Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: Quarterly and nine-month periods ended October 3, 2015, compared with September 27, 2014. The request metadata references “2014 Q3,” but the filing is the 2015 third-quarter Form 10-Q. Financial statements are unaudited and presented in U.S. dollars, except per-share data.
Business Context
Darling is a global producer of sustainable ingredients from animal by-products, used cooking oil, food residuals and other bio-nutrients. Operations span more than 200 locations across five continents and are organized into Feed Ingredients, Food Ingredients and Fuel Ingredients. The company also owns 50% of the Diamond Green Diesel joint venture with Valero.
Key Financial Metrics
| Metric | Q3 2015 | Q3 2014 | First 9 Months 2015 | First 9 Months 2014 |
|---|---|---|---|---|
| Net sales | $853.8 million | $978.7 million | $2.588 billion | $2.956 billion |
| Operating income | $38.8 million | $49.9 million | $109.9 million | $124.8 million |
| Net income/(loss) attributable to Darling | $(9.1) million | $14.3 million | $(5.9) million | $(5.7) million |
| Diluted EPS | $(0.06) | $0.09 | $(0.04) | $(0.03) |
| Adjusted EBITDA | $106.1 million | $117.2 million | $309.9 million | $325.3 million |
| Pro forma Adjusted EBITDA | $107.4 million | $119.4 million | $317.7 million | $401.5 million |
| Net cash from operating activities | Not separately reported | Not separately reported | $296.7 million | $179.3 million |
Margins: Consolidated gross margin was 21.4% in Q3 2015 versus 21.9% in Q3 2014. For the first nine months, gross margin was 21.8% versus 21.2%; however, the 2014 period included a $49.8 million non-cash VION inventory step-up, and the comparable adjusted 2014 margin was 22.9%.
Balance sheet and liquidity: Cash and cash equivalents were $148.9 million at October 3, 2015, compared with $108.8 million at January 3, 2015. Working capital was $550.3 million, with a 2.21-to-1 working-capital ratio. Total debt was approximately $2.024 billion, including $47.97 million of current maturities. Revolver availability was $920.1 million after borrowings and letters of credit.
Cash flow and capital spending: Nine-month capital expenditures were $162.3 million, compared with $154.0 million in the prior-year period. The company expected an additional $55 million to $65 million of capital expenditures for the remainder of fiscal 2015. The Oracle ERP implementation had incurred approximately $37.9 million of costs and was expected to require total cash spending of approximately $40 million to $42 million.
Material Changes Versus the Prior Comparable Period
- Q3 sales decreased 12.8%, primarily because of lower finished-product prices and unfavorable foreign exchange translation, partly offset by higher raw-material volumes.
- Q3 net income attributable to Darling declined from $14.3 million to a $9.1 million loss. Management attributed the deterioration primarily to lower commodity prices, the stronger U.S. dollar, DGD joint-venture losses and tax effects.
- Feed Ingredients Q3 sales declined to $525.2 million from $607.3 million, while operating income declined to $35.6 million from $46.4 million. Higher volumes were more than offset by lower prices for proteins, fats and used cooking oil.
- Food Ingredients Q3 operating income decreased to $11.6 million from $14.0 million, with casing-related margin pressure partly offset by improved gelatin and European edible-fat performance.
- Fuel Ingredients generated Q3 operating income of $0.2 million excluding DGD, but a segment loss of $12.1 million including DGD, versus segment income of $1.3 million in the prior-year quarter. DGD was adversely affected by lower petroleum prices and an uncertain renewable-fuel regulatory environment.
- Q3 raw-material processed volumes increased approximately 6.6% year over year to 2.39 million metric tons, but pricing pressure reduced profitability.
- Nine-month operating cash flow increased $117.4 million, largely due to working-capital changes and a $26.2 million distribution from unconsolidated subsidiaries. The prior-year period included $2.076 billion of acquisition spending for VION.
- Nine-month Adjusted EBITDA declined to $309.9 million from $325.3 million. Pro forma Adjusted EBITDA declined substantially to $317.7 million from $401.5 million, primarily because of lower finished-product prices, foreign exchange effects and the absence of prior-year acquisition-related adjustments.
- In June 2015, the company issued €515 million of 4.75% senior notes due 2022 and used the proceeds principally to refinance euro-denominated Term Loan B debt. The refinancing generated a $10.6 million deferred-loan-cost write-off.
- In August 2015, the company authorized a $100 million share-repurchase program. During Q3, it repurchased approximately $5.9 million of common stock, leaving approximately $94.1 million authorized.
Guidance, Outlook, Risks and Unusual Items
- The company does not provide forward-looking financial or operational estimates because results are highly sensitive to commodity prices, agricultural conditions, weather, energy costs, currency movements, government programs and global demand.
- Management expects operating cash flow, cash on hand and revolver availability to be sufficient for working capital, scheduled debt service, taxes and planned maintenance and compliance expenditures over the next twelve months.
- Management identified substantial leverage as a risk. The company relies partly on dividends, distributions and intercompany repayments from subsidiaries to service parent-level obligations and reported compliance with its debt covenants at October 3, 2015. The maximum total leverage covenant was amended to 5.5-to-1.0 in September 2015.
- Commodity-price declines, particularly for fats, proteins, used cooking oil, palm oil and soy meal, can reduce revenue and margins. Raw-material availability and finished-product pricing are subject to agricultural cycles and supply-demand changes.
- Foreign currency exposure is significant. The nine-month foreign-currency translation loss recorded in other comprehensive income was $131.8 million, compared with $57.5 million in the prior-year period; the accumulated other comprehensive loss reached $306.0 million.
- DGD reported a third-quarter net loss of $24.7 million and a nine-month net loss of $21.6 million. Its performance remains exposed to petroleum prices, renewable identification number values, renewable-fuel mandates and operating conditions.
- Potential unusual or non-recurring items included acquisition and integration costs, the $10.6 million deferred-loan-cost write-off, a $1.8 million foreign tax-asset write-down and prior-year VION purchase-accounting inventory charges.
- The company faces food-safety, environmental, permitting, litigation, pension and regulatory risks. Reserves for insurance, environmental, litigation and tax contingencies totaled approximately $57.1 million, while management stated that identified matters were not expected to have a material effect.
- Potentially material exposures include underfunded multiemployer pension plans, the Lower Passaic River environmental matter, the Fresno facility permit litigation and future compliance costs under the Food Safety Modernization Act.
- Management noted that prolonged weakness in fuel and feedstock margins or elimination of the blender’s tax credit could result in a fourth-quarter impairment charge for the Canada Fuel reporting unit, which had approximately $30.1 million of goodwill at October 3, 2015.
Important Facts for Investors to Verify
- Reconcile reported and adjusted earnings, including acquisition costs, amortization, tax effects and the deferred-loan-cost write-off.
- Monitor debt maturities, variable-rate exposure, covenant headroom and the $920.1 million of reported revolver availability.
- Assess whether commodity prices and raw-material volumes stabilize sufficiently to restore Feed Ingredients margins.
- Track DGD profitability, renewable-fuel mandates, RIN values, petroleum prices and potential additional working-capital requirements.
- Evaluate foreign exchange sensitivity, particularly to the euro and Canadian dollar, and the effect of translation losses on equity.
- Review the annual goodwill and intangible-asset impairment analysis, especially for the Canada Fuel reporting unit.
- Consider the cash requirements for ERP implementation, capital expenditures, pension funding, contingencies and share repurchases.
- Verify the status and potential cost of environmental, permitting, litigation and multiemployer pension matters.