Darling Ingredients Inc. — Form 10-Q Summary
Business context and reporting period
This filing covers the 13 and 26 weeks ended July 4, 2015, with comparisons to June 28, 2014. The filing is a second-quarter fiscal 2015 report, despite the request metadata referring to “2014 Q2.” Darling develops sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients for feed, food, fuel, pharmaceutical and industrial markets. Operations span more than 200 locations across five continents and are organized into Feed Ingredients, Food Ingredients and Fuel Ingredients.
Key financial metrics
| Metric | Three months ended July 4, 2015 | Three months ended June 28, 2014 | Six months ended July 4, 2015 | Six months ended June 28, 2014 |
|---|---|---|---|---|
| Net sales | $859.3 million | $1,031.3 million | $1,734.0 million | $1,977.6 million |
| Operating income | $39.3 million | $75.5 million | $71.1 million | $74.9 million |
| Net income attributable to Darling | $3.1 million | $32.8 million | $3.2 million | $(20.0) million |
| Diluted EPS | $0.02 | $0.20 | $0.02 | $(0.12) |
| Adjusted EBITDA | $105.5 million | $143.0 million | $203.8 million | $208.1 million |
| Pro forma adjusted EBITDA | $106.7 million | $152.1 million | $210.3 million | $282.1 million |
| Gross margin | 22.2% | 23.4% | 22.0% | 20.9% |
Six-month operating cash flow was $187.6 million, compared with $41.0 million in the prior-year period. Capital expenditures were $98.7 million, compared with $103.5 million. Ending cash and cash equivalents were $126.0 million, versus $108.8 million at January 3, 2015.
At July 4, 2015, total debt was $2.045 billion, including $50.9 million of current maturities and $1.994 billion of long-term debt. Debt included $500.0 million of 5.375% senior notes due 2022, $571.5 million of euro-denominated 4.75% senior notes due 2022, and term loans and revolver borrowings. Revolver availability was $908.4 million after borrowings and letters of credit. Working capital was $571.5 million, with a 2.23-to-1 working-capital ratio.
Material changes versus the prior comparable period
- Second-quarter sales declined 16.7%, and first-half sales declined 12.3%, primarily because of lower finished-product commodity prices and the stronger U.S. dollar.
- Second-quarter operating income fell $36.2 million. Feed Ingredients operating income declined to $35.4 million from $74.7 million, while Food Ingredients operating income increased to $15.5 million from $11.3 million and Fuel Ingredients operating income declined to $2.0 million from $5.2 million, excluding the DGD joint venture.
- Commodity price benchmarks were substantially lower year over year in the second quarter, including declines of approximately 29% to 36% for major protein products, 31% for yellow grease, 31% for bleachable fancy tallow and 23% for corn.
- Raw material processed increased approximately 7.1% in the second quarter and 8.3% for the first six months, partially offsetting lower selling prices.
- Six-month net income improved from a prior-year loss, but the comparison benefited from significant prior-year acquisition-related charges, including a $49.8 million inventory step-up, $20.8 million of 8.5% notes retirement costs and $8.3 million of foreign-exchange hedge losses.
- The company issued €515.0 million of 4.75% senior notes in June 2015 and used the proceeds primarily to refinance euro term-loan B borrowings. The refinancing generated a $10.6 million write-off of deferred loan costs.
- Accumulated other comprehensive loss increased to $267.0 million from $177.1 million, primarily because of a $90.2 million after-tax foreign-currency translation loss.
Guidance, outlook, commentary and risks
The company does not provide forward-looking financial or operational estimates because results are sensitive to volatile commodity prices, energy costs, weather, crop conditions, government policies, foreign exchange and global demand. Management expects remaining fiscal 2015 capital expenditures of $110 million to $135 million. The Oracle ERP implementation is expected to be completed in 2016, with total expected cash impact of $40 million to $42 million; approximately $37.4 million had been spent through July 4, 2015.
Management believed operating cash flow, cash on hand and revolver availability would be sufficient for the next twelve months to fund working capital, scheduled debt service, taxes and planned maintenance and compliance capital expenditures. The company reported compliance with its debt covenants. The May 2015 amendment maintained the maximum total leverage ratio at 5.0-to-1.0 rather than requiring further step-downs.
- Key operating risks include further declines in protein, fat, used cooking oil and other commodity prices; reduced raw-material availability; higher energy costs; foreign-exchange volatility; and adverse biofuel policies or renewable-fuel volume requirements.
- The DGD joint venture’s results were affected by lower petroleum prices and uncertainty regarding U.S. renewable volume obligations. Darling received a $25.0 million distribution from DGD during the first half.
- Bird flu had not materially affected results as of the filing date, but future animal disease could reduce raw-material volumes or product demand.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $57.5 million, with $11.4 million of insurance recovery receivables. The company stated that additional exposure from disclosed litigation was not expected to be material, although ultimate costs cannot be assured.
- Potentially material exposure exists to underfunded multiemployer pension plans, including withdrawal liabilities that management cannot currently quantify.
- Off-balance-sheet commitments included $57.1 million of commodity purchase commitments, $34.6 million of operating lease obligations expected over the next twelve months, and $43.8 million of letters of credit and foreign bank guarantees.
- In August 2015, after quarter-end, the board authorized repurchases of up to $100 million of common stock through August 2017, subject to market conditions and debt-agreement limitations.
Most important facts for investors to verify
- Whether lower commodity prices and currency movements continue to pressure Feed Ingredients margins and consolidated EBITDA.
- The company’s leverage, covenant headroom, variable-rate exposure and ability to refinance or repay debt due in 2018, 2021 and 2022.
- Actual cash generation after capital expenditures, ERP spending, pension funding and potential share repurchases.
- The sustainability of DGD joint-venture earnings and distributions amid petroleum prices and renewable-fuel regulatory uncertainty.
- Progress and final cost of the ERP implementation and remaining VION and Rothsay integration activities.
- Potential liabilities from environmental matters, litigation, tax positions, animal-disease events and underfunded multiemployer pension plans.
- The effect of new accounting standards, particularly revenue recognition, inventory measurement and debt-issuance-cost presentation, which the company was still evaluating.