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Domtar Corporation (NYSE:UFS)

Q3 2008 Earnings Call

November 4, 2008 10:00 a.m. ET

Executives

Pascal Bossé - Director of Investor Relations

Daniel Buron - Senior Vice President and Chief Financial Officer

Raymond Royer - President and Chief Executive Officer

Richard Thomas - Senior Vice President, Sales

Michael Edwards - Senior VP, Pulp and Paper Manufacturing

Analysts

Mark Connelly – Credit Suisse

Christopher Chun – Deutsche Bank

Steven Chercover – D.A. Davidson & Co.

George Staphos – Banc of America Securities

Claudia Shank Hueston – JP Morgan

Robert Howard – Prospector Partners

Steven Atkinson – BMO Capital Markets

Benoit LaPlante – Scotia Capital

Sean Stewart – TD Newcrest

Mark Wild – Deutsche Bank

Operator

Good day. Ladies and gentlemen and welcome to Domtar third quarter 2008 financial results conference call. At this time, all participants are in a listen-only mode. But following the presentation, we will conduct a question-and-answer session. (Operator Instructions)

And now I would now like to turn the meeting over to Pascal Bossé.

Pascal Bossé

Thank you, Sylvie. Good morning, everyone. Welcome to our third quarter 2008 earnings call. Joining me today are President and CEO, Raymond Royer; Senior VP and CFO, Daniel Buron; Senior VP of Sales, Dick Thomas, and Senior VP Pulp and Paper Manufacturing, Mike Edwards.

Raymond and Daniel will start the brief remarks on the results and then we will open up the call to questions from the investment community. Just as a reminder, our speakers will make references to supporting slides and you can find those in the investor section over the website.

I wish to remind you that our listeners on this call, we will make references with forward-looking statements based upon the number of estimates and assumptions that are subject to risks and uncertainties that could cause results to materially differ. I invite you to review Domtar's filings with the Securities Commissions for a listing of those. And finally, certain non-U.S. GAAP financial measures will be presented and discussed and you can find the reconciliation for the closest GAAP measures in the appendix of this morning's release and on our website.

So with that, I'll turn the call over to CEO Raymond Royer. Remo?

Raymond Royer

Thank you Pascal, and good morning to all our listeners. Domtar posted earnings before items of $51 million on sales of $1.6 billion. EBITDA before items was $250 million or 15% of total sales. I am encouraged by the results achieved despite economic turmoil, continued in wood cost increases and softer demand that marked the quarter. Again, we continued to focus on free cash flow and we generated $82 million in this quarter.

Our net debt was further reduced and it is now $176 million below December levels bringing the net debt to total capitalization to 39%, so, again, a solid performance in the wake of the weakening economic environment.

I will now turn the call over to Daniel for the financial review and I will come back with more comments in the outlook. Daniel?

Daniel Buron

Thank you, Remo, and good morning, everyone. Starting with the sequential review of our results on slide four, sales were down $14 million with lower overall volume offsetting higher prices for paper and lumber. Cost of goods sold were favorable $43 million and that despite higher cost for chemical, freight, fiber, and energy of $24 million.

The major improvement in the cost of sales line is mostly due to t the continued benefit from our synergy program as well as the impact of the Port Edwards mill closure in June.

SG&A increased $8 million primarily due to the fact that the second quarter included a non-recurring gain of $6 million for the sale of trademark. Finally interest expense was $2 million lower and the effective tax rate was in the low 40% as expected.

Turning to slide five; reported net earnings were $43 million or $0.08 per share. This includes two after item, synergies and integration cost of $6 million and closure and (inaudible 00:04:19) cost of $2 million. So, excluding these items, earnings were $51 million or $0.10 per share.

Now, turning to cash flow on slide six, cash flow from operating activities amounted to $131 million in the second quarter, an increase of $18 million when compared to the second quarter. This increase occurred despite that finished goods and (inaudible 00:04:46) inventories were up in the third quarter resulting in the use of cash of $68 million.

Capital expenditures amounted to $36 million in Q3 or 41% of D&A. And, finally, we spent $2 million of the term loan B and increased cash to $127 million on the balance sheet. This led to a net debt reduction of $72 million in the third quarter for net debt to total capital integration ratio of 39%.

Now, turning to the EBITDA with the following on slide seven. When compared to the second quarter, we benefited from higher selling prices in the amount of $35 million, energy and chemical usage was reduced by $10 million. Major maintenance was favorable $10 million, a strong U.S. dollar against the Canadian dollar contributed $ 7 million net averages and cost reduction including synergies were a favorable $6 million in this quarter. The negative were continued inflation on material and freight for $24 million and lower volume that net for $16 million.

Just to circle back to input cost increase, inflation on chemical, freight, fiber, and energy since the same quarter last year has not reached more than $400 million on an annualized basis. You can see the detail of that on slide 20.

Now, the segmented review, for our paper segment on slide eight, the operating income before item was $131 million in the third quarter on a D&A charge of $111 million. So, the EBITDA before I&M was $242 million compared to $260 million in the second quarter.

The increase in operating income from second quarter came from higher selling prices for papers, lower usage of energy and chemicals, lower cost related to major maintenance, and favorable foreign exchange rate and lower other cost including synergies. This positive were mitigated by higher cost related to chemical, fiber, energy, and freight and lower paper and pulp shipment.

On transaction prices for copy and offset were strong again this quarter, up more than $40 per ton on the sequential basis. Pulp prices decrease $8 per metric ton for soft wood and $17 per metric ton for hard wood grade compared to Q2. On slide 10, paper shipment were 58,000 tons or 5% lower than the second quarter and a 182,000 tons or 14% lower than last year.

As a reminder, Domtar shipped 106% of its paper production capacity in the third quarter last year compared to 97% this quarter. Pulp shipments were 6% lower than the second quarter. As you can see on slide 11, we have built 24,000 tons of inventories in the quarter and sold 36,000 tons of lack of order downtime. To balance our system, we have announced yesterday the closure of paper machine number one at our Dryden Ontario Mill with a paper-making capacity of about 160,000 tons.

Moving to our merchant segment on slide 12, the segment added an operating income of $1 million dollars in the quarter on a D&A charge of $1 million. Higher deliveries and selling prices were move than offset by higher cost from purchase paper prices and an increase in allowance for (inaudible 00:08:25) account.

Now, the wood business on slide 13, the segment posting operating lot of $11 million in the quarter and other sequential improvements translating into EBITDA dollars now going to $4 million. This improvement is mostly due to higher selling prices for lumber and by product, lower cost and better productivity and a favorable exchange rate. And this was partially ousted by lower shipment.

Now, our current stakeholder, the strengthening of the U.S. dollar is having a positive impact on the possibility of our Canadian operation exporting to the U.S.. Given the volatility and to help understand our sensitivity to the exchange rate including our current portfolio averages, we have provided on slide 15 a simulated impact of the fluctuation of the foreign exchange rate on our profitability.

This slide shows the impact on our next 12 months EBITDA of various currency scenarios when compared to the last 12 months average exchange rate of $0.99. For example, the current exchange rate of $0.87, our next 12 months EBITDA would increase by approximately $115 million. We intend to continue our systematic approach for hedging and have the opportunity 50% of our next 12 months cash flow over protected.

Finally, our debt structure, we have no maturity prior to 2011 and mandatory repayments on our term long of $8 million per year with maturity in 2014. Our craft position at quarter end was $127 million. We have no drawing under our revolving credit (inaudible 00:10:07) which comprises of $30 in strong syndicate and we are in compliance with all our covenant.

So, we have a strong financial position. We are generating cash and will maintain our priority to debt reduction. So, this conclude my review, and with that, I will turn the call to Raymond.

Raymond Royer

Thank you, Daniel. As Daniel just mentioned, our financial position is quite strong. Since the closing of the transaction, our priority has remained on maintaining financial flexibility and deliberating our balance sheet. We have managed to decrease our net debt by over 20% in only six quarters including paying down close to $200 million of the secured term loan debt and buying back over $150 million of high coupon Canadian bonds.

As we intend to continue to manage our already solid balance sheet, we are making progress on our total debt reduction target of $400 million to $500 million set earlier this year and the focus remains on generating free cash flow to further strengthen our company's position and endure challenging times ahead in an uncertain economy.

Despite the financial stress in the market, our commitment to bring down debt and improving our credit profile was recently recognized when we received an upgrade from both S&P and (inaudible 00:11:41).

Turning to synergies, our profitability continues to benefit from the synergy program. Our internal analysis shows that we have already surpassed our initial target of a total run rate of $200 million before March 2009 and I am more confident than ever that we will meet our revised target of $250 by year end.

This is a key competitive advantage during a period of high inflation and clear sign that our teams have worked relentlessly since the closing of the transaction. Given adverse economic conditions and the continuous softening of demand for fine papers, we continue to take the necessary steps to manage our capacity to be the most efficient uncoated freesheet producer in North America.

Yesterday, we announced the closure of the Dryden paper machine and its remaining converting operations representing 151,000 tons of capacity. This is in addition to the closure of the Port Edwards mill last June made possible with the successful transfer of premium grade to more efficient lower cost operations.

Domtar's total capacity reduction since March 2007 now totals close to 700,000 tons of paper. The Dryden machine was the last high cost operation in our system for high volume grade and we believe we have now the lowest delivered cost position in North America.

For the fourth quarter, pricing on our core paper product is expected to remain flat, to slightly higher. Why do we expect further weakness in pulp prices and also price erosion in lumber? Volume should be down sequentially across all segments due to the typical seasonality of our business and a deterioration of the economy. Despite lower oil and natural gas prices, raw materials cost remain high and we expect higher energy usage during the quarter.

Lastly, if favorable foreign exchange rate savings from our synergy program and the leveling off of energy prices are expected to benefit Domtar's profitability in the fourth quarter. Looking ahead into next year, the debt and the duration of the slow down and the negative impact it will have on white collar employment, advertising, and direct mail activity makes fine paper demand difficult to predict for the next quarters.

Under those circumstances, we do not expect nor are we planning for any improvement in uncoated freesheet demand trends in the short term. Despite demand decline of over 5% year to date, similar to last year with unprecedented input cost increase and all these as we were working on integration of our two large businesses, our performances is remarkable and with demonstrated, we could deliver the synergies under any circumstances.

Our company as a leading position in the uncoated freesheet market and is better positioned from a financial standpoint. So, I am confident that our employees are in a much better competitive position to address the challenges ahead. I would like to take this opportunity to thank them all for their continued efforts and dedication and for making the new Domtar such a great company in a challenged industry. Thank you all, and I will turn back to Pascal.

Pascal Bossé

Thank you, Remo. Syvie, we are now ready to open up the call for the questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, if you do have any questions at this time, (Operator Instructions) And our first question will now come from George Staphos of Banc of America Securities. Please go ahead.

George Staphos – Banc of America Securities

Thanks, everyone. Good morning. Thanks for all the details.

Pascal Bossé

Good morning.

George Staphos – Banc of America Securities

And congratulations on the performance, I guess the first question I had with Dryden one now out of the mix, are you at a point where if you need to take any other capacity out, you begin to cut in some muscle, how would you manage capacity relative to demand which can continue to decline from your comments?

Pascal Bossé

I think, George, Daniel will take care of that. Very good question, in fact, that does not change our goal of managing our own supply in line with our customer demand. The first action that will always take when there is a lack of order is to take short term lack of order down turn and if there is some lack of order down time that deserve to look at maybe doing more drastic action like closing and other permission will look at it at the time when it is going to be needed.

George Staphos – Banc of America Securities

Okay, fair enough. As you think out maybe the next two or three years, what amount of cash might you need to deploy for further capacity reductions and severance? You have a figure that you could share with investors on this type or form?

Pascal Bossé

It is very difficult when it comes to kind of a forecast. There is many variables when you look into that. That depends of market decline, the demand decline. So far, we have been able to close mill, I would consider as very little cash impact and you have seen the AP on Dryden. I think that is the trend. That is probably likely to happen again, that type of value in the future but that all depends on where you reduce your capacity, what type of labor law exists there, what type of labor argument we have and what the environmental footprints of the mill.

So, it would be risky to give you a number but definitely, we are looking into that and we are trying to. It is part of our analysis of which mills should be next.

George Staphos – Banc of America Securities

Okay.

Raymond Royer

But I would like to add, Daniel, though that all of our people now are used to manage in a mature declining market and they understand what it means. And this is why they have been so strong in delivering the synergies ahead of time and has allowed me to increase the target to $250 million. But of course, after the synergy program, there will be something else also because the people understand that if we cannot move the cost, then we cannot be in that game. So, I see our people working very hard to continue to reduce the cost so that they can still operate.

George Staphos – Banc of America Securities

Thanks, Raymond, for that color. I guess two quick ones, I will turn it over one, how much do you think the build and inventory in the quarter help earnings in this quarter, how much do you expect you will need to throttle back reduction on the fourth quarter again to take inventories down? Thanks very much, guys.

Pascal Bossé

Obviously, we believe that our inventory can be and should be lowered and it was at the end of the quarter, so we are doing everything that we can do to end the year with a more reasonable number and that the same answer that we are really working at balancing our supply with customer demand taking into account the fact that we have built 24,000 turnover inventories.

George Staphos – Banc of America Securities

Alright, guys. I will turn it over.

Pascal Bossé

Thank you.

Raymond Royer

Thank you, George.

Operator

Our next question will now come from Mark Connelly of Credit Suisse.

Mark Connelly – Credit Suisse

Thank you. Just two question. First, when you look at the inventory pipeline, Domtar and any industry have done a nice job of keeping that inventory in balanced and that certainly help us on pricing, but we have seen customer inventories get out of whack in the past and I know you guys have said that it is harder for that to happen now with consolidation and distribution channel, but now that we have seen this big drop in consumption, how much do you worry about that that in fact some of the visibility maybe going away again with the variability and consumption?

Richard Thomas

Mark, it is Dick. I want to make sure I understand your question. I am not sure that there is less visibility in the customer inventories than in the past, we have lot of our large customers share this information with us and they have got fairly sophisticated supply chain programs where they order based on a targeted inventory level. In a number of cases, we see what that level is. So, but I think the other aspect of this is we have worked hard over the last year and a half to have a service platform where our customers do not have to carry as much inventory if they buy from us and we think this a key competitive advantage that we offer. And I guess the last -

Mark Connelly – Credit Suisse

Do you think the risk of customer inventory back up is substantially lower then? I mean obviously it killed us in 1995.

Richard Thomas

I think it is significantly lower. We have better data. We get data from AF and PA. We get data from our customers and really in the credit environment we are in today, people are carrying less inventory and again, not to repeat myself, but we think that is becoming more and more a key reason why they want to buy from us because we enable them to do that.

Mark Connelly – Credit Suisse

And a quick question for Daniel. Cash flow operations, obviously very nice and strong in this quarter, are there any important one time issue we should be keeping in mind for the fourth quarter?

Daniel Buron

Not really, Mark. I think the fourth quarter is expected except for Dryden that you have seen the numbers in the AK except for Dryden, Q4 should be as usual. Normally, Q4 is also a good cash flow quarter. There is after U.S. thanksgiving, we have kind of a slowdown in the business and we do create cash at the other time by reducing receivable and managing our inventories. So, I think we are expecting Q4 to be a good cash flow quarter.

Mark Connelly – Credit Suisse

Thank you.

Daniel Buron

You are welcome.

Richard Thomas

Thank you, Mark.

Operator

Thank you. Our next question will now come from Claudia Hueston of JP Morgan.

Claudia Shank Hueston – JP Morgan

Thanks. Good morning.

Raymond Royer

Good morning, Claudia.

Claudia Shank Hueston – JP Morgan

I was hoping if you could just provide a little bit more color on what you have seen in demand terms for uncoated freesheet as it moves through September and into October here have turned sort of stabilized or is there any real shift in terms of the subgrades of uncoated freesheet.

Richard Thomas

Thanks, Claudia. This is Dick. What we have seen is demand was softer in July and August as it customarily is and then it did not pick up in September and October. So, I would not say it fell off but from a GAAP standpoint, it did, because normally September and October are busy times for us, and this year, we did not see that pick up materialized. So, I guess the bottom line is as Raymond said, this 5% ballpark range, we do not see anything that would suggest it is going to improve.

Claudia Shank Hueston – JP Morgan

Okay. But it does not seem like it is getting materially worse from that level either?

Richard Thomas

No. We want to say the direct mail was suffering but really, they have suffered all year. So, marginally, worse given the economic circumstances perhaps, but I think what we have missed here is this pulp pickup.

Claudia Shank Hueston – JP Morgan

Okay. That is helpful. I also was just hoping if you could talk a little about fiber cost and what your expectations are for the fourth quarter. Have they had a peak? Are you getting any release yet from diesel of do you expect them to move higher from here or at least versus third quarter average?

Michael Edwards

Good morning. This is Mike Edwards, VP of Manufacturing. We are starting to see a leveling off of fiber cost from other cost and system going into fourth quarter.

Claudia Shank Hueston – JP Morgan

Okay. And then just, finally, do you have any thoughts on CapEx yet for 2009?

Daniel Buron

Not yet. We are in the budget forecast in this similar time every year, I would be able to give you more color on the Q4 conference call.

Claudia Shank Hueston – JP Morgan

Okay. And then you just remind me of your target for 2008 please, for CapEx?

Daniel Buron

The target, the lower range was $180 million and we should be very close to that lower range.

Claudia Shank Hueston – JP Morgan

Okay, thank you very much.

Daniel Buron

Thank you.

Operator

Thank you. Our next question will now come from Steven Chercover of D.A. Davidson. Please go ahead.

Steven Chercover – D.A. Davidson & Co.

Thank you. My first question is would the shutdown of the machine at Dryden, will the pulp mill still run into that, therefore, increase your market pulp availability?

Daniel Buron

Yes, Steve. You are right. The pulp mill will still run. That is going to give us a very limited increase of market pulp because the mills at Dryden are limited so that should not have a big impact on our net pulp position.

Michael Edwards

Again, this is Mike Edward, that the pulp at Dryden is very fairly favorable long fiber pulp that is used in tissue and toweling and Dryden is a very desirable long fiber pulp and it is also (inaudible 00:26:20). As for pulp flows as well we will use this as a opportunity rebalance in our pulp flows across our manufacturing system.

Steven Chercover – D.A. Davidson & Co.

Okay, thanks. I really like your simulated EBITDA slide, the effects on. If we look at the comment on profitability in the fourth quarter, should we just basically say that affects and the synergies and energy will offset lower volumes and also the impact of declining pulp prices?

Daniel Buron

Assuming everything stay the same and we all know that the effect has move to $0.20 in 20 days in October and it is now moving on the other side. So, it would be a wild assumption to believe that it is going to stay stable until the end of the year but they are offsetting factors.

Steven Chercover – D.A. Davidson & Co.

Great, thanks, Daniel and thanks for everything, Raymond.

Raymond Royer

Thank you.

Operator

Thank you. Our next question will now come from Robert Howard of Prospector Partners. Please go ahead.

Robert Howard - Prospector Partners

Good morning.

Daniel Buron

Good morning.

Robert Howard - Prospector Partners

I want to check about the share count. I noticed that it is up to $515 million shares and I did not see any shares that you want to lose. Is that a bunch of new shares coming out from maybe management incentive type things or what was?

Raymond Royer

There was no real issue of shares since the inception of the company in March 2007. So, may be the (inaudible 00:27:57) come from some reports are quoting only the share that are listed that are attached to the Domtar Corporation. There is an exchangeable portion of those share that are exchangeable on a one-to-one basis for Domtar Corp share so that full amount of shares since the beginning of this venture is 515 million shares.

Robert Howard - Prospector Partners

Okay. Because in the last 10-Q, it said there were 492 million shares.

Raymond Royer

I guess you are referring to the way that rate number of share?

Robert Howard - Prospector Partners

Just page one of the last 10-Q says as of August 6, there were 492 million shares outstanding.

Raymond Royer

Again, including the exchangeable share, it has been 515 million and —

Robert Howard - Prospector Partners

Okay.

Raymond Royer

—since the beginning. If you are looking at the EPS or the number that is being used to calculate the EPS, per accounting rule, there is some assumption you have to make before the inception of the corporation on March 2007 and that accrual or change a little bit the weighted average number of share, but the outstanding share or the real outstanding shares since the inception is 515 million shares.

Robert Howard - Prospector Partners

Okay. Yes. I just wanted to queue here and see that. Okay, great, thanks. And then, what do you see with the big energy cost drop drastically over the last few months. What do you expect, part of the increase in inventories has come from higher energy cost and other things, raw materials and other things, how much of the reversal might there be in the next few months and benefits there?

Raymond Royer

In terms of direct consumption and energy, we are consuming the natural gas and bunker oil, we have not seen the same type of increasing bunker oil than in the crude oil but we should see some benefits form that and natural gas is also going down so we should have some benefits. There is also an indirect portion of impact on us on freight and we have not seen so far a lot of decline in the diesel price in the U.S., so the freight or the indirect portion energy impact on us is kind of still very high.

Robert Howard - Prospector Partners

Okay, this benefit I guess does not have any sort of quantified.

Raymond Royer

Not yet.

Robert Howard - Prospector Partners

Yes. Okay, great. Thanks. Good results this quarter.

Daniel Buron

Thank you.

Operator

Thank you. Our next question will come from Christopher Chun of Deutsche Bank. Please go ahead.

Christopher Chun – Deutsche Bank

Yes. Thanks. Good morning, guys.

Daniel Buron

Good morning.

Christopher Chun – Deutsche Bank

I just wanted to talk a little bit about your outlook about prices in pulp and paper. You mentioned that you are seeing pulp prices go down but you are expecting paper prices to hold up. What would you say to the argument that given the fact that they are non-integrated producers out there that declining pulp market gives them increased margins, perhaps giving them the leeway to chase volume with price going forward?

Richard Thomas

This is Dick. Let me see if I can respond to that. Certainly, what you described from a connecting-the-dot standpoint is accurate. The question is whether there are enough players of that site to impact the marketplace in the balance and we do not think that there are. In fact, there are fewer non-integrated players in North America than they were three, four, or five years ago while the capacity that you have seen shut down due to weak cost position has been these non-integrated.

So, we think that there about as separated as they can be and that pulp price while it will help some players who were struggling, it is an economic benefit. We do not see it as enough of a dynamic to affect the marketplace. So, to be honest with you, I think we are probably more concerned about exchange rates than we are about pulp prices at this point. The strengthening of the dollar is something we are watching carefully.

Christopher Chun – Deutsche Bank

Yes. That was actually my next question. We are actually, here, there maybe new capacity coming in Europe that may be targeting the North American market and I am wondering what the U.S. dollar where it is, what your thoughts would be on the relative competitive position of your mills versus potential foreign competition.

Richard Thomas

Well, history says that we have never seen a big influx in uncoated freesheet into the U.S. regardless of the exchange rate. So, there are other factors certainly product expectations delivery. We talked earlier about inventory and service positions. So, there are other hurdles to climb. It does not mean it cannot happen and as I said, we are watching it carefully but we feel that within North America, we have got a very competitive system and we have also got a much enhanced competitive position to what we had a year and a half ago, and when you think about it, that is really what we have been working on this time.

We have got consolidated distribution system with our key products there. We have consolidated our brands. We have expanded our earth choice FSC products and we have got better channel balance than we have ever had. So, we feel very good about our ability to compete.

Christopher Chun – Deutsche Bank

Okay. My final question has to do with the potential impact of declining volume on your cost position. You talked about how the first thing you would do at this point in case of weaker demand would be to take market down time but I am wondering to what extent taking market downtime would tend to drive up your average cost. Can you talk about the relationship there?

Daniel Buron

Let me try to answer that question. This is Daniel speaking. I think when we take lack of order downtown it is because there is no order for the capacity we have. So, one way or the other, it is beneficial to take rebound from lack of orders from a financial standpoint. And so it – definitely there’s a cost associated with lack of orders on time. If you compare it to being able to sell your entire capacity but I don’t think this is true comparison that we would make it able to do that.

So, on the – it’s more costly to run to take downtime than to run. It’s beneficial overall. And when we look at our mill system, we rank the asset and we’re going to try to take down time where it’s the most efficient say down time. And again, if we come to conclusion at some point that there’s enough lack of better down time to be forced to make a permanent decision somewhere, we’ll reduce capacity at our highest cost paper machine. Which should have an impact of improving our average cost overall.

Christopher Chun – Deutsche Bank

Right, I guess I was kind of thinking in terms of fixed costs versus variable costs because you know, if you have weaker volumes, you would tend to still have your fixed costs spread out over a lower volume which would be bad. But your variable cost you know, you can take out right along with…

Daniel Buron

You’re absolutely right. And that’s what happened over the last few years. We were taking lack of orders on time and when you do take the permanent decision, when there’s enough lack of hold down time, the benefit of that action is to remove the fixed costs that are attached to a part or piece of asset.

Christopher Chun – Deutsche Bank

Okay. Thanks for your help.

Operator

Thank you. Our next question will now come from Steven Atkinson from BMO Capital Marketss the most efficient say down time. and the asset and we' to do that. so .

Steven Atkinson – BMO Capital Markets

Morning. Thank you. Couple quick questions. Any savings or costs associated with the Dryden shutdown?

Daniel Buron

I think the city will see, Steven, is the fixed asset we refer to in the prior question. We took lack of orders on time into June 3, 2010. We took like a whole (inaudible 00:37:10) at the beginning of this quarter again to balance our – to plow with our customer demand. By removing Dryden, the fixed costs of Dryden will be felt here and we will then serve our customers from other locations.

Steven Atkinson – BMO Capital Markets

So there’d be a…

Michael Edwards

We moved the capacity of the production out of Dryden to lower cost facilities who were taking less market down time in the lower cost facilities.

And also, what we’ve been doing as well is we’re looking at trying to balance by now going forward, we will use every opportunity we’ve got to be cutting on all higher cost fiber. In some cases, when we were looking at where we’re taking our down time in some of these input costs, optimize our costs and these particular facilities where you do have some higher fiber if you’re going further afield for fibers, an example.

Steven Atkinson – BMO Capital Markets

Okay. So, in effect, down the road, then we would see the benefit as you balance the shall we say the wood supply and the orders?

Michael Edwards

That is correct.

Steven Atkinson – BMO Capital Markets

There was a 12 million dollar business acquisition in the quarter. What was that?

Daniel Buron

That’s the acquisition of 50% joint venture that we had with the partner in the Ste Marie operation. What was – that partner had a right to put on us after the creation of the Lumber Corporation on March 7th. So, we had no other choice than to buy under the shareholder agreement that we had with them.

Steven Atkinson – BMO Capital Markets

Okay. And so while we’re on Lumber, any plans there or any progress on the sale or disposition?

Michael Edwards

Well two points to raise with the lumber, first you know that we had an agreement with the Quebec government and unfortunately this agreement has not been confirmed in writing. But at the same time, our employees are working very hard to reduce the cost and the results that we are, that we have now are a result of all those efforts. With the election that must be announced or should be announced today in Quebec, I don’t think we will have anything in writing before the end of this year. So, it’s postponing this transaction. But at the same time, the weakening of the Canadian dollar is such that this operation will lower its cash loss if the Canadian dollar remains where it is now.

Steven Atkinson – BMO Capital Markets

Okay. Uh hm. And finally, on the hedging program, if the Canadian dollar was to go above the U.S., do you have a, shall we say, protection?

Daniel Buron

The prediction is around, if my memory serves me well, I think it’s 98 cents at the publishing rate and we’re participating currently I think up to 86 or something. So, yes, we buy range forward most of the time, Steven, on that front.

Steven Atkinson – BMO Capital Markets

Okay, so you have a collar, in effect.

Daniel Buron

Okay. Thanks a lot.

Daniel Buron

You’re welcome.

Operator

Thank you. Our next question will now come from Benoit LaPlante of Scotia Capital.

Benoit LaPlante – Scotia Capital

Thank you, good morning. This one’s for you Daniel Buron, if you just, on the cash taxes side, can you give us an indication in terms of what your situation if we assume profitability remains more or less at the same level. What’s your cash tax situation and is there any changes in coming quarters from what we’ve seen in the last few quarters?

Daniel Buron

I think we’ve seen an abnormal situation in profitability in this quarter as a result of the transaction of Mark VII and we have a kind of tree group of taxes we have to follow in order to give them some sort of guidance. There’s a Canadian asset and there’s no cash tax in Canada and we know why, with the difficult environment in Canada the last few years.

In the U.S. we have the legacy of Weyerhaeuser where we’ve, and as I said, very low taxes were being cash taxed from – I mean, with very limited tax shield. And the legacy Domtar U.S. asset, we had significant lot carried forward that were coming from an asset acquisition in 2001 and we – and the quick depreciation from a taxing point in the U.S.. At this quarter, we have this special situation where we made the significant containment for charges from our Canadian operations to our U.S. operations that edge any type of charges that were assimilating since March ’07. And since per tax rule, that type of charge can be deducted just when you pay, you actually make the payment. And then when you accrue the expense from a cash standpoint or a cash tax standpoint in this quarter, we were able to resume that to almost zero. But we should be back to normal situation in Q4.

Benoit LaPlante – Scotia Capital

Okay, great. And maybe just on the maintenance side. How much more maintenance would be planning through forwards of Q3 dollar wise?

Daniel Buron

Maintenance CapEx or are you referring to maintenance of the…

Benoit LaPlante – Scotia Capital

Maintenance CapEx.

Daniel Buron

Well maintenance CapEx is indeed the forecast is at the highest will be 180 million and we’re at 114 so far this year. So, we’ll continue to progress on our CapEx and I doubt this will reach the 180 but that’s the forecast for the time being.

Benoit LaPlante – Scotia Capital

And any round rate going forward?

Daniel Buron

In 2009, we’re in the budget to assist and win and we’ll do as we’ve done last year at the Q4 call. We’ll give some guidance on key items like CapEx would be on, interest expense and other type of guidance as we gave last year will be given out too at the Q4 call.

Benoit LaPlante – Scotia Capital

Great. Thank you.

Daniel Buron

Thank you.

Operator

Thank you. Our next question will come from Sean Stewart of TD Newcrest.

Sean Stewart – TD Newcrest

Good morning, thank you.

Daniel Buron

Good morning.

Sean Stewart – TD Newcrest

Raymond, just wanted to clarify your comments on the wood business. Is it correct to assume that if the government provided better clarity on the cutting rates, that you still have interested parties? Or I would have guessed, just with the capital markets being what they are that it might’ve been tougher for potential buyers to pull the capital together.

Raymond Royer

No, we’ll still have interested parties because the operation now you know in Quebec, we are very productive and with all the saw mill shutdowns, people are very interested by our assets that we have both in Quebec and in Ontario. And especially with the quality of the fiber that we have in the stock of lumber here. So, we have interested parties but you cannot come through just any transaction when you don’t know exactly how many cubic meters you will have at the end of the day. So, we know that we have about 2.5 million cubic meters in Ontario. The question is, how many will we have in Quebec? Is it one million, is it one and a half million? And this will affect of course, the value of this asset.

Sean Stewart – TD Newcrest

Okay. And another follow up, I guess question for Mike on Dryden, following on Steve’s question earlier. Just trying to understand that mill’s competitive position as a stand alone pulp mill now. At the current exchange rate, could you comment on where that mill would fit on a North American cost curve at this stage?

Michael Edwards

On the north, and this again is Mike. On the North American cost that Dryden does suffer from high fiber costs and high energy costs. But at the same time, the fiber is very desirable from markets in North America. And I would believe that Dryden would sit in the middle of the pack from a North American, northern with perspective in terms of manufacturing costs.

Sean Stewart – TD Newcrest

Okay, that’s helpful. Thank you.

Daniel Buron

So we have time maybe for one last question.

Operator

All right. Our last question will come from Mark Wild of Deutsche Bank. Please go ahead.

Mark Wild – Deutsche Bank

Morning.

Daniel Buron

Good morning, Mark.

Mark Wild – Deutsche Bank

Dick, is it possible to just get a little more of an update on the price situation. You guys had been exporting I think some paper over to Europe, perhaps elsewhere and maybe you can just talk about what you’re doing in the export side, whether that’s changing with currency and then also what you might be seeing in terms of imports.

Richard Thomas

Great question. And very dynamic. As you know, our position Mark, reflects really what we’ve talked about earlier. We continue to export textiles. We view that as a strategic position and for the reasons we talked about before, that continues. Obviously the net backs today aren’t what they were a few months ago but, again, that’s directionally a business we plan to continue to sell.

On the world side, you remember that in the third quarter a year ago, we shipped a significant amount of world business to export and that’s a big part of the reason we’re able to ship 106% of our capacity during that quarter. That opportunity was not there this year because of exchange rates and so we exported a little bit of world business but not a heck of a lot. It just wasn’t the right environment. It was a question of net backs as well as the overall climate just wasn’t conducive to trying to export world business.

So, going forward, we’ve talked about this a lot and we don’t see a dramatic change. We’ll continue to be a bit opportunistic on the world side. Obviously there’s circumstances where it makes sense to export some product. But on the cut size, we continue to export and at a pretty steady rate, honestly. Regarding imports, as you know, our data lags a couple of months but what we see so far is anecdotally, maybe a little bit of an increase. We’re watching it carefully. I don’t have any evidence that there’s a significant increase at this time. So, again, it’s definitely something to watch.

Mark Wild – Deutsche Bank

Okay. Another kind of question for you I guess, Dick. The LWC volumes were down quite a bit. Can you just talk about how you’re trying to manage the situation down in Columbus?

Richard Thomas

The, we’ve done a lot of work to improve our cost position at that mill and it’s taken some time. I’m not sure we’ve talked about this previously but we converted that mill to outgoing a year ago and that was a difficult changeover. We’ve done a lot of great work over that ensuing year to improve the cost position and we feel much better about it today. The fact of the matter is that LWC is totally on its heels at this point. Demand has fallen off a cliff. You know and late in the second quarter and so we’re struggling. We’ve taken some market down time there and you know, it’s a tough business.

Mark Wild – Deutsche Bank

Well I just, you know, it looked like you were down almost 50% year on year in shipments. And I didn’t know how much of that was you know, down time or whether there were some other issues involved there.

Richard Thomas

There were a combination of down – certainly wasn’t all down time. It was partly that we ran much better in the equivalent quarter a year ago than we did this year. So, and so–

Mark Wild – Deutsche Bank

Okay.

Richard Thomas

From a combination of factors.

Mark Wild – Deutsche Bank

Okay. One other question, just the performance in the merchant group, well it’s you know not a lot. It seems to be lagging on an event margin basis to one of your other integrated peers. And I wondered if we could just get some thoughts on that.

Daniel Buron

Let me give you some color on that market. First of all, our merchant business is a pure paper merchant business. My guess of your comparison that it’s selling a lot more type of products than just pure paper.

Mark Wild – Deutsche Bank

Yes.

Daniel Buron

I think our merchant business is also impacted by the live entry evaluation. Every time that there’s a price increases, they have some sort of difficulty to pass that on to their own customers. But for gap because of live full, what they have to put in there costs of goods sold line is last pricing that we bought that paper for, from. So, that’s one other reason that explains the lag. I think it’s a good news because price are increasing but there’s a negative impact because of live full. And there’s a little bit of created bad debt probably increasing bad business and we all know that the merchant business is challenged in the current credit environment.

Mark Wild – Deutsche Bank

Okay. And actually, one other question. One of your smaller competitors was out with earnings yesterday. They were mentioning perhaps a little bit of pricing softness in encoded free sheets. I’m kind of hearing about imports coming in at a little lower price. Can you just, can you talk about that at all?

Richard Thomas

Yes, Dick again. We’re not, we actually, our view that is fourth quarter prices will be the same or marginally higher just because we had increases that were flowing through to the bottom line in the third quarter. So, I don’t see any reason to forecast price declines at this point. You know, we absolutely got the full increases on copy paper and the other grades that were announced during the summer. So, I think we feel pretty solid about pricing.

Mark Wild – Deutsche Bank

Okay, very good. Thanks, good luck fourth quarter.

Richard Thomas

Thank you.

Daniel Buron

Thank you very much. Thank you to all of our participants today and we wish you a very good day. Thank you.

Richard Thomas

Thank you all.

Operator

Thank you. Ladies and gentlemen, this does conclude your conference call for today. Once again, thank you for participating and at this time we ask that you please disconnect your line. Have yourselves a great day.

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Source: Domtar Corporation Q3 2008 Earnings Call Transcript
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