Domtar Corporation (NYSE: UFS) (TSX: UFS) today reported net earnings of $19 million ($0.34 per share) for the second quarter of 2020 compared to net earnings of $5 million ($0.09 per share) for the first quarter of 2020 and net earnings of $18 million ($0.28 per share) for the second quarter of 2019. Sales for the second quarter of 2020 were $1.0 billion.

Excluding items listed below, the Company had earnings before items¹of $20 million ($0.36 per share) for the second quarter of 2020 compared to earnings before items¹ of $5 million ($0.09 per share) for the first quarter of 2020 and earnings before items¹ of $36 million ($0.57 per share) for the second quarter of 2019.

ITEMS

QUARTERLY REVIEW

“We have been proactive in reducing risk and safeguarding our ability to weather the current crisis. We are taking the appropriate steps to optimize our operations and to remain an agile, reliable partner to our customers,” said John D. Williams, President and Chief Executive Officer. “Despite the significant challenges we faced in Pulp and Paper markets, we have been able to manage costs while initiating cash and cost conservation initiatives across the network.”

Mr. Williams added, “In Personal Care, second quarter revenues were lower following a record first quarter, which was driven partly by consumer pantry loading. While revenues were lower than prior quarter, good cost control and improved operational efficiencies supported a solid EBITDA performance. The second quarter ended with an EBITDA margin of 14.4%, which was a 160 basis point improvement when compared to the first quarter and the highest divisional margin since the fourth quarter of 2015.”

Operating income was $14 million in the second quarter of 2020 compared to operating income of $19 million in the first quarter of 2020. Depreciation and amortization totaled $71 million in the second quarter of 2020.

Operating income before items¹ was $15 million in the second quarter of 2020 compared to operating income before items¹of $19 million in the first quarter of 2020.

The decrease in operating income in the second quarter of 2020 was the result of lower volume and unfavorable productivity. These factors were partially offset by lower maintenance costs and lower salaries and wages, mostly due to wage subsidies, lower selling, general and administrative expenses, lower raw material costs, favorable exchange rates and lower fixed and other costs.

When compared to the first quarter of 2020, manufactured paper shipments were down 32% and pulp shipments increased 10%. The shipment-to-production ratio for paper was 105% in the second and the first quarters of 2020. Paper inventories decreased by 22,000 tons, and pulp inventories decreased by 2,000 metric tons when compared to the first quarter of 2020.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow from operating activities amounted to $67 million and capital expenditures were $40 million, resulting in free cash flow¹ of $27 million for the second quarter of 2020. Domtar’s net debt-to-total capitalization ratio¹ stood at 30% at June 30, 2020 and at March 31, 2020. At June 30, 2020, we had total liquidity of approximately $906 million ($124 million of cash on hand, $782 million in available credit facilities) with no near-term debt maturities.

OUTLOOK

We expect the overall environment to continue to be challenging. In Paper, we expect demand to remain weak, with some incremental recovery expected in quarter three and towards year-end. We expect near-term pulp markets to be impacted by seasonal softness, elevated global inventories, and weak demand trends from paper markets. Personal Care will continue to benefit from productivity gains and the impact from new customer wins. Overall raw material costs are expected to remain stable.

STRATEGIC INITIATIVES

COST REDUCTION PROGRAM

The Company is implementing a cost reduction program, targeting $200 million in annual run-rate cost savings to be realized by the end of 2021. The goal of the program is to build a stronger business operation, enhance the Company’s cost efficiency, and improve operating margins and maximize productivity and cash flow. The cost saving initiatives include capacity reduction and asset closures, mill-level cost savings and rightsizing support functions. The leaner organizational structure is also expected to improve communication flow and cross-functional collaboration, leveraging more efficient business processes.

As part of the cost savings program, the Company will permanently close the uncoated freesheet manufacturing at the Kingsport, Tennessee and Port Huron, Michigan mills, the remaining paper machine at the Ashdown, Arkansas mill and the converting center in Ridgefields, Tennessee. These actions will reduce the Company’s annual uncoated freesheet paper capacity by approximately 721,000 short tons, and will result in a workforce reduction of approximately 780 employees. The Kingsport and Ashdown paper machines, which have been idled since April 2020, will not recommence operations. The Port Huron and Ridgefields mills are expected to shut down by the end of the first quarter of 2021.

“We remain disciplined in our efforts to manage our costs to improve profitability and further strengthen our balance sheet. In line with these goals and current market conditions, we are implementing a significant cost savings program to streamline operations, maximize productivity and improve margins. This program will create a stronger, leaner organization aligned to meet the needs of the business and our customers in a post COVID-19 era,” said Mr. Williams. “This important and necessary step is expected to reduce our annualized costs by more than $200 million, while significantly improving our free cash flow and return on invested capital. We have a talented and dedicated workforce at Domtar, and decisions that affect people are never easy. However, we are taking the necessary steps to better position our business for the future.”

EXECUTION OF THE ASSET CONVERSION ROADMAP

Domtar’s decision to repurpose assets at Kingsport, Tennessee and Ashdown, Arkansas follows a disciplined and measured review of the Company’s manufacturing footprint. This conversion program is consistent with the roadmap that Domtar made public in 2018. The previously announced multi-mill conversion roadmap is designed to increase shareholder value as we adjust our paper capacity to align with our customer demand. Through this process, we have identified up to four large scale paper machine/mill repurposing projects that have the ability to produce 2.5 million tons of containerboard and/or 570,000 ADMT of additional market softwood and fluff pulp.

Entering the recycled linerboard market at Kingsport, Tennessee

The Company plans to enter the linerboard market with the conversion of the Kingsport paper machine. Once in full operation, the mill will produce and market approximately 600,000 tons annually of high-quality recycled linerboard and medium, providing the Company with a strategic footprint in a growing adjacent market. The conversion is expected to be completed by the first quarter of 2023.

Domtar estimates the conversion cost to be between $300 and $350 million. Once fully operational, the mill is expected to be a very low-cost, first quartile recycled linerboard mill in North America. The converted mill is expected to directly employ approximately 160 employees.

“Repurposing the Kingsport mill provides Domtar with the best strategic entry point into a growing market with a very competitive, low-cost asset and represents a first step to building a large and cost-competitive business,” said Mr. Williams. “Kingsport is well positioned to be the go-to supplier to independent converters for quality, service and innovation as the mill is less than a day’s drive from over 60 customers representing an addressable 3.9 million tons of annual containerboard demand.”

Completing the conversion to softwood and fluff pulp at Ashdown, Arkansas

The Company will complete the conversion of the Ashdown mill to 100% softwood and fluff pulp, which will require $15 to $20 million of capital investments and will take 12 to 14 months to implement. The mill will produce additional market hardwood pulp until it converts the fiberline to softwood pulp. The conversion of the fiberline to 100% softwood is also necessary for an eventual expansion into containerboard. Following the fiberline conversion, Ashdown will be a world-class market pulp mill with annual production capactiy of 775,000 tons of fluff and softwood pulp.

With these two conversions, Domtar continues to deliver on its strategic roadmap to make value creating investments in its world-class facilities, and to this end, provides a bright future for the Kingsport and Ashdown mills.

REVIEW OF STRATEGIC ALTERNATIVES FOR PERSONAL CARE DIVISION

The Company has commenced a strategic review process to explore a range of value-creating alternatives for its Personal Care division, which may include a sale of the business. The strategic review process will be conducted with the assistance of Domtar’s independent financial and legal advisors and will consider a full range of potential alternatives with respect to the Company’s Personal Care division.

“Over the past year, we have significantly improved the operating structure and cost profile of our Personal Care division due in large part to the hard work and perseverance of our teams. In addition, the scale-up of new customer and sales pipeline gives us confidence in the long-term prospects for the business.” Mr. Williams said. “With this positive momentum, we believe now is the right time to initiate a strategic review.”

The Company has not set a deadline for the conclusion of its review of strategic alternatives, and does not intend to comment further unless and until the Board of Directors has approved a specific course of action or the Company has otherwise determined that further disclosure is appropriate or necessary.