Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: Three months ended March 31, 2018, compared with three months ended April 1, 2017. The request metadata identifies “2017 Q1,” but the filing is for the first quarter of fiscal 2018. Results are unaudited and cover 13 weeks.
Business Context
Darling operates globally across Feed Ingredients, Food Ingredients and Fuel Ingredients. Its businesses collect and convert animal by-products, used cooking oil, bakery residuals and other organic materials into fats, proteins, gelatin, collagen, bioenergy and renewable fuels. The Fuel Ingredients segment includes the company’s 50% investment in Diamond Green Diesel Holdings LLC, a joint venture with Valero.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $875.4 million | $878.5 million | (0.4%) |
| Operating income | $31.8 million | $32.5 million | (2.2%) |
| Operating margin | 3.6% | 3.7% | Down slightly |
| Net income attributable to Darling | $97.3 million | $5.8 million | +$91.5 million |
| Diluted earnings per share | $0.58 | $0.04 | +$0.54 |
| Adjusted EBITDA | $110.4 million | $103.6 million | +6.5% |
| Net cash provided by operations | $26.9 million | $94.5 million | ($67.6 million) |
| Capital expenditures | $56.6 million | $62.3 million | ($5.7 million) |
Net income benefited substantially from $97.2 million of equity income from unconsolidated subsidiaries, principally the DGD joint venture, compared with $0.7 million in the prior-year quarter. DGD recorded approximately $160.4 million of retroactively reinstated 2017 biodiesel blenders tax credits, of which Darling’s share was approximately $80.2 million. The tax credits have not been reinstated for fiscal 2018.
Gross margin was $197.3 million, or 22.5% of sales, compared with $190.5 million, or 21.7%, in the prior-year quarter. The reported comparison is affected by adoption of Topic 606, under which billed freight is excluded from revenue and recorded in cost of sales; the filing estimates a $46.2 million reduction to both reported sales and cost of sales versus the prior accounting presentation.
Segment Performance and Changes
- Feed Ingredients: Sales declined 12.1% to $485.8 million and operating income declined 31.1% to $21.7 million. Lower fat and other finished-product prices more than offset a 3.2% increase in processed raw-material volume. Reported gross margin was 24.0%, compared with 21.7%, partly reflecting Topic 606 freight presentation.
- Food Ingredients: Sales increased to $305.5 million from $266.2 million, aided by currency translation and higher gelatin and casing volumes. Operating income declined 17.5% to $11.8 million as European gelatin margins and volumes weakened, China operating costs increased, and fat and casing markets softened.
- Fuel Ingredients: Sales increased to $84.1 million from $59.7 million. Segment operating income excluding DGD rose to $17.2 million from $3.6 million, primarily because of approximately $12.6 million of reinstated 2017 blenders tax credits. Including DGD equity income, segment income increased to $114.4 million from $4.2 million.
- Currency: Management estimates that foreign-currency translation reduced operating income by approximately $8.1 million on a comparable-rate basis.
Cash Flow, Debt and Liquidity
Cash, cash equivalents and restricted cash totaled $123.0 million at March 31, 2018, including $122.9 million of unrestricted cash, versus $106.9 million at December 30, 2017. Working capital increased to $464.2 million from $397.0 million, and the current ratio improved to 1.92 from 1.71.
Total debt was $1.78 billion, including $1.76 billion of long-term debt net of current maturities. The company had $55.4 million drawn on its revolving facility, $22.9 million of letters of credit and $921.8 million of remaining revolver availability. Management stated that the company was in compliance with its debt covenants.
Operating cash flow fell primarily because of working-capital movements and the absence of a $25.0 million distribution from unconsolidated subsidiaries received in the prior-year quarter. Financing activities provided $46.2 million, primarily reflecting net revolving-facility borrowings.
Outlook, Guidance and Unusual Items
- The filing provides no formal full-year revenue or earnings guidance. Management does not provide forward-looking financial or operating estimates because results are sensitive to commodity prices, weather, crop conditions, government programs, global demand and other unpredictable factors.
- The company expects approximately $276.0 million of additional capital expenditures for the remainder of fiscal 2018, including new construction, and expects to fund these expenditures from operating cash flow.
- The DGD joint venture expected to complete its expansion from 160 million to 275 million gallons of annual renewable diesel capacity in late July 2018, with approximately 40 days of planned downtime for final tie-ins. A potential further expansion to 550 million gallons remained under review.
- On May 2, 2018, after quarter-end, Darling issued €515.0 million of 3.625% senior notes due 2026. Proceeds, together with revolver borrowings, were intended to refinance the €515.0 million 4.75% notes due 2022 during the second quarter.
- The company adopted the new revenue recognition standard using the modified retrospective method and early adopted ASU 2018-02, resulting in a $4.8 million reclassification from accumulated other comprehensive loss to retained earnings.
Risks and Contingencies
- Commodity-price volatility, especially in fats, proteins, oils, corn and soybean meal, can materially affect sales, margins and raw-material availability.
- Renewable-fuel economics and profitability depend on government policies, renewable fuel standards, low-carbon fuel standards and biofuel tax credits. The 2017 blenders tax credits were reinstated retroactively, but 2018 credits had not been reinstated as of the filing.
- The company is highly leveraged and exposed to variable interest rates, foreign-currency movements and limitations on cash transfers from subsidiaries.
- Contingency reserves for insurance, environmental, litigation and tax matters totaled approximately $62.4 million. Potential liabilities related to the Lower Passaic River Superfund site and the Fresno facility permit litigation remain unresolved, although management did not expect a material impact based on information available at filing.
- Two multiemployer pension plans could produce material withdrawal liabilities if certain events occur. The company had accrued approximately $1.7 million for known withdrawal liability, but stated that potential additional obligations cannot currently be estimated.
- Approximately $67.5 million of commodity purchase commitments and $44.9 million of operating lease obligations were expected over the next 12 months and were not recorded as balance-sheet liabilities at quarter-end.
Investor Verification Priorities
- Determine the recurring earnings impact excluding the one-time or nonrecurring benefit from reinstated 2017 blenders tax credits.
- Verify DGD’s expansion timing, construction costs, operating performance and future distribution capacity.
- Monitor Feed Ingredients pricing, raw-material volumes and the effect of lower fat and used-cooking-oil prices on margins.
- Assess leverage, covenant compliance, revolver usage and the completion and economics of the post-quarter-end refinancing.
- Reconcile reported sales and margins under Topic 606 with prior periods because freight presentation changed materially.
- Evaluate exposure to environmental, litigation, pension, commodity, foreign-exchange and regulatory contingencies.