Darling Ingredients Inc. — Form 10-Q Summary
Period covered: Fiscal quarter and nine months ended October 1, 2016, compared with October 3, 2015. The request metadata identifies “2015 Q3,” but the filing is the 2016 third-quarter Form 10-Q, filed November 10, 2016.
Business Context and Reporting Period
Darling Ingredients is a global producer of sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Operations are organized into Feed Ingredients, Food Ingredients and Fuel Ingredients. The filing covers 13 weeks and 39 weeks ended October 1, 2016. The financial statements are unaudited and prepared under U.S. GAAP.
Key Financial Metrics
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net sales | $853.9 million | $853.8 million | $2.511 billion | $2.588 billion |
| Operating income | $35.5 million | $38.8 million | $116.7 million | $109.9 million |
| Net income attributable to Darling | $28.7 million | $(9.1) million | $61.8 million | $(5.9) million |
| Diluted EPS | $0.17 | $(0.06) | $0.37 | $(0.04) |
| Adjusted EBITDA | $106.2 million | $106.1 million | $329.1 million | $309.9 million |
| Gross margin | 21.4% | 21.4% | 22.4% | 21.8% |
Quarterly net income margin was approximately 3.4%, compared with negative 1.1% in the prior-year quarter. Nine-month net income margin was approximately 2.5%, compared with negative 0.2% in the prior-year period. Quarterly operating margin was approximately 4.2%; nine-month operating margin was approximately 4.6%.
- Operating cash flow: $280.6 million for the first nine months, versus $296.7 million in the prior-year period.
- Capital expenditures: $168.2 million, versus $162.3 million; management expected approximately $62.2 million of additional capital expenditures for the remainder of fiscal 2016.
- Cash and liquidity: $148.6 million of unrestricted cash and $973.7 million of available revolving credit capacity at October 1, 2016.
- Debt: $1.846 billion of total debt before current maturities and deferred financing costs; carrying value of long-term debt was $1.818 billion. Approximate gross debt less cash was $1.697 billion.
- Working capital: $503.3 million, with a 2.10-to-1 current ratio, compared with $490.1 million and 2.11-to-1 at January 2, 2016.
- Balance sheet: Total assets were $4.817 billion and total stockholders’ equity was $2.085 billion at October 1, 2016.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue was essentially flat, while nine-month revenue declined approximately 3.0%, primarily reflecting lower protein and other finished-product prices.
- Quarterly net income improved by $37.8 million, moving from a $9.1 million loss to $28.7 million of profit. The improvement was primarily attributable to stronger Diamond Green Diesel results, including biodiesel blenders tax credits, higher Renewable Identification Number values and higher fuel prices, together with a tax benefit.
- Nine-month net income improved by $67.7 million, moving from a $5.9 million loss to $61.8 million of profit. Nine-month operating income increased $6.8 million, while Adjusted EBITDA increased $19.2 million.
- Feed Ingredients quarterly operating income declined slightly to $35.3 million from $35.6 million, as lower finished-product prices and higher depreciation offset higher volumes.
- Food Ingredients quarterly operating income declined to $7.9 million from $11.6 million. The filing cites weaker European edible fats performance, lower gelatin demand and a $3.5 million China gelatin inventory adjustment, partly offset by improved casing results after the reopening of the Chinese border.
- Fuel Ingredients quarterly segment income, including the Diamond Green Diesel joint venture, increased to $24.1 million from a $12.1 million loss. Nine-month segment income increased to $56.0 million from a $6.0 million loss.
- Raw material processed increased 5.2% year over year in the quarter and 3.6% for the first nine months.
- Interest expense decreased to $23.9 million from $24.8 million for the quarter and to $71.7 million from $82.2 million for the nine months, partly because the prior year included a $10.6 million deferred loan-cost write-off.
- Acquisition and integration costs declined to zero in the quarter and $0.4 million for the nine months, versus $1.3 million and $7.8 million, respectively, in the prior-year periods.
Guidance, Outlook, Risks and Unusual Items
- Management did not provide specific forward financial or operating estimates, citing volatility in commodity prices, energy costs, weather, currency rates, government policies and global demand.
- Management expected operating cash flow, cash on hand and revolving-credit availability to be sufficient for working capital, maintenance and compliance capital expenditures, scheduled debt service, taxes and other planned needs for the next twelve months.
- Diamond Green Diesel planned to expand annual renewable diesel capacity from 160 million gallons to 275 million gallons. Estimated construction costs were $190 million, funded by joint-venture cash flow, with completion and commissioning expected in early second quarter 2018.
- The DGD joint venture received $156.4 million of 2015 blenders tax credits, repaid approximately $54.7 million of debt and distributed $25.0 million to each partner. The continuation and value of biofuel tax credits and Renewable Identification Number values remain important to results.
- Principal risks include commodity-price and raw-material volatility, energy costs, foreign exchange, high leverage and variable-rate debt, dependence on subsidiary cash distributions, biofuel policy changes, food-safety and environmental regulation, disease outbreaks, DGD operating and expansion risks, ERP implementation, pension and multiemployer-plan obligations, and Brexit-related uncertainty.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $54.4 million. Potential liability relating to the Lower Passaic River Superfund site could not be determined, although management did not expect a material effect based on information available at filing.
- Goodwill of approximately $531.2 million was allocated to four reporting units whose estimated fair values were less than 10% above carrying value; management reported no impairment trigger as of October 1, 2016.
- The company reported compliance with its debt covenants and effective disclosure controls. It also disclosed SOX control changes related to an accounting-software upgrade at international operations.
Important Facts for Investors to Verify
- Whether earnings improvement remains sustainable without unusually favorable biofuel tax credits, RIN values and fuel-price conditions.
- Current commodity prices, particularly protein, fats, used cooking oil, palm oil and soy meal, and their effect on Feed and Food Ingredients margins.
- Progress, cost discipline, financing and expected returns for the $190 million DGD expansion.
- Debt maturities, covenant headroom, variable-rate exposure and the company’s ability to upstream cash from non-guarantor subsidiaries.
- Potential goodwill impairment at the four closely valued reporting units.
- Exposure to multiemployer pension withdrawal liabilities, environmental claims and other contingencies.
- Implementation costs and control implications of the Oracle ERP project.
- Remaining authorization under the $100 million share-repurchase program; approximately $89.1 million remained at October 1, 2016.