of tax of $(7) and $(4), respectively (2013 – $2 and $(3), respectively)

    (10     2         (5     (6

Less: Reclassification adjustment for losses included in net earnings, net of tax of nil and $(3), respectively (2013 – $(1) and $(2), respectively)

    2        2         5        3   

Foreign currency translation adjustments

    (118     33         (130     (27

Change in unrecognized gains and prior service cost related to pension and post-retirement benefit plans, net of tax of $1 and $(1), respectively (2013 –$(9) and $(17), respectively)

    (1     18         4        39   
 

 

 

   

 

 

    

 

 

   

 

 

 

Other comprehensive (loss) income

    (127     55         (126     9   
 

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive income

    154        82         234        35   
 

 

 

   

 

 

    

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

3


Table of Contents

DOMTAR CORPORATION

CONSOLIDATED BALANCE SHEETS

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

 

     At  
     September 30,
2014
    December 31,
2013
 
     (Unaudited)  
     $     $  

Assets

    

Current assets

    

Cash and cash equivalents

     134        655   

Receivables, less allowances of $6 and $4

     663        601   

Inventories (NOTE 9)

     719        685   

Prepaid expenses

     30        23   

Income and other taxes receivable

     48        61   

Deferred income taxes

     61        52   
  

 

 

   

 

 

 

Total current assets

     1,655        2,077   

Property, plant and equipment, at cost

     8,927        8,883   

Accumulated depreciation

     (5,758     (5,594
  

 

 

   

 

 

 

Net property, plant and equipment

     3,169        3,289   

Goodwill (NOTE 10)

     628        369   

Intangible assets, net of amortization (NOTE 11)

     613        407   

Other assets

     127        136   
  

 

 

   

 

 

 

Total assets

     6,192        6,278   
  

 

 

   

 

 

 

Liabilities and shareholders’ equity

    

Current liabilities

    

Bank indebtedness

     3        15   

Trade and other payables

     720        673   

Income and other taxes payable

     26        17   

Long-term debt due within one year

     170        4   
  

 

 

   

 

 

 

Total current liabilities

     919        709   

Long-term debt

     1,202        1,510   

Deferred income taxes and other

     790        923   

Other liabilities and deferred credits

     343        354   

Commitments and contingencies (NOTE 15)

    

Shareholders’ equity

    

Common stock
$0.01 par value; authorized 2,000,000,000 shares; issued: 65,001,104 and 85,148,956 shares

     1        —     

Treasury stock (NOTE 14)
$0.01 par value; 530,780 and 21,434,054 shares

     —          —     

Exchangeable shares
No par value; unlimited shares authorized; issued and held by nonaffiliates: nil and 1,123,020 shares

     —          44   

Additional paid-in capital

     2,030        1,999   

Retained earnings

     1,098        804   

Accumulated other comprehensive loss

     (191     (65
  

 

 

   

 

 

 

Total shareholders’ equity

     2,938        2,782   
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

     6,192        6,278   
  

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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Table of Contents

DOMTAR CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

 

    Issued and
outstanding
common
and
exchangeable
shares
(millions
of shares)
    Common
stock,
at par
    Exchangeable
shares
    Additional
paid-in
capital
    Retained
earnings
    Accumulated
other
comprehensive
loss
    Total
shareholders’
equity
 
    (Unaudited)  
          $     $     $     $     $     $  

Balance at December 31, 2013

    32.4        —          44        1,999        804        (65     2,782   

Conversion of exchangeable shares

    —          —          (12     12        —          —          —     

Stock split

    32.5        1        —          —          —          —          1   

Redemption of exchangeable shares

    —          —          (32     32        —          —          —     

Stock-based compensation, net of tax

    0.1        —          —          6        —          —          6   

Net earnings

    —          —          —          —          360        —          360   

Net derivative losses on cash flow hedges:

             

Net losses arising during the period, net of tax of $(4)

    —          —          —          —          —          (5     (5

Less: Reclassification adjustments for losses included in net earnings, net of tax of $(3)

    —          —          —          —          —          5        5   

Foreign currency translation adjustments

    —          —          —          —          —          (130     (130

Change in unrecognized gains and prior service cost related to pension and post-retirement benefit plans, net of tax of $(1)

    —          —          —          —          —          4        4   

Stock repurchase

    (0.5     —          —          (19     —          —          (19

Cash dividends declared

    —          —          —          —          (66     —          (66
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2014

    64.5        1        —          2,030        1,098        (191     2,938   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

5


Table of Contents

DOMTAR CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN MILLIONS OF DOLLARS)

 

     For the nine months ended  
     September 30,
2014
    September 30,
2013
 
     (Unaudited)  
     $     $  

Operating activities

  

 

Net earnings

     360        26   

Adjustments to reconcile net earnings to cash flows from operating activities

    

Depreciation and amortization

     291        281   

Deferred income taxes and tax uncertainties

     (202     (9

Impairment and write-down of property, plant and equipment

     —          15   

Net losses on disposals of property, plant and equipment

     —          9   

Stock-based compensation expense

     3        4   

Equity loss, net

     —          1   

Other

     1        (4

Changes in assets and liabilities, excluding the effects of acquisition and sale of businesses

    

Receivables

     21        (46

Inventories

     (22     (19

Prepaid expenses

     (4     (5

Trade and other payables

     (22     15   

Income and other taxes

     22        (11

Difference between employer pension and other post-retirement contributions and pension and other post-retirement expense

     —          23   

Other assets and other liabilities

     —          7   
  

 

 

   

 

 

 

Cash flows provided from operating activities

     448        287   
  

 

 

   

 

 

 

Investing activities

    

Additions to property, plant and equipment

     (157     (180

Proceeds from disposals of property, plant and equipment and sale of business

     1        55   

Acquisition of businesses, net of cash acquired

     (546     (287

Other

     5        (1
  

 

 

   

 

 

 

Cash flows used for investing activities

     (697     (413
  

 

 

   

 

 

 

Financing activities

    

Dividend payments

     (60     (50

Net change in bank indebtedness

     (13     (13

Change in revolving bank credit facility

     (160     —     

Proceeds from receivables securitization facilities

     90        —     

Payments on receivables securitization facilities

     (108     —     

Repayment of long-term debt

     (4     (99

Stock repurchase

     (19     (183

Other

     4        2   
  

 

 

   

 

 

 

Cash flows used for financing activities

     (270     (343
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (519     (469

Impact of foreign exchange on cash

     (2     (1

Cash and cash equivalents at beginning of period

     655        661   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

     134        191   
  

 

 

   

 

 

 

Supplemental cash flow information

    

Net cash payments for:

    

Interest (including $2 million of redemption premiums in 2013)

     70        60   

Income taxes paid (refund), net

     32        (8
  

 

 

   

 

 

 

The accompanying notes are an integral part of the consolidated financial statements.

 

6


Table of Contents

INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

NOTE 1    BASIS OF PRESENTATION    8
NOTE 2    RECENT ACCOUNTING PRONOUNCEMENTS    9
NOTE 3    ACQUISITION OF BUSINESSES    11
NOTE 4    DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT    14
NOTE 5    EARNINGS PER COMMON SHARE    19
NOTE 6    PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS    20
NOTE 7    OTHER OPERATING (INCOME) LOSS, NET    22
NOTE 8    INCOME TAXES    23
NOTE 9    INVENTORIES    24
NOTE 10    GOODWILL    25
NOTE 11    INTANGIBLE ASSETS, NET    26
NOTE 12    CLOSURE AND RESTRUCTURING COSTS AND LIABILITY AND IMPAIRMENT AND WRITE-DOWN OF PROPERTY, PLANT AND EQUIPMENT    27
NOTE 13    CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT    29
NOTE 14    SHAREHOLDERS’ EQUITY    31
NOTE 15    COMMITMENTS AND CONTINGENCIES    33
NOTE 16    SEGMENT DISCLOSURES    37
NOTE 17    SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION    39
NOTE 18    SALE OF ARIVA U.S.    48

 

7


Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 1. BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and, in the opinion of Management, include all adjustments that are necessary for the fair statement of Domtar Corporation’s (“the Company”) financial position, results of operations, and cash flows for the interim periods presented. Results for the first nine months of the year may not necessarily be indicative of full year results. It is suggested that these consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Domtar Corporation Annual Report on Form 10-K for the fiscal year ended December 31, 2013, as filed with the Securities and Exchange Commission. The December 31, 2013 Consolidated Balance Sheet, presented for comparative purposes in this interim report, was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING CHANGES IMPLEMENTED

FOREIGN CURRENCY MATTERS

In March 2013, the FASB issued ASU 2013-05, an update to Foreign Currency Matters, which indicates that a cumulative translation adjustment is attached to the parent’s investment in a foreign entity and should be released in a manner consistent with the derecognition guidance on investments in entities. Thus, the entire amount of the cumulative translation adjustment associated with the foreign entity would be released when there has been (1) a sale of a subsidiary or group of net assets within a foreign entity and the sale represents the substantially complete liquidation of the investment in the foreign entity; (2) a loss of a controlling financial interest in an investment in a foreign entity; or (3) a step acquisition for a foreign entity. The update does not change the requirement to release a pro rata portion of the cumulative translation adjustment of the foreign entity into earnings for a partial sale of an equity method investment in a foreign entity.

The Company adopted the new requirement on January 1, 2014 with no impact on the Company’s consolidated financial statements, as no triggering event occurred throughout the period.

INCOME TAXES

In July 2013, the FASB issued ASU 2013-11, which provides guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward exists. ASU 2013-11 requires entities to present an unrecognized tax benefit as a reduction of a deferred tax asset for a NOL or tax credit carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This accounting standard update requires entities to assess whether or not to net the unrecognized tax benefit with a deferred tax asset as of the reporting date.

The Company adopted the new requirement on January 1, 2014 with no material impact on the Company’s consolidated financial statements except for the change in presentation.

FUTURE ACCOUNTING CHANGES

DISCONTINUED OPERATIONS

In April 2014, the FASB issued ASU 2014-08, an update on Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this update change the requirements for reporting discontinued operations and require additional disclosures for both disposal transactions that meet the criteria for a discontinued operation and disposals that do not meet these criteria. The objective of this update is to reach a greater convergence between the FASB’s and IASB’s reporting requirements for discontinued operations.

The amendments are effective for interim and annual periods beginning after December 15, 2014 and will not have an impact on the Company’s consolidated financial statements unless a disposal transaction occurs after the effective date. Early adoption is permitted.

REVENUE FROM CONTRACTS WITH CUSTOMERS

In May 2014, the FASB issued ASU 2014-09, an update on revenue from contracts with customers. The core principal of this guideline is that an entity should recognize revenue, to depict the transfer of promised goods or services to customers, in an amount that reflects the consideration for which the entity is entitled to, in exchange for those goods and services. Guidance in this section supersedes the revenue recognition requirements found in topic 605.

The amendment will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently evaluating these changes to determine whether they have an impact on the presentation of the consolidated financial statements. The Company is still evaluating the impact on the consolidated financial statements.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)

 

STOCK COMPENSATION

In June 2014, the FASB issued ASU 2014-12, an update on stock compensation. The guideline requires performance targets, which affect vesting and can be achieved after the requisite service period, to be treated as a performance condition. Accordingly, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If achievement of the performance target becomes probable before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period.

The amendments are effective for interim and annual periods beginning after December 15, 2015. Early adoption is permitted. The Company is currently evaluating these changes to determine whether they have an impact on the presentation of the Consolidated Balance Sheets and Consolidated Statements of Earnings and Comprehensive Income. The Company does not expect these changes to have a material impact on the consolidated financial statements.

GOING CONCERN

In August 2014, the FASB issued ASU 2014-15, an update on going concern financial statements disclosure. The amendment requires the entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Management’s evaluation should be based on relevant conditions and events that are known and reasonably knowable at the date that the financial statements are issued.

The amendments in this update are effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. This amendment is not expected to have an impact on the Company’s consolidated financial statements unless conditions or events raise a substantial doubt about the Company’s ability to continue as a going concern.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 3. ACQUISITION OF BUSINESSES

Acquisition of Laboratorios Indas

On January 2, 2014, Domtar Corporation completed the acquisition of 100% of the outstanding shares of Laboratorios Indas, S.A.U. (“Indas”) a branded incontinence products manufacturer and marketer in Spain. Indas has approximately 570 employees and operates two manufacturing facilities in Spain. The results of Indas’ operations have been included in the Personal Care reportable segment as of January 2, 2014. The purchase price was $546 million (€399 million) in cash, net of cash acquired of $46 million (€34 million). The acquisition was accounted for as a business combination under the acquisition method of accounting, in accordance with the Business Combinations Topic of FASB Accounting Standards Codification (“ASC”).

The total purchase price was allocated to tangible and intangible assets acquired and liabilities assumed based on the Company’s estimates of their fair value, which are based on information currently available. The fair value of all elements, including expected useful lives of tangible and intangibles assets are preliminary and remain to be finalized. The Company will complete the valuation of all assets and liabilities within the next three months.

The table below illustrates the preliminary purchase price allocation:

 

Fair value of net assets acquired at the date of acquisition

  

  

Receivables

        101   

Inventory

        28   

Income and other taxes receivable

        3   

Property, plant and equipment

        72   

Intangible assets

     

Customer relationships(1)

     142      

Trade names(2)

     81      

Catalog rights(2)

     29      
        252   

Goodwill

        287   

Deferred income tax assets

        16   
     

 

 

 

Total assets

        759   

Less: Liabilities

     

Trade and other payables

        71   

Income and other taxes payable

        3   

Long-term debt (including short-term portion)

        42   

Deferred income tax liabilities

        96   

Other liabilities and deferred credits

        1   
     

 

 

 

Total liabilities

        213   

Fair value of net assets acquired at the date of acquisition

        546   

 

(1) 

The preliminary useful life of the Customer relationships acquired is expected to be between 15-25 years.

(2)

Indefinite useful life.

Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill is attributable to the general reputation of the business, the assembled workforce, the expected synergies and the expected future cash flows of the business. Disclosed goodwill is not deductible for tax purposes.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 3. ACQUISITION OF BUSINESSES (CONTINUED)

 

Acquisition of Associated Hygienic Products LLC

On July 1, 2013, Domtar Corporation completed the acquisition of 100% of the outstanding shares of Associated Hygienic Products LLC (“AHP”). AHP manufactures and markets infant diapers in the United States. AHP has approximately 500 employees and operates two manufacturing facilities, a 376,500 square foot manufacturing facility in Delaware, Ohio and a 312,500 square foot manufacturing facility in Waco, Texas. AHP also operates a distribution center in Duluth, Georgia. The results of AHP’s operations are included in the Personal Care reportable segment as of July 1, 2013. The purchase price was $276 million in cash, including working capital, net of cash acquired of $2 million. The acquisition was accounted for as a business combination under the acquisition method of accounting, in accordance with the Business Combinations Topic of FASB ASC.

The total purchase price was allocated to tangible and intangible assets acquired and liabilities assumed based on the Company’s estimates of their fair value, which are based on information currently available. During the fourth quarter of 2013, the Company completed the evaluation of all assets and liabilities.

The table below illustrates the purchase price allocation:

 

Fair value of net assets acquired at the date of acquisition

  

  

Receivables

        26   

Inventory

        29   

Property, plant and equipment

        99   

Intangible assets

     

Customer relationships (1)

     67      

Licence rights (2)

     29      
        96   

Goodwill

        103   
     

 

 

 

Total assets

        353   

Less: Liabilities

     

Trade and other payables

        37   

Intangible lease liability

        13   

Deferred income tax liabilities

        27   
     

 

 

 

Total liabilities

        77   

Fair value of net assets acquired at the date of acquisition

        276   

 

(1) 

The useful life of the Customer relationships acquired is 20 years.

(2) 

The useful life of the License rights acquired is 12 years.

Goodwill represents the future economic benefit arising from other assets acquired that could not be individually identified and separately recognized. The goodwill is attributable to the general reputation of the business, the assembled workforce, the expected synergies and the expected future cash flows of the business. Disclosed goodwill is not deductible for tax purposes.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 3. ACQUISITION OF BUSINESSES (CONTINUED)

 

Xerox

On June 1, 2013, Domtar Corporation completed the acquisition of Xerox’s paper and print media product’s assets in the United States and Canada. The transaction includes a broad range of coated and uncoated papers and specialty print media including business forms, carbonless as well as wide-format paper formerly distributed by Xerox. The results of this business are presented in the Pulp and Paper reportable segment. The purchase price was $7 million in cash plus inventory on a dollar for dollar basis. The acquisition was accounted for as a business combination under the acquisition method of accounting, in accordance with the Business Combinations Topic of FASB ASC.

The total purchase price was allocated to tangible and intangible assets acquired based on the Company’s estimates of their fair value, which was based on information currently available. During the third quarter of 2013, the Company completed the evaluation of all assets and liabilities.

The table below illustrates the purchase price allocation:

 

Inventory

        4   

Intangible assets

     

Customer relationships (1)

     1      

License rights (2)

     6      
        7   
     

 

 

 

Total assets

        11   

Fair value of assets acquired at the date of acquisition

        11   

 

(1) 

The useful life of the Customer relationships acquired is 20 years.

(2) 

Indefinite useful life.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT

INTEREST RATE RISK

The Company is exposed to interest rate risk arising from fluctuations in interest rates on its cash and cash equivalents, bank indebtedness, bank credit facility and long-term debt. The Company may manage this interest rate exposure through the use of derivative instruments such as interest rate swap contracts.

CREDIT RISK

The Company is exposed to credit risk on the accounts receivable from its customers. In order to reduce this risk, the Company reviews new customers’ credit history before granting credit and conducts regular reviews of existing customers’ credit performance. As of September 30, 2014, one of Domtar’s Pulp and Paper segment customers located in the United States represented 11% ($72 million) (2013 – 12% ($73 million)) of the Company’s receivables.

The Company is also exposed to credit risk in the event of non-performance by counterparties to its financial instruments. The Company minimizes this exposure by entering into contracts with counterparties that are believed to be of high credit quality. Collateral or other security to support financial instruments subject to credit risk is usually not obtained. The credit standing of counterparties is regularly monitored. Additionally, the Company is exposed to credit risk in the event of non-performance by its insurers. The Company minimizes this exposure by doing business only with large reputable insurance companies.

COST RISK

Cash flow hedges:

The Company purchases natural gas at the prevailing market price at the time of delivery. In order to manage the cash flow risk associated with purchases of natural gas, the Company may utilize derivative financial instruments or physical purchases to fix the price of forecasted natural gas purchases. The Company formally documents the hedge relationships, including identification of the hedging instruments and the hedged items, the risk management objectives and strategies for undertaking the hedge transactions, and the methodologies used to assess effectiveness and measure ineffectiveness. Current contracts are used to hedge a portion of forecasted purchases over the next 39 months. The effective portion of changes in the fair value of derivative contracts designated as cash flow hedges is recorded net of taxes in Other comprehensive (loss) income, and is recognized in Cost of sales in the period in which the hedged transaction occurs.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

 

The following table presents the volumes under derivative financial instruments for natural gas contracts outstanding as of September 30, 2014 to hedge forecasted purchases:

 

Commodity

   Notional contractual  quantity
under derivative contracts
           Notional contractual  value
under derivative contracts
(in millions of dollars)
     Percentage of  forecasted
purchases under
derivative contracts for
 
                         2014 (2)     2015     2016     2017  

Natural gas

     19,530,000         MMBTU  (1)    $ 81         49     50     34     11

 

(1)

MMBTU: Millions of British thermal units

(2) 

Represents the remaining three months of 2014

The natural gas derivative contracts were fully effective for accounting purposes as of September 30, 2014. The critical terms of the hedging instruments and the hedged items match. As a result, there were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three and nine months ended September 30, 2014 resulting from hedge ineffectiveness (three and nine months ended September 30, 2013 – nil).

FOREIGN CURRENCY RISK

Cash flow hedges:

The Company has manufacturing operations in the United States, Canada, Sweden and Spain. As a result, it is exposed to movements in foreign currency exchange rates in Canada and Europe. Moreover, certain assets and liabilities are denominated in currencies other than the U.S. dollar and are exposed to foreign currency movements. As a result, the Company’s earnings are affected by increases or decreases in the value of the Canadian dollar and of European currencies relative to the U.S. dollar. The Company’s Swedish and Spanish subsidiaries are exposed to movements in foreign currency exchange rates on transactions denominated in a currency other than its Euro functional currency. The Company’s risk management policy allows it to hedge a significant portion of its exposure to fluctuations in foreign currency exchange rates for periods up to three years. The Company may use derivative instruments (currency options and foreign exchange forward contracts) to mitigate its exposure to fluctuations in foreign currency exchange rates or to designate them as hedging instruments in order to hedge the subsidiary’s cash flow risk for purposes of the Consolidated Financial Statements.

The Company formally documents the relationship between hedging instruments and hedged items, as well as its risk management objectives and strategies, for undertaking the hedge transactions. Foreign exchange derivative contracts designated as cash flow hedges are used to hedge forecasted purchases in Canadian dollars by the Canadian subsidiary over the next 24 months. Foreign exchange derivative option contracts designated as cash flow hedges are used to hedge forecasted sales in British Pound Sterling and forecasted purchases in U.S. dollars by the Swedish and Spanish subsidiaries over the next 12 months. The effective portion of changes in the fair value of derivative contracts designated as cash flow hedges is recorded net of taxes in Other comprehensive (loss) income and is recognized in Cost of sales or Sales in the period in which the hedged transaction occurs.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

 

The following table presents the currency values under contracts pursuant to currency derivatives outstanding as of September 30, 2014 to hedge forecasted purchases and sales:

 

Contract

          Notional contractual value      Percentage of forecasted net exposures
under contracts for
 
                   2014     2015  

Currency derivatives purchased

     CDN       $ 600         53     31
     USD       $ 55         58     77
     GBP       £ 14         100     84

Currency derivatives sold

     CDN       $ 600         53     31
     USD       $ 55         58     77
     GBP       £ 14         100     84

The currency options and forwards are fully effective as at September 30, 2014. The critical terms of the hedging instruments and the hedged items match. As a result, there were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three and nine months ended September 30, 2014 resulting from hedge ineffectiveness (for the three and nine months ended September 30, 2013 – nil and nil, respectively).

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

 

FAIR VALUE MEASUREMENT

The accounting standards for fair value measurements and disclosures, establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three levels. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is available and significant to the fair value measurement.

 

  Level 1 Quoted prices in active markets for identical assets or liabilities.
  Level 2 Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
  Level 3 Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.

The following tables present information about the Company’s financial assets and financial liabilities measured at fair value on a recurring basis (except Long-term debt, see (c) below) at September 30, 2014 and December 31, 2013, in accordance with the accounting standards for fair value measurements and disclosures and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value.

Fair Value of financial instruments at:

 

Derivatives designated as cash flow and net investment hedging instruments under the Derivatives and Hedging Topic of FASB ASC:    

 

September 30,

2014

  

  

   

 

 

 

Quoted prices in

active markets for

identical assets

(Level 1)

  

  

  

  

   

 

 

 

Significant

observable

inputs

(Level 2)

  

  

  

  

   

 

 

 

Significant

unobservable

inputs

(Level 3)

  

  

  

  

 

Balance sheet classification

    $     $     $     $      

Asset derivatives

         

Currency derivatives

    7        —          7        —       

(a)  Prepaid expenses

Currency derivatives

    5        —          5        —       

(a)  Intangible assets and deferred charges

Natural gas swap contracts

    1        —          1        —       

(a)  Prepaid expenses

 

 

 

   

 

 

   

 

 

   

 

 

   

Total Assets

    13        —          13        —       
 

 

 

   

 

 

   

 

 

   

 

 

   

Liabilities derivatives

         

Currency derivatives

    11        —          11        —       

(a)  Trade and other payables

Currency derivatives

    7        —          7        —       

(a)  Other liabilities and deferred credits

Natural gas swap contracts

    1        —          1        —       

(a)  Trade and other payables

Natural gas swap contracts

    2        —          2        —       

(a)  Other liabilities and deferred credits

 

 

 

   

 

 

   

 

 

   

 

 

   

Total Liabilities

    21        —          21        —       
 

 

 

   

 

 

   

 

 

   

 

 

   

Other Instruments:

         

Asset backed notes

    1        —          —          1     

(b)  Other assets

Long-term debt

    1,498        1,498        —          —       

(c)  Long-term debt

 

 

 

   

 

 

   

 

 

   

 

 

   

The cumulative loss recorded in Other comprehensive (loss) income relating to natural gas contracts of $2 million at September 30, 2014, will be recognized in Cost of sales upon maturity of the derivatives over the next 39 months at the then prevailing values, which may be different from those at September 30, 2014.

The cumulative loss recorded in Other comprehensive (loss) income relating to currency options and forwards hedging forcasted purchases of $6 million at September 30, 2014, will be recognized in Cost of sales or Sales upon maturity of the derivatives over the next 24 months at the then prevailing values, which may be different from those at September 30, 2014.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

 

Fair Value of financial instruments at:

 

Derivatives designated as cash flow hedging instruments under the Derivatives and Hedging Topic of FASB ASC:     

 

December 31,

2013

  

  

    

 

 

 

Quoted prices in

active markets for

identical assets

(Level 1)

  

  

  

  

    

 

 

 

Significant

observable

inputs

(Level 2)

  

  

  

  

    

 

 

 

Significant

unobservable

inputs

(Level 3)

  

  

  

  

 

Balance sheet classification

     $      $      $      $      

Asset derivatives

             
Currency derivatives      3         —           3         —       

(a)  Prepaid expenses

Natural gas swap contracts      2         —           2         —       

(a)  Prepaid expenses

Natural gas swap contracts      1         —           1         —       

(a)  Intangible assets and deferred charges

  

 

 

    

 

 

    

 

 

    

 

 

   
Total Assets      6         —           6         —       
  

 

 

    

 

 

    

 

 

    

 

 

   

Liabilities derivatives

             
Currency derivatives      10         —           10         —       

(a)  Trade and other payables

Natural gas swap contracts      1         —           1         —       

(a)  Other liabilities and deferred credits

  

 

 

    

 

 

    

 

 

    

 

 

   
Total Liabilities      11         —           11         —       
  

 

 

    

 

 

    

 

 

    

 

 

   

Other Instruments:

             
Asset backed notes      6         —           5         1     

(b)  Other assets

Long-term debt      1,620         1,620         —           —       

(c)  Long-term debt

  

 

 

    

 

 

    

 

 

    

 

 

   

 

(a) Fair value of the Company’s derivatives is classified under Level 2 (inputs that are observable; directly or indirectly) as it is measured as follows:

 

  For currency derivatives: Fair value is measured using techniques derived from the Black-Scholes pricing model. Interest rates, forward market rates and volatility are used as inputs for such valuation techniques.

 

  For natural gas contracts: Fair value is measured using the discounted difference between contractual rates and quoted market future rates.

 

(b) Asset Backed Notes (“ABN”) are reported at fair value utilizing Level 2 or Level 3 inputs. Fair value of ABN reported under Level 2 is based on current market quotes. Fair value of ABN reported under Level 3 is based on the value of the collateral investments held in the conduit issuer, reduced by the negative value of credit default derivatives, with an additional discount applied for illiquidity.

 

(c) Fair value of the Company’s long-term debt is measured by comparison to market prices of its debt. In accordance with US GAAP, the Company’s long-term debt is not carried at fair value on the Consolidated Balance Sheets at September 30, 2014 and December 31, 2013. However, fair value disclosure is required. The carrying value of the Company’s long-term debt is $1,372 million and $1,514 million at September 30, 2014 and December 31, 2013, respectively.

Due to their short-term maturity, the carrying amounts of cash and cash equivalents, receivables, bank indebtedness, trade and other payables and income and other taxes approximate their fair values.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 5. EARNINGS PER COMMON SHARE

On April 30, 2014, the Company’s Board of Directors approved a 2-for-1 split of its common stock to be effected through a stock dividend. Shareholders of record on June 10, 2014 were entitled to receive one additional share for every share they owned on that date.

The following table provides the reconciliation between basic and diluted earnings per common share:

 

     For the three
months ended
     For the nine
months ended
 
     September 30,      September 30,      September 30,      September 30,  
     2014      2013      2014      2013  

Net earnings

   $ 281       $ 27       $ 360       $ 26   

Weighted average number of common and exchangeable shares outstanding (millions)

     64.8         65.3         64.9         67.2   

Effect of dilutive securities (millions)

     0.1         0.1         0.1         0.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average number of diluted common and exchangeable shares outstanding (millions)

     64.9         65.4         65.0         67.3   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic net earnings per common share (in dollars)

   $ 4.34       $ 0.41       $ 5.55       $ 0.39   
  

 

 

    

 

 

    

 

 

    

 

 

 

Diluted net earnings per common share (in dollars)

   $ 4.33       $ 0.41       $ 5.54       $ 0.39   
  

 

 

    

 

 

    

 

 

    

 

 

 

The following table provides the securities that could potentially dilute basic earnings per common share in the future, but were not included in the computation of diluted earnings per common share because to do so would have been anti-dilutive:

 

     For the three
months ended
     For the nine
months ended
 
     September 30,      September 30,      September 30,      September 30,  
     2014      2013      2014      2013  

Options

     399,059         443,784         263,012         443,784   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 6. PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS

DEFINED CONTRIBUTION PLANS

The Company has several defined contribution plans and multi-employer plans. The pension expense under these plans is equal to the Company’s contribution. For the three and nine months ended September 30, 2014, the related pension expense was $7 million and $22 million, respectively (2013 - $6 million and $22 million, respectively).

DEFINED BENEFIT PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS

The Company sponsors both contributory and non-contributory U.S. and non-U.S. defined benefit pension plans. Non-unionized employees in Canada joining the Company after June 1, 2000 participate in a defined contribution pension plan. Salaried employees in the U.S. joining the Company after January 1, 2008 participate in a defined contribution pension plan. Most unionized employees in the U.S. and all U.S. non-hourly employees that are not grandfathered under the existing defined benefit pension plans, participate in a defined contribution pension plan for future service. The Company also sponsors a number of other post-retirement benefit plans for eligible U.S. and non-U.S. employees; the plans are unfunded and include life insurance programs and medical and dental benefits. The Company also provides supplemental unfunded defined benefit pension plans and supplemental unfunded defined contribution pension plans to certain senior management employees.

Components of net periodic benefit cost for pension plans and other post-retirement benefit plans:

 

     For the three months ended      For the nine months ended  
     September 30, 2014      September 30, 2014  
     Pension
plans
    Other
post-retirement
benefit plans
     Pension
plans
    Other
post-retirement
benefit plans
 
     $     $      $     $  

Service cost

     9        1         27        2   

Interest expense

     20        —           60        3   

Expected return on plan assets

     (27     —           (79     —     

Amortization of net actuarial loss

     2        —           7        —     

Amortization of prior year service costs

     2        —           3        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Net periodic benefit cost

     6        1         18        5   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 6. PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS (CONTINUED)

 

Components of net periodic benefit cost for pension plans and other post-retirement benefit plans:

 

     For the three months ended      For the nine months ended  
     September 30, 2013      September 30, 2013  
     Pension
plans
    Other
post-retirement
benefit plans
     Pension
plans
    Other
post-retirement
benefit plans
 
     $     $      $     $  

Service cost

     10        1         32        2   

Interest expense

     19        2         56        4   

Expected return on plan assets

     (24     —           (72     —     

Amortization of net actuarial loss

     6        —           20        1   

Curtailment loss

     1        —           1        —     

Settlement loss (a)

     —          —           13        —     

Amortization of prior year service costs

     1        —           2        —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Net periodic benefit cost

     13        3         52        7   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(a) The settlement loss of $13 million in the pension plans for the nine months ended September 30, 2013 is related to the previously closed Big River and Dryden mills for $6 million and $7 million, respectively (see Note 12 “Closure and restructuring costs and liability and impairment and write-down of property, plant and equipment”).

The Company contributed nil and $19 million for the three and nine months ended September 30, 2014, respectively (2013 – $17 million and $31 million, respectively) to the pension plans. The Company also contributed $1 million and $4 million for the three and nine months ended September 30, 2014, respectively (2013 - $2 million and $5 million, respectively) to the other post-retirement benefit plans.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 7. OTHER OPERATING (INCOME) LOSS, NET

Other operating (income) loss, net is an aggregate of both recurring and occasional loss or income items and, as a result, can fluctuate from period to period. The Company’s other operating (income) loss, net includes the following:

 

     Three months ended      Nine months ended  
     September 30,     September 30,      September 30,     September 30,  
     2014     2013      2014     2013  
     $     $      $     $  

Alternative fuel tax credits (Note 8)

     (18     —           (18     26   

Loss on sale of business (1)

     —          19         —          19   

Gain on sale of property, plant and equipment (2)

     —          —           —          (10

Environmental provision

     1        —           1        2   

Foreign exchange loss (gain)

     1        1         —          (1

Weston litigation (3)

     —          —           —          49   

Other

     (1     2         —          4   
  

 

 

   

 

 

    

 

 

   

 

 

 

Other operating (income) loss, net

     (17     22         (17     89   
  

 

 

   

 

 

    

 

 

   

 

 

 

 

(1) 

On July 31, 2013, the Company completed the sale of its Ariva U.S business. The transaction closed at the end of July 2013. The Company recorded a loss on sale of business of $19 million in the third quarter of 2013 (see Note 18 “Sale of Ariva U.S.” for further information).

 

(2) 

On March 22, 2013, the Company sold the building, remaining equipment and related land of the closed pulp and paper mill in Port Edwards, Wisconsin and recorded a gain on the sale of approximately $10 million. The transaction included specific machinery, equipment, furniture, parts, supplies, tools, real estate, land improvements, and other fixed or tangible assets. The assets were sold “as is” for proceeds of approximately $9 million and the environmental provision of $3 million related to these assets was contractually passed on to the buyer and released from the Company’s liabilities. The net book value of the assets sold was approximately $2 million.

 

(3) 

On June 24, 2013, the parties agreed to settle the Weston litigation for a payment by Domtar to Weston of $49 million (CDN $50 million).

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 8. INCOME TAXES

For the third quarter of 2014, the Company’s income tax benefit amounted to $186 million, consisting of a current tax expense of $10 million and a deferred tax benefit of $196 million. This compares to an income tax expense of $1 million in the third quarter of 2013, consisting of a current income tax expense of $10 million and a deferred income tax benefit of $9 million. The Company made income tax payments, net of refunds, of $13 million during the third quarter of 2014 (2013 – $1 million) and the effective tax rate was -196% compared to an effective tax rate of 4% in the third quarter of 2013. The effective tax rates for both the third quarter of 2014 and the third quarter of 2013 were impacted by the recognition of additional tax benefits related to the finalization of certain estimates in connection with the filing of our 2013 and 2012 tax returns, respectively. Additionally, the effective tax rate for the third quarter of 2014 was impacted by the recognition of previously unrecognized tax benefits of approximately $204 million as a result of the closure of U.S. federal tax audits for tax years 2009 through 2011, as well as the impact of recognizing $18 million of Alternative Fuel Tax Credits (“AFTC”) income in the third quarter of 2014 with no related tax expense. Excluding those items, the Company’s tax rate in the third quarter of 2014 would have been 23%. The effective tax rate for the third quarter of 2013 was also impacted by the benefit of enacted state and provincial tax law changes in North Carolina and British Columbia.

For the first nine months of 2014, the Company’s income tax benefit amounted to $158 million, consisting of a current tax expense of $44 million and a deferred tax benefit of $202 million. This compares to an income tax benefit of $26 million for the first nine months of 2013, consisting of a current income tax benefit of $17 million and a deferred income tax benefit of $9 million. The Company made income tax payments, net of refunds, of $32 million during the nine months of 2014 (2013 – refund of $8 million) and the effective tax rate was negative in the first nine months of both 2014 and 2013. The effective tax rate for the first nine months of 2014 was impacted by the recognition of previously unrecognized tax benefits of approximately $204 million as a result of the closure of U.S. federal tax audits for tax years 2009 through 2011, as well as the impact of recognizing $18 million of AFTC income with no related tax expense. Excluding those items, the Company’s tax rate for the first nine months of 2014 would have been 25%. The effective tax rate for the first nine months of 2013 was impacted by the conversion of $26 million of AFTC from the 2009 tax year into $55 million of Cellulosic Biofuel Producer Credits (“CBPC”) ($33 million benefit after-tax) as well as a reduction of unrecognized tax benefits of $8 million previously associated with AFTC from 2009 that were converted into CBPC, and the enacted tax law changes in North Carolina and British Columbia. These tax benefits were partially offset by the $49 million (CDN $50 million) litigation settlement payment, due to $38 million (CDN $39 million) being non-deductible for income tax purposes.

As of September 30, 2014, the Company had no remaining gross unrecognized tax benefits and interest or related deferred tax assets associated with the AFTC claimed on the 2009 tax return. The Company recognized these benefits, $178 million net of deferred taxes, during the third quarter of 2014, thus impacting the effective tax rate.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 9. INVENTORIES

The following table presents the components of inventories:

 

     September 30,      December 31,  
     2014      2013  
     $      $  

Work in process and finished goods

     391         386   

Raw materials

     128         102   

Operating and maintenance supplies

     200         197   
  

 

 

    

 

 

 
     719         685   
  

 

 

    

 

 

 

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 10. GOODWILL

The carrying value and any changes in the carrying value of goodwill are as follows:

 

     September 30,
2014
 
     $  

Balance at December 31, 2013

     369   

Acquisition of Laboratorios Indas

     287   

Effect of foreign currency exchange rate change

     (28
  

 

 

 

Balance at end of period

     628   
  

 

 

 

The goodwill at September 30, 2014 is entirely related to the Personal Care segment. (See Note 3 “Acquisition of businesses” for further information on the increase in 2014).

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 11. INTANGIBLE ASSETS, NET

The following table presents the components of intangible assets, net:

 

     Estimated useful
lives (in years)
     September 30, 2014      December 31, 2013  
            Gross
carrying
amount
     Accumulated
amortization
    Net      Gross
carrying
amount
     Accumulated
amortization
    Net  
            $      $     $      $      $     $  

Intangible assets subject to amortization

                  

Water rights

     40         8         (1     7         8         (1     7   

Customer relationships (1)

     10 - 40         382         (28     354         256         (14     242   

Technology

     7 - 20         8         (2     6         8         (1     7   

Non-Compete

     9         1         —          1         1         —          1   

License rights

     12         28         (3     25         29         (1     28   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
        427         (34     393         302         (17     285   

Intangible assets not subject to amortization

                  

Trade names (1)

        187         —          187         116         —          116   

License rights

        6         —          6         6         —          6   

Catalog rights (1)

        27         —          27         —           —          —     
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total

        647         (34     613         424         (17     407   
     

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Amortization expense related to intangible assets for the three and nine months ended September 30, 2014 was $5 million and $16 million, respectively (2013 – $3 million and $7 million, respectively).

Amortization expense for the next five years related to intangible assets is expected to be as follows:

 

     2014      2015      2016      2017      2018  
     $      $      $      $      $  

Amortization expense related to intangible assets

     20         20         20         20         20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Increase relates to the acquisition of Laboratorios Indas on January 2, 2014.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 12. CLOSURE AND RESTRUCTURING COSTS AND LIABILITY AND IMPAIRMENT AND WRITE-DOWN OF PROPERTY, PLANT AND EQUIPMENT

The Company regularly reviews its overall production capacity with the objective of aligning its production capacity with anticipated long-term demand, which in some cases could result in closure or impairment costs being recorded in earnings.

In relation to the withdrawal from one of the Company’s multiemployer pension plans in 2011, the Company recorded an additional charge to earnings of $1 million due to a revision in estimated withdrawal liability during the first quarter of 2013. During the second quarter of 2013, the Company decided to withdraw from another of its multiemployer pension plans and recorded a withdrawal liability and a charge to earnings of $3 million. At September 30, 2014, the current accrual balance is $62 million. At September 30, 2014, this is the Company’s best estimate of the ultimate cost of the withdrawal from these plans. Further, the Company remains liable for potential additional withdrawal liabilities to the fund in the event of a mass withdrawal, as defined by statute, occurring anytime within the next two years.

During the second quarter of 2013, the Company also incurred pension settlement losses in the amount of $13 million related to the previously closed Big River sawmill and Dryden paper mill for $6 million and $7 million, respectively.

Ariva U.S.

On July 31, 2013, the Company completed the sale of its Ariva U.S. business which had approximately 400 employees in the United States. As a result of this agreement, during the second quarter of 2013, the Company recorded a $5 million impairment of property, plant and equipment at its Ariva U.S. location, in Impairment and write-down of property, plant and equipment on the Consolidated Statement of Earnings and Comprehensive Income.

Kamloops, British Columbia pulp facility

On December 13, 2012, the Company announced the permanent shut down of one pulp machine at its Kamloops, British Columbia mill. This decision resulted in a permanent curtailment of Domtar’s annual pulp production by approximately 120,000 air dried metric tons of sawdust softwood pulp and affected approximately 125 employees.

As a result, the Company recognized, under Impairment and write-down of property plant and equipment, $10 million of accelerated depreciation in the first quarter of 2013. The pulp machine ceased production in March 2013. Further, during the first quarter of 2013 the Company reversed $1 million of severance and termination costs. During the second quarter of 2013, the Company reversed an additional $1 million of severance and termination costs, reversed $1 million of inventory obsolescence, and incurred $2 million of other costs.

Other Costs

For the three and nine months ended September 30, 2014, the Company also incurred other costs related to previous and ongoing closures which includes $2 million and $3 million of severance and termination costs, respectively (2013—nil and $2 million, respectively).

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 12. CLOSURE AND RESTRUCTURING COSTS AND LIABILITY AND IMPAIRMENT AND WRITE-DOWN OF PROPERTY, PLANT AND EQUIPMENT (CONTINUED)

 

The following tables provide the components of closure and restructuring costs by segment:

 

     Three months ended
September 30, 2014
     Three months ended
September 30, 2013
 
     Pulp and
Paper
     Personal
Care
     Corporate      Total      Pulp and
Paper
     Personal
Care
     Corporate      Total  
     $      $      $      $      $      $      $      $  

Severance and termination costs

     2         —           —           2         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Closure and restructuring costs

     2         —           —           2         —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Nine months ended
September 30, 2014
     Nine months ended
September 30, 2013
 
     Pulp and
Paper
     Personal
Care
     Corporate      Total      Pulp and
Paper
    Personal
Care
     Corporate      Total  
     $      $      $      $      $     $      $      $  

Severance and termination costs

     2         1         —           3         (2     2         —           —     

Inventory obsolescence

     —           —           —           —           (1     —           —           (1

Pension settlement and withdrawal liability

     —           —           —           —           11        —           6         17   

Other

     —           —           —           —           2        —           —           2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

Closure and restructuring costs

     2         1         —           3         10        2         6         18   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

 

The following table provides the activity in the closure and restructuring liability:

 

     September 30,
2014
 
     $  

Balance at December 31, 2013

     3   

Additions

     3   

Acquisition of business

     1   

Payments

     (3
  

 

 

 

Balance at end of period

     4   
  

 

 

 

The above provision is comprised of severance and termination costs all related to the Pulp and Paper segment.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 13. CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT

The following table presents the changes in Accumulated other comprehensive loss by component(1) for the periods ended September 30, 2014 and 2013:

 

     Net derivative
gains (losses)
on cash flow
hedges
    Pension
items(2)
    Post-retirement
benefit items(2)
    Foreign
currency
items
    Total  

Balance at December 31, 2013

     —          (210     (7     152        (65
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Natural gas swap contracts

     1        N/A        N/A        N/A        1   

Currency options

     (7     N/A        N/A        N/A        (7

Forward contracts

     1        N/A        N/A        N/A        1   

Foreign currency items

     N/A        N/A        N/A        (130     (130

Remeasurement of pension plan obligation(3)

     N/A        (3     N/A        N/A        (3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive loss before reclassifications

     (5     (3     —          (130     (138
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amounts reclassified from Accumulated other comprehensive loss

     5        7        —          —          12   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net current period other comprehensive income (loss)

     —          4        —          (130     (126
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2014

     —          (206     (7     22        (191
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2012

     5        (326     (15     208        (128
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Natural gas swap contracts

     (2     N/A        N/A        N/A        (2

Currency options

     (3     N/A        N/A        N/A        (3

Net investment hedge

     (1     N/A        N/A        N/A        (1

Foreign currency items

     N/A        N/A        N/A        (27     (27

Remeasurement of pension plan obligation

     N/A        19        —          N/A        19   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income before reclassifications

     (6     19        —          (27     (14
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Amounts reclassified from Accumulated other comprehensive loss

     3        18        2        —          23   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net current period other comprehensive (loss) income

     (3     37        2        (27     9   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2013

     2        (289     (13     181        (119
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

All amounts are after tax. Amount in parenthesis indicate losses.

(2)

The accrued benefit obligation is actuarially determined on an annual basis as of December 31.

(3) 

Remeasurement loss of $3 million recorded in Accumulated other comprehensive loss by component.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 13. CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT (CONTINUED)

 

The following tables present reclassifications out of Accumulated other comprehensive loss:

 

Details of Accumulated other
comprehensive loss components

   Amount reclassified from
Accumulated other
comprehensive loss
   

Affected line item in the
Consolidated Statements of
Earnings (Loss)
and Comprehensive Income (Loss)

     For the three months ended      
     September 30,
2014
    September 30,
2013
     

Net derivative gains on cash flow hedges

      

Natural gas swap contracts

     —          1     

Cost of Sales

Currency options

     2        2     

Cost of Sales

  

 

 

   

 

 

   

Total before tax

     2        3     

Tax (benefit) expense

     —          (1   Income tax (benefit) expense
  

 

 

   

 

 

   

Net of tax

     2        2     
  

 

 

   

 

 

   

Amortization of defined benefit pension items

      

Amortization of net actuarial loss and prior year service cost

     4        8      (a)

Tax expense (benefit)

     (2     (9   Income tax (benefit) expense
  

 

 

   

 

 

   

Net of tax

     2        (1  
  

 

 

   

 

 

   

 

Details of Accumulated other
comprehensive loss components

   Amount reclassified from
Accumulated other
comprehensive loss
   

Affected line item in the
Consolidated Statements of
Earnings (Loss)
and Comprehensive Income (Loss)

     For the nine months ended      
     September 30,
2014
    September 30,
2013
     

Net derivative gains (losses) on cash flow hedges

      

Natural gas swap contracts

     (3     3      Cost of Sales

Currency options

     11        2      Cost of Sales
  

 

 

   

 

 

   

Total before tax

     8        5     

Tax benefit

     (3     (2   Income tax benefit
  

 

 

   

 

 

   

Net of tax

     5        3     
  

 

 

   

 

 

   

Amortization of defined benefit pension items

      

Amortization of net actuarial loss and prior year service cost

     10        37      (a)

Tax benefit

     (3     (17   Income tax benefit
  

 

 

   

 

 

   

Net of tax

     7        20     
  

 

 

   

 

 

   

 

(a) These amounts are included in the computation of net periodic benefit cost. Refer to Note 6 “Pension plans and other post-retirement benefit plans” for additional details.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 14. SHAREHOLDERS’ EQUITY

On February 18, 2014, the Company’s Board of Directors approved a quarterly dividend of $0.275 per share, on a post-split basis, to be paid to holders of the Company’s common stock, as well as holders of exchangeable shares of Domtar (Canada) Paper Inc. Total dividends of approximately $18 million were paid on April 15, 2014 to shareholders of record on March 14, 2014.

On April 30, 2014, the Company’s Board of Directors approved a 2-for-1 split of its common stock to be effected through a stock dividend. Shareholders of record on June 10, 2014 received one additional share for every share they owned on that date. As a result of the stock split, total shares of the Company’s common stock outstanding increased from approximately 32.5 million to 65 million.

In addition, the Company’s Board of Directors approved an increase in the quarterly dividend on its common stock on a post-split basis, from $0.275 to $0.375 per share. This is equivalent to, on a pre-split basis, an increase of $0.20 per share (36%) per quarter. Total dividends of approximately $24 million were paid on July 15, 2014 to shareholders of record on July 2, 2014.

On July 30, 2014, the Company’s Board of Directors approved a quarterly dividend of $0.375 per share to be paid to holders of the Company’s common stock. Total dividends of approximately $24 million were paid on October 15, 2014, to shareholders of record on October 2, 2014.

On October 29, 2014, the Company’s Board of Directors approved a quarterly dividend of $0.375 per share to be paid to holders of the Company’s common stock. This dividend is to be paid on January 15, 2015, to shareholders of record on January 2, 2015.

STOCK REPURCHASE PROGRAM

In 2010, the Company’s Board of Directors authorized a stock repurchase program (“the Program”) of up to $1 billion of Domtar Corporation’s common stock. Under the Program, the Company is authorized to repurchase from time to time shares of its outstanding common stock on the open market or in privately negotiated transactions in the United States. The timing and amount of stock repurchases will depend on a variety of factors, including the market conditions as well as corporate and regulatory considerations. The Program may be suspended, modified or discontinued at any time and the Company has no obligation to repurchase any amount of its common stock under the Program. The Program has no set expiration date. The Company repurchases its common stock, from time to time, in part to reduce the dilutive effects of stock options, awards, and to improve shareholders’ returns.

The Company makes open market purchases of its common stock using general corporate funds. Additionally, the Company enters into structured stock repurchase agreements with large financial institutions using general corporate funds in order to lower the average cost to acquire shares. The agreements require the Company to make up-front payments to the counterparty financial institutions which results in either the receipt of stock at the beginning of the term of the agreements followed by a share adjustment at the maturity of the agreements, or the receipt of either stock or cash at the maturity of the agreements, depending upon the price of the stock.

During the first three quarters of 2014, the Company repurchased 530,780 shares at an average price of $36.62 for a total cost of $19 million.

During the first three quarters of 2013, the Company repurchased 5,019,606 shares at an average price of $36.55 for a total cost of $183 million.

Since the inception of the Program, the Company repurchased 22,871,793 shares at an average price of $39.18 for a total cost of $896 million. All shares repurchased are recorded as Treasury stock on the Consolidated Balance Sheets under the par value method at $0.01 per share.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 14. SHAREHOLDERS’S EQUITY (CONTINUED)

 

Domtar (Canada) Paper Inc. Exchangeable Shares

Upon the consummation of a series of transactions whereby the Fine Paper Business of Weyerhaeuser Company was transferred to the Company and it acquired Domtar Inc. on March 7, 2007 (the “Transaction”), Domtar Inc. shareholders had the option to receive either common stock of the Company or shares of Domtar (Canada) Paper Inc., a subsidiary of Domtar Corporation, that were exchangeable for common stock of the Company. The exchangeable shares of Domtar (Canada) Paper Inc. were intended to be substantially the economic equivalent to shares of the Company’s common stock. These shareholders could exchange the exchangeable shares for shares of Domtar Corporation common stock on a one-for-one basis at any time.

On June 2, 2014 (the “Redemption Date”), Domtar (Canada) Paper Inc. redeemed all of its outstanding exchangeable shares from the holders thereof. On the Redemption Date, holders of exchangeable shares received, in exchange for each exchangeable share, one share of common stock of Domtar Corporation (plus cash in the amount of all declared and unpaid dividends, if any, provided that the record date for the payment of such dividends was prior to the Redemption Date).

As a result of the redemption of exchangeable shares, the Company reclassified $32 million from Exchangeable shares to Additional paid-in capital.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 15. COMMITMENTS AND CONTINGENCIES

ENVIRONMENT

The Company is subject to environmental laws and regulations enacted by federal, provincial, state and local authorities.

An action was commenced by Seaspan International Ltd. (“Seaspan”) in the Supreme Court of British Columbia, on March 31, 1999 against the Company and others with respect to alleged contamination of Seaspan’s site bordering Burrard Inlet in North Vancouver, British Columbia, including contamination of sediments in Burrard Inlet, due to the presence of creosote and heavy metals. Beyond the filing of preliminary pleadings, no steps have been taken by the parties in this action. On February 16, 2010, the government of British Columbia issued a Remediation Order to Seaspan and the Company (“responsible persons”) in order to define and implement an action plan to address soil, sediment and groundwater issues. This Order was appealed to the Environmental Appeal Board (“Board”) on March 17, 2010 but there is no suspension in the execution of this Order unless the Board orders otherwise. The relevant government authorities selected a remediation approach on July 15, 2011, and on January 8, 2013, the same authorities decided that each responsible persons’ implementation plan is satisfactory and that the responsible persons should decide which plan is to be used. Most of the remaining appeals that were to be heard before the Board were abandoned by the parties during the course of the Board proceedings which were held in the fall of 2013. Seaspan and Domtar have selected a remedial plan and have applied to the Vancouver Fraser Port Authority for permitting approval. The Company has recorded an environmental reserve to address its estimated exposure. The possible loss in excess of the reserve is not considered to be material for this matter.

The following table reflects changes in the reserve for environmental remediation and asset retirement obligations:

 

     September 30,
2014
 
     $  

Balance at beginning of period

     67   

Additions

     3   

Environmental spending

     (6

Effect of foreign currency exchange rate change

     (2
  

 

 

 

Balance at end of period

     62   
  

 

 

 

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 15. COMMITMENTS AND CONTINGENCIES (CONTINUED)

 

The Company is also a party to various proceedings relating to the cleanup of hazardous waste sites under the Comprehensive Environmental Response Compensation and Liability Act, commonly known as “Superfund,” and similar state laws. The EPA and/or various state agencies have notified the Company that it may be a potentially responsible party with respect to other hazardous waste sites as to which no proceedings have been instituted against the Company. The Company continues to take remedial action under its Care and Control Program at its former wood preserving sites, and at a number of operating sites due to possible soil, sediment or groundwater contamination. The investigation and remediation process is lengthy and subject to the uncertainties of changes in legal requirements, technological developments and, if and when applicable, the allocation of liability among potentially responsible parties.

Climate change regulation

In response to the Kyoto Protocol, which calls for reductions of certain emissions that may contribute to increases in atmospheric greenhouse gas (“GHG”) concentrations, various international, national and local laws have been proposed or implemented focusing on reducing GHG emissions. These actual or proposed laws do or may apply in the jurisdictions where the Company currently has, or may have in the future, manufacturing facilities or investments.

In the United States, Congress has considered legislation to reduce emissions of GHGs. Although the legislation has not passed, it appears that the federal government will continue to consider methods to reduce GHG emissions from public utilities and certain other emitters. The U.S. Environmental Protection Agency (“EPA”) has adopted and implemented GHG permitting requirements for certain new sources and modifications of existing industrial facilities and has proposed GHG performance standards for newly constructed, reconstructed and modified electric utilities under the existing Clean Air Act. The EPA has also relied on the existing Clean Air Act to propose a “Clean Power Plan” that would establish emission guidelines for existing electric utilities and require states to develop plans for reducing GHG emissions by making significant changes to the energy resources utilized within the state. The EPA is also developing a biogenic carbon accounting framework to account for carbon dioxide emissions from biomass fuels for Clean Air Act permitting purposes. The EPA also references this framework in the proposals addressing GHG performance standards for the electric utilities. Furthermore, several states are already regulating GHG emissions from public utilities and certain other significant emitters, primarily through regional GHG cap-and-trade programs or renewable energy requirements.

The U.S. Supreme Court held on June 23, 2014 that the EPA had exceeded its statutory authority in establishing its GHG permitting program. Specifically, the Court determined that the EPA could not impose GHG permitting requirements on a source unless that source had already triggered permitting requirements for other non-GHG pollutants. However, for sources already subject to permitting, the Court held that the Clean Air Act did not preclude the EPA from requiring those sources to install “best available control technology” for GHGs.

Passage of GHG legislation by Congress or individual states, or the adoption of regulations by the EPA or analogous state agencies, that restrict emissions of GHGs in areas in which the Company conducts business could have a variety of impacts upon the Company, including requiring it to implement GHG reduction programs or to pay taxes or other fees with respect to its GHG emissions. This, in turn, will increase the Company’s operating costs and capital spending. The Company does not expect to be disproportionately affected by these measures compared with other pulp and paper producers in the United States.

The Government of Canada has committed to reducing greenhouse gases by 17 percent from 2005 levels by 2020. A sector by sector approach is being used to set performance standards to reduce greenhouse gases. On September 5, 2012 final regulations were published for the coal-fired electrical generators which are scheduled to become effective July 1, 2015. Performance standards for industrial sectors will also be developed. The pulp and paper sector is currently undergoing review. The Company does not expect the performance standards to be disproportionately affected by these future measures compared with other pulp and paper producers in Canada.

 

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DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 15. COMMITMENTS AND CONTINGENCIES (CONTINUED)

 

The province of Quebec initiated a GHG cap-and-trade system on January 1, 2012. Reduction targets for Quebec have been promulgated and were effective January 1, 2013. The Company does not expect the cost of compliance will have a material impact on the Company’s financial position, results of operations or cash flows. British Columbia imposed a carbon tax in 2008, which applies to the purchase of fossil fuels within the province. There are currently no other federal or provincial statutory or regulatory obligations that affect the emission of GHGs for the Company’s pulp and paper operations elsewhere in Canada. The Province of Ontario is reviewing a potential regulatory program for GHG emission reductions that may include a cap-and-trade component.

While it is likely that there will be increased regulation relating to GHG emissions in the future, at this time it is not possible to estimate either a timetable for the promulgation or implementation of any new regulations or the Company’s cost of compliance to said regulations. The impact could, however, be material.

Industrial Boiler Maximum Achievable Control Technology Standard (“MACT”)

On December 2, 2011, the EPA proposed a new set of standards related to emissions from boilers and process heaters included in some of the Company’s manufacturing processes. These standards are generally referred to as Boiler MACT and seek to require reductions in the emission of certain hazardous air pollutants or surrogates of hazardous air pollutants. The EPA announced the final rule on December 20, 2012 and it was subsequently published in the Federal Register on January 31, 2013 for major sources. The Company is developing plans to bring facilities affected by the Boiler MACT rule into compliance by the January 2016 regulatory deadline for major sources. The Company expects that the capital cost required to comply with the Boiler MACT rules is between $18 million and $25 million. As at September 30, 2014, the Company has spent $7 million for costs associated with Boiler MACT compliance. The Company is currently assessing the associated increase in operating costs as well as alternate compliance strategies.

The EPA has agreed to reconsider a limited number of issues in the most recent Boiler MACT rule, and elements of the EPA’s rule have been legally challenged. Since the consequences of these activities cannot be predicted, adjustments to compliance plans may be needed to accommodate any changes to the final rule.

CONTINGENCIES

In the normal course of operations, the Company becomes involved in various legal actions mostly related to contract disputes, patent infringements, environmental and product warranty claims, and labor issues.

Spanish Competition Investigation

Following preliminary inquiries commenced in January 2014, in September 2014, Spain’s National Commission of Markets and Competition initiated a formal investigation of several companies and their parent companies, including Indas (a subsidiary of the Company, acquired on January 2, 2014), and two of its affiliates, as well as an industry association, Federacion Espanola de Empresas de Tecnologia Sanitaria (FENIN), with respect to possible unlawful conduct, consisting of fixing prices, commercial terms and dispensation of heavy adult incontinence products in the Spanish market. The activities under investigation predate the acquisition of Indas by the Company. The sellers of Indas made representations and warranties to the Company in the purchase agreement regarding, among other things, Indas’ and its subsidiary’s compliance with competition laws. The liability retained by the sellers is backed by bank guarantees, and limited insurance coverage has been purchased with regard to excess liability. As a result, while the final outcome with respect to the investigation cannot be predicted with certainty, it is management’s opinion that its resolution will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 15. COMMITMENTS AND CONTINGENCIES (CONTINUED)

 

INDEMNIFICATIONS

In the normal course of business, the Company offers indemnifications relating to the sale of its businesses and real estate. In general, these indemnifications may relate to claims from past business operations, the failure to abide by covenants and the breach of representations and warranties included in the 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. At September 30, 2014, the Company is 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 a significant expense in the past.

Pension Plans

The Company has indemnified and held harmless the trustees of its 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 the Company or for failing to act in the absence of authorized instructions. These indemnifications survive the termination of such agreements. At September 30, 2014 the Company has not recorded a liability associated with these indemnifications, as it does not expect to make any payments pertaining to these indemnifications.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 16. SEGMENT DISCLOSURES

The Company operates in the two reportable segments described below. Each reportable segment offers different products and services and requires different manufacturing processes, technology and/or marketing strategies. The following summary briefly describes the operations included in each of the Company’s reportable segments:

 

   

Pulp and Paper Segment – comprises the design, manufacturing, marketing and distribution of communication, specialty and packaging papers, as well as softwood, fluff and hardwood market pulp.

 

   

Personal Care Segment – consists of the manufacturing, marketing and distribution of absorbent hygiene products.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 16. SEGMENT DISCLOSURES (CONTINUED)

 

An analysis and reconciliation of the Company’s reportable segment information to the respective information in the financial statements is as follows:

 

     For the three months ended     For the nine months ended  

SEGMENT DATA

   September 30,
2014
    September 30,
2013
    September 30,
2014
    September 30,
2013
 
     $     $     $     $  

Sales

        

Pulp and Paper

     1,186        1,204        3,514        3,650   

Personal Care

     231        175        698        394   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total for reportable segments

     1,417        1,379        4,212        4,044   

Intersegment sales – Pulp and Paper

     (12     (4     (28     (12
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated sales

     1,405        1,375        4,184        4,032   
  

 

 

   

 

 

   

 

 

   

 

 

 

Depreciation and amortization and impairment and write-down of property, plant and equipment

        

Pulp and Paper

     79        84        241        260   

Personal Care

     17        9        50        21   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total for reportable segments

     96        93        291        281   

Impairment and write-down of property, plant and equipment – Pulp and Paper

     —          —          —          15   
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated depreciation and amortization and impairment and write-down of property, plant and equipment

     96        93        291        296   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

        

Pulp and Paper

     109        42        247        96   

Personal Care

     13        11        42        34   

Corporate

     (2     (4     (11     (62
  

 

 

   

 

 

   

 

 

   

 

 

 

Consolidated operating income

     120        49        278        68   

Interest expense, net

     25        21        76        67   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes and equity loss

     95        28        202        1   

Income tax (benefit) expense

     (186     1        (158     (26

Equity loss, net of taxes

     —          —          —          1   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

     281        27        360        26   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

38


Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 17. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION

The following information is presented as required under Rule 3-10 of Regulation S-X, in connection with the Company’s issuance of debt securities that are fully and unconditionally guaranteed by Domtar Paper Company, LLC, a 100% owned subsidiary of the Company, Domtar Industries LLC (and subsidiaries, excluding Domtar Funding LLC), Ariva Distribution Inc., Domtar Delaware Investments Inc., Domtar Delaware Holdings, LLC, Domtar A.W. LLC (and subsidiary), Domtar AI Inc., Attends Healthcare Inc., and EAM Corporation, all 100% owned subsidiaries of the Company (“Guarantor Subsidiaries”), on a joint and several basis. The Guaranteed Debt will not be guaranteed by certain of Domtar’s own 100% owned subsidiaries; including Domtar Delaware Holdings Inc. and its foreign subsidiaries, including Attends Healthcare Limited, Domtar Inc. and Laboratorios Indas. S.A.U., (collectively the “Non-Guarantor Subsidiaries”). The subsidiary’s guarantee may be released in certain customary circumstances, such as if the subsidiary is sold or sells all of its assets, if the subsidiary’s guarantee of the Credit Agreement is terminated or released and if the requirements for legal defeasance to discharge the indenture have been satisfied.

The following supplemental condensed consolidating financial information sets forth, on an unconsolidated basis, the Balance Sheets at September 30, 2014 and December 31, 2013 and the Statements of Earnings and Comprehensive Income for the three and nine months ended September 30, 2014 and September 30, 2013 and Statements of Cash Flows for the nine months ended September 30, 2014 and September 30, 2013 for Domtar Corporation (the “Parent”), and on a combined basis for the Guarantor Subsidiaries and, on a combined basis, the Non-Guarantor Subsidiaries. The supplemental condensed consolidating financial information reflects the investments of the Parent in the Guarantor Subsidiaries, as well as the investments of the Guarantor Subsidiaries in the Non-Guarantor Subsidiaries, using the equity method.

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 17. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

 

     For the three months ended September 30, 2014  

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS AND
COMPREHENSIVE INCOME (LOSS)

   Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Consolidating
Adjustments
    Consolidated  
     $     $     $     $     $  

Sales

     —          1,125        560        (280     1,405   

Operating expenses

          

Cost of sales, excluding depreciation and amortization

     —          961        424        (280     1,105   

Depreciation and amortization

     —          67        29        —          96   

Selling, general and administrative

     5        49        45        —          99   

Closure and restructuring costs

     —          —          2        —          2   

Other operating loss (income), net

     1        (18     —          —          (17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     6        1,059        500        (280     1,285   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

     (6     66        60        —          120   

Interest expense (income), net

     25        7        (7     —          25   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) earnings before income taxes and equity loss

     (31     59        67        —          95   

Income tax (benefit) expense

     (9     (198     21        —          (186

Share in earnings of equity accounted investees

     303        46        —          (349     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

     281        303        46        (349     281   

Other comprehensive loss

     —          (11     (116     —          (127
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

     281        292        (70     (349     154   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

40


Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 17. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

 

     For the nine months ended September 30, 2014  

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS AND
COMPREHENSIVE INCOME (LOSS)

   Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Consolidating
Adjustments
    Consolidated  
     $     $     $     $     $  

Sales

     —          3,325        1,684        (825     4,184   

Operating expenses

          

Cost of sales, excluding depreciation and amortization

     —          2,810        1,331        (825     3,316   

Depreciation and amortization

     —          200        91        —          291   

Selling, general and administrative

     23        164        126        —          313   

Closure and restructuring costs

     —          1        2        —          3   

Other operating loss (income), net

     1        (17     (1     —          (17
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     24        3,158        1,549        (825)        3,906   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

     (24     167        135        —          278   

Interest expense (income), net

     75        19        (18     —          76   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) earnings before income taxes and equity loss

     (99     148        153        —          202   

Income tax (benefit) expense

     (26     (175     43        —          (158

Share in earnings of equity accounted investees

     433        110        —          (543     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

     360        433        110        (543     360   

Other comprehensive income (loss)

     1        (3     (124     —          (126
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

     361        430        (14     (543     234   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

41


Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 17. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

 

     For the three months ended September 30, 2013  

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS AND
COMPREHENSIVE INCOME

   Parent     Guarantor
Subsidiaries
     Non-
Guarantor
Subsidiaries
    Consolidating
Adjustments
    Consolidated  
     $     $      $     $     $  

Sales

     —          1,148         494        (267     1,375   

Operating expenses

           

Cost of sales, excluding depreciation and amortization

     —          968         415        (267     1,116   

Depreciation and amortization

     —          69         24        —          93   

Selling, general and administrative

     8        60         27        —          95   

Impairment and write-down of property, plant and equipment

     —          —           —          —          —     

Closure and restructuring costs

     —          —           —          —          —     

Other operating loss, net

     1        19         2        —          22   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 
     9        1,116         468        (267     1,326   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Operating (loss) income

     (9     32         26        —          49   

Interest expense (income), net

     23        5         (7     —          21   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

(Loss) earnings before income taxes and equity loss

     (32     27         33        —          28   

Income tax (benefit) expense

     (9     4         6        —          1   

Equity loss, net of taxes

     —          —           —          —          —     

Share in earnings of equity accounted investees

     50        27         —          (77     —     
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Net earnings

     27        50         27        (77     27   

Other comprehensive income

     2        11         42        —          55   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive income

     29        61         69        (77     82   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

 

NOTE 17. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

 

     For the nine months ended September 30, 2013  

CONDENSED CONSOLIDATING STATEMENT OF EARNINGS AND
COMPREHENSIVE INCOME

   Parent     Guarantor
Subsidiaries
    Non-
Guarantor
Subsidiaries
    Consolidating
Adjustments
    Consolidated  
     $     $     $     $