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 March 31, 2019

OR

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

For the transition period from ________to_______

COMMISSION FILE NUMBER 001-33164

DOMTAR CORPORATION

(Exact name of registrant as specified in its charter)

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

234 Kingsley Park Drive, Fort Mill, SC 29715

(Address of principal executive offices)

(zip code)

(803) 802-7500

(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act: Common Stock, Par Value $0.01 Per Share; Common stock traded on the New York Stock Exchange; trading symbol UFS.

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 every Interactive Data File required to be submitted 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 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	☐	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 April 30, 2019, 63,100,572 shares of the issuer’s common stock were outstanding.

DOMTAR CORPORATION

FORM 10-Q

For the Quarterly Period Ended March 31, 2019

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	37
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK	45
ITEM 4.	CONTROLS AND PROCEDURES	45
PART II	OTHER INFORMATION	45
ITEM 1.	LEGAL PROCEEDINGS	45
ITEM 1A.	RISK FACTORS	46
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	46
ITEM 3.	DEFAULT UPON SENIOR SECURITIES	46
ITEM 4.	MINE SAFETY DISCLOSURES	46
ITEM 5.	OTHER INFORMATION	46
ITEM 6.	EXHIBITS	47

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
	March 31,			March 31,
	2019			2018
	(Unaudited)
	$			$
Sales		1,376			1,345
Operating expenses
Cost of sales, excluding depreciation and amortization		1,052			1,084
Depreciation and amortization		73			79
Selling, general and administrative		123			110
Impairment of property, plant and equipment (NOTE 11)		10			—
Closure and restructuring costs (NOTE 11)		4			—
Other operating income, net (NOTE 6)		(1	)		(5	)
		1,261			1,268
Operating income		115			77
Interest expense, net		13			16
Non-service components of net periodic benefit cost (NOTE 5)		(3	)		(4	)
Earnings before income taxes and equity loss		105			65
Income tax expense (NOTE 7)		24			11
Equity loss, net of taxes		1			—
Net earnings		80			54
Per common share (in dollars) (NOTE 4)
Net earnings
Basic		1.27			0.86
Diluted		1.27			0.86
Weighted average number of common shares    outstanding (millions)
Basic		63.0			62.7
Diluted		63.2			62.9
Cash dividends per common share		0.44			0.42
Net earnings		80			54
Other comprehensive income (loss) (NOTE 12):
Net derivative gains (losses) on cash flow hedges:
Net gains (losses) arising during the period, net of tax of    $(4) (2018 – $3)		11			(9	)
Less: Reclassification adjustment for losses (gains) included    in net earnings, net of tax of nil (2018 – $1)		1			(2	)
Foreign currency translation adjustments		2			(11	)
Change in unrecognized gains and prior service cost related to    pension and post-retirement benefit plans, net of tax of    $(1) (2018 – $(1))		3			2
Other comprehensive income (loss)		17			(20	)
Comprehensive income		97			34

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
	March 31,			December 31,
	2019			2018
	(Unaudited)
	$			$
Assets
Current assets
Cash and cash equivalents		94			111
Receivables, less allowances of $7 and $6		699			670
Inventories (NOTE 8)		813			762
Prepaid expenses		25			24
Income and other taxes receivable		21			22
Total current assets		1,652			1,589
Property, plant and equipment, net		2,564			2,605
Operating lease right-of-use assets (NOTE 9)		81			—
Intangible assets, net (NOTE 10)		587			597
Other assets		138			134
Total assets		5,022			4,925
Liabilities and shareholders' equity
Current liabilities
Bank indebtedness		3			—
Trade and other payables		675			757
Income and other taxes payable		49			25
Operating lease liabilities due within one year (NOTE 9)		25			—
Long-term debt due within one year		1			1
Total current liabilities		753			783
Long-term debt		853			853
Operating lease liabilities (NOTE 9)		65			—
Deferred income taxes and other		477			476
Other liabilities and deferred credits		266			275
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; 1,900,532 and 2,086,535 shares		—			—
Additional paid-in capital		1,982			1,981
Retained earnings		1,075			1,023
Accumulated other comprehensive loss		(450	)		(467	)
Total shareholders' equity		2,608			2,538
Total liabilities and shareholders' equity		5,022			4,925

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, 2018		62.9		1		1,981		1,023			(467	)		2,538
Stock-based compensation, net of tax		0.2		—		1		—			—			1
Net earnings		—		—		—		80			—			80
Net derivative gains on cash flow hedges:
Net gains arising during the period,    net of tax of $(4)		—		—		—		—			11			11
Less: Reclassification adjustment for losses    included in net earnings, net of tax of nil		—		—		—		—			1			1
Foreign currency translation adjustments		—		—		—		—			2			2
Change in unrecognized gains and prior service cost    related to pension and post-retirement benefit    plans, net of tax of $(1)		—		—		—		—			3			3
Cash dividends declared		—		—		—		(28	)		—			(28	)
Balance at March 31, 2019		63.1		1		1,982		1,075			(450	)		2,608

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 three months ended
	March 31, 2019			March 31, 2018
	(Unaudited)
	$			$
Operating activities
Net earnings		80			54
Adjustments to reconcile net earnings to cash flows from operating activities
Depreciation and amortization		73			79
Deferred income taxes and tax uncertainties		(3	)		(3	)
Impairment of property, plant and equipment		10			—
Net gains on disposals of property, plant and equipment		—			(1	)
Stock-based compensation expense		2			3
Equity loss, net		1			—
Other		—			(1	)
Changes in assets and liabilities
Receivables		(30	)		(2	)
Inventories		(49	)		(13	)
Prepaid expenses		—			(2	)
Trade and other payables		(69	)		(37	)
Income and other taxes		26			16
Difference between employer pension and other post-retirement    contributions and pension and other post-retirement expense		1			—
Other assets and other liabilities		13			(3	)
Cash flows from operating activities		55			90
Investing activities
Additions to property, plant and equipment		(46	)		(25	)
Proceeds from disposals of property, plant and equipment		—			1
Other		—			(4	)
Cash flows used for investing activities		(46	)		(28	)
Financing activities
Dividend payments		(27	)		(26	)
Net change in bank indebtedness		3			—
Proceeds from receivables securitization facility		20			—
Repayments of receivables securitization facility		(20	)		(25	)
Other		(1	)		—
Cash flows used for financing activities		(25	)		(51	)
Net (decrease) increase in cash and cash equivalents		(16	)		11
Impact of foreign exchange on cash		(1	)		2
Cash and cash equivalents at beginning of period		111			139
Cash and cash equivalents at end of period		94			152
Supplemental cash flow information
Net cash payments for:
Interest		16			19
Income taxes		6			4

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	11
NOTE 4	EARNINGS PER COMMON SHARE	15
NOTE 5	PENSION PLANS AND OTHER POST-RETIREMENT BENEFIT PLANS	16
NOTE 6	OTHER OPERATING INCOME, NET	17
NOTE 7	INCOME TAXES	18
NOTE 8	INVENTORIES	19
NOTE 9	LEASES	20
NOTE 10	INTANGIBLE ASSETS	23
NOTE 11	CLOSURE AND RESTRUCTURING COSTS 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	30
NOTE 16	SUPPLEMENTAL GUARANTOR FINANCIAL INFORMATION	31

7

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(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 three 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, 2018, as filed with the Securities and Exchange Commission. The December 31, 2018 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.

On January 1, 2019, upon the adoption of ASU 2016-02, “Leases”, the Company’s accounting policy related to leases became as follows:

LEASES

At inception of an arrangement, the Company determines whether the arrangement contains a lease. A lease conveys the right to control the use of identified property, plant, or equipment (asset) for a period of time in exchange for consideration. Control over the use of the identified asset means that the Company has both the right to obtain substantially all of the economic benefits from the use of the asset and the right to direct the use of the asset.

For each lease arrangement that has an original lease term of more than 12 months, a right-of-use asset and a lease liability are recorded in the Consolidated Balance Sheets. The right-of-use asset represents the Company’s right to use an underlying asset for the lease term while the lease liability represents the obligation to make lease payments arising from the lease. The right-of-use asset and the lease liability are initially recorded at the same amount at the lease commencement date based on the present value of the remaining lease payments discounted using the rate implicit in the lease when readily determined or, in most cases, the Company’s incremental borrowing rate. Lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. The right-of-use asset is tested for impairment in accordance with ASC 360 – “Property, Plant and Equipment”.

The terms of a lease arrangement determine how a lease is classified (operating or finance), the resulting recognition pattern in the Consolidated Statements of Earnings and Comprehensive Income and the classification in the Consolidated Balance Sheets.

Finance lease expense is represented by the interest on the lease liability determined using the effective interest method and the amortization of the finance lease right-of-use asset calculated using the straight-line method over the estimated useful life of the identified asset. Finance lease related balances are included in the Consolidated Balance Sheets in Property, plant and equipment, net,  Long-term debt due within one year and Long-term debt.

Operating lease expense is recorded on a straight-line basis over the lease term by adding interest expense determined using the effective interest method to the amortization of the right-of-use asset. Operating lease related balances are included in the Consolidated Balance Sheets in Operating lease right-of-use assets, Operating lease liabilities due within one year and Operating lease liabilities. Operating lease right-of-use assets exclude previously recognized liabilities relating to unfavorable terms of leases acquired as part of a business combination.

For operating lease arrangements with lease and non-lease components, the Company accounts for the lease and non-lease components as a single lease component.

8

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 2.

_________________

RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING CHANGES IMPLEMENTED

LEASES

In February 2016, the FASB issued ASU 2016-02, “Leases”, which requires lessees to recognize right-of-use assets and lease liabilities for all of their operating leases while continuing to recognize expenses in the Consolidated Statement of Earnings and Comprehensive Income in a manner similar to previous accounting standards. Under the new standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.

The Company elected to initially apply the new leases standard as of January 1, 2019 with certain available practical expedients which are discussed below. No cumulative-effect adjustments on retained earnings were necessary as of January 1, 2019. The most significant impact of adopting the new standard was the recognition of right-of-use assets and lease liabilities for operating leases. The accounting for finance leases remains substantially unchanged.

In transitioning to the new standard, the Company elected to use the practical expedient package.  Accordingly, we did not reassess the following:

• Whether existing or expired contracts are or contained a lease (including executory contracts).

• The lease classification of existing or expired leases previously made by management.

• Whether initial direct costs for existing leases would qualify under the new standard.

Furthermore, the Company elected to use the hindsight practical expedient in determining the lease term and assessing impairment of the right-of-use assets.

For all comparative periods prior to the adoption of the new leases standard, the Company will continue to report operating leases in the consolidated financial statements under ASC 840 “Leases” and provide the related required disclosures.

COMPREHENSIVE INCOME

In February 2018, the FASB issued ASU 2018-02, “Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income”, regarding the reclassification of certain income tax effects reported in accumulated comprehensive income (loss) in response to the U.S. Tax Reform enacted on December 22, 2017. For businesses, one of the main provisions of the U.S. Tax Reform was the reduction in the corporate federal income tax rate to 21% from 35%. Under current income tax accounting requirements, an entity was required to remeasure applicable U.S. deferred tax assets and deferred tax liabilities at the 21% tax rate effective on the U.S. Tax Reform enactment date. This remeasurement was required to be recognized in an entity’s income tax provision in its income statement. However, certain of these deferred tax assets and deferred tax liabilities relate to income tax effects initially recognized at the 35% tax rate through other comprehensive income (loss) on items reported within accumulated other comprehensive income (loss) on an entity’s balance sheet. Consequently, an entity’s financial statements will reflect an inconsistency between the deferred tax assets and deferred tax liabilities measured at 21% and the related income tax effects in accumulated other comprehensive income (loss) recorded at 35%. Accordingly, this guidance provides a one-time option to remeasure the income tax effects within accumulated other comprehensive income (loss) at the 21% income tax rate. The impact from this remeasurement is to be recorded directly in retained earnings on an entity’s balance sheet.

This guidance became effective for the Company on January 1, 2019. The Company has decided not to elect this option, as permitted in the new guidance.

9

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

NOTE 2. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)

FUTURE ACCOUNTING CHANGES

IMPLEMENTATION COSTS FOR CLOUD COMPUTING ARRANGEMENTS

In August 2018, the FASB issued ASU 2018-15, “Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract”. Under the guidance, implementation costs for cloud computing arrangements (“CCA”) should be evaluated for capitalization using the same approach as implementation costs associated with internal-use software and expensed over the term of the hosting arrangement. The ASU also provides the following guidance on presentation and disclosure:

• Capitalized implementation costs should be presented in the same line item on the balance sheet as amounts prepaid for the hosted CCA service, if any (generally as an “other asset”).

• The amortization of capitalized implementation costs should be presented in the same statement of earnings line item as the fees associated with the hosted CCA service. Accordingly, the amortization of capitalized implementation costs should not be included with depreciation or amortization expense related to property, plant, and equipment or intangible assets.

• Cash flows related to capitalized implementation costs should be presented as operating activities, consistent with the presentation of cash flows for the fees related to the hosted CCA service.

• Entities are required to disclose the nature of the hosting arrangements that are service contracts and significant judgments made when applying the guidance. Additionally, companies are required to provide quantitative disclosures, including amounts capitalized, amortized, and impaired.

This ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption.

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

10

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(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 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 March 31, 2019, two of Domtar’s Pulp and Paper segment customers located in the U.S. represented 13% or $93 million, and 10% or $73 million, respectively, of the Company’s receivables (December 31, 2018 – one Pulp and Paper segment customer located in the U.S. represented 10% or $67 million).

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 securitization, term loan 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 45 months.

11

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(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 March 31, 2019 to hedge forecasted purchases:

Commodity	Notional contractual quantity under derivative contracts MMBTu(2)		Notional contractual value under derivative contracts (in millions of dollars)			Percentage of forecasted purchases under derivative contracts
Natural gas
2019 (1)		9,030,000		$	27	45%
2020		11,165,000		$	34	40%
2021		9,270,000		$	27	33%
2022		9,270,000		$	25	33%

⁽¹⁾ Represents the remaining nine months of 2019

⁽²⁾ MMBTu: Millions of British thermal units

The natural gas derivative contracts were fully effective as of March 31, 2019. There were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three months ended March 31, 2019 resulting from hedge ineffectiveness (three months ended March 31, 2018 – 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 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. 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.

The following table presents the currency values under significant currency positions pursuant to currency derivatives outstanding as of March 31, 2019 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
CAD/USD	Pulp and Paper	2019 (1)	526 CAD	78%	1 USD = 1.2914	1 USD = 1.3176
CAD/USD	Pulp and Paper	2020	405 CAD	67%	1 USD = 1.2944	1 USD = 1.3028
CAD/USD	Pulp and Paper	2021	76 CAD	13%	1 USD = 1.3124	1 USD = 1.3124

⁽¹⁾ Represents the remaining nine months of 2019

12

DOMTAR CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2019

(IN MILLIONS OF DOLLARS, UNLESS OTHERWISE NOTED)

(UNAUDITED)

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

The foreign exchange derivative contracts were fully effective as of March 31, 2019. There were no amounts reflected in the Consolidated Statements of Earnings and Comprehensive Income for the three months ended March 31, 2019 resulting from hedge ineffectiveness (three months ended March 31, 2018 – 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.

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 March 31, 2019 and December 31, 2018, 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:	March 31, 2019		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		2		—		2		—	(a)	Prepaid expenses
Natural gas swap contracts		1		—		1		—	(a)	Other assets
Total Assets		3		—		3		—
Liabilities derivatives
Currency derivatives		11		—		11		—	(a)	Trade and other payables
Natural gas swap contracts		1		—		1		—	(a)	Trade and other payables
Currency derivatives		4		—