DARLING INGREDIENTS INC. annual report, FY2014

Darling Ingredients Inc. Form 10-K Summary

Reporting period: Fiscal year ended January 3, 2015, comprising 53 weeks. The provided metadata references “2013 Q4,” but the filing is the fiscal 2014 Form 10-K, not a 2013 quarterly filing. Fiscal 2014 included 52 weeks of VION operations and 53 weeks of Rothsay operations.

Business Context

Darling Ingredients is a global producer of sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Its products serve feed, pet food, food, pharmaceutical, fertilizer, biodiesel, renewable diesel and industrial markets. Following the VION Ingredients and Rothsay acquisitions, the Company operated more than 200 locations across five continents and reorganized its reporting structure into Feed Ingredients, Food Ingredients and Fuel Ingredients.

Feed Ingredients revenue: $2.421 billion, or 61.2% of net sales.
Food Ingredients revenue: $1.248 billion, or 31.6% of net sales.
Fuel Ingredients revenue: $286.6 million, or 7.2% of net sales.

Financial Performance and Key Metrics

Metric	Fiscal 2014	Fiscal 2013
Net sales	$3.956 billion	$1.802 billion
Operating income	$164.5 million	$169.6 million
Net income	$68.3 million	$109.0 million
Net income attributable to Darling	$64.2 million	$109.0 million
Diluted EPS	$0.39	$0.91
Adjusted EBITDA	$434.0 million	$268.4 million
Gross margin	21.1%	25.7%
Cash flow from operations	$275.2 million	$210.7 million
Capital expenditures	$228.9 million	$118.3 million

Reported earnings were reduced by acquisition-related and unusual items, including a $49.8 million non-cash VION inventory step-up, $27.3 million of redemption premium on retired 8.5% senior notes, $4.3 million of deferred loan cost write-offs, $24.7 million of acquisition and integration costs, and a $12.6 million loss on VION-related foreign exchange contracts. Management reported adjusted diluted EPS of $1.20, compared with $1.13 in fiscal 2013, although this is a non-GAAP measure.

Excluding the VION inventory step-up, fiscal 2014 gross margin would have been approximately 22.3%. The additional fiscal week contributed approximately $71 million of sales and $3 million of operating income.

Cash Flow, Debt and Liquidity

Cash and cash equivalents declined to $108.8 million from $870.9 million, primarily because of acquisition spending.
Cash used in investing activities was $2.324 billion, including $2.094 billion of acquisitions, principally VION.
Cash provided by financing activities was $1.276 billion.
Total debt was approximately $2.152 billion, consisting primarily of $1.518 billion of term loans, $101.9 million of revolver borrowings and $500 million of 5.375% notes due 2022.
Revolving credit availability was $865.9 million, after borrowings and letters of credit.
Working capital was $569.6 million, compared with $950.7 million in the prior year.
Management stated that operating cash flow, unrestricted cash and revolver availability were expected to fund working capital, maintenance and compliance capital expenditures, debt service and other needs for the next 12 months.

Material Changes Versus the Prior Comparable Period

Revenue more than doubled because fiscal 2014 included the VION business for the full year and Rothsay for substantially the full year.
Operating income declined modestly despite the acquisitions, while Adjusted EBITDA increased substantially because of the acquired businesses.
Net income and diluted EPS declined because of higher interest expense, acquisition costs, inventory purchase-accounting charges, foreign-exchange losses and other financing-related items.
Gross margin contracted from 25.7% to 21.1%; lower finished-product fat prices, Feed Ingredients margin pressure and the VION inventory step-up were significant factors.
Interest expense increased to $135.4 million from $38.1 million, reflecting acquisition financing and the retirement of the 8.5% notes.
The Company’s international exposure increased materially, resulting in a $125.9 million foreign-currency translation loss in other comprehensive income.
Diamond Green Diesel contributed $63.8 million of equity income, aided by approximately $126 million of blender tax credits recorded by the joint venture. The facility was shut down after a fire on August 3, 2014 and resumed operations on September 18, 2014.

Guidance, Outlook, Risks and Unusual Items

The Company does not provide forward-looking financial or operating estimates because results are highly sensitive to commodity prices, raw-material volumes, weather, energy costs, foreign exchange rates and government policies. Management expected fiscal 2015 capital expenditures of approximately $250 million, including ERP-related spending. The Oracle ERP implementation was expected to be completed in 2016, with an estimated remaining cash impact of approximately $40 million to $42 million.

Commodity-price volatility may affect selling prices, gross margins and inventory values.
Raw-material availability is exposed to supplier concentration, meat-processing volumes, competition for used cooking oil, disease outbreaks and weather.
The Company is highly leveraged and approximately $1.6 billion of debt was subject to variable interest rates; management estimated that a 1% rate increase would raise annual interest expense by approximately $16.1 million.
Biofuel results depend on renewable-fuel mandates, RIN values and tax incentives. The biofuel tax incentive had expired at fiscal year-end and its reauthorization was uncertain.
DGD remains exposed to operational disruptions, technology, insurance, debt-service and regulatory risks; its earnings had not yet been distributed to the venture partners.
Goodwill was approximately $1.320 billion. No impairment was recorded, but seven of nine reporting units had fair values less than 30% above carrying values, creating sensitivity to lower commodity prices or weaker supplier economics.
Insurance, environmental and litigation reserves totaled approximately $54.9 million, net of related insurance recovery receivables of $11.4 million.
The Company is involved in the Lower Passaic River environmental matter and a Fresno facility permitting lawsuit; management did not expect either matter to have a material financial effect, although ultimate outcomes remained uncertain.
The Company had an unfunded pension liability of approximately $66.9 million and potential exposure to underfunded multiemployer pension plans that could be material.

Most Important Facts for Investors to Verify

Whether post-acquisition operating performance and synergies offset the higher interest burden and integration costs.
Actual fiscal 2015 cash generation relative to approximately $250 million of planned capital expenditures and scheduled debt service.
Compliance with the credit agreement’s leverage and interest-coverage covenants.
The sustainability of DGD earnings without the approximately $126 million of blender tax credits recorded in fiscal 2014.
Exposure to commodity prices, RIN values, raw-material supply and foreign exchange, particularly the euro and Canadian dollar.
Progress and final cost of the ERP implementation and integration of VION and Rothsay controls and systems.
Potential goodwill impairment, pension funding requirements and changes in environmental, litigation or regulatory reserves.
The effect of the absence of cash dividends; the Company had not paid dividends since January 3, 1989 and did not expect to pay dividends in 2015.