Darling Ingredients Inc. Form 10-Q Summary
Reporting period: The filing covers the 13 weeks ended March 28, 2020, compared with the 13 weeks ended March 30, 2019. The request identifies “2019 Q1,” but the filing is for the first quarter of fiscal 2020 and was filed May 6, 2020.
Business Context and Financial Results
Darling develops sustainable ingredients from animal by-products, used cooking oil, food residuals and other bio-nutrients. Its reportable segments are Feed Ingredients, Food Ingredients and Fuel Ingredients. The company operates globally across feed, food, pharmaceutical, pet food, fuel, bioenergy and fertilizer markets.
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $852.8 million | $835.1 million | Up 2.1% |
| Gross margin | $205.9 million; 24.1% | $184.2 million; 22.1% | Margin up 200 bps |
| Operating income | $122.8 million | $48.6 million | Up 152.7% |
| Income before taxes | $104.4 million | $24.9 million | Up 319.0% |
| Net income attributable to Darling | $85.5 million | $18.0 million | Up 374.8% |
| Diluted earnings per share | $0.51 | $0.11 | Up $0.40 |
| Adjusted EBITDA | $109.7 million | $103.4 million | Up 6.0% |
| Darling share of DGD Adjusted EBITDA | $103.6 million | $29.8 million | Up materially |
Net margin increased to approximately 10.0% from 2.2%. Operating income benefited substantially from the company’s 50% share of Diamond Green Diesel joint-venture earnings, which increased to $97.8 million from $24.3 million.
Segment Performance
- Feed Ingredients: Sales increased 3.4% to $512.6 million. Gross margin improved to 24.2% from 22.0%, and operating income increased 9.9% to $16.7 million. Raw material processed increased 2.9% to 2.24 million metric tons.
- Food Ingredients: Sales declined to $270.3 million from $279.2 million. Gross margin improved to 24.0% from 23.3%, but operating income fell 19.1% to $19.1 million due primarily to lower collagen volumes, particularly in China, and effects from African Swine Fever.
- Fuel Ingredients: Operating income increased to $105.0 million from $27.3 million. The improvement was primarily attributable to DGD’s recognition of approximately $80.0 million of blender tax credits in the quarter; the prior-year quarter included no such credits.
Cash Flow, Debt and Liquidity
- Operating cash flow was $34.5 million, down from $48.6 million in the prior-year quarter.
- Capital expenditures were $61.6 million, compared with $84.3 million. Cash used in investing activities was $64.6 million.
- Financing activities provided $40.4 million, including higher revolving-credit borrowings and $55.0 million of share repurchases.
- Cash, cash equivalents and restricted cash totaled $76.4 million at quarter-end, including unrestricted cash of $76.3 million.
- Total debt carrying value was approximately $1.75 billion, including $157.8 million outstanding under the revolving facility, a $487.7 million Term Loan B balance, $493.7 million of 5.25% senior notes due 2027 and $560.2 million of euro-denominated 3.625% senior notes due 2026.
- Revolving-credit availability was $795.9 million. Working capital was $278.3 million, with a 1.43-to-1 working-capital ratio, versus $228.9 million and 1.33-to-1 at December 28, 2019.
- Management stated that operating cash flow, unrestricted cash and available credit should be sufficient for the next 12 months, subject to COVID-19, commodity, currency and broader economic risks.
Material Changes and Unusual Items
- DGD recorded approximately $80.0 million of blender tax credits in Q1 2020. In April 2020, after the quarter-end, DGD distributed approximately $125.0 million to Darling.
- DGD is constructing a new parallel facility expected to increase annual renewable-diesel capacity from 275 million gallons to 675 million gallons. Estimated project cost is approximately $1.1 billion, with expected startup in the fourth quarter of 2021.
- Darling acquired the remaining 50% interest in EnviroFlight for approximately $8.8 million and acquired related intellectual property for approximately $3.4 million.
- The company repurchased approximately 2.37 million shares for $55.0 million. Approximately $125.8 million remained under the repurchase authorization at March 28, 2020.
- Other comprehensive loss was $62.7 million, primarily due to a $65.2 million foreign-currency translation loss.
- Management reclassified DGD equity earnings into operating income for all periods presented, reducing comparability with previously published historical operating results.
Guidance, Outlook and Risks
The company does not provide forward-looking financial or operational estimates because results are affected by volatile commodity prices, raw-material volumes, weather, energy costs, government programs and global demand.
- COVID-19 had not materially affected first-quarter operations, and facilities remained operational because the company’s activities were generally classified as critical or essential. However, management reported that second-quarter raw-material volumes had begun to decline because of slaughterhouse and food-service closures and disruptions.
- The company temporarily reduced non-essential capital expenditures because of COVID-19 uncertainty. It had previously expected fiscal 2020 capital expenditures of approximately $306.0 million; the filing does not provide a revised full-year estimate.
- Key risks include reduced raw-material supply, lower finished-product prices, weaker fuel demand, changes to renewable-fuel mandates or tax credits, foreign-exchange volatility, interest-rate exposure, leverage, customer and supplier disruptions, and potential future goodwill impairment.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $69.7 million. Multiemployer pension withdrawal liabilities accrued were approximately $5.5 million, although additional liabilities could be material.
- Darling guaranteed its proportionate share of DGD obligations under terminaling agreements, up to $50 million. No liability was recorded because management considered payment unlikely.
- The company accepted a $0.6 million EPA settlement offer concerning the lower Passaic River, subject to administrative approval. A separate New Jersey environmental enforcement matter may involve penalties exceeding $100,000 but is not expected to be material.
Investor Verification Checklist
- Verify the sustainability of DGD’s earnings after the one-time or periodic benefit from blender tax credits and the timing, funding and returns of its expansion projects.
- Monitor COVID-19 effects on slaughterhouse, restaurant and other raw-material volumes, as well as demand for renewable diesel and other finished products.
- Reconcile reported operating income and historical comparisons for the reclassification of DGD equity earnings.
- Assess leverage, variable-rate debt, revolving-credit availability and compliance with the 5.50-to-1 total leverage and 3.00-to-1 interest-coverage covenants.
- Track foreign-currency translation losses, commodity-price movements and potential goodwill impairment, particularly for the Canada Feed reporting unit.
- Review capital-expenditure reductions against DGD funding obligations, environmental compliance needs and planned capacity expansion.
- Confirm that management’s liquidity assessment remains valid as COVID-19, commodity and credit-market conditions evolve.