Business Context and Reporting Period
Darling Ingredients Inc. is a global producer of sustainable ingredients from animal by-products, recycled oils and food residuals, operating in Feed Ingredients, Food Ingredients and Fuel Ingredients. This unaudited Form 10-Q covers the 13 and 39 weeks ended September 29, 2018, compared with September 30, 2017. The supplied metadata identifies “2017 Q3,” but the filing is for fiscal 2018 third quarter.
Financial Performance and Liquidity
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $812.6 million | $936.3 million | $2.535 billion | $2.710 billion |
| Operating income | $18.2 million | $34.4 million | $71.6 million | $105.1 million |
| Operating margin | 2.2% | 3.7% | 2.8% | 3.9% |
| Net income attributable to Darling | $(6.0) million | $7.8 million | $60.8 million | $22.7 million |
| Diluted EPS | $(0.04) | $0.05 | $0.37 | $0.14 |
| Adjusted EBITDA | $97.0 million | $111.6 million | $322.5 million | $326.4 million |
| Cash flow from operations | Not separately provided | Not separately provided | $199.7 million | $268.8 million |
Q3 gross margin was $164.5 million, or 20.2%, versus $193.8 million, or 20.7%, in the prior-year quarter. Nine-month gross margin was $555.4 million, or 21.9%, versus $580.0 million, or 21.4%.
- September 29, 2018 unrestricted cash was $81.5 million, compared with $106.8 million at December 30, 2017.
- Working capital was $392.6 million, with a current ratio of 1.81:1.
- Total debt carrying value was $1.679 billion, including $23.0 million drawn on the revolving facility. Approximate net debt was $1.598 billion before considering restricted cash.
- Revolver availability was $953.9 million, including the effect of outstanding borrowings and letters of credit.
- Capital expenditures were $213.7 million in the first nine months, compared with $196.4 million in the prior-year period. Management expected approximately $119.0 million of additional fiscal 2018 capital expenditures.
Material Changes Versus the Prior Comparable Period
- Q3 revenue declined 13.2%, while nine-month revenue declined 6.5%. The adoption of ASC 606 removed billed freight from revenue and cost of sales; the filing shows a $39.8 million quarterly and $131.4 million nine-month reduction in both reported revenue and cost of sales. Prior-year revenue includes approximately $40.9 million of quarterly and $117.0 million of nine-month billed freight, limiting reported-period comparability.
- Feed Ingredients Q3 sales fell 16.1% and operating income fell 65.3%, primarily because of lower finished-product prices and approximately $7.2 million of inventory write-downs in China related to African Swine Fever.
- Food Ingredients Q3 operating income decreased 13.9%, reflecting weaker European gelatin markets, lower edible-fat prices and lower casing earnings. The nine-month decline was 52.6%, including approximately $15.0 million of restructuring and impairment charges associated with closing the Hurlingham, Argentina gelatin plant.
- Fuel Ingredients Q3 operating income excluding the DGD Joint Venture increased to $4.5 million from $0.2 million, aided by higher Ecoson volumes and an approximately $4.1 million business-interruption insurance gain. Including DGD, segment income declined to $1.9 million from $7.4 million because of downtime for expansion work.
- Nine-month equity income from the DGD Joint Venture increased to $109.6 million from $16.7 million, primarily because the joint venture recorded approximately $160.4 million of retroactively reinstated 2017 biodiesel blender tax credits. The filing states that the 2018 biodiesel credit had not been reinstated.
- Operating cash flow declined $69.1 million, primarily from lower accounts payable and accrued expenses and lower income-tax-related cash flows.
- The Company refinanced its euro-denominated 4.75% notes with €515.0 million of 3.625% senior notes due 2026. It recognized $23.5 million of debt extinguishment costs.
Outlook, Management Commentary, Risks and Unusual Items
- No formal revenue or earnings guidance is provided. Management stated that operating results are difficult to forecast because of commodity prices, energy costs, weather, raw-material volumes, currency movements, government policies and global demand.
- Management expected cash from operations, unrestricted cash and revolver availability to fund working capital, maintenance and compliance capital expenditures, scheduled debt and interest payments, taxes and other needs for the next twelve months.
- DGD completed its expansion to approximately 275 million gallons of annual renewable diesel capacity, but a catalyst problem caused reduced efficiency and an outage in early October 2018. Management expected full-capacity operations for the remainder of the year.
- DGD partners approved a further expansion to approximately 675 million gallons of annual capacity, including naphtha separation. Estimated cost is approximately $1.1 billion, with completion and startup expected in the fourth quarter of 2021 and funding expected from DGD cash flow.
- African Swine Fever had spread to 10 Chinese provinces by the filing date, reducing slaughter volumes, raw-material availability and demand for porcine plasma products in China.
- Key risks include commodity-price and margin volatility, foreign exchange exposure, variable-rate debt, dependence on subsidiary cash distributions, renewable-fuel policy and tax-credit changes, DGD execution, environmental and regulatory matters, and animal diseases.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $61.5 million. The Passaic River CERCLA matter remains unresolved; potential liability cannot currently be determined.
- The Company had approximately $59.9 million of commodity purchase commitments and $42.3 million of operating lease obligations due during the next twelve months. It also had $41.1 million of letters of credit and foreign bank guarantees.
- The Company disclosed approximately $1.7 million of accrued multiemployer pension withdrawal liabilities, while potential liabilities for other underfunded plans could be material but cannot be calculated.
Most Important Facts to Verify
- Confirm that the intended filing period is Q3 2018 rather than Q3 2017.
- Reconcile revenue and margin trends after adjusting for ASC 606 freight presentation, especially when comparing with 2017.
- Assess the sustainability of nine-month earnings given the one-time DGD blender tax credits and the absence of a reinstated 2018 credit.
- Monitor DGD catalyst repairs, operating performance, financing and execution of the approximately $1.1 billion expansion.
- Evaluate leverage, variable-rate exposure, covenant headroom and the Company’s reliance on subsidiary distributions to service debt.
- Track African Swine Fever effects on Chinese volumes, inventory values and plasma demand, as well as commodity prices and foreign-exchange movements.
- Review the Passaic River litigation, multiemployer pension exposure, environmental contingencies and the potential balance-sheet impact of adopting lease accounting.