Domtar (UFS) 10-Q 2017 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2017

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 ofIncorporation)	(I.R.S. Employer Identification No.)

234 Kingsley Park Drive, Fort Mill, SC 29715

(Address of principal executive offices)

(zip code)

(803) 802-7500

(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  ☒    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  ☒    NO  ☐

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

Large accelerated filer	☒	Accelerated filer	☐
Non-accelerated filer	☐  (Do not check if a small reporting company)	Small reporting company	☐
Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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

At July 31, 2017, 62,654,157 shares of the issuer’s common stock were outstanding.

DOMTAR CORPORATION

FORM 10-Q

For the Quarterly Period Ended June 30, 2017

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	39
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	49
ITEM 4.	CONTROLS AND PROCEDURES	49
PART II	OTHER INFORMATION	49
ITEM 1.	LEGAL PROCEEDINGS	49
ITEM 1A.	RISK FACTORS	50
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	50
ITEM 3.	DEFAULT UPON SENIOR SECURITIES	50
ITEM 4.	MINE SAFETY DISCLOSURES	50
ITEM 5.	OTHER INFORMATION	50
ITEM 6.	EXHIBITS	51

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)

	Three months ended			Three months ended			Six months ended			Six months ended
	June 30,			June 30,			June 30,			June 30,
	2017			2016			2017			2016
	(Unaudited)
	$			$			$			$
Sales		1,224			1,267			2,528			2,554
Operating expenses
Cost of sales, excluding depreciation and amortization		968			1,013			2,043			2,063
Depreciation and amortization		79			87			159			176
Selling, general and administrative		111			104			219			207
Impairment of property, plant and    equipment (NOTE 11)		—			3			—			24
Closure and restructuring costs (NOTE 11)		—			21			—			23
Other operating loss, net (NOTE 6)		2			—			1			4
		1,160			1,228			2,422			2,497
Operating income		64			39			106			57
Interest expense, net		17			15			34			32
Earnings before income taxes		47			24			72			25
Income tax expense (NOTE 7)		9			6			14			3
Net earnings		38			18			58			22
Per common share (in dollars) (NOTE 4)
Net earnings
Basic		0.61			0.29			0.93			0.35
Diluted		0.61			0.29			0.93			0.35
Weighted average number of common  shares    outstanding (millions)
Basic		62.6			62.6			62.6			62.7
Diluted		62.7			62.7			62.7			62.8
Cash dividends per common share		0.415			0.40			0.83			0.80
Net earnings		38			18			58			22
Other comprehensive income (loss) (NOTE 12):
Net derivative gains (losses) on cash flow hedges:
Net gains arising during the period, net of tax of    $(2) and $(2), respectively (2016 – $(5)    and $(18), respectively)		2			9			2			29
Less: Reclassification adjustment for (gains) losses    included in net earnings, net of tax of nil and $2,    respectively (2016 – $(3) and $(8), respectively)		(1	)		5			(4	)		13
Foreign currency translation adjustments		67			(30	)		82			55
Change in unrecognized gains and prior service cost related to    pension and post-retirement benefit plans, net of tax of    $(1) and $(2), respectively (2016 – $(1) and $(2), respectively)		3			2			5			3
Other comprehensive income (loss)		71			(14	)		85			100
Comprehensive income		109			4			143			122

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

3

DOMTAR CORPORATION

CONSOLIDATED BALANCE SHEETS

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

	At
	June 30,			December 31,
	2017			2016
	(Unaudited)
	$			$
Assets
Current assets
Cash and cash equivalents		124			125
Receivables, less allowances of $7 and $7		613			613
Inventories (NOTE 8)		759			759
Prepaid expenses		41			40
Income and other taxes receivable		18			31
Total current assets		1,555			1,568
Property, plant and equipment, net		2,779			2,825
Goodwill (NOTE 9)		569			550
Intangible assets, net (NOTE 10)		625			608
Other assets		139			129
Total assets		5,667			5,680
Liabilities and shareholders' equity
Current liabilities
Bank indebtedness		—			12
Trade and other payables		627			656
Income and other taxes payable		28			22
Long-term debt due within one year		1			63
Total current liabilities		656			753
Long-term debt		1,203			1,218
Deferred income taxes and other		677			675
Other liabilities and deferred credits		361			358
Commitments and contingencies (NOTE 14)
Shareholders' equity (NOTE 13)
Common stock $0.01 par value; authorized 2,000,000,000 shares; issued:    65,001,104 and 65,001,104 shares		1			1
Treasury stock $0.01 par value; 2,346,947 and 2,412,267 shares		—			—
Additional paid-in capital		1,966			1,963
Retained earnings		1,217			1,211
Accumulated other comprehensive loss		(414	)		(499	)
Total shareholders' equity		2,770			2,676
Total liabilities and shareholders' equity		5,667			5,680

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

4

DOMTAR CORPORATION

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

	Issued and outstanding common shares (millions of shares)		Common stock, at par		Additional paid-in capital		Retained earnings			Accumulated other comprehensive loss			Total shareholders' equity
	(Unaudited)
			$		$		$			$			$
Balance at December 31, 2016		62.6		1		1,963		1,211			(499	)		2,676
Stock-based compensation, net of tax		0.1		—		3		—			—			3
Net earnings		—		—		—		58			—			58
Net derivative losses on cash flow hedges:
Net gains arising during the period, net of tax    of $(2)		—		—		—		—			2			2
Less: Reclassification adjustments for gains    included in net earnings, net of tax of $2		—		—		—		—			(4	)		(4	)
Foreign currency translation adjustments		—		—		—		—			82			82
Change in unrecognized gains and prior service cost    related to pension and post-retirement benefit    plans, net of tax of $(2)		—		—		—		—			5			5
Cash dividends declared		—		—		—		(52	)		—			(52	)
Balance at June 30, 2017		62.7		1		1,966		1,217			(414	)		2,770

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

5

DOMTAR CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN MILLIONS OF DOLLARS)

	For the six months ended
	June 30, 2017			June 30, 2016
	(Unaudited)
	$			$
Operating activities
Net earnings		58			22
Adjustments to reconcile net earnings to cash flows from operating activities
Depreciation and amortization		159			176
Deferred income taxes and tax uncertainties		(12	)		(5	)
Impairment of property, plant and equipment		—			24
Stock-based compensation expense		3			3
Other		—			(4	)
Changes in assets and liabilities, excluding the effect of acquisition of business
Receivables		11			25
Inventories		10			18
Prepaid expenses		(4	)		(13	)
Trade and other payables		(35	)		(8	)
Income and other taxes		21			(16	)
Difference between employer pension and other post-retirement    contributions and pension and other post-retirement expense		—			(3	)
Other assets and other liabilities		1			(4	)
Cash flows from operating activities		212			215
Investing activities
Additions to property, plant and equipment		(71	)		(219	)
Acquisition of business, net of cash acquired		—			(1	)
Cash flows used for investing activities		(71	)		(220	)
Financing activities
Dividend payments		(52	)		(50	)
Stock repurchase		—			(10	)
Net change in bank indebtedness		(12	)		1
Change in revolving credit facility		(30	)		(50	)
Proceeds from receivables securitization facility		25			120
Repayments of receivables securitization facility		(15	)		(20	)
Repayments of long-term debt		(63	)		(1	)
Other		(1	)		(1	)
Cash flows used for financing activities		(148	)		(11	)
Net decrease in cash and cash equivalents		(7	)		(16	)
Impact of foreign exchange on cash		6			1
Cash and cash equivalents at beginning of period		125			126
Cash and cash equivalents at end of period		124			111
Supplemental cash flow information
Net cash payments for:
Interest		31			32
Income taxes		15			27

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

6

INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1	BASIS OF PRESENTATION	8
NOTE 2	RECENT ACCOUNTING PRONOUNCEMENTS	9
NOTE 3	DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT	12
NOTE 4	EARNINGS PER COMMON SHARE	17
NOTE 5	PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS	18
NOTE 6	OTHER OPERATING LOSS, NET	19
NOTE 7	INCOME TAXES	20
NOTE 8	INVENTORIES	21
NOTE 9	GOODWILL	22
NOTE 10	INTANGIBLE ASSETS	23
NOTE 11	CLOSURE AND RESTRUCTURING COSTS AND LIABILITY AND IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT	24
NOTE 12	CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT	25
NOTE 13	SHAREHOLDERS’ EQUITY	27
NOTE 14	COMMITMENTS AND CONTINGENCIES	28
NOTE 15	SEGMENT DISCLOSURES	31
NOTE 16	SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION	32

7

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(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 six 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, 2016, as filed with the Securities and Exchange Commission. The December 31, 2016 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.

8

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 2.

_________________

RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING CHANGES IMPLEMENTED

INVENTORY

In July 2015, the FASB issued Accounting Standard Update (“ASU”) 2015-11, “Simplifying the Measurement of Inventory,” which simplifies the measurement of inventories valued under FIFO – first-in, first-out – and moving average methods. Under this new guidance, inventories valued under these methods would be valued at the lower of cost or net realizable value. Net realizable value is defined as the estimated selling prices less reasonable costs to sell the inventory. This ASU does not change the measurement principles for inventories valued under the LIFO – last-in, first-out – method.

The Company adopted the new guidance on January 1, 2017 with no impact on the consolidated financial statements.

SHARE-BASED PAYMENTS

In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. 

The Company adopted the new guidance on January 1, 2017 with no significant impact on the consolidated financial statements.

FUTURE ACCOUNTING CHANGES

REVENUE FROM CONTRACTS WITH CUSTOMERS

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers.” The core principal of this guidance 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. This new guidance will supersede the revenue recognition requirements found in topic 605.

ASU 2014-09 will be effective for annual reporting periods beginning after December 15, 2017 including interim periods within that reporting period. Early adoption is permitted only for annual and interim periods beginning after December 15, 2016.

Entities are permitted to adopt the new revenue standard by restating all prior periods under the full retrospective approach following ASC 250 “Accounting Changes and Error Corrections” or entities can elect to use a modified retrospective approach. Under the modified retrospective approach, entities will recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings in the period of initial application and comparative prior year periods would not be adjusted.

The Company is assessing the impact that the guidance will have on the consolidated financial statements and related disclosures. The Company currently expects to adopt the new revenue standards in its first quarter of 2018 utilizing the full retrospective transition method. Further, the Company expects to identify similar performance obligations under the new guidance as compared with deliverables previously identified. As a result, the Company expects the timing and amount of its revenue to remain substantially the same.

The Company does not expect this new guidance to have a material impact on the consolidated financial statements aside from the additional required disclosures related to revenue in the notes thereto.

.

9

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)

FINANCIAL INSTRUMENTS

In January 2016, the FASB issued ASU 2016-01, “Recognition and Measurement of Financial Assets and Financial Liabilities,” which amends the guidance on the classification and measurement of financial instruments. Although the ASU retains many current requirements, it significantly revises an entity’s accounting related to the classification and measurement of investments in equity securities and the presentation of certain fair value changes for financial liabilities measured at fair value. The ASU also amends certain disclosure requirements associated with the fair value of financial instruments.

The amendments in this update are effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2017. To adopt the amendments, companies will be required to make a cumulative-effect adjustment to beginning retained earnings as of the beginning of the fiscal year in which the guidance is effective. Early adoption is permitted.

The Company does not expect this new guidance to have a material impact on the consolidated financial statements.

LEASES

In February 2016, the FASB issued ASU 2016-02, “Leases,” which requires lessees to recognize a right-of-use asset and a lease liability for all of their leases with a lease term greater than 12 months while continuing to recognize expenses in the statement of earnings in a manner similar to current accounting standards. For lessors, the new standard modifies the classification criteria and the accounting for sales-type and direct financing leases.

As a lessee, Domtar’s various leases under existing guidance are classified as operating leases that are not recorded on the balance sheet but are recorded in the statement of earnings as expense is incurred. Upon adoption of the new guidance, the Company will be required to record substantially all leases on the Consolidated Balance Sheets as a right-of-use asset and a lease liability. The timing of expense recognition and classification in the Consolidated Statements of Earnings and Comprehensive Income could change based on the classification of leases as either operating or financing.

This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted as of the beginning of an interim or annual reporting period.

The Company will adopt the ASU on January 1, 2019 using the modified retrospective approach required by the guidance. The Company is currently evaluating the impact of this guidance on the consolidated financial statements, including analyzing all contracts that contain a lease.

DERIVATIVES AND HEDGING

In March 2016, the FASB issued ASU 2016-05, “Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships,” which clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument in an existing hedging relationship would not, in and of itself, be considered a termination of the derivative instrument or a change in a critical term of the hedging relationship. As long as all other hedge accounting criteria in ASC 815 are met, a hedging relationship in which the hedging derivative instrument is novated would not be discontinued or require redesignation. This clarification applies to both cash flow and fair value hedging relationships. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted as of the beginning of an interim or annual reporting period.

The Company does not expect this new guidance to have a material impact on the consolidated financial statements.

10

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 2 – RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)

CLASSIFICATION OF CASH FLOWS

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows,” which amends ASC 230 to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. The new guidance is intended to reduce diversity in practice in how certain transactions are classified in the statement of cash flows. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The guidance must be applied retrospectively to all periods presented but it may be applied prospectively if retrospective application would be impracticable. Early adoption is permitted.

The Company does not expect this new guidance to have a material impact on the consolidated financial statements.

GOODWILL IMPAIRMENT

In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment,” which removes the requirement for an entity to calculate the implied fair value of goodwill in measuring a goodwill impairment loss, referred to as the Step II test. As a result, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and should recognize an impairment charge for the amount for which the carrying value exceeds the reporting unit’s fair value. The impairment loss recognized should be recorded against goodwill and should not exceed the total amount of goodwill allocated to that reporting unit. This ASU is effective for annual or any interim goodwill impairment tests performed in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests with measurement dates after January 1, 2017.

The Company expects to adopt this new guidance concurrently with its 2017 annual goodwill impairment test.

RETIREMENT BENEFITS

In March 2017, the FASB issued ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,” which requires an entity to present the service cost component of the net periodic benefit cost with other employee compensation costs in operating income. Only the service cost components will be eligible for capitalization in assets. The other components of the net periodic benefit cost (i.e., interest expense, expected return on plan assets, amortization of actuarial gains or losses and amortization of prior year service costs) will be presented outside of any subtotal of operating income. An appropriate disclosure of the line(s) used to present other components of net periodic benefit costs is required if the components are not presented separately in the statement of earnings. This ASU is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted as of the beginning of an annual period for which financial statements have not been issued or made available for issuance.

The Company will adopt the ASU on January 1, 2018 using a retrospective approach for the presentation of the service cost component and the other components of net periodic benefit costs in the Consolidated Statement of Earnings and prospectively for the capitalization of the service cost component of net periodic benefit costs in assets. The guidance includes a practical expedient that permits an entity to estimate amounts for comparative periods using the information previously disclosed in its pension plans and other post-retirement benefit plans footnote.

While the Company is still evaluating the impact of adopting this new guidance, it does not expect this new guidance to have a material impact on the consolidated earnings.

11

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 3.

_________________

DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT

HEDGING PROGRAMS

The Company is exposed to market risk, such as changes in currency exchange rates, commodity prices, and interest rates. To the extent the Company decides to manage the volatility related to these exposures, the Company may enter into various financial derivatives that are accounted for under the derivatives and hedging guidance. These transactions are governed by the Company's hedging policies which provide direction on acceptable hedging activities, including instrument type and acceptable counterparty exposure.

Upon inception, the Company formally documents the relationship between hedging instruments and hedged items. At inception and quarterly thereafter, the Company formally assesses whether the financial instruments used in hedging transactions are effective at offsetting changes in either the cash flow or the fair value of the underlying exposures. The ineffective portion of the qualifying instrument is immediately recognized to earnings. The amount of ineffectiveness recognized was immaterial for all periods presented. The Company does not hold derivative financial instruments for trading purposes.

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 June 30, 2017, one of Domtar’s Pulp and Paper segment customers located in the U.S. represented 12% or $74 million (2016 – 12% or $74 million) of the Company’s receivables.

The Company is exposed to credit risk in the event of non-performance by counterparties to its financial instruments. The Company attempts to minimize 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.

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, revolving credit facility and long-term debt. The Company’s objective in managing exposure to interest rate changes is to minimize the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. The Company may manage this interest rate exposure through the use of derivative instruments such as interest rate swap contracts, whereby it agrees to exchange the difference between fixed and variable interest amounts calculated by reference to an agreed upon notional principal amount.

COST RISK

Cash flow hedges:

The Company is exposed to price volatility for raw materials and energy used in its manufacturing process. The Company manages its exposure to cost risk primarily through the use of supplier contracts. The Company purchases natural gas at the prevailing market price at the time of delivery. To reduce the impact on cash flow and earnings due to pricing volatility, the Company may utilize derivatives to fix the price of forecasted natural gas purchases. The changes in the fair value on qualifying instruments are included in Accumulated other comprehensive loss to the extent effective, and reclassified into Cost of sales in the period during which the hedged transaction affects earnings. Current contracts are used to hedge a portion of forecasted purchases over the next 60 months.

12

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 3. 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 June 30, 2017 to hedge forecasted purchases:

Commodity	Notional contractual quantity under derivative contracts MMBTU(3)		Notional contractual value under derivative contracts (in millions of dollars)			Percentage of forecasted purchases under derivative contracts
Natural Gas
2017 (1)		4,255,000		$	13		35%
2018		12,695,000		$	38		50%
2019		9,175,000		$	28		36%
2020		5,750,000		$	18		23%
2021		3,920,000		$	12		15%
2022 (2)		2,070,000		$	6		15%

⁽¹⁾ Represents the remaining six months of 2017

⁽²⁾ Represents the first six months of 2022

⁽³⁾ MMBTU: Millions of British thermal units

The natural gas derivative contracts were fully effective as of June 30, 2017. There were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three and six months ended June 30, 2017 resulting from hedge ineffectiveness (three and six months ended June 30, 2016 – nil).

FOREIGN CURRENCY RISK

Cash flow hedges:

The Company has manufacturing operations in the United States, Canada and Europe. 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. Accordingly, the Company’s earnings are affected by increases or decreases in the value of the Canadian dollar and the European currencies. The Company’s European subsidiaries are also exposed to movements in foreign currency exchange rates on transactions denominated in a currency other than their 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 financial instruments (currency options and foreign exchange forward contracts) to mitigate its exposure to fluctuations in foreign currency exchange rates.

Derivatives are used to hedge forecasted purchases in Canadian dollars by the Company’s Canadian subsidiary over the next 24 months and to hedge a portion of forecasted sales by its U.S. subsidiaries in British pounds over the next 6 months. Derivatives are also currently used to hedge a portion of forecasted sales in British pounds and Norwegian krone and a portion of forecasted purchases in U.S. dollars and Swedish krona by its European subsidiaries over the next 12 months. Such derivatives are designated as cash flow hedges. The changes in the fair value on qualifying instruments are included in Accumulated other comprehensive loss to the extent effective, and reclassified into Sales or Cost of sales in the period during which the hedged transaction affects earnings.

13

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

The following table presents the currency values under significant currency positions pursuant to currency derivatives outstanding as of June 30, 2017 to hedge forecasted purchases and sales:

Currency exposure hedged	Business Segment	Year of maturity	Notional contractual value	Percentage of forecasted net exposures under contracts		Average Protection rate	Average Obligation rate
		2017 (1)
CDN/USD	Pulp and Paper		254 CDN		66%	1 USD = 1.3200	1 USD = 1.3712
USD/Euro	Personal Care		27 USD		77%	1 Euro = 1.1345	1 Euro = 1.1345
		2018
CDN/USD	Pulp and Paper		374 CDN		48%	1 USD = 1.3026	1 USD = 1.3547
USD/Euro	Personal Care		26 USD		36%	1 Euro = 1.1218	1 Euro = 1.1218
		2019
CDN/USD	Pulp and Paper		101 CDN		13%	1 USD = 1.2897	1 USD = 1.3471

⁽¹⁾Represents the remaining six months of 2017 

The foreign exchange derivative contracts were fully effective as of June 30, 2017. There were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three and six months ended June 30, 2017 resulting from hedge ineffectiveness (three and six months ended June 30, 2016 – nil).

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.

14

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

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 (b) below) at June 30, 2017 and December 31, 2016, 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:	June 30, 2017		Quoted prices in active markets for identical assets (Level 1)		Significant observable inputs (Level 2)		Significant unobservable inputs (Level 3)			Balance sheet classification
	$		$		$		$
Derivatives designated as    hedging instruments:
Asset derivatives
Currency derivatives		13		—		13		—	(a)	Prepaid expenses
Natural gas swap contracts		3		—		3		—	(a)	Prepaid expenses
Currency derivatives		6		—		6		—	(a)	Other assets
Total Assets		22		—		22		—
Liabilities derivatives
Currency derivatives		3		—		3		—	(a)	Trade and other payables
Natural gas swap contracts		2		—		2		—	(a)	Trade and other payables
Currency derivatives		3		—		3		—	(a)	Otherliabilities and deferred credits
Natural gas swap contracts		4		—		4		—	(a)	Other liabilities and deferred credits
Total Liabilities		12		—		12		—
Other Instruments:
Stock-based compensation -    liability awards		2		2		—		—		Trade and other payables
Stock-based compensation -    liability awards		15		15		—		—		Other liabilities and deferred credits
Long-term debt		1,272		—		1,272		—	(b)	Long-term debt

The net cumulative loss recorded in Accumulated other comprehensive loss relating to natural gas contracts is $3 million at June 30, 2017, of which a gain of $1 million will be recognized in Cost of sales upon maturity of the derivatives over the next 12 months at the then prevailing values, which may be different from those at June 30, 2017.

The net cumulative gain recorded in Accumulated other comprehensive loss relating to currency options and forwards hedging forecasted purchases is $13 million at June 30, 2017, of which a gain of $10 million will be recognized in Cost of sales or Sales upon maturity of the derivatives over the next 12 months at the then prevailing values, which may be different from those at June 30, 2017.

15

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES AND FAIR VALUE MEASUREMENT (CONTINUED)

Fair Value of financial instruments at:	December 31, 2016		Quoted prices in active markets for identical assets (Level 1)		Significant observable inputs (Level 2)		Significant unobservable inputs (Level 3)			Balance sheet classification
	$		$		$		$
Derivatives designated as    hedging instruments:
Asset derivatives
Currency derivatives		18		—		18		—	(a)	Prepaid expenses
Natural gas swap contracts		6		—		6		—	(a)	Prepaid expenses
Currency derivatives		6		—		6		—	(a)	Other assets
Natural gas swap contracts		2		—		2		—	(a)	Other assets
Total Assets		32		—		32		—
Liabilities derivatives
Currency derivatives		10		—		10		—	(a)	Trade and other payables
Natural gas swap contracts		1		—		1		—	(a)	Trade and other payables
Currency derivatives		6		—		6		—	(a)	Other liabilities and deferred credits
Natural gas swap contracts		4		—		4		—	(a)	Other liabilities and deferred credits
Total Liabilities		21		—		21		—
Other Instruments:
Stock-based compensation -    liability awards		2		2		—		—		Trade and other payables
Stock-based compensation -    liability awards		17		17		—		—		Other liabilities and deferred credits
Long-term debt		1,313		—		1,313		—	(b)	Long-term debt

(a) Fair value of the Company’s derivatives are 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) Fair value of the Company’s long-term debt is measured by comparison to market prices of its debt. The Company’s long-term debt is not carried at fair value on the Consolidated Balance Sheets at June 30, 2017 and December 31, 2016. However, fair value disclosure is required. The carrying value of the Company’s long-term debt is $1,204 million and $1,281 million at June 30, 2017 and December 31, 2016, 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.

16

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE4.

_________________

EARNINGS PER COMMON SHARE

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

	For the three months ended				For the six months ended
	June 30,		June 30,		June 30,		June 30,
	2017		2016		2017		2016
Net earnings	$	38	$	18	$	58	$	22
Weighted average number of common shares    outstanding (millions)		62.6		62.6		62.6		62.7
Effect of dilutive securities (millions)		0.1		0.1		0.1		0.1
Weighted average number of diluted common shares    outstanding (millions)		62.7		62.7		62.7		62.8
Basic net earnings per common share (in dollars)	$	0.61	$	0.29	$	0.93	$	0.35
Dilutednetearningspercommonshare(indollars)	$	0.61	$	0.29	$	0.93	$	0.35

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 six months ended
	June 30,		June 30,		June 30,		June 30,
	2017		2016		2017		2016
Options		517,246		314,287		419,161		412,372

17

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 5.

_________________

PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS

DEFINED CONTRIBUTION PLANS

The Company has several defined contribution plans and multiemployer plans. The pension expense under these plans is equal to the Company’s contribution. For the three and six months ended June 30, 2017, the pension expense was $8 million and $19 million, respectively (2016 – $8 million and $18 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 January 1, 1998 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. Unionized and non-union hourly employees in the U.S. who 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 six months ended
	June 30, 2017					June 30, 2017
	Pension plans			Other post-retirement benefit plans		Pension plans			Other post-retirement benefit plans
	$			$		$			$
Service cost		7			1		15			1
Interest expense		13			1		25			2
Expected return on plan assets		(20	)		—		(40	)		—
Amortization of net actuarial loss		2			—		4			—
Amortization of prior year service costs		2			—		3			—
Net periodic benefit cost		4			2		7			3

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

	For the three months ended					For the six months ended
	June 30, 2016					June 30, 2016
	Pension plans			Other post-retirement benefit plans		Pension plans			Other post-retirement benefit plans
	$			$		$			$
Service cost		8			1		16			1
Interest expense		13			1		25			2
Expected return on plan assets		(20	)		—		(39	)		—
Amortization of net actuarial loss		1			—		2			—
Amortization of prior year service costs		1			—		2			—
Net periodic benefit cost		3			2		6			3

For the three and six months ended June 30, 2017, the Company contributed $3 million and $6 million, respectively (2016 – $5 million and $9 million, respectively) to the pension plans and $1 million and $2 million, respectively (2016 – $1 million and $2 million, respectively) to the other post-retirement benefit plans.

18

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 6.

_________________

OTHER OPERATING LOSS, NET

Other operating 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 loss, net includes the following:

	For the three months ended						For the six months ended
	June 30,			June 30,			June 30,			June 30,
	2017			2016			2017			2016
	$			$			$			$
Bad debt expense		1			—			1			—
Environmental provision		2			—			2			—
Litigation settlement		—			2			—			2
Foreign exchange loss		—			—			1			4
Other		(1	)		(2	)		(3	)		(2	)
Other operating loss, net		2			—			1			4

19

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 7.

_________________

INCOME TAXES

For the second quarter of 2017, the Company’s income tax expense was $9 million, consisting of a current income tax expense of $17 million and a deferred income tax benefit of $8 million. This compares to an income tax expense of $6 million in the second quarter of 2016, consisting of a current income tax expense of $8 million and a deferred income tax benefit of $2 million. The effective tax rate was 19% compared with an effective tax rate of 25% in the second quarter of 2016. The effective tax rate for the second quarter of 2017 was favorably impacted by enacted law changes in several U.S. states and by the recognition of additional tax credits associated with the filing of certain 2016 income tax returns.

For the first half of 2017, the Company’s income tax expense amounted to $14 million, consisting of a current income tax expense of $26 million and a deferred income tax benefit of $12 million. This compares to an income tax expense of $3 million in the first half of 2016, consisting of a current income tax expense of $8 million and a deferred income tax benefit of $5 million. The effective tax rate was 19% compared to an effective tax rate of 12% in the first half of 2016. The effective tax rate for the first half of 2017 was favorably impacted by the recognition of previously unrecognized tax benefits due to a statute expiration in a foreign jurisdiction and also a U.S. state tax audit finalization, enacted law changes in several U.S. states, and the recognition of additional tax credits associated with the filing of certain 2016 income tax returns. The effective tax rate for the first half of 2016 was impacted by the approval of a state tax credit in the U.S.

20

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 8.

_________________

INVENTORIES

The following table presents the components of inventories:

	June 30,		December 31,
	2017		2016
	$		$
Work in process and finished goods		405	413
Raw materials		135	132
Operating and maintenance supplies		219	214
		759	759

21

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 9.

_________________

GOODWILL

Changes in the carrying value of goodwill are as follows:

	June 30, 2017
	$
Balance at December 31, 2016		550
Effect of foreign currency exchange rate change		19
Balance at end of period		569

The goodwill at June 30, 2017 is entirely related to the Personal Care segment.

22

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 10.

_________________

INTANGIBLE ASSETS

The following table presents the components of intangible assets:

		June 30, 2017							December 31, 2016
	Estimated useful lives (in years)	Gross carrying amount		Accumulated amortization			Net		Gross carrying amount		Accumulated amortization			Net
		$		$			$		$		$			$
Definite-lived intangible    assets subject    to amortization
Water rights	40		3		(1	)		2		3		(1	)		2
Customer relationships	10 – 40		383		(70	)		313		369		(60	)		309
Technology	7 – 20		8		(3	)		5		8		(3	)		5
Non-Compete	9		1		(1	)		—		1		—			1
License rights	12		29		(10	)		19		28		(8	)		20
			424		(85	)		339		409		(72	)		337
Indefinite-lived intangible    assets not subject    to amortization
Water rights			4		—			4		4		—			4
Trade names			237		—			237		225		—			225
License rights			6		—			6		6		—			6
Catalog rights			39		—			39		36		—			36
Total			710		(85	)		625		680		(72	)		608

Amortization expense related to intangible assets for the three and six months ended June 30, 2017 was $5 million and $10 million, respectively (2016 – $4 million and $9 million, respectively).

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

	2017		2018		2019		2020		2021
	$		$		$		$		$
Amortization expense related to intangible assets		21		21		21		21		20

23

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 11.

_________________

CLOSURE AND RESTRUCTURING COSTS AND LIABILITY AND IMPAIRMENT OF PROPERTY, PLANT AND EQUIPMENT

Ashdown, Arkansas mill

On December 10, 2014, the Company announced a project to convert a paper machine at its Ashdown, Arkansas mill to a high quality fluff pulp line used in absorbent applications such as baby diapers, feminine hygiene and adult incontinence products. The Company also invested in a pulp bale line that will provide flexibility to manufacture papergrade softwood pulp, contingent on market conditions. The conversion work commenced during the second quarter of 2016 and the production of bale softwood pulp began in the third quarter of 2016. The fluff pulp line will allow for the production of up to 516,000 metric tons of fluff pulp per year once the machine is in full operation. The project resulted in the permanent reduction of 364,000 short tons of annual uncoated freesheet production capacity on March 31, 2016.

The Company recorded $3 million and $24 million for the three and six months ended June 30, 2016, respectively, of accelerated depreciation under Impairment of property, plant and equipment on the Consolidated Statement of Earnings and Comprehensive Income. The Company also recorded $21 million of costs related to the fluff pulp conversion outage under Closure and restructuring costs during the second quarter of 2016. During the first quarter of 2016, the Company recorded $1 million of severance and termination costs under Closure and restructuring costs.

Other costs

For the three and six months ended June 30, 2016, other costs related to previous and ongoing closures include nil and $1 million, respectively, of severance and termination costs related to Pulp and Paper.

24

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 12.

_________________

CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT

The following table presents the changes in Accumulated other comprehensive loss by component⁽¹⁾ for the six months ended June 30, 2017 and the year ended December 31, 2016:

	Netderivative (losses) gainson cashflow hedges			Pension items(2)			Post-retirement benefit items(2)			Foreign currency items			Total
	$			$			$			$			$
Balance at December 31, 2015		(30	)		(190	)		(10	)		(271	)		(501	)
Natural gas swap contracts		4		N/A			N/A			N/A				4
Net investment hedge		(1	)	N/A			N/A			N/A				(1	)
Currency options		8		N/A			N/A			N/A				8
Foreign exchange forward contracts		16		N/A			N/A			N/A				16
Net gain	N/A				(38	)		(1	)	N/A				(39	)
Foreign currency items	N/A			N/A			N/A				(7	)		(7	)
Other comprehensive income (loss)    before reclassifications		27			(38	)		(1	)		(7	)		(19	)
Amounts reclassified from Accumulated    other comprehensive loss		14			7			—			—			21
Net current period other comprehensive    income (loss)		41			(31	)		(1	)		(7	)		2
Balance at December 31, 2016		11			(221	)		(11	)		(278	)		(499	)
Natural gas swap contracts		(4	)	N/A			N/A			N/A				(4	)
Currency options		6		N/A			N/A			N/A				6
Foreign currency items	N/A			N/A			N/A				82			82
Other comprehensive income    before reclassifications		2			—			—			82			84
Amounts reclassified from Accumulated    other comprehensive loss		(4	)		5			—			—			1
Net current period other comprehensive    (loss) income		(2	)		5			—			82			85
Balance at June 30, 2017		9			(216	)		(11	)		(196	)		(414	)

⁽¹⁾ All amounts are after tax. Amounts in parenthesis indicate losses.

⁽²⁾ The accrued benefit obligation is actuarially determined on an annual basis as of December 31.

25

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 12. CHANGES IN ACCUMULATED OTHER COMPREHENSIVE LOSS BY COMPONENT (CONTINUED)

The following table presents reclassifications out of Accumulated other comprehensive loss:

Details about Accumulated other comprehensive loss components	Amounts reclassified from Accumulated other comprehensive loss(1)
	For the three months ended
	June 30, 2017			June 30, 2016
	$			$
Net derivative (losses) gains on cash flow hedge
Natural gas swap contracts		—			5		(2)
Currency options and forwards		(1	)		3		(2)
Total before tax		(1	)		8
Tax expense		—			(3	)
Net of tax		(1	)		5
Amortization of defined benefit pension items
Amortization of net actuarial loss and prior year    service cost		4			3		(3)
Tax expense		(1	)		(1	)
Net of tax		3			2

Details about Accumulated other comprehensive loss components	Amounts reclassified from Accumulated other comprehensive loss(1)
	For the six months ended
	June 30, 2017			June 30, 2016
	$			$
Net derivative (losses) gains on cash flow hedges
Natural gas swap contracts		(1	)		10		(2)
Currency options and forwards		(5	)		11		(2)
Total before tax		(6	)		21
Tax benefit (expense)		2			(8	)
Net of tax		(4	)		13
Amortization of defined benefit pension items
Amortization of net actuarial loss and prior year    service cost		7			5		(3)
Tax expense		(2	)		(2	)
Net of tax		5			3

⁽¹⁾ Amounts in parentheses indicate losses.

⁽²⁾ These amounts are included in Cost of Sales in the Consolidated Statements of Earnings and Comprehensive Income.

⁽³⁾ These amounts are included in the computation of net periodic benefit cost (see Note 5 “Pension Plans and Other Post-Retirement Benefit Plans” for more details).

26

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 13.

_________________

SHAREHOLDERS’ EQUITY

On February 21, 2017 and May 3, 2017, the Company’s Board of Directors approved a quarterly dividend of $0.415 per share, respectively, to be paid to holders of the Company’s common stock. Dividends of $26 million were paid on April 17, 2017 and July 17, 2017, respectively, to shareholders of record on April 3, 2017 and July 3, 2017, respectively.

On August 1, 2017, the Company’s Board of Directors approved a quarterly dividend of $0.415 per share to be paid to holders of the Company’s common stock. This dividend is to be paid on October 16, 2017, to shareholders of record on October 2, 2017.

STOCK REPURCHASE PROGRAM

The Company’s Board of Directors has authorized a stock repurchase program (the “Program”) of up to $1.3 billion. 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. 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 in part to reduce the dilutive effects of stock options and awards, and to improve shareholders’ returns.

The Company makes open market purchases of its common stock using general corporate funds. Additionally, the Company may enter 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 would require the Company to make up-front payments to the counterparty financial institutions, which would result 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 half of 2017, there were no shares repurchased under the Program.

During the first half of 2016, the Company repurchased 304,915 shares at an average price of $32.21 for a total cost of $10 million.

Since the inception of the Program, the Company has repurchased 24,853,827 shares at an average price of $39.33 for a total cost of $977 million. All shares repurchased are recorded as Treasury stock on the Consolidated Balance Sheets under the par value method at $0.01 per share.

27

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE14.

_________________

COMMITMENTS AND CONTINGENCIES

ENVIRONMENT

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

On February 16, 2010, the government of British Columbia issued a Remediation Order to Seaspan International Ltd. (“Seaspan”) and the Company, in order to define and implement a remediation plan to address soil, sediment and groundwater issues. Construction began in January 2017. The Company has previously recorded an environmental reserve to address its estimated exposure. The possible cost 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:

	June 30, 2017
	$
Balance at beginning of year		50
Additions		2
Environmental spending		(3	)
Effect of foreign currency exchange rate change		1
Balance at end of period		50

The U.S. Environmental Protection Agency (“EPA”) and/or various state agencies have notified the Company that it may be a potentially responsible party under the Comprehensive Environmental Response Compensation and Liability Act, commonly known as “Superfund,” and similar state laws 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.

Climate change regulation

Various national and local laws and regulations have been established or are emerging in jurisdictions where the Company currently has, or may have in the future, manufacturing facilities or investments. The Company does not expect to be disproportionately affected by these measures compared with other pulp and paper producers located in these jurisdictions.

The United States EPA Clean Power Plan regulation is being litigated and has been stayed. President Trump issued an Executive Order on March 28, 2017, directing his Administration to review and then suspend, revise, or rescind the Clean Power Plan, as appropriate and consistent with law. As a result, the EPA filed a motion with the D.C. Circuit to hold the case in abeyance while it reconsiders the rule, which the D.C. Circuit granted in part to allow time for additional briefing on how and whether the litigation should proceed. Regardless of the outcome of the litigation and/or the Executive Order, the Company does not expect to be disproportionately affected compared with other pulp and paper producers located in the states where the Company operates.

The Government of Canada is reviewing national policies to further reduce greenhouse gases (“GHG”) and has announced its intent to impose a cost on carbon emissions. The Company does not expect its facilities to be disproportionately affected by these measures compared with other pulp and paper producers in Canada.

28

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 14. COMMITMENTS AND CONTINGENCIES (CONTINUED)

The provinces of Quebec and Ontario have GHG cap-and-trade systems with reduction targets. British Columbia has a carbon tax that applies to the purchase of fossil fuels within the province. The Company does not expect to be disproportionately affected compared to the other pulp and paper producers located in these provinces.

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. While the final outcome with respect to actions outstanding or pending at June 30, 2017, cannot be predicted with certainty, it is management’s opinion that their resolution will not have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Spanish Competition Investigation

On October 15, 2015, the Competition Directorate of Spain’s National Commission of Markets and Competition (“CNMC”) filed a Statement of Objections against a number of industry participants alleging the existence of a series of agreements between manufacturers, distributors and pharmacists to fix prices and to allocate margins for heavy adult incontinence products within the pharmacy channelin Spain during the period from December 1996 through January 2014. Among the parties named in the Statement of Objections was Indas, which the Company acquired in January 2014, and two of its affiliates.

On January 4, 2016, the Competition Directorate issued a proposed decision confirming the allegations of the Statement of Objections. The proposed decision recommended the imposition of fines on the parties without recommending the amount of any fines. The Company recorded a €0.2 million ($0.2 million) provision in the fourth quarter of 2015 in Other operating loss, net.

On May 26, 2016, the CNMC rendered its final decision, which declared that a number of manufacturers of adult heavy incontinence products, the sector association and certain individuals participated in price fixing during the period from December 1996 through January 2014. Indas and one of its subsidiaries were fined a total of €13.5 million ($14.9 million) for their participation. A provision was recorded in the second quarter of 2016 in the amount of €13.3 million ($14.7 million) in Other operating loss, net.

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 was backed by a retained purchase price of €3 million ($3.3 million) and bank guarantees of €9 million ($9.9 million).

On June 27, 2016, in light of the CNMC decision, the sellers, in terms of their indemnity obligations, agreed to the appropriation by the Company of the retained purchase price and the release of the bank guarantees. Accordingly, a recovery of €12 million ($13.2 million) was recorded in the second quarter of 2016  and included in Other operating loss, net.

In July 2016, the fines were paid and Indas and two of its affiliates named in the final decision appealed the decision to the Spanish courts.

The Company purchased limited insurance coverage with respect to the purchase agreement, and is seeking to recover the remaining €1.5 million ($1.7 million) under the insurance policy. Any recovery from the insurers would be recorded in the period when the proceeds are received.

29

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 14. 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 June 30, 2017, 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 June 30, 2017, the Company has not recorded a liability associated with these indemnifications, as it does not expect to make any payments pertaining to these indemnifications.

30

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 15.

_________________

SEGMENT DISCLOSURES

The Company’s two reportable segments described below also represent its two operating segments. 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 – consists of the design, manufacturing, marketing and distribution of communication, specialty and packaging papers, as well as softwood, fluff and hardwood market pulp.

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

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

	For the three months ended						For the six months ended
	June 30,			June 30,			June 30,			June 30,
SEGMENT DATA	2017			2016			2017			2016
	$			$			$			$
Sales by segment
Pulp and Paper		999			1,054			2,072			2,139
Personal Care		241			228			490			444
Total for reportable segments		1,240			1,282			2,562			2,583
Intersegment sales		(16	)		(15	)		(34	)		(29	)
Consolidated sales		1,224			1,267			2,528			2,554
Sales by product group
Paper		734			816			1,520			1,660
Market pulp		249			223			518			450
Absorbent hygiene products		241			228			490			444
Consolidated sales		1,224			1,267			2,528			2,554
Depreciation and amortization    of property, plant and equipment
Pulp and Paper		63			72			127			145
Personal Care		16			15			32			31
Total for reportable segments		79			87			159			176
Impairment of property, plant and    equipment - Pulp and Paper		—			3			—			24
Consolidated depreciation and amortization and impairment    of property, plant and equipment		79			90			159			200
Operating income (loss)
Pulp and Paper		65			35			99			54
Personal Care		13			15			29			29
Corporate		(14	)		(11	)		(22	)		(26	)
Consolidated operating income		64			39			106			57
Interest expense, net		17			15			34			32
Earnings before income taxes		47			24			72			25
Income tax expense		9			6			14			3
Net earnings		38			18			58			22

31

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16.

_________________

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), Domtar A.W. LLC, Attends Healthcare Products Inc., EAM Corporation, Associated Hygienic Products LLC and Home Delivery Incontinent Supplies Co., all 100% owned subsidiaries of the Company (“Guarantor Subsidiaries”), on a joint and several basis. Pursuant to the amendment and restatement of the 2016 Credit Agreement on August 18, 2016, the Guaranteed Debt will not be guaranteed by certain of Domtar’s 100% owned subsidiaries; including Domtar Delaware Holdings Inc. and its foreign subsidiaries, including Attends Healthcare Limited, Domtar Inc. and Laboratorios Indas. S.A.U.. Also excluded are Ariva Distribution Inc., Domtar Delaware Investments Inc., Domtar Delaware Holdings LLC, Domtar AI Inc., Domtar Personal Care Absorbent Hygiene Inc., Domtar Wisconsin Dam Corp. and Palmetto Enterprises LLC, (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 June 30, 2017 and December 31, 2016, the Statements of Earnings and Comprehensive Income for the three and six months ended June 30, 2017 and 2016 and the Statements of Cash Flows for the six months ended June 30, 2017 and 2016 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.

	For the three months ended
	June 30, 2017
						Non-
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS				Guarantor		Guarantor			Consolidating
AND COMPREHENSIVE INCOME	Parent			Subsidiaries		Subsidiaries			Adjustments			Consolidated
	$			$		$			$			$
Sales		—			1,011		499			(286	)		1,224
Operating expenses
Cost of sales, excluding depreciation and amortization		—			878		376			(286	)		968
Depreciation and amortization		—			58		21			—			79
Selling, general and administrative		2			31		78			—			111
Other operating loss, net		—			—		2			—			2
		2			967		477			(286	)		1,160
Operating (loss) income		(2	)		44		22			—			64
Interest expense (income), net		16			22		(21	)		—			17
(Loss) earnings before income taxes		(18	)		22		43			—			47
Income tax (benefit) expense		(5	)		3		11			—			9
Share in earnings of equity accounted investees		51			32		—			(83	)		—
Net earnings		38			51		32			(83	)		38
Other comprehensive income		71			76		69			(145	)		71
Comprehensive income		109			127		101			(228	)		109

32

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	For the six months ended
	June 30, 2017
							Non-
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS				Guarantor			Guarantor			Consolidating
AND COMPREHENSIVE INCOME	Parent			Subsidiaries			Subsidiaries			Adjustments			Consolidated
	$			$			$			$			$
Sales		—			2,097			1,015			(584	)		2,528
Operating expenses
Cost of sales, excluding depreciation and amortization		—			1,848			779			(584	)		2,043
Depreciation and amortization		—			117			42			—			159
Selling, general and administrative		4			64			151			—			219
Other operating (income) loss, net		—			(2	)		3			—			1
		4			2,027			975			(584	)		2,422
Operating (loss) income		(4	)		70			40			—			106
Interest expense (income), net		33			42			(41	)		—			34
(Loss) earnings before income taxes		(37	)		28			81			—			72
Income tax (benefit) expense		(9	)		5			18			—			14
Share in earnings of equity accounted investees		86			63			—			(149	)		—
Net earnings		58			86			63			(149	)		58
Other comprehensive income		85			94			85			(179	)		85
Comprehensive income		143			180			148			(328	)		143

	For the three months ended
	June 30, 2016
							Non-
CONDENSED CONSOLIDATING STATEMENT OF				Guarantor			Guarantor			Consolidating
EARNINGS (LOSS) AND COMPREHENSIVE INCOME (LOSS)	Parent			Subsidiaries			Subsidiaries			Adjustments			Consolidated
	$			$			$			$			$
Sales		—			1,040			498			(271	)		1,267
Operating expenses
Cost of sales, excluding depreciation and amortization		—			874			410			(271	)		1,013
Depreciation and amortization		—			63			24			—			87
Selling, general and administrative		2			25			77			—			104
Impairment of property, plant and equipment		—			3			—			—			3
Closure and restructuring costs		—			21			—			—			21
Other operating loss (income), net		1			(1	)		—			—			—
		3			985			511			(271	)		1,228
Operating (loss) income		(3	)		55			(13	)		—			39
Interest expense (income), net		16			7			(8	)		—			15
(Loss) earnings before income taxes		(19	)		48			(5	)		—			24
Income tax (benefit) expense		(5	)		12			(1	)		—			6
Share in earnings of equity accounted investees		32			(4	)		—			(28	)		—
Net earnings (loss)		18			32			(4	)		(28	)		18
Other comprehensive loss		(14	)		(25	)		(29	)		54			(14	)
Comprehensive income (loss)		4			7			(33	)		26			4

33

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	For the six months ended
	June 30, 2016
							Non-
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS				Guarantor			Guarantor			Consolidating
AND COMPREHENSIVE INCOME	Parent			Subsidiaries			Subsidiaries			Adjustments			Consolidated
	$			$			$			$			$
Sales		—			2,106			1,019			(571	)		2,554
Operating expenses
Cost of sales, excluding depreciation and amortization		—			1,846			788			(571	)		2,063
Depreciation and amortization		—			128			48			—			176
Selling, general and administrative		10			52			145			—			207
Impairment of property, plant and equipment		—			24			—			—			24
Closure and restructuring costs		—			23			—			—			23
Other operating loss (income), net		1			(1	)		4			—			4
		11			2,072			985			(571	)		2,497
Operating (loss) income		(11	)		34			34			—			57
Interest expense (income), net		32			16			(16	)		—			32
(Loss) earnings before income taxes		(43	)		18			50			—			25
Income tax (benefit) expense		(10	)		4			9			—			3
Share in earnings of equity accounted investees		55			41			—			(96	)		—
Net earnings		22			55			41			(96	)		22
Other comprehensive income		100			90			56			(146	)		100
Comprehensive income		122			145			97			(242	)		122

34

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	June 30, 2017
					Non-
			Guarantor		Guarantor		Consolidating
CONDENSED CONSOLIDATING BALANCE SHEET	Parent		Subsidiaries		Subsidiaries		Adjustments			Consolidated
	$		$		$		$			$
Assets
Current assets
Cash and cash equivalents		1		8		115		—			124
Receivables		—		280		333		—			613
Inventories		—		521		238		—			759
Prepaid expenses		9		20		12		—			41
Income and other taxes receivable		—		10		14		(6	)		18
Intercompany accounts		281		289		42		(612	)		—
Total current assets		291		1,128		754		(618	)		1,555
Property, plant and equipment, net		—		1,920		859		—			2,779
Goodwill		—		313		256		—			569
Intangible assets, net		—		273		352		—			625
Investments in affiliates		4,156		2,798		—		(6,954	)		—
Intercompany long-term advances		6		81		1,444		(1,531	)		—
Other assets		36		—		126		(23	)		139
Total assets		4,489		6,513		3,791		(9,126	)		5,667
Liabilities and shareholders' equity
Current liabilities
Trade and other payables		48		350		229		—			627
Intercompany accounts		235		55		322		(612	)		—
Income and other taxes payable		17		—		17		(6	)		28
Long-term debt due within one year		—		—		1		—			1
Total current liabilities		300		405		569		(618	)		656
Long-term debt		812		298		93		—			1,203
Intercompany long-term loans		588		942		1		(1,531	)		—
Deferred income taxes and other		—		540		160		(23	)		677
Other liabilities and deferred credits		19		172		170		—			361
Shareholders' equity		2,770		4,156		2,798		(6,954	)		2,770
Total liabilities and shareholders' equity		4,489		6,513		3,791		(9,126	)		5,667

35

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	December 31, 2016
					Non-
			Guarantor		Guarantor		Consolidating
CONDENSED CONSOLIDATING BALANCE SHEET	Parent		Subsidiaries		Subsidiaries		Adjustments			Consolidated
	$		$		$		$			$
Assets
Current assets
Cash and cash equivalents		17		14		94		—			125
Receivables		—		305		308		—			613
Inventories		—		548		211		—			759
Prepaid expenses		15		19		6		—			40
Income and other taxes receivable		—		16		15		—			31
Intercompany accounts		331		184		47		(562	)		—
Total current assets		363		1,086		681		(562	)		1,568
Property, plant and equipment, net		—		2,000		825		—			2,825
Goodwill		—		313		237		—			550
Intangible assets, net		—		279		329		—			608
Investments in affiliates		3,976		2,678		—		(6,654	)		—
Intercompany long-term advances		6		80		1,411		(1,497	)		—
Other assets		15		18		103		(7	)		129
Total assets		4,360		6,454		3,586		(8,720	)		5,680
Liabilities and shareholders' equity
Current liabilities
Bank indebtedness		—		12		—		—			12
Trade and other payables		48		391		217		—			656
Intercompany accounts		136		115		311		(562	)		—
Income and other taxes payable		16		—		6		—			22
Long-term debt due within one year		63		—		—		—			63
Total current liabilities		263		518		534		(562	)		753
Long-term debt		841		299		78		—			1,218
Intercompany long-term loans		560		937		—		(1,497	)		—
Deferred income taxes and other		—		556		126		(7	)		675
Other liabilities and deferred credits		20		168		170		—			358
Shareholders' equity		2,676		3,976		2,678		(6,654	)		2,676
Total liabilities and shareholders' equity		4,360		6,454		3,586		(8,720	)		5,680

36

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	For the six months ended
	June 30, 2017
CONDENSED CONSOLIDATING STATEMENT OF    CASH FLOWS	Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated
	$			$			$			$			$
Operating activities
Net earnings		58			86			63			(149	)		58
Changes in operating and intercompany assets and    liabilities and non-cash items, included in net earnings		77			(107	)		35			149			154
Cash flows provided from (used for) operating activities		135			(21	)		98			—			212
Investing activities
Additions to property, plant and equipment		—			(39	)		(32	)		—			(71	)
Cash flows used for investing activities		—			(39	)		(32	)		—			(71	)
Financing activities
Dividend payments		(52	)		—			—			—			(52	)
Net change in bank indebtedness		—			(12	)		—			—			(12	)
Change in revolving credit facility		(30	)		—			—			—			(30	)
Proceeds from receivables securitization facility		—			—			25			—			25
Repayments of receivables securitization facility		—			—			(15	)		—			(15	)
Repayments of long-term debt		(63	)		—			—			—			(63	)
Increase in long-term advances to related parties		(5	)		—			(61	)		66			—
Decrease in long-term advances to related parties		—			66			—			(66	)		—
Other		(1	)		—			—			—			(1	)
Cash flows (used for) provided from financing activities		(151	)		54			(51	)		—			(148	)
Net (decrease) increase in cash and cash equivalents		(16	)		(6	)		15			—			(7	)
Impact of foreign exchange on cash		—			—			6			—			6
Cash and cash equivalents at beginning of period		17			14			94			—			125
Cash and cash equivalents at end of period		1			8			115			—			124

37

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2017

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 16. SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION (CONTINUED)

	For the six months ended
	June 30, 2016
CONDENSED CONSOLIDATING STATEMENT OF    CASH FLOWS	Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Consolidating Adjustments			Consolidated
	$			$			$			$			$
Operating activities
Net earnings		22			55			41			(96	)		22
Changes in operating and intercompany assets and    liabilities and non-cash items, included in net earnings		24			108			(35	)		96			193
Cash flows from operating activities		46			163			6			—			215
Investing activities
Additions to property, plant and equipment		—			(184	)		(35	)		—			(219	)
Acquisition of business, net of cash acquired		—			(1	)		—			—			(1	)
Cash flows used for investing activities		—			(185	)		(35	)		—			(220	)
Financing activities
Dividend payments		(50	)		—			—			—			(50	)
Stock repurchase		(10	)		—			—			—			(10	)
Net change in bank indebtedness		—			1			—			—			1
Change in revolving credit facility		(50	)		—			—			—			(50	)
Proceeds from receivables securitization facility		—			—			120			—			120
Repayments of receivables securitization facility		—			—			(20	)		—			(20	)
Repayments of long-term debt		—			(1	)		—			—			(1	)
Increase in long-term advances to related parties		—			—			(60	)		60			—
Decrease in long-term advances to related parties		34			26			—			(60	)		—
Other		(1	)		—			—			—			(1	)
Cash flows (used for) provided from financing    activities		(77	)		26			40			—			(11	)
Net (decrease) increase in cash and cash equivalents		(31	)		4			11			—			(16	)
Impact of foreign exchange on cash		—			—			1			—			1
Cash and cash equivalents at beginning of period		49			2			75			—			126
Cash and cash equivalents at end of period		18			6			87			—			111

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations should be read in conjunction with Domtar Corporation’s unaudited interim financial statements and notes thereto included in the Quarterly Report on Form 10-Q. The MD&A should also be read in conjunction with the historical financial information contained in our Annual Report on Form 10-K for the year ended December 31, 2016, filed with the Securities and Exchange Commission (“SEC”) on February 24, 2017. Throughout this MD&A, unless otherwise specified, “Domtar Corporation,” “the Company,” “Domtar,” ���we,” “us” and “our” refers to Domtar Corporation and its subsidiaries. Domtar Corporation’s common stock is listed on the New York Stock Exchange and the Toronto Stock Exchange. Except where otherwise indicated, all financial information reflected herein is determined on the basis of accounting principles generally accepted in the United States.

The information contained on our website, www.domtar.com, is not incorporated by reference into this Form 10-Q and should in no way be construed as a part of this or any other report that we file with or furnish to the SEC.

In accordance with industry practice, in this report, the term “ton” or the symbol “ST” refers to a short ton, an imperial unit of measurement equal to 0.9072 metric tons. The term “metric ton” or the symbol “ADMT” refers to an air dry metric ton. In this report, unless otherwise indicated, all dollar amounts are expressed in U.S. dollars, and the term “dollars” and the symbol “$” refer to U.S. dollars. In the following discussion, unless otherwise noted, references to increases or decreases in income and expense items, prices, contribution to net earnings (loss), and shipment volumes are based on three and six months ended June 30, 2017 and 2016. The three month and six month periods are also referred to as the second quarter and first half of 2017 and 2016. Reference to notes refers to footnotes to the consolidated financial statements and notes thereto included in Item 1 of this Form 10-Q.

This MD&A of financial condition and results of operations is intended to provide investors with an understanding of our recent performance, financial condition and outlook. Topics discussed and analyzed include:

• Overview

• Highlights for the three month and six month periods ended June 30, 2017

• Outlook

• Consolidated Results of Operations and Segment Review

• Liquidity and Capital Resources

OVERVIEW

We design, manufacture, market and distribute a wide variety of fiber-based products, including communication papers, specialty and packaging papers, and absorbent hygiene products. The foundation of our business is a network of wood fiber converting assets that produce paper grade, fluff and specialty pulp. More than 50% of our pulp production is consumed internally to manufacture paper and other consumer products with the balance sold as market pulp. We are the largest integrated marketer of uncoated freesheet paper in North America serving a variety of customers, including merchants, retail outlets, stationers, printers, publishers, converters and end-users. We are also a marketer and producer of a broad line of incontinence care products as well as infant diapers. To learn more, visit www.domtar.com.

We have two reportable segments as described below, which also represent our two operating segments. 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 our reportable segments.

Pulp and Paper: Our Pulp and Paper segment consists of the design, manufacturing, marketing and distribution of communication, specialty and packaging papers, as well as softwood, fluff and hardwood market pulp.

Personal Care: Our Personal Care segment consists of the design, manufacturing, marketing and distribution of absorbent hygiene products.

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HIGHLIGHTS FOR THE THREE MONTH PERIOD ENDED JUNE 30, 2017

• Operating income and net earnings increased by 64% and 111%, respectively, from the second quarter of 2016

• Sales decreased by 3% from the second quarter of 2016. Net average selling prices for paper were down from the second quarter of 2016 while net average selling prices for pulp were up. Our manufactured paper volumes were down while our pulp volumes were up when compared to the second quarter of 2016.

• We paid $26 million in dividends

HIGHLIGHTS FOR THE SIX MONTH PERIOD ENDED JUNE 30, 2017  

• Operating income and net earnings increased by 86% and 164%, respectively, from the first half of 2016

• Sales decreased by 1% from the first half of 2016. Net average selling prices for paper were down from the first half of 2016 while net average selling prices for pulp were flat. Our manufactured paper volumes were down while our pulp volumes were up when compared to the first half of 2016. Our Personal Care volumes were up, in part due to the acquisition of Home Delivery Incontinent Supplies (“HDIS”) on October 1, 2016

• A mechanical failure on the largest turbine generator at our Kamloops mill in the first quarter of 2017 negatively impacted our results by approximately $3 million, net of insurance proceeds, in the first half of 2017

• We paid $52 million in dividends

	Three months ended										Six months ended
					Variance										Variance
FINANCIAL HIGHLIGHTS	June 30, 2017		June 30, 2016		$			%			June 30, 2017		June 30, 2016		$			%
(In millions of dollars, unless otherwise noted)
Sales	$	1,224	$	1,267	$	(43	)		-3	%	$	2,528	$	2,554	$	(26	)		-1	%
Operating income		64		39		25			64	%		106		57		49			86	%
Net earnings		38		18		20			111	%		58		22		36			164	%
Net earnings per common share    (in dollars)1:
Basic	$	0.61	$	0.29	$	0.32			110	%	$	0.93	$	0.35	$	0.58			166	%
Diluted	$	0.61	$	0.29	$	0.32			110	%	$	0.93	$	0.35	$	0.58			166	%
															At June 30, 2017			At December 31, 2016
Total assets															$	5,667		$	5,680
Total long-term debt, including current    portion															$	1,204		$	1,281

¹ See Note 4 “Earnings per Common Share” of the financial statements in this Quarterly Report on Form 10-Q for more information on the calculation of net earnings per common share.

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OUTLOOK

For the remainder of the year, we expect our paper shipments to be in-line with market demand. Our pulp shipments should be higher due to the ramp-up of the Ashdown fluff pulp line, while mix should continue to improve as we convert more volume to fluff pulp. In Personal Care, investments in advertising and promotion in addition to new customer wins should drive higher sales, while raw material costs are expected to increase marginally.

CONSOLIDATED RESULTS OF OPERATIONS AND SEGMENT REVIEW

This section presents a discussion and analysis of our second quarter and first half of 2017 and 2016 sales, operating income (loss) and other information relevant to the understanding of our results of operations.

ANALYSIS OF SALES
By Business Segment	Three months ended											Six months ended
							Variance											Variance
	June 30, 2017			June 30, 2016			$			%		June 30, 2017			June 30, 2016			$			%
Pulp and Paper	$	999		$	1,054			(55	)		-5%	$	2,072		$	2,139			(67	)		-3%
Personal Care		241			228			13			6%		490			444			46			10%
Total for reportable segments		1,240			1,282			(42	)		-3%		2,562			2,583			(21	)		-1%
Intersegment sales		(16	)		(15	)		(1	)				(34	)		(29	)		(5	)
Consolidated		1,224			1,267			(43	)		-3%		2,528			2,554			(26	)		-1%
Shipments
Paper - manufactured (in thousands of ST)		698			752			(54	)		-7%		1,443			1,538			(95	)		-6%
Communication Papers		582			627			(45	)		-7%		1,204			1,284			(80	)		-6%
Specialty and Packaging		116			125			(9	)		-7%		239			254			(15	)		-6%
Paper - sourced from third parties (in thousands of ST)		26			29			(3	)		-10%		55			61			(6	)		-10%
Paper - total (in thousands of ST)		724			781			(57	)		-7%		1,498			1,599			(101	)		-6%
Pulp (in thousands of ADMT)		383			360			23			6%		836			729			107			15%

ANALYSIS OF CHANGES IN SALES
	Second quarter of 2017 versus Second quarter of 2016													First half of 2017 versus First half of 2016
	% Change in Sales due to													% Change in Sales due to
	Net Price			Volume / Mix				Currency			Total			Net Price			Volume / Mix				Currency			Total
Pulp and Paper		-1	%		-4	%			-	%		-5	%		-1	%		-2	%			-	%		-3	%
Personal Care		-1	%		9	%	(a)		-2	%		6	%		-2	%		14	%	(a)		-2	%		10	%
Consolidated sales		-1	%		-2	%			-	%		-3	%		-2	%		1	%			-	%		-1	%

Commentary:

(a) Includes sales of HDIS acquired on October 1, 2016.

ANALYSIS OF OPERATING INCOME (LOSS)
	Three months ended												Six months ended
By Business Segment							Variance												Variance
	June 30, 2017			June 30, 2016			$			%			June 30, 2017			June 30, 2016			$		%
Operating income (loss)
Pulp and Paper		65			35			30			86	%		99			54			45		83	%
Personal Care		13			15			(2	)		-13	%		29			29			-		-	%
Corporate		(14	)		(11	)		(3	)		-27	%		(22	)		(26	)		4		15	%
Consolidated operating income (loss)		64			39			25			64	%		106			57			49		86	%

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Second quarter of 2017 versus Second quarter of 2016
	$ Change in Segmented Operating Income (Loss) due to
	Volume/Mix				Net Price			Input Costs (b)		Operating Expenses  (c)			Currency		Depreciation/ Impairment(d)		Restructuring (e)		Other Operating Income/ Expense(f)			Total
Pulp and Paper		(10	)			(10	)		8		—			11		11		21		(1	)		30
Personal Care		2		(a)		(4	)		2		(2	)		—		—		—		—			(2	)
Corporate		—				—			—		(2	)		—		—		—		(1	)		(3	)
Consolidated operating income (loss)		(8	)			(14	)		10		(4	)		11		11		21		(2	)		25

(a) Includes results of HDIS acquired on October 1, 2016.

(b) Includes raw materials (such as fiber, chemicals, nonwovens and super absorbent polymers) and energy expenses.

(c) Includes maintenance, freight costs, selling, general and administrative (“SG&A”) expenses and other costs.

(d) In the second quarter of 2017, we did not record any accelerated depreciation compared to $3 million of accelerated depreciation related to the conversion of a paper machine to a high quality fluff pulp line at our Ashdown mill, in the second quarter of 2016. Depreciation charges were lower by $8 million in the second quarter of 2017, excluding foreign currency impact.

(e) In the second quarter of 2017, there were no restructuring charges. In the second quarter of 2016, we incurred restructuring charges of $21 million related to the conversion at Ashdown described above.

(f)

Second quarter of 2017 other operating income/ expense includes:	Second quarter of 2016 other operating income/ expense includes:
- Environmental provision ($2 million) - Bad debt expense ($1 million) - Other income ($1 million)	- Litigation settlement ($2 million) - Other income ($2 million)

Commentary – Second quarter of 2017 compared to Second quarter of 2016

Interest Expense, net

We incurred $17 million of net interest expense in the second quarter of 2017, an increase of $2 million compared to net interest expense of $15 million in the second quarter of 2016. This increase was mostly due to a reduction in capitalized interest and an increase in interest expense related to the Term Loan Agreement and was partially offset by the maturity of the 9.5% Notes due in August 2016 and of the 10.75% Notes due in June 2017.

Income Taxes

In the second quarter of 2017, our income tax expense was $9 million, consisting of current income tax expense of $17 million and a deferred income tax benefit of $8 million. This compares to an income tax expense of $6 million in the second quarter of 2016, consisting of a current income tax expense of $8 million and a deferred income tax benefit of $2 million. We made income tax payments, net of refunds, of $23 million during the second quarter of 2017. Our effective tax rate was 19% compared with an effective tax rate of 25% in the second quarter of 2016. The effective tax rate for the second quarter of 2017 was favorably impacted by enacted law changes in several U.S. states and by the recognition of additional tax credits associated with the filing of certain 2016 income tax returns.

First half of 2017 versus First half of 2016
	$ Change in Segmented Operating Income (Loss) due to
	Volume/Mix				Net Price			Input Costs (b)		Operating Expenses (c)			Currency			Depreciation/ Impairment(d)		Restructuring (e)		Other Operating Income/ Expense(f)		Total
Pulp and Paper		(19	)			(32	)		14		(1	)		16			42		23		2		45
Personal Care		7		(a)		(7	)		7		(5	)		(2	)		—		—		—		—
Corporate		—				—			—		3			—			—		—		1		4
Consolidated operating income (loss)		(12	)			(39	)		21		(3	)		14			42		23		3		49

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(a) Includes results of HDIS acquired on October 1, 2016.

(b) Includes raw materials (such as fiber, chemicals, nonwovens and super absorbent polymers) and energy expenses.

(c) Includes maintenance, freight costs, selling, general and administrative (“SG&A”) expenses and other costs.

(d) In the first half of 2017, we did not record any accelerated depreciation compared to $24 million of accelerated depreciation related to the conversion of a paper machine to a high quality fluff pulp line at our Ashdown mill, recorded in the first half of 2016. Depreciation charges were lower by $18 million in the first half of 2017, excluding foreign currency impact.

(e) In the first half of 2017, there were no restructuring charges. In the first half of 2016, we incurred restructuring charges of $23 million mostly related to the conversion at Ashdown described above.

(f)

First half of 2017 other operating income/ expense includes:	First half of 2016 other operating income/ expense includes:
- Environmental provision ($2 million) - Foreign currency loss on working capital items    ($1 million) - Bad debt expense ($1 million) - Other income ($3 million)	- Foreign currency loss on working capital items ($4 million) - Litigation settlement ($2 million) - Other income ($2 million)

Commentary – First half of 2017 compared to first half of 2016

Interest Expense, net

We incurred $34 million of net interest expense in the first half of 2017, an increase of $2 million compared to net interest expense of $32 million in the first half of 2016. This increase was mostly due to a reduction in capitalized interest and an increase in interest expense related to the Term Loan Agreement. This increase was partially offset by the maturity of the 9.5% Notes due in August 2016 and of the maturity of the 10.75% Notes due in June 2017.

Income Taxes

In the first half of 2017, our income tax expense was $14 million, consisting of current income tax expense of $26 million and a deferred income tax benefit of $12 million. This compares to an income tax expense of $3 million in the first half of 2016, consisting of a current income tax expense of $8 million and a deferred income tax benefit of $5 million. We made income tax payments, net of refunds, of $15 million during the first half of 2017. Our effective tax rate was 19% compared to an effective tax rate of 12% in the first half of 2016. The effective tax rate for the first half of 2017 was favorably impacted by the recognition of previously unrecognized tax benefits due to a statute expiration in a foreign jurisdiction and also a U.S. state tax audit finalization, enacted law changes in several U.S. states, and the recognition of additional tax credits associated with the filing of certain 2016 income tax returns.  The effective tax rate for the first half of 2016 was impacted by the approval of a state tax credit in the U.S.  

Commentary – Segment Review

Pulp and Paper Segment

Sales in our Pulp and Paper segment decreased by $55 million, or 5% when compared to sales in the second quarter of 2016. This decrease in sales is mostly due to a 1% decrease in net average selling prices, mostly due to a decrease in our net average selling price for paper, as well as a decrease in our paper sales volumes. This decrease was partially offset by an increase in our pulp sales volume.

Operating income in our Pulp and Paper segment amounted to $65 million in the second quarter of 2017, an increase of $30 million, when compared to operating income of $35 million in the second quarter of 2016. Our results were positively impacted by:

• Lower restructuring costs mostly related to the conversion of a paper machine to a high quality fluff pulp line at our Ashdown mill, recorded in the second quarter of 2016 ($21 million)

• Lower depreciation charges ($11 million) due to accelerated depreciation related to our 2014 decision to convert a paper machine at our Ashdown facility to a high quality fluff pulp line in the second quarter of 2016 and lower depreciation charges due to certain assets being fully depreciated

• Positive impact of a weaker Canadian dollar on our Canadian denominated expenses as well as from our hedging program  ($11 million)

• Lower input costs ($8 million) mostly related to lower fiber costs as a result of improved yields and lower energy costs, partially offset by higher chemicals costs

This increase was partially offset by:

• Lower average selling prices for paper partially offset by higher average selling prices for pulp ($10 million)

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• Lower volume/ mix ($10 million) mostly related to lower volume of paper, partially offset by higher volume of pulp  

• Higher other operating income/expense ($1 million)

Sales in our Pulp and Paper segment decreased by $67 million, or 3% when compared to sales in the first half of 2016. This decrease in sales is mostly due to a 1% decrease in net average selling prices for paper as well as a decrease in our paper sales volumes. This decrease was partially offset by an increase in our pulp sales volumes.

Operating income in our Pulp and Paper segment amounted to $99 million in the first half of 2017, an increase of $45 million, when compared to operating income of $54 million in the first half of 2016. Our results were positively impacted by:

• Lower depreciation charges ($42 million) due to accelerated depreciation related to our 2014 decision to convert a paper machine at our Ashdown facility to a high quality fluff pulp line in the first half of 2016 and lower depreciation charges due to certain assets being fully depreciated

• Lower restructuring costs mostly related to the conversion of a paper machine to a high quality fluff pulp line at our Ashdown mill, recorded in the second quarter of 2016 ($23 million)

• Positive impact of our hedging program as well as a weaker Canadian dollar on our Canadian denominated expenses ($16 million)

• Lower input costs ($14 million) mostly related to lower fiber costs as a result of improved yields and better weather and lower energy costs, partially offset by higher chemicals costs

• Lower other operating income/expense ($2 million)

This increase was partially offset by:

• Lower average selling prices for paper while average selling prices for pulp were stable ($32 million)

• Lower volume/ mix ($19 million) mostly related to lower volume of paper, partially offset by higher volume of pulp  

• Higher operating expenses ($1 million)

The markets in which our pulp and paper business operate are highly competitive with well-established domestic and foreign manufacturers. In uncoated freesheet, we compete primarily on the basis of product quality, breadth of offering, service solutions and competitively priced paper products. We also compete with electronic transmission and document storage alternatives. As a result of such competition, we are experiencing ongoing decreasing demand for most of our existing paper products. Most of our products offering are commodities that are widely available from other producers as well. Because commodity products have few distinguishing qualities from producer to producer, competition for these products is based primarily on price, which is determined by supply relative to demand.

The pulp market is highly fragmented with many manufacturers competing worldwide. Competition is primarily on the basis of access to low-cost wood fiber, product quality and competitively priced pulp products.

For the remainder of the year, we expect our paper shipments to be in-line with market demand. Our pulp shipments should be higher due to the ramp-up of the Ashdown fluff pulp line, while mix should continue to improve as we convert more volume to fluff pulp.

Personal Care Segment

Sales in our Personal Care segment increased by $13 million, or 6% when compared to sales in the second quarter of 2016. This increase in sales was driven by higher sales volume/mix of 9% mostly due to the acquisition of HDIS on October 1, 2016. This increase was partially offset by lower selling prices of 1% and unfavorable foreign currency rates of 2% due to the fluctuation between European currencies.

Operating income decreased by $2 million or 13% in the second quarter of 2017 compared to the second quarter of 2016. Our results were negatively impacted by:

• Unfavorable average net selling prices ($4 million)

• Higher operating expenses ($2 million) mostly due to higher salaries and wages and higher selling, general and administrative expenses

This decrease was partially offset by:

• Higher sales volume and mix ($2 million) in part due to the inclusion of HDIS as a result of the acquisition on October 1, 2016

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• Lower input costs ($2 million) mostly due to favorable pricing as a result of lower negotiated contract pricing as well as insourcing initiatives

Sales in our Personal Care segment increased by $46 million, or 10% when compared to sales in the first half of 2016. This increase in sales was driven by higher sales volume/mix of 14%, partially offset by lower selling prices of 2% and unfavorable foreign currency rates of 2% due to fluctuations between European currencies.

Operating income remained stable in the first half of 2017 when compared to the first half of 2016.

Our results were negatively impacted by:

• Unfavorable average net selling prices ($7 million)

• Higher operating expenses ($5 million) mostly due to higher salaries and wages and higher selling, general and administrative expenses

• Unfavorable foreign exchange mostly between the GBP and the Euro and the U.S. Dollar and Euro, net of our hedging program ($2 million)

This decrease was offset by:

• Higher sales volume and mix ($7 million)

• Lower input costs ($7 million) mostly due to favorable pricing as a result of lower negotiated contract pricing as well as insourcing initiatives

In our absorbent hygiene products business, we compete in an industry with fundamental drivers for long-term growth. While we are expected to benefit from the overall increase in healthcare spending due to an aging population, it is not clear how recent administrative changes in the various national governments may impact the source of the funding. Changes in the balance of public versus private funding may be forthcoming and these could impact overall consumption or the channels in which consumption occurs. The principal methods and elements of competition include brand recognition and loyalty, product innovation, quality and performance, price and marketing and distribution capabilities.

For the remainder of the year, we expect investments in advertising and promotion. New customer wins should drive higher sales, while raw material costs are expected to increase marginally.

STOCK-BASED COMPENSATION EXPENSE

For the first half of 2017, stock-based compensation expense recognized in our results of operations was $7 million for all outstanding awards which includes the mark-to-market recovery related to liability awards of $2 million. This compares to a stock-based compensation expense of $6 million for all outstanding awards which includes the mark-to-market recovery related to liability awards of $3 million in the first half of 2016. Compensation costs for performance awards are based on management’s best estimate of the final performance measurement.

LIQUIDITY AND CAPITAL RESOURCES

Our principal cash requirements are for ongoing operating costs, pension contributions, working capital and capital expenditures, as well as principal and interest payments on our debt and income tax payments. We expect to fund our liquidity needs primarily with internally generated funds from our operations and, to the extent necessary, through borrowings under our contractually committed $700 million credit facility, of which $680 million is currently undrawn and available, or through our $150 million receivables securitization facility, of which $11 million is currently undrawn and available. Under adverse market conditions, there can be no assurance that these agreements would be available or sufficient. See “Capital Resources” below.

Our ability to make payments on the requirements mentioned above will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our credit and receivable securitization facilities and debt indentures impose various restrictions and covenants on us that could limit our ability to respond to market conditions, to provide for unanticipated capital investments or to take advantage of business opportunities.

A portion of our cash is held outside the U.S. by foreign subsidiaries. The earnings of the foreign subsidiaries, which reflect full provision for local income taxes, are currently indefinitely reinvested in foreign operations. We do not intend on repatriating those

45

funds and no provision is made for income taxes that would be payable upon the distribution of earnings from foreign subsidiaries as computation of these amounts is not practical.

Operating Activities

Our operating cash flow requirements are primarily for salaries and benefits, the purchase of raw materials, including fiber and energy and other expenses such as income tax and property taxes.

Cash flows from operating activities totaled $212 million in the first half of 2017, a $3 million decrease compared to cash flows from operating activities of $215 million in the first half of 2016. This decrease in cash flows provided from operating activities is primarily due to an increase in working capital requirements in the first half of 2017 when compared to the first half of 2016, partially offset by an increase in profitability (excluding the non-cash impairment charge of $24 million in the first half of 2016). We made income tax payments, net of refunds of $15 million in the first half of 2017 compared to income tax payments, net of refunds of $27 million during the first half of 2016.

Investing Activities

Cash flows used for investing activities in the first half of 2017 amounted to $71 million, a $149 million decrease compared to cash flows used for investing activities of $220 million in the first half of 2016.

The use of cash in the first half of 2017 was attributable to additions to property, plant and equipment of $71 million.

The use of cash in the first half of 2016 was attributable to additions to property, plant and equipment of $219 million.

Our capital expenditures for 2017 are expected to be approximately between $210 million and $230 million.

Financing Activities

Cash flows used for financing activities totaled $148 million in the first half of 2017 compared to cash flows used for financing activities of $11 million in the first half of 2016.

The use of cash in the first half of 2017 was primarily the result of dividend payments ($52 million), the net repayments of borrowings under our credit facilities (revolver and receivable securitization) and long-term debt ($83 million) and a decrease in our bank indebtedness ($12 million).

The use of cash in the first half of 2016 was primarily the result of dividend payments ($50 million), the repurchase of our common stock ($10 million) and the repayment of long-term debt ($1 million). These were partially offset by the net proceeds from borrowings under our credit facilities (revolver and receivable securitization) ($50 million) and an increase in our bank indebtedness ($1 million).

Capital Resources

Net indebtedness, consisting of bank indebtedness and long-term debt, net of cash and cash equivalents, was $1,080 million as of June 30, 2017 compared to $1,168 million as of December 31, 2016.

Notes Maturity

Our 9.5% Notes, in aggregate principal amount of $39 million, matured on August 1, 2016.

Our 10.75% Notes, in aggregate principal amount of $63 million, matured on June 1, 2017.

Term Loan

In the third quarter of 2015, a wholly owned subsidiary of Domtar borrowed $300 million under an unsecured 10-year Term Loan Agreement that matures on July 20, 2025, with certain domestic banks. The facility was fully drawn down on August 19, 2015. The Company and certain significant domestic subsidiaries of the Company unconditionally guarantee any obligations from time to time arising under the Term Loan Agreement. On August 18, 2016, Domtar entered into an amendment to its Term Loan Agreement, pursuant to which, among other things, certain insignificant subsidiaries were released from their guarantees of the borrower’s obligations under the Term Loan Agreement.

Borrowings under the Term Loan Agreement bear interest at LIBOR plus a margin of 1.875%. The Term Loan Agreement contains customary covenants, including two financial covenants: (i) an interest coverage ratio, as defined in the Term Loan Agreement, that

46

must be maintained at a level of not less than 3 to 1 and (ii) a leverage ratio, as defined in the Term Loan Agreement that must be maintained at a level of not greater than 3.75 to 1. At June 30, 2017, we were in compliance with these financial covenants.

Revolving Credit Facility

In August 2016, we amended and restated our unsecured revolving credit facility (the “Credit Agreement”) with certain domestic and foreign banks, increasing the amount available from $600 million to $700 million and extending the Credit Agreement’s maturity date from October 3, 2019 to August 18, 2021. The amendment also allows certain foreign subsidiaries to be borrowers under the facility. The maturity date of the facility may be extended by one year and the lender commitments may be increased by up to $400 million, subject to lender approval and customary requirements.

Borrowings by the Company under the Credit Agreement are guaranteed by our significant domestic subsidiaries. Borrowings by foreign borrowers under the Credit Agreement are guaranteed by the Company, our significant domestic subsidiaries and certain of our foreign significant subsidiaries. The amendment allowed certain insignificant domestic subsidiaries that were previously guarantors, to be released from their guarantees of any obligations under the credit facility.

Borrowings under the Credit Agreement bear interest at the LIBOR, EURIBOR Canadian bankers’ acceptance or prime rate as applicable, plus a margin linked to our credit rating. In addition, we pay facility fees quarterly at rates dependent on our credit ratings.

The Credit Agreement contains customary covenants and events of default for transactions of this type, including two financial covenants: (i) an interest coverage ratio, as defined in the Credit Agreement, that must be maintained at a level of not less than 3 to 1 and (ii) a leverage ratio, as defined in the Credit Agreement that must be maintained at a level of not greater than 3.75 to 1 (or 4.00 to 1 upon the occurrence of certain qualifying material acquisitions). At June 30, 2017, we were in compliance with these financial covenants.  At June 30, 2017, we had $20 million of borrowing (June 30, 2016– nil) and no outstanding letters of credit (June 30, 2016 – nil), leaving $680 million unused and available under this facility.  

Receivables Securitization

We have a $150 million receivables securitization facility that matures in March 2019.

At June 30, 2017, borrowings under the receivables securitization facility amounted to $80 million and $59 million of letters of credit were issued under the program (June 30, 2016 – $100 million and $38 million, respectively). The program contains certain termination events, which include, but are not limited to, matters related to receivable performance, certain defaults occurring under the credit facility or our failure to repay or satisfy material obligations. At June 30, 2017, we had $11 million unused and available under this facility.

Common Stock

On February 21, 2017 and May 3, 2017, our Board of Directors approved a quarterly dividend of $0.415 per share, respectively, to be paid to holders of our common stock. Dividends of $26 million were paid on April 17, 2017 and July 17, 2017, respectively, to shareholders of record on April 3, 2017 and July 3, 2017, respectively.

On August 1, 2017, our Board of Directors approved a quarterly dividend of $0.415 per share to be paid to holders of our common stock. This dividend is to be paid on October 16, 2017, to shareholders of record on October 2, 2017.

OFF BALANCE SHEET ARRANGEMENTS

In the normal course of business, we finance certain of our activities off balance sheet through operating leases.

GUARANTEES

Indemnifications

In the normal course of business, we offer indemnifications relating to the sale of our businesses and real estate. In general, these indemnifications may relate to claims from past business operations, the failure to abide by covenants and the breach of representations and warranties included in sales agreements. Typically, such representations and warranties relate to taxation, environmental, product and employee matters. The terms of these indemnification agreements are generally for an unlimited period of time. At June 30, 2017, we were unable to estimate the potential maximum liabilities for these types of indemnification guarantees as the amounts are contingent upon the outcome of future events, the nature and likelihood of which cannot be reasonably estimated at this time. Accordingly, no provision has been recorded. These indemnifications have not yielded significant expenses in the past.

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Pension Plans

We have indemnified and held harmless the trustees of our pension funds, and the respective officers, directors, employees and agents of such trustees, from any and all costs and expenses arising out of the performance of their obligations under the relevant trust agreements, including in respect of their reliance on authorized instructions from us or for failing to act in the absence of authorized instructions. These indemnifications survive the termination of such agreements. At June 30, 2017, we have not recorded a liability associated with these indemnifications, as we do not expect to make any payments pertaining to these indemnifications.

RECENT ACCOUNTING PRONOUNCEMENTS

Refer to Note 2 “Recent Accounting Pronouncements,” of the financial statements in this Quarterly Report on Form 10-Q.

CRITICAL ACCOUNTING ESTIMATES AND POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates, assumptions and choices amongst acceptable accounting methods that affect our reported results of operations and financial position. Critical accounting estimates pertain to matters that contain a significant level of management estimates about future events, encompass the most complex and subjective judgments and are subject to a fair degree of measurement uncertainty. On an ongoing basis, management reviews its estimates, including those related to environmental matters and asset retirement obligations, impairment and useful lives of long-lived assets, closure and restructuring costs, goodwill and intangible assets impairment, pension and other post-retirement benefit plans, income taxes, business combinations and contingencies related to legal claims. These critical accounting estimates and policies have been reviewed with the Audit Committee of our Board of Directors. We believe these accounting policies, and others, should be reviewed as they are essential to understanding our results of operations, cash flows and financial condition. Actual results could differ from those estimates.

There has not been any material change to our policies since December 31, 2016. For more details on critical accounting policies, refer to our Annual Report on Form 10-K for the year ended December 31, 2016.

FORWARD-LOOKING STATEMENTS

The information included in this Quarterly Report on Form 10-Q, contains forward-looking statements relating to trends in, or representing management’s beliefs about, Domtar Corporation’s future growth, results of operations, performance and business prospects and opportunities. These forward-looking statements are generally denoted by the use of words such as “anticipate”, “believe”, “expect”, “intend”, “aim”, “target”, “plan”, “continue”, “estimate”, “project”, “may”, “will”, “should” and similar expressions. These statements reflect management’s current beliefs and are based on information currently available to management. Forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by management, are inherently subject to known and unknown risks and uncertainties and other factors that could cause actual results to differ materially from historical results or those anticipated. Accordingly, no assurances can be given that any of the events anticipated by the forward-looking statements will occur, or if any occurs, what effect they will have on Domtar Corporation’s results of operations or financial condition. These factors include, but are not limited to:

• continued decline in usage of fine paper products in our core North American market;

• our ability to implement our business diversification initiatives, including strategic acquisitions;

• product selling prices;

• raw material prices, including fiber, chemical and energy;

• conditions in the global capital and credit markets, and the economy generally, particularly in the U.S., Canada and Europe;

• performance of Domtar Corporation’s manufacturing operations, including unexpected maintenance requirements;

• the level of competition from domestic and foreign producers;

• the effect of, or change in, forestry, land use, environmental and other governmental regulations (including tax), and accounting regulations;

• the effect of weather and the risk of loss from fires, floods, windstorms, hurricanes and other natural disasters;

• transportation costs;

• the loss of current customers or the inability to obtain new customers;

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• legal proceedings;

• changes in asset valuations, including impairment of property, plant and equipment, inventory, accounts receivable or other assets for impairment or other reasons;

• changes in currency exchange rates, particularly the relative value of the U.S. dollar to the Canadian dollar and European currencies;

• the effect of timing of retirements and changes in the market price of Domtar Corporation’s common stock on charges for stock-based compensation;

• performance of pension fund investments and related derivatives, if any; and

• the other factors described under “Risk Factors”, in item 1A of our Annual Report on Form 10-K, for the year ended December 31, 2016.

You are cautioned not to unduly rely on such forward-looking statements, which speak only as of the date made, when evaluating the information presented in this Quarterly Report on Form 10-Q. Unless specifically required by law, Domtar Corporation disclaims any obligation to update or revise these forward-looking statements to reflect new events or circumstances.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Information relating to quantitative and qualitative disclosure about market risk is contained in our Annual Report on Form 10-K for the year ended December 31, 2016. There have been no material changes in our exposure to market risk since December 31, 2016. A full discussion on Quantitative and Qualitative Disclosure about Market Risk, is found in Note 3 “Derivatives and Hedging Activities and Fair Value Measurement,” of the financial statements in this Quarterly Report on Form 10-Q.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports under the Securities and Exchange Act of 1934, as amended (“Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. As of June 30, 2017, an evaluation was performed by members of management, at the direction and with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act). Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2017, our disclosure controls and procedures were effective.

Change in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting during the period covered by this report.

PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 14 “Commitments and Contingencies” of the financial statements in this Quarterly Report on Form 10-Q for the discussion regarding legal proceedings.

For a description of previously reported legal proceedings refer to Part I, Item 3, “Legal Proceedings,” of our Annual Report on Form 10-K for the year ended December 31, 2016.

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ITEM 1A. RISK FACTORS

Our Annual Report on Form 10-K for the year ended December 31, 2016, contains important risk factors that could cause our actual results to differ materially from those projected in any forward-looking statement. There have been no material changes from the risk factors described in our Annual Report on Form 10-K for the year ended December 31, 2016.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During the second quarter and the first half of 2017, we did not repurchase any shares under our stock repurchase program (the “Program”). We currently have $323 million of remaining availability under our Program. The Program may be suspended, modified or discontinued at any time and we have no obligation to repurchase any amount of our common stock under the Program. The Program has no set expiration date. We repurchase our common stock, from time to time, in part to reduce the dilutive effects of our stock options and awards and to improve shareholders’ returns. The timing and amount of stock repurchases will depend on a variety of factors, including market conditions, availability under the program as well as corporate and regulatory considerations. All shares repurchased are recorded as Treasury stock on the Consolidated Balance Sheets under the par value method at $0.01 per share.

ITEM 3. DEFAULT UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

				Incorporated  by reference to:
Exhibit Number	Exhibit Description			Form	Exhibit	Filing Date
10.1*		Amended and Restated DB SERP for Management Committee Members of Domtar
10.2*		Amended and Restated DC SERP for Designated Executives of Domtar
10.3*		Amended and Restated Supplementary Pension Plan for Designated Managers of Domtar Inc.
10.4*		Amended and Restated DC SERP for Designated Executives of Domtar Personal Care
10.5*		Amended and Restated Domtar Corporation 2007 Omnibus Incentive Plan	DEF14A		Annex B		03/31/2017
10.6*		Domtar Corporation Annual Incentive Plan for Members of the Management Committee	DEF14A		Annex A		03/31/2017
12.1		Computation of Ratio of Earnings to Fixed Charges
31.1		Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Extension Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
101.PRE		XBRL Extension Presentation Linkbase

* Indicates management contract of compensatory arrangement

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereto duly authorized.

DOMTAR CORPORATION
Date: August 4, 2017
By:	/s/ Daniel Buron
	Daniel Buron
	Senior Vice-President and Chief Financial Officer
By:	/s/ Razvan L. Theodoru
	Razvan L. Theodoru
	Vice-President, Corporate Law and Secretary

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