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Domtar Corporation (NYSE:UFS)

Q1 FY08 Earnings Call

May 06, 2008, 10:00 AM ET

Executives

Pascal Bossé - Director of IR

Daniel Buron - Sr. VP and CFO

Raymond Royer - President and CEO

Richard L. Thomas - Sr. VP, Sales

Analysts

George Staphos - Banc of America Securities

Mark Connelly - Credit Suisse

Richard Skidmore - Goldman Sachs

Claudia Hueston - J.P. Morgan

Mark Wilde - Deutsche Bank

Chip Dillon - Citigroup

Benoit Laprade - Scotia Capital

Tora Williams - Omega Advisors

Operator

Good day ladies and gentlemen and welcome to Domtar first quarter 2008 financial conference call. At this time, all participants are in a listen-only mode. 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. Please go ahead, sir.

Pascal Bossé - Director of Investor Relations

Yes, thank you Sylvie [ph] and good morning everyone. Welcome to Domtar's first quarter 2008 conference call. Joining me on the call today are President and CEO, Raymond Royer; Executive Vice President and COO Marvin Cooper, Senor Vice President and CFO, Daniel Buron; and Senior Vice President of Sales, Dick Thomas.

We will start-off this morning with brief remarks on the result and then we will open-up the call for questions from the investment community. People from the media and others stakeholders will be placed in a listen-only mode. As a reminder, our speakers will make references to supporting slides and you can find those in the Investor section of the website to the right hand side, under reports and documents.

I wish to remind you that this call will contain forward-looking statements based upon a number of estimates and assumptions that are subject to risks and uncertainties. I invite you to review the company's filings with the Securities Commissions for listings of those.

Finally, Domtar Corporation reports according to U.S. GAAPs and dollar figures discussed are all U.S. dollars, unless specified otherwise.

And with that, I'll turn the call over to our CFO, Daniel Buron for opening remarks. Daniel?

Daniel Buron - Senior Vice President and Chief Financial Officer

Thank you, Pascal. Good morning, everyone. Domtar reported today net earnings of $0.07 per share in the first quarter, compared to a net loss of $0.05 per share in the fourth quarter of 2007. As you are seeing, for items that I'll cover in a minute, our earnings before items was $0.05 per share in the first quarter. This compares to $0.06 per share recorded in the fourth quarter. The EBITDA before items in Q1 declined $15 million from the fourth quarter to $196 million. Worth mentioning is the inflation on fiber, chemical, energy and freight of $40 million that reduced net earnings by approximately $0.05 per share in the first quarter when again compared to the fourth quarter of 2007.

On slide five, you can see that there were three non recurring items impacting our results in the quarter. A provision reversal of $23 million related to the early termination of an unfavorable contract assumed by the corporation at the time of it's transaction with Domtar Inc.

Cost of $8 million related to synergies and integration and cost of $1 million for restructuring. Excluding these items, earnings per share stood at $0.05 in the quarter.

Turning to slide six, sales were up $12 million in the quarter, mainly due to higher selling prices for paper and pulp offset by overall lower volume in mix. Cost of sales increased $23 million in the quarter. As mentioned, inflation on fiber, chemical, energy and freight amounted to $40 million and this was partially offset by the $23 million provision reversal, I just mentioned.

Depreciation and amortization declined $70 million in the quarter and this is mainly due the finalization of the purchase price adjustment related to the Domtar-Weyerhaeuser transaction and also the impact of the write-off of one paper machine at our Dryden facility in the fourth quarter of 2007.

Finally SG&A declined $24 million from the fourth quarter. Approximately, $13 million of this decrease is due to lower synergy and integration cost incurred in this quarter.

Turning to cash flow on slide 7, cash flow from operating activities amounted to $27 million in the first quarter, a reduction compared to the fourth quarter. This is primarily due to the seasonal investment and working capital including $55 million for receivables.

Capital expenditure amounted to $29 million in the first quarter or 25% of D&A. We also sold some land in Quebec representing approximately 42,000 acres for a total proceeds of $21 million. Net debt was reduced by $21 million in the quarter translating into the net debt-to-total capitalization of 41% unchanged from the fourth quarter.

The water fall slide on page 8 shows that we benefited from higher selling prices for paper and pulp, but this was partially offset by lower prices for longer product for an overall positive $25 million in the quarter. The benefits from our good performance on cost saving and synergies up $11 million, and a favorable foreign exchange rate that reduced our Canadian cost by $8 million. These positives were more than offset by inflation on fiber, chemical, energy, and freights reducing EBITDA by $40 million.

Higher uses for energy, fiber, and chemical amounting to $17 million and lower overall volumes and mix for $2 million.

Slide nine to eleven provide you with more information on our raw material cost. Starting with fiber representing approximately 19% of our quarter sales. We split the mills into three regions, you'll find at the bottom of the slide. The recent escalation in wood cost translated into sequential and year-over-year fiber cost increases of 5% and more than 10% respectively on a procurement basis. Kamloops, BC, Dryden, Ontario, Woodland, Maine and Ashdown, Arkansas are mills that have experienced the most significant cost increases when compared to last year.

Turning to chemicals on slide ten. We provide example of cost increases for five of our largest chemical. On the positive side, we have seen large cost increases for sodium chlorate, caustic soda and sulfuric acid while on the paper making side, cost of starch and calcium carbonate have also increased significantly. I would like to mention that these five chemicals account for about 60% of our total chemical cost.

Finally, for energy cost on slide eleven, we have seeing significant increase on direct energy consumption including natural gas and Brent Crude oil which will provide sensitivity for. But, in addition we also consume coal and purchase power where we have also seen cost increases. All in all, direct energy cost accounts for about 8% of our cost of sales.

Turning to our segmental review, starting with paper on slide twelve. This segment posted an operating income of $114 million in the first quarter and depreciation and amortization charges up $110 million. That translates into an EBITDA of $224 million or $210 million before the impact of the three non-recurring items, I mentioned earlier. At the operational level paper shipment in Q1 were 45,000 tons higher than in the fourth quarter. On the pulp front shipments were downed 64,000 metric tons due to a combination of higher than normal shipment in the fourth quarter and lack of availability of vessels in the first quarter.

Transaction prices were strong and continued their upstream across all paper grades with copy paper prices and offset roll prices up $14 and $15 on the ton basis. Same story for pulp where momentum continued particularly for hardwood grade and this translate into higher prices of $46 a metric ton on a hardwood and $19 a metric ton on softwood. We expect improved price realization in the second quarter as the increases announced and implemented will reach their full impact.

In terms of variances, the decline operating income from the fourth quarter was due to higher cost end user for raw materials and lower cost shipment. These factors were mitigated by higher selling prices for paper and pulp, higher paper shipment, a favorable foreign exchange rate and the benefit of our synergy program.

Turning to slide 13, with the reorganization of production at our Dryden mill, we have not taken any lack of orders on timing our paper operation in the first quarter. In line with our commitment to balance our production to our customer demand, our shipment production rates still stood at 103% in the first quarter compared to 98% in the fourth quarter of last year.

Finally, on slide 15 and 16 paper inventories were reduced by 27,000 tons and pulp inventory increased by 22,000 metric tons in the quarter.

Turning to our paper segment on slide 17. The segment posted an operating income of $3 million in the first quarter. The $2 million increase in operating income when compared to the fourth quarter is due to higher delivers to customers that reached an all time record for the Distribution Group and lower the D&A in the quarter.

Finally, on our wood business on slide 18. The segment posted an operating loss of $22 million in the quarter, unchanged with the fourth quarter before the goodwill impairment. The D&A dollars grew $2 million to $16 million in the quarter and this is due to lower selling prices in the amount of $17 a 1,000 a roll sheet and lower shipments that decreased 7% from the fourth quarter.

Our efforts to minimize cash losses continue and we have announced temporary shutdown in the second quarter at the Dryden and St. Mary Sawmilling operation for seven and four weeks respectively.

Finally on slide 19, we haven't made any changes to our key financial assumption for fiscal 2008. But, just a reminder on slide 20, our second quarter is a busy quarter for maintenance work at several of our pulp and paper mills and this is expected to increase maintenance cost by approximately $70 million compared to the first quarter.

This concludes my review and with that I'll turn the call over to Raymond.

Raymond Royer - President and Chief Executive Officer

Thank you, Daniel. Good morning to all our listeners. Before turning to questions, I would like to quickly look at some of the key financials on a rolling 12 months basis, review our operations accomplishment, our recent sales and marketing initiatives and finally provide an outlook for the upcoming quarter.

Reported EBIDTA before items was $196 million in the first quarter on record sales of $1.7 billion. This brings out full year of operation to end last twelve month EBITDA before items of $867 million on LTM sales of $6.6 billion.

While we've seen a slight reduction from the year end pro forma EBITDA before items of $808 million due to unforeseen cost inflation for raw materials, the benefit from synergies are clear with more than $120 million of incremental EBITDA over the 2006 pro forma number.

To offset inflation, we've announced in January and implemented in March price increases for business papers and commercial printing and publication papers including increases of $60 per tons on cut size and a similar increase on offset rolls.

All in all these increases cover over $3 million tons of our paper product offering and the late implementation in March will result in most of the impact flowing through our results in the second quarter.

Turning to slide 23, the free cash flow in the quarter was negative $2 million and this is due to the investment made in working capital items mostly receivables of more than a $100 million. Our LTM free cash flow is now running little over $400 million. Net indebtedness was mostly flat from year end levels translating into a net debt-to-total capitalization of 41%, unchanged from the fourth quarter.

Turning to operations beside an extended maintenance shut down at Plymouth, our operations ran well in the quarter with better production at approximately the same level as then in the fourth quarter. Our customers continue to show great support to Domtar, and we had good order books that allowed us not to take any lack of order downtime, while bringing paper inventory levels down by 27,000 tons with price realization inline with trade publications.

The announced closure of the Port Edwards mill is scheduled for the second -- for the end of the second quarter and the transfer of the grades to the Nekoosa and Hawesville mills is currently underway.

In the process, we have also announced the sale of our text cover in writing brands that could not be transferred to other mills, in an effort to support our customers. This transaction will continued to reinforce our focus as the North American market leader in the areas of commercial printing, business and office as well as converting and other specialty papers.

Finally, while there were few incremental benefits from synergies on a run rate basis in Q1. We continue to make progress on our synergy projects and the later needs our initiatives launch, work the consolidation of our retail and distribution centers and the start-up of the Chicago folio sheeter.

Our plans are on track, and I'm confident we can surpass the $200 million synergy target by year end. Let's take a look at some of our sales and marketing initiatives during the quarter.

I am happy to welcome the Lynx Opaque line of products and its integration into the EarthChoice family. Once again, I believe Domtar is heading in the right direction to deliver quality environmentally, friendly products that are highly regarded by our customers.

We continue to focus on brand rationalization and SKU reduction with initiative such as the launch of Husky offset as the Domtar offset and it's reintroduction in the market with an SFI labeling. We've also launched Saturn, a new number coated groundwood paper made in the Columbus Mississippi mill that will compliment number five Choctaw that is currently produced while improving the mills financial performance.

Finally, I'm very pleased that Domtar has been recognized as a supplier of choice by Staples. The Staple suppliers Soul Award was presented to Domtar during their 2008 global sales meeting and suppliers show and I'd like to congratulate our sales marketing and logistic team for this honor.

Turning over to our wood business due to continuing deteriorating demand and prices for lumber products, we will be reducing operations to one shift at our Timmins, Ontario sawmill operation and we will be taking down time at our Val d'Or and Sainte-Marie samill for seven and for weeks respectively. There is no doubt that their market continue to be challenging for Eastern Canadian operation and our employees are not sparing any efforts on things under our control to limit cash losses of the business. On this note, we have announced last week an agreement in principal with the Quebec government for the reallocation our harvesting right in Northern Quebec by guaranteeing the required volume of fiber this announcement will have us restore the viability of the Matagami and Val d'Or sawmills through the addition of second and third shifts. Clearly this agreement represent the best news in a long time for our employees and those communities and we will cooperate with public authorities through the consultation process.

Looking forward, as Daniel mentioned cost inflation was significantly higher than the budget in the quarter, and we expect continued pressure from the soaring energy prices on fiber and chemicals cost, as well as freight cost. We believe the uncoated freesheet market is balanced with industry operating rates for the quarter at an estimated 94%.

Our paper inventories are in good shape. We are not contemplating any lack of order down time as this shown to be closed spotted mills, will further tighten our mill system. Having said that our industry is not sheltered against an economic slowdown and the risk of a demand decline more pronounced than the long term trends have increased. In those circumstances, we will closely monitor our order books and backlog and we will adjust production to our customers demand.

Before turning the call to Pascal, I would like to say a few words on Domtars capital allocation and the priorities over the next quarters. From the very beginning last year, Domtar executed on its commitment and made a lot of progress in paying down debt, to improve its profile in the credit market.

Our business fundamental are sound and we've seen developing a good balance between supply and demand in our coat, uncoated freesheet business. However, the current environment with severe inflation pressure, and the economic slowdown in the US represent added challenges to our organization and the current uncertain financial market remind us how important it is to maintain access to the capital markets at reasonable terms and condition.

In the past month, we have carefully looked at our capital structure supported by external advice and consistent with our previous stated leverage targets of 40% debt-to-cap ratio and 2.5 times debt-to-EBITDA, it is clear that the best way to create stockholder value is to lower our cost of capital by pursuing the same focus on debt reduction to get as close as possible to investment grade.

Domtar currently at $1.5 Billion worth of unsecured debt rated single B-plus that was issued when the company was triple B-minus and we must be able to refinance on their similar terms and conditions.

Domtar Corporation is a new organization with investment seizes, rest on a strong financial position and we believe that the rigor we've demonstrated so far in managing our balance sheet enhances our investment profile within our industry. We are considering that pursing the same path and not implementing a dividend at this point is a best way to lower our cost of capital and ensuring long-term sustainability stock value. Thank you all for your support and I will turn the call back to Pascal.

Pascal Bossé - Director of Investor Relations

Yeah, thank you Raymond. And, Operator we're now ready to open up the call for questions from the investment community.

Question-And-Answer Session

Operator

Thank you, sir. (Operator Instructions). And our first question will come from George Staphos of Banc of America Securities.

George Staphos - Banc of America Securities

Thanks. Hi, everyone good morning.

Daniel Buron - Senior Vice President and Chief Financial Officer

Good morning.

George Staphos - Banc of America Securities

Two or three questions quickly. First of all, Daniel or Raymond, can you let us know what run rate of inflation are you currently experiencing 2Q versus 1Q? Is that definitely at currently levels would we see further negative variances on the cost side versus what you saw on the first quarter? Secondly, did you comment on recent demand trends in North America, specifically March on freesheet. How much do you think the shipment that it was operational, how much you think was reflecting pre-buying and what trends are you seeing April? Thank you.

Daniel Buron - Senior Vice President and Chief Financial Officer

Good morning, George. I'll take the first part on cost inflation and Dick will answer your second part on the demand trends. It's difficult to answer that question, we were surprised by the magnitude of the increases that we had to face in the first quarter with the barrel currently at $120. It's kind of difficult to predict what's going to happen. I think, everybody know that we're all using, or energy is used in almost everything in our life. So, definitely our chemical suppliers are consuming energy, so their price and their cost is influenced by that. So, I think we're going remain under pressure for additional inflation until the price of oil stabilizes.

George Staphos - Banc of America Securities

Would it fair to say that directionally cost at this juncture are higher than what you saw on the first quarter?

Daniel Buron - Senior Vice President and Chief Financial Officer

I think they've increased slowly in the first quarter, so the end up the of quarter was higher than the beginning of it.

George Staphos - Banc of America Securities

Got your point

Daniel Buron - Senior Vice President and Chief Financial Officer

So, I think we're going see the tail, I mean, there is no indication of further inflation in the second, but we're going to see kind of the tail-end of those cost increases.

George Staphos - Banc of America Securities

Fair enough and on demand?

Richard L. Thomas - Senior Vice President, Sales

This is Dick, George. Let me try to respond, you're absolutely right. A good portion of what we saw industry wide in March was related to the timing of the price increase and

shipments ahead of that. But, I do think at the same time that March was weaker. We've seen that in the commercial printing and direct mail and in fact I just received some data over the weekend from the postal service in terms of unit shipments through the postal service looking particularly standard direct mail and March was significantly worse there.

So it's not just buying ahead, but at the same time if you look at the overall trends for the first quarter, I'd say at 3.5%, given everything we've been through that's really not too bad. I think, this our view with this is that a good portion of this is psychological. We're trying to find a bottom. We know the financial institutions are very reluctant to spend a lot a lot of money on direct mail. So, I think the question is have we found a bottom. Our order books right now are solid. We feel good about order entry. There is no question, there are some customers that are busier than others, but overall we're solid and our backlogs are very strong. I think, going forward we've got a lot of changes in our system particularly this [IRC] distribution network that remove reference to that. I think, we're going bring more value to our customers and honestly we're very excited about the path forward.

George Staphos - Banc of America Securities

So, if order books are solid, what kind of shipment data are you seeing right now early in 2Q?

Richard L. Thomas - Senior Vice President, Sales

I can only comment on ours at this point, but it's good. Obviously, we've got a bit of a break here because we've got some mill maintenance in the in the second quarter. So, you've got a little bit of lower production right now. But, it isn't that significant.

George Staphos - Banc of America Securities

Okay. Thanks very much.

Daniel Buron - Senior Vice President and Chief Financial Officer

Thank you.

Operator

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

Mark Connelly - Credit Suisse

Yes, thank you. Two questions, first for Daniel. It looks like there was a massive negative working capitals swing and yet, if I understood correctly inventories went down. So, I was wondering if you could walk us through that. And, a question for Raymond, you have earlier said that succession planning would more or less move forward in the second half of this year, or that was your original target, is that still the plan? Is there any update?

Daniel Buron - Senior Vice President and Chief Financial Officer

Okay. Mark, Daniel Buron, thank you, good morning. I'm going to answer the first part of it. You're right that I would qualify the increase in working capital as seasonal only. In fact, if you look at, for instance receivable this is only the invoicing or the sale of the last two weeks of December versus the last two weeks of March. I have explained that difference. There is a little bit of price increase obviously in all that, but that's just good working capital. Inventory went down on the paper side, went up a little bit on the pulp side. We've invested in raw material and it's and also the case in Q1 in the wood business. And, payables are down and that's mostly due to payment of annual incentive plan that happens in Q1. And, we are building that provision during the fourth quarter the -- all quarter of the year and we're paying in Q1, so it's a purely seasonal. We should see a reversal of that in the coming quarters.

Mark Connelly - Credit Suisse

Okay, that's helpful. Thank you.

Raymond Royer - Chief Executive Officer

As for your second question, Mark this is Raymond. A mandate was given by the board to an upside front to start the hunt of the new President and CEO. And, the process is going according to the plan. And we are targeting an announcement sometimes in the fourth quarter.

Mark Connelly - Credit Suisse

Okay, so there is no change there?

Raymond Royer - Chief Executive Officer

No.

Mark Connelly - Credit Suisse

If I could just squeeze in one more question Raymond, you mentioned the price hikes in uncoated freesheet that are already announced. But, can you comment generally on pricing power? From an investors point of view, the big frustration with the paper industry in general is that leaving aside the first quarter inflation, is that we haven't seen much pricing power relative to other commodity businesses. Certainly that's been true in container board but what is your sense as you look at the market? Would you say that uncoated freesheet on the commodity side as well as the specialties, would you say that this business has reasonable pricing power or doesn't? And, I'm not asking you to speculate on this particular price hike? I'm thinking more generally. Are the markets balanced enough that over a few quarters you guys can recoup your raw material cost and move on?

Daniel Buron - Senior Vice President and Chief Financial Officer

Well, when I look at what is being done by our sales people, they are doing a tremendous job as filling up the order books and positioning the franchise that we have established by taking Domtar paper solution to the market and at the end of the day it will show results.

Mark Connelly - Credit Suisse

Now, you talked about the price section in the commodity side, in the specialty grades are we seeing similar price movement or appropriate price movement to deal with these costs issues.

Richard L. Thomas - Senior Vice President, Sales

Mark, this is Dick. Let me try to respond to that. The, you probably doesn't get as much press and in some cases there are industries that are used to price of certain of these product particularly the technical grades, but in the where there is commodity or value added, prices are moving up. They may not do so simultaneously. I would just comment across the board that we are very much recognize our obligation to protect our stakeholders from these cost increases and we fully intend to do that regardless of product And again the timing may not be cogent in terms of everything happening at the same time, but it will be there.

Mark Connelly - Credit Suisse

Okay. Thank you. That's helpful.

Operator

Thank you. Our next question will come from Rick Skidmore of Goldman Sachs

Richard Skidmore - Goldman Sachs

Good morning. Just wanted to follow up on the free cash flow. Daniel, can you just talk about have your interest change that you're targeting from a debt-to-cap perspective and from a EBITDA-to-interest perspective.

Daniel Buron - Senior Vice President and Chief Financial Officer

Rick yes. The targets that we used are not changing, and that we're still, we still believe that we can be closed to investment grade with a debt-to-cap will be lower than 40%. We're not there yet and there is an addition of that. I think we need to take into account the off balance sheet, 3Q position that we have of $113 million, and debt-to-EBITDA of 2.5 times of a over a cycle. So, we need to have that to reach that target for more than a quarter before being able to declare victory on that. So, we haven't change our target. Adding in mind that we want to be as close as possible to investment grade to be able to refinance before 2011 a $600 million the debenture that's becomes due at reasonable, flexible terms and conditions.

Richard Skidmore - Goldman Sachs

I guess Raymond's point about the dividend, is the priority then to get those metrics down over next twelve to eighteen months before reconsidering looking at the dividends?.

Daniel Buron - Senior Vice President and Chief Financial Officer

The forward looking, what we – we came to the conclusion discussing with our advisors and looking at both the uncertain financial market and the slowing economy, we came to the conclusion that, if we could reduced our debt by another $500 million, this would be the best way to really improve shareholder value in a sustainable manner in year 2008 end, so in fiscal 2000. So, this is what we intend to do and the board will review theoretically where we spend on our metrics.

Richard Skidmore - Goldman Sachs

And Raymond just one bigger picture question. Can you just talk about how your technical and specialties business is different to what you are trying to do from a commodity perspective? And, is that business one is Domtar (inaudible)?

Daniel Buron - Senior Vice President and Chief Financial Officer

If you, Daniel Buron taking here Rick. If you are referring to the official key business, which is the physical gowns and food packaging that two locations that's Port Huron and Espanola, they are delivering good results. That's definitely not the same business of the uncoated freesheet but they are still part to our portfolio and consider as core.

Richard L. Thomas - Senior Vice President, Sales

Operator, I think we have lost Rick. We may move on to the next question.

Operator

Certainly sir. The next question will come from Claudia Hueston of J.P. Morgan.

Claudia Hueston - J.P. Morgan

Thanks very much. Good morning.

Raymond Royer - President and Chief Executive Officer

Good morning.

Daniel Buron - Senior Vice President and Chief Financial Officer

Good morning.

Claudia Hueston - J.P. Morgan

I know you mentioned in your agreement with Quebec Government in terms of wood availability, but I was wondering if you could just talk a little bit more about the overall strategy for the lumber business and if you see any option for alternative ownership or operating structures of that business?

Raymond Royer - President and Chief Executive Officer

Well, first, we are very pleased with the agreement that we've reached with the Quebec Government, because it takes away uncertainty for the time being of that business especially in Quebec. Now, we know we can operate two sawmill in Northern Quebec at I would say full capacity, one on three shifts, the other one on two shifts. But, this is subject to nevertheless a review with the population in that area. But, this is normal way because in Quebec whenever there is a change in the allocation of lumber, you need to consult with their population and this will take about two months. But at the same time, we're working continuously in reducing our cost. The people in lumber business are very serious about getting their costs down and already we see results from that operation. The target remains the same is to have an operation that is self sufficient, but at the same time it is not a core asset value for us. And, what we are trying to do with the people in that division is to improve the results.

Claudia Hueston - J.P. Morgan

Okay. So you're still sort of looking at options there and right now the focus is really just on the cost side there?

Raymond Royer - President and Chief Executive Officer

Absolutely.

Claudia Hueston - J.P. Morgan

Okay. And then, just looking at synergy realizations here, you said they were modest in the quarter. Can you just comment on what gives you confidence in the $200 million target and then how we should think about the realization of those synergies coming through over the reminder of this year? Has that sort of changed at all from the comment at the Investor Day last year?

Daniel Buron - Senior Vice President and Chief Financial Officer

Yeah. Claudia, Daniel Buron here. I think, we –as Raymond mentioned, we haven't made on the run rate basis, a lot of progress, but as you can see on the water fall slide, our cost decrease. If we exclude the inflation and uses in the quarter, so we're still benefiting from the synergies that we've been able to implement last year. We were more – we've seen in Q1 in planning mode for second wave or third wave of project that will start to kick in early in the quarter. So, there is still a lot of opportunities that has been identified at the acquisition time that we haven't implemented. So, we're definitely excited about, around the possibility of beating the $200 million run rate by the end of the…

Claudia Hueston - J.P. Morgan

Okay. And, then just finally can you just comment if you're hedged off for natural gas?

Raymond Royer - President and Chief Executive Officer

Natural gas we do have a physical contracted price for -- between 20% and 25% of our consumption for the next two years, so we do have a nice portfolio there.

Claudia Hueston - J.P. Morgan

Okay, great. Thank you.

Raymond Royer - President and Chief Executive Officer

Thank you.

Operator

Thank you. And, our next question will now come from Mark Wilde of Deutsche Bank. Please go ahead.

Mark Wilde - Deutsche Bank

Good morning.

Raymond Royer - President and Chief Executive Officer

Good morning Mark.

Daniel Buron - Senior Vice President and Chief Financial Officer

Morning Mark.

Mark Wilde - Deutsche Bank

I wonder, if we can sort of just by given a some sense perhaps the Dick Thomas, kind of where prices is stand right now relative to what you're average in the first quarter?

Richard L. Thomas - Senior Vice President, Sales

Sure I'll be happy to. I saw your note, I was a little surprised that you reaction, I thought that what we share over the quarter-over-quarter given the timing of the increases was more or less, at least what I would have expected. So, I would say that one thing we know is we didn't have any carry over of fall increases into the first quarter. So, I mean we started the year at a base, and then announced these increases. So, I would sort of unsurprised by those, but be that as it may. It's looking good. I've looked at the data through March and through April on a weekly basis for the key grades and cut size is right there and offset while it was maybe a little more circuitous path that it looks to be there as well. So, I don't have any bad news here to report at all Mark.

Mark Wilde - Deutsche Bank

So, what you're really suggesting that is you're going to have the $60 on the offset and on the cut size by part way through the second quarter is that correct?

Richard L. Thomas - Senior Vice President, Sales

Yeah. And, we always have a little more element of doubt on offset because there is more spot players and what not but. So, I may, we've just noted hesitation there but right now it's looks very good for exactly that outcome and cut size certainly does even more so.

Mark Wilde - Deutsche Bank

And Dick -- what about the other papers. I mean I have seen some of that specialty paper producers out with even bigger price increase announcements out there. Is that going to affect much of the remainder of your portfolio?

Richard L. Thomas - Senior Vice President, Sales

It's a little hard to answer because everybody's definition of what these products comprise is different.

Mark Wilde - Deutsche Bank

Yeah.

Richard L. Thomas - Senior Vice President, Sales

But, certainly there increases out on outlook paper covers some of the high end forms paper. They went up with the commodities, even though they are not commodities. So, I think you've got text and cover, which of course we are not involved in and then the technical grades, again some of those are index to various others, for example, pulp [3C] pulp but that's a pretty small percentage of our total. I don't think there is a lot of leverage there in terms of our total performance. And, they all can move. It just a question of they don't all move when offset moves smooth.

Mark Wilde - Deutsche Bank

Yeah, I guess this is kind a hard to understand, given all of the other cost pressures that you're under, why you wouldn't be plan to aggressively move on some of those other grades?

Richard L. Thomas - Senior Vice President, Sales

I did mean to imply we aren't. So, we absolutely are.

Mark Wilde - Deutsche Bank

Okay.

Richard L. Thomas - Senior Vice President, Sales

And that's a -- and we have announced increases. They just don't hit the trade publications. Because, they tend to be specific products that affect a few customers and they don't get the press talk. So, and we can talk about this separately, if you'd like as examples I -- but, I think there is more doing on there than probably you're hearing about.

Mark Wilde - Deutsche Bank

Okay. One other thing Dick I wanted about kind a going on within the numbers maybe we don't see is what you might be doing on the export side of the business?

Richard L. Thomas - Senior Vice President, Sales

Our export in the first quarter was, really just cut sizes and of course as we talk before that's something we plan to continue for reasons that we've talked about before. So, we did variable roll export in the first quarter. We didn't need to cut size. That's something we continue to do, and it continues to do good things for us from a customer standpoint.

Mark Wilde - Deutsche Bank

Just order of magnitude Dick, can you give us some idea of what that export business might look like in terms of size or how it's changed over the last 12 months?

Richard L. Thomas - Senior Vice President, Sales

The cut size has been -- let me get to the size second, let me try to describe the trend if you.

Mark Wilde - Deutsche Bank

Okay.

Richard L. Thomas - Senior Vice President, Sales

If I may? The cut size has been steady because we view that as a strategic move and we plan to stick with it. So, that's been very steady. The role business we had a spike in roll exports in the third quarter of last year. You may remember as we were looking at our system and preparing for some rationalization we had an balance in some extra inventory. We did move some roll product at that time. That was more opportunistic and that has drifted back down to very low levels at this point. So, from an order of magnitude the rolls are insignificant and the cut size is well under 5% of our total.

Mark Wilde - Deutsche Bank

Okay. And, I'd like to turn now to just any other non core assets that you might be looking at for the balance for the year as you bring that debt down. I wondered kind of remaining land, what the situation is with the high drill up in Canada and then finally I would like to talk a little bit about the light weight coated machine because that market is so tight right now. It seems that if you are going to exit that business, this is a market try to look at doing that in?

Raymond Royer - President and Chief Executive Officer

Well Mark this is Raymond. If you are talking about Columbus, when we made the announcement of the deal, one of the things that we committed to do was to review each mill and identifying improvement opportunities. And, we had meetings with the Columbus people involving everybody at downtime. And, the conference people reacted very positively to that challenge of what they could do to improve. As a good example they have just introduced a # 4 coded groundwood called Saturn. And, this was new for them because the only thing they were producing at that time was the number five. So, we are very satisfied with the progress that they have made trying to bring a mill to whatever this mill can deliver and we are very supportive of what they are doing. So, Columbus is not in our claim to dispose off.

As for the other assets it will depend --. You are talking about (inaudible)

Mark Wilde - Deutsche Bank

Yeah, exactly.

Raymond Royer - President and Chief Executive Officer

It will depend. We have done most of the things that could be done except for high dose and we are looking at different opportunities for high dose and at the same time, we are being interested by what is happening with the carbon market. And, we will look into it.

Mark Wilde - Deutsche Bank

Any sense, Raymond of whether we might see something this year? Whether that we can kind of contribute to your cash available for debt reduction?

Raymond Royer - President and Chief Executive Officer

No, I don't think so because many of these things take time, if you want have a fare price for what you are trying to do.

Mark Wilde - Deutsche Bank

Okay, that's fine. I think, we all want you to have a fair price. May be even a little better than fair. Alright Thanks.

Raymond Royer - President and Chief Executive Officer

Thank you Mark.

Operator

Thank you and our next question will now come from Chip Dillon of Citi. Please go ahead.

Chip Dillon - Citigroup

Yes. Good morning.

Raymond Royer - President and Chief Executive Officer

Good morning Chip.

Richard L. Thomas - Senior Vice President, Sales

Good morning, Chip.

Chip Dillon - Citigroup

Hi. Just one question on the demand side do you think, Easter had any impact on the poor March numbers given how we had Easter in March this year and not last year or is that just not, is that one or two business phase would actually will be 5% or 10% of the month not really matter?

Raymond Royer - President and Chief Executive Officer

It probably matter some, but our shipments, we were able to get product out of door. That may be part of how we're setup with offset converting and things like that. But, I hear from customers that some other mills struggle with that. So, that probably was a factor. So, thank you.

Chip Dillon - Citigroup

And then on the separate note, when you look at imports of uncoated, a lot of those coming from Asia in converted form like notebooks. Are you seeing any change in that pattern given the weak dollar or given the high ocean going freight rate?

Raymond Royer - President and Chief Executive Officer

The school supply business, you may remember there was a punitive terror enacted against a portion of that, I guess a year and half or two years ago. So, that certainly had an affect on the product coming in from specific countries. Based on what we see in terms of activity in the school supply market from domestic converters, I would say the ocean freight rates are probably having an effect because these converted by and larger or quite busy.

Chip Dillon - Citigroup

Okay. And then last question. If you look at our system and you say okay in the next year or two you might need to rationalize capacity in uncoated. Is it likely that you would still be able to run the pulp in that facility as you have done mostly in the past?

Richard L. Thomas - Senior Vice President, Sales

I think the answer to your question is yes. In fact, we probably know already what we're going to do next if we have to do an additional closure and that would be a paper machine in an integrated mill and then pulp mill could continue to produce.

Chip Dillon - Citigroup

Got you. Thank you.

Operator

Our next question will now come from Benoit Laprade of Scotia Capital.

Benoit Laprade - Scotia Capital

Good morning. Thank you. Daniel, maybe if you… a housekeeping questions, SG&A has been quite volatile and quite low this quarter. Is there any guidance you can give us for the coming or for the year total?

Daniel Buron - Senior Vice President and Chief Financial Officer

I think this quarter includes $8 million of integration cost. I would believe that we're going to see a small increase of integration costs in Q2, Q3 because there is important IT transition service agreement that are ending. So, there is lot of work that's going to happen in Q2, Q3, going back slowly to more normal. However, after all that, after integration completion, our SG&A should be just north of $100 million per quarter. There is little bit of seasonality in that, but that should be close to $400 million per year.

Benoit Laprade - Scotia Capital

Okay. So that would be a good number for '09?

Daniel Buron - Senior Vice President and Chief Financial Officer

Should be, yeah.

Benoit Laprade - Scotia Capital

Good. Similar question on depreciation, is Q1 a good indication of whether you're… because you said just in your slide, $480 million to $500 million, even though Q1 annualized would be $464 million or so?

Daniel Buron - Senior Vice President and Chief Financial Officer

Yes, I think there is the exchange rate, that can play a little bit, because there are depreciation in Canada. The final price allocation is done for the Domtar Inc. asset. So, other than exchange rate and new CapEx that will be amortized, depreciation should be more stable in the future.

Benoit Laprade - Scotia Capital

Okay. Can you just touch on CapEx, again? Q1 looks pretty low given the guidance for year, is there a chance that it would come below the --

Daniel Buron - Senior Vice President and Chief Financial Officer

I think there is definitely more chance that we are going to come below than we're going to go above. We're still managing our CapEx with lot of care and we're authorizing only CapEx that do meet our financial criteria and there is not a lot of CapEx on the table as speak right now. So, I will adjust this number, I mean later in the year, it depends on how Q2 will unfold.

Benoit Laprade - Scotia Capital

Okay. And finally again going back to pricing and more conceptually would you see that the Q1 price increase in 7 [ph], March was to cover Q4 inflation or the Q1 inflation, what are the thinking right now in terms of getting another price increase to cover these new unforeseen costs inflation?

Daniel Buron - Senior Vice President and Chief Financial Officer

I think Benoit the… we told that we were little bit a head of the curve in the terms of our price increases versus the inflation that we rp would be facing, we're surprised by Q1 inflation. And I think, we're also very careful about what will be the impact in Q2 and the rest of the year. We haven't -- we don't see any fees on that front. So, we're probably a little bit behind right now in terms of price increases. I am confident that we're going to be able with the… the full impact of the price increases in Q1 we'll be able to cover most of Q4 and Q1 inflation. But we'll have to check that in the future and that -- I think the theory behind the company or the strategy of the company has not change. We should be able to increase price to absorb cost increases and we should deliver the synergies and that should be there to stay in our bottomline and benefit to our shareholders. So we are going to continue to monitor that that I mean we were ahead of the inflation, we are probably little bit behind, so if it is unfolded, I am (inaudible) that we are behind, we're going to definitely look at what we are going to do in terms of passing those cost increases to our customers.

Benoit Laprade - Scotia Capital

And your comfortable that these customer are going to absorb it, without having some sort of negative impact on demand in terms of elasticity?

Daniel Buron - Senior Vice President and Chief Financial Officer

That's very good… I mean that's a very good question, difficult to answer. So far, demand is declining, that is because of price or is it because of the economic [inaudible] that's very difficult to answer. We are confident that it… if the costs are higher and if costs that we don't control… price would reflect that.

Benoit Laprade - Scotia Capital

Great. Thank you.

Operator

Thank you our next question will come from Tora Williams [ph] of Omega Advisors. Please go ahead.

Tora Williams - Omega Advisors

My question was answered, with each increases in costs, would that not lead to more closures in the offset business, and in efficient… excuse me in the uncured efficient markets, in the near future?

Daniel Buron - Senior Vice President and Chief Financial Officer

In our own network the answer to that question is no I mean all of our mills are --

Tora Williams - Omega Advisors

Yes I know, I was… could you speculate on --

Daniel Buron - Senior Vice President and Chief Financial Officer

I'm not. I mean I will not speculate on that though, there the cost structure is something that is available from third-party sources, there are some mails that are not integrated, they don't have the same buying power that we have. So they are certainly other organizations that are experiencing higher inflation then we do. So, we will see what those costs increases we will have as an impact on them.

Raymond Royer - President and Chief Executive Officer

Tora, this is Raymond. I will also add that, because of our mill footprint, we have delivery costs that are difficult to match overall by our competition and this is what we are playing, this is what why we are putting many of our mills, commercial paper that match each other. So we have the footprint and we have the synergy. The synergy should bring, as Daniel said before, $40 a ton if we delivered a $200 million synergy, $200 million and $40 per ton. This is quite a cost reduction for us, but we don't intend to tap that to the customer. The pricing will always be done in accordance with the balance between supply and demand.

Operator

Did you have any further questions Mr. Williams?

Tora Williams - Omega Advisors

No.

Operator

Thank you.

Raymond Royer - President and Chief Executive Officer

Thank you.

Operator

(Operator Instructions). And we have a follow-up question from Mark Wilde of Deutsche Bank.

Mark Wilde - Deutsche Bank

Raymond, I would like to come back to this thing you mentioned with Staples and I really have two questions. I have one, did that have anything to do with Staples backing away from one of these Indonesian paper suppliers. I think during the first quarter? And secondly, I am kind of curious about why you or some of the other converters in the school and office products business don't seem to raise more questions about where that paper is sourced that's going in those school and office products. Seems like the school market is particularly sensitive to these environmental issues, and so forth, suddenly it gives up the school with all these notebooks made with Indonesian paper that seems like a legitimate issue.

Richard L. Thomas - Senior Vice President, Sales

Mark its Dick. Let me comment it and Raymond may want to weigh in as well. On the Staples question, I guess all of these are in a way related because I think our major customers and almost every channel are becoming increasingly aware and concerned and interested in, savvy about environmental and sustainability issue. So, in that sense I would say, it's absolutely related. I wouldn't say Staples announcement about APP and our winning this award directly liked it anyway, but I think it's part of the thinking that you see all over particularly to big bucks and the mach market, and as I said last of other channels including the financial institutions today. So I think in that sense, they are related.

On the school supply, I agree with you that, your thinking would be the last place you would see this kind of things take place but, all I can say is the converters, the domestic converters are working really hard to identify where something has been mislabeled or misrepresented, and so I think actions are being taken.

Mark Wilde - Deutsche Bank

And, I mean, I am correct, I heard that much of those the notebooks and samples and everything are coming in from.

South East Asia, is that correct.

Richard L. Thomas - Senior Vice President, Sales

Yes, as well as presume.

Mark Wilde - Deutsche Bank

Okay

Richard L. Thomas - Senior Vice President, Sales

So, but again the total magnitude of those import market is going down because of the punitive tariff. We have heard reports about our pricing being re-routed through several countries, and so for that and I don't know if any of that's true, but everybody is intent is on this and the domestic converters and some of them we do some business with have been busy over the last couple of years than they were previously.

So, it's a bit of softening on for the overall uncoated balance here in North America.

Mark Wilde - Deutsche Bank

Okay thanks Dick.

Richard L. Thomas - Senior Vice President, Sales

Thank you

Operator

Thank you. And at this time Mr. Bossé we have no other questions registered.

Pascal Bossé - Director of Investor Relations

Okay well I would like to thank all our participants on the call and I invite you to join us for our second quarter earnings call that's scheduled for August the 08. Thank you very much and you all have a good day. Thank you

Raymond Royer - President and Chief Executive Officer

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 lines. Have yourselves a great day.

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Source: Domtar Corp. Q1 2008 Earnings Call Transcript
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