Darling Ingredients Inc. Form 10-Q Summary
Reporting period: The filing is for the 13 and 26 weeks ended July 2, 2016, compared with July 4, 2015. The request metadata identifies “2015 Q2,” but the filing itself is a second-quarter 2016 report. Financial statements are unaudited and presented in accordance with U.S. GAAP.
Business Context
Darling is a global producer of sustainable ingredients derived 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 company operates internationally and is exposed to commodity prices, raw-material volumes, energy costs and foreign currency movements.
Key Financial Metrics
| Metric | Q2 2016 | Q2 2015 | First six months 2016 | First six months 2015 |
|---|---|---|---|---|
| Net sales | $877.3 million | $859.3 million | $1,657.0 million | $1,734.0 million |
| Operating income | $54.5 million | $39.3 million | $81.2 million | $71.1 million |
| Net income attributable to Darling | $32.0 million | $3.1 million | $33.1 million | $3.2 million |
| Diluted EPS | $0.19 | $0.02 | $0.20 | $0.02 |
| Adjusted EBITDA | $124.0 million | $105.5 million | $222.9 million | $203.8 million |
| Operating cash flow | Not separately provided | Not separately provided | $168.2 million | $187.6 million |
Q2 gross margin was $200.2 million, or 22.8% of sales, compared with $191.0 million, or 22.2%, in the prior-year quarter. For the first six months, gross margin was $381.0 million, or 23.0%, compared with $381.2 million, or 22.0%. Q2 operating margin was approximately 6.2%, compared with 4.6% in the prior-year quarter. The six-month operating margin was approximately 4.9%, compared with 4.1%.
- Feed Ingredients: Q2 sales increased to $543.0 million from $529.4 million, and operating income increased to $41.4 million from $35.4 million. Higher fats and used cooking oil prices, higher raw-material volumes and lower selling, general and administrative expense offset lower protein prices.
- Food Ingredients: Q2 sales declined to $272.1 million from $283.4 million, while operating income increased to $19.7 million from $15.5 million. Improvements reflected currency-hedge gains, better casing results following the reopening of the Chinese border to meat by-products, and stronger European edible-fat pricing.
- Fuel Ingredients: Q2 sales increased to $62.3 million from $46.5 million. Segment operating income, including the equity contribution from the Diamond Green Diesel joint venture, increased to $20.2 million from $5.8 million. The improvement reflected better Canadian biodiesel operations, stronger European results and biodiesel blenders’ tax credits at the joint venture.
Cash Flow, Liquidity and Debt
| Balance-sheet item | July 2, 2016 | January 2, 2016 |
|---|---|---|
| Cash and cash equivalents | $157.8 million | $156.9 million |
| Working capital | $537.5 million | $490.1 million |
| Total debt, carrying value | $1,905.3 million | $1,931.0 million |
| Total liabilities | $2,801.8 million | $2,786.0 million |
| Total stockholders’ equity | $2,058.1 million | $1,974.6 million |
- Six-month operating cash flow was $168.2 million, down $19.4 million year over year, primarily because of working-capital and foreign-currency hedge movements.
- Investing cash outflows were $114.0 million, including $109.4 million of capital expenditures and $8.5 million of acquisitions.
- Financing cash outflows were $55.3 million, including $59.3 million of long-term debt repayments and $5.0 million of share repurchases.
- Revolver availability was approximately $969.9 million after $3.9 million of borrowings and $26.3 million of letters of credit. Management stated that the company was in compliance with its debt covenants.
- Debt includes $500.0 million of 5.375% senior notes due 2022, €515.0 million of 4.75% senior notes due 2022, Term Loan A and Term Loan B borrowings, and other obligations. Portions of the debt bear variable interest rates and are denominated in euros or Canadian dollars.
Material Changes and Unusual Items
- Profitability improved substantially despite lower first-half sales, primarily because of higher operating margins, lower interest expense, lower integration costs, stronger Food and Fuel Ingredients performance and higher DGD joint-venture earnings.
- Q2 2015 included a $10.6 million deferred-loan-cost write-off and $1.2 million of acquisition and integration costs. Q2 2016 had no material unusual items identified; acquisition and integration costs were $0.1 million.
- The DGD joint venture received $156.4 million of prior-year biodiesel blenders’ tax credits, paid down approximately $54.7 million of debt and distributed $25.0 million to each partner. Darling recorded $19.5 million of equity income from the joint venture in the first six months, compared with $2.4 million in the prior-year period.
- Darling repurchased approximately $5.0 million of common stock during the first six months. Approximately $89.1 million remained under the $100 million authorization at July 2, 2016.
- Accumulated other comprehensive loss improved to $282.2 million from $335.9 million, mainly because of foreign-currency translation gains.
Outlook, Risks and Contingencies
Management did not provide formal financial or operating guidance, stating that commodity prices, weather, crop harvests, government programs, global demand and other factors make forward-looking estimates unpredictable. Management expected cash flows, cash on hand and revolver availability to fund working capital, maintenance and compliance capital expenditures, debt service, taxes and other needs for at least the next twelve months.
- The company expected approximately $121.0 million of additional capital expenditures during the remainder of fiscal 2016. Total ERP-related cash costs were expected to be approximately $40.0 million to $42.0 million; $38.8 million had been spent through July 2, 2016.
- The DGD joint venture planned to expand annual renewable-diesel capacity from 160 million gallons to 275 million gallons, with anticipated completion in the fourth quarter of 2017 and production ramp-up in the first quarter of 2018. The project remained subject to final engineering and cost analysis.
- Key risks include volatility in fats, proteins, agricultural commodities, energy and renewable-fuel credits; reduced raw-material availability; foreign exchange; variable-rate debt; regulatory changes; animal diseases; food-safety matters; ERP implementation; and the ability of subsidiaries to upstream cash for debt service.
- Goodwill at four reporting units with fair values less than 10% above carrying value totaled approximately $533.9 million. No impairment trigger was identified at July 2, 2016, but future declines in volumes, margins, growth or valuation assumptions could result in impairment.
- Loss reserves for insurance, environmental, litigation and tax contingencies totaled approximately $55.8 million, with $12.2 million of insurance recovery receivables. The company stated that additional liability from disclosed litigation was not expected to be material, although ultimate costs could exceed estimates.
- Potential multiemployer pension withdrawal liabilities could be material but could not be quantified. Approximately $1.9 million was accrued for scheduled payments under two plans.
- Off-balance-sheet commitments included $65.4 million of commodity purchases and approximately $36.0 million of operating lease obligations due during the next twelve months, plus $35.9 million of letters of credit and foreign bank guarantees.
- The filing added Brexit as a risk, citing uncertainty regarding European market access, legal requirements, employee mobility and economic conditions.
Investor Verification Priorities
- Verify the extent to which DGD tax credits and distributions, rather than recurring operating performance, drove Fuel Ingredients earnings and cash generation.
- Monitor protein, fat, used cooking oil, energy and renewable-fuel credit prices, along with raw-material volumes and segment margins.
- Reconcile reported debt, foreign-currency exposure, variable-rate borrowings, maturity schedules and compliance with leverage and interest-coverage covenants.
- Assess the funding, timing, cost and execution risk of the DGD expansion and ERP implementation.
- Review goodwill sensitivity, multiemployer pension exposure, environmental and litigation contingencies, and the company’s ability to upstream cash from non-guarantor subsidiaries.