Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: The filing is for the 13 weeks ended April 1, 2017, with comparison to the 13 weeks ended April 2, 2016. The request metadata identifies “2016 Q1,” but the filing itself is the first quarter of fiscal 2017. Financial statements are unaudited.
Business Context
Darling is a global developer and producer of sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. It operates through Feed Ingredients, Food Ingredients and Fuel Ingredients segments across more than 15 countries.
Key Financial Metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $880.1 million | $779.6 million | +12.9% |
| Operating income | $31.4 million | $26.7 million | +17.6% |
| Operating margin | 3.6% | 3.4% | +0.2 percentage points |
| Net income | $7.4 million | $2.7 million | +177.8% |
| Net income attributable to Darling | $5.8 million | $1.1 million | +440.3% |
| Diluted earnings per share | $0.04 | $0.01 | Increased |
| Adjusted EBITDA | $102.5 million | $98.9 million | +3.6% |
| Net cash provided by operating activities | $94.5 million | $45.0 million | +$49.5 million |
| Capital expenditures | $62.3 million | $53.4 million | +16.7% |
Consolidated gross margin was $190.4 million, or 21.6% of sales, compared with 23.2% in the prior-year quarter. The effective tax rate was 19.7%, compared with 41.2% in Q1 2016; excluding discrete items, management reported an effective rate of 46.1% versus 38.6%.
Segments and Material Changes
- Feed Ingredients: Sales increased 16.0% to $552.6 million and operating income increased 121.6% to $30.8 million. Higher finished-product prices, sales volumes and raw-material volumes drove the improvement. Gross margin remained 21.7%.
- Food Ingredients: Sales increased to $267.8 million, but operating income fell 35.6% to $14.1 million. Gross margin declined to 21.2% from 25.1%, primarily because of lower production volumes, higher raw-material costs and oversupply of hide gelatin in South America.
- Fuel Ingredients: Segment income, including the DGD Joint Venture, declined to $4.1 million from $11.7 million. The primary factor was the expiration of the biodiesel blenders tax credit, which benefited Q1 2016 but was not recorded in Q1 2017. Gross margin excluding DGD declined to 22.9% from 26.8%.
- DGD Joint Venture: Darling recorded $0.7 million of equity income versus $5.6 million in the prior-year quarter and received a $25.0 million dividend distribution. The venture’s renewable diesel expansion is expected to increase annual capacity from 160 million to 275 million gallons, with estimated construction costs of $190 million and expected completion in the second quarter of 2018.
- Corporate costs: Corporate selling, general and administrative expense increased to $14.1 million from $10.6 million, primarily due to higher benefits and accelerated equity-compensation costs. Acquisition and integration costs declined to zero from $0.3 million.
Debt, Liquidity and Cash Flow
- Cash and cash equivalents were $138.9 million at April 1, 2017, compared with $114.6 million at December 31, 2016.
- Total debt was $1.75 billion, including $500.0 million of 5.375% senior notes, $550.3 million of euro-denominated 4.75% senior notes, $120.9 million of Term Loan A and $582.0 million of Term Loan B.
- Debt carrying value, net of current maturities, was $1.73 billion. The company reported $973.7 million of available revolving-credit capacity after borrowings and letters of credit.
- Working capital was $475.5 million, with a 2.05-to-1 current ratio, versus $441.5 million and 1.98-to-1 at December 31, 2016.
- Operating cash flow exceeded capital expenditures by approximately $32.2 million before other investing and financing activity. Financing activities used $10.6 million, and cash increased by $24.3 million during the quarter.
- Management expected approximately $176.7 million of additional capital expenditures during the remainder of fiscal 2017. The ERP project had incurred approximately $40.8 million of costs, with total expected cash impact of $41.0 million to $42.0 million.
Outlook, Risks and Unusual Items
Management did not provide formal financial or operational estimates because results are highly sensitive to commodity prices, weather, crop conditions, government policies, global demand, foreign exchange and raw-material availability. Management stated that operating cash flows, cash on hand and available credit were expected to fund working capital, maintenance and compliance capital expenditures, scheduled debt and interest payments, taxes and other needs for the next twelve months.
- Key risks include volatility in agricultural and energy commodities, reduced rendering feedstock, lower finished-product prices, foreign-exchange movements, variable interest rates and substantial leverage.
- The expiration of biofuel tax incentives materially reduced Fuel Ingredients and DGD results versus Q1 2016.
- Goodwill totaled $1.23 billion. Six of nine reporting units had fair value less than 30% above carrying value, including one reporting unit with approximately $181.5 million of goodwill and only an 8% valuation cushion. No impairment trigger was identified at April 1, 2017.
- Loss reserves for insurance, environmental, litigation and tax contingencies were approximately $52.8 million. The company is involved in the Lower Passaic River environmental matter and Fresno facility permit litigation; management did not expect either matter to have a material effect, but ultimate outcomes remain uncertain.
- The company reported potential material withdrawal liabilities relating to underfunded multiemployer pension plans. Accrued withdrawal liability for two plans was approximately $1.8 million, while additional exposure cannot currently be calculated and could be material.
- Off-balance-sheet commitments included $61.0 million of commodity purchases, $39.8 million of operating lease payments due over the next twelve months, $26.3 million of standby letters of credit and $10.1 million of foreign bank guarantees.
- In April and May 2017, the company acquired a New Jersey used-cooking-oil service provider and a Florida rendering business for approximately $20.0 million in aggregate, funded with cash.
Accounting and Controls
The company adopted ASU 2016-09 on share-based payment accounting in the quarter; the effect was not material. Management concluded that disclosure controls were effective as of April 1, 2017. The filing noted SOX control changes related to an accounting-software upgrade at international operations.
Investor Verification Points
- Verify whether higher Feed Ingredients prices and volumes are sustainable under changing commodity and livestock-cycle conditions.
- Assess the ongoing effect of the expired blenders tax credit and the economics, funding and execution risk of the DGD expansion.
- Review leverage, variable-rate exposure, debt maturities and the company’s reliance on subsidiary distributions to service parent-level obligations.
- Monitor the Food Ingredients margin recovery, particularly South American hide-gelatin pricing and raw-material costs.
- Evaluate goodwill impairment sensitivity, especially for the ERS Feed reporting unit and other units with limited valuation cushions.
- Track environmental, permit, litigation and multiemployer-pension exposures, including liabilities that could exceed recorded reserves.
- Reconcile adjusted EBITDA to GAAP results and note that adjusted EBITDA is a non-GAAP measure that excludes or adjusts for items affecting comparability.