DARLING INGREDIENTS INC. annual report, FY2017

Darling Ingredients Inc. — Form 10-K Summary

Reporting period: Fiscal year ended December 30, 2017, consisting of 52 weeks. The provided filing is the fiscal 2017 annual report, not a 2016 Q4 filing. Comparative figures are primarily for the 52 weeks ended December 31, 2016.

Business context

Darling Ingredients is a global producer of sustainable ingredients derived from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Its products serve feed, pet food, food, pharmaceutical, industrial, fertilizer, bioenergy and renewable-fuel markets. Operations span more than 200 locations across five continents and are organized into Feed Ingredients, Food Ingredients and Fuel Ingredients.

Feed Ingredients generated 61.1% of 2017 external sales.
Food Ingredients generated 31.6% of 2017 external sales.
Fuel Ingredients generated 7.3% of 2017 external sales.

Financial performance

Metric	FY2017	FY2016	Change
Net sales	$3.662 billion	$3.392 billion	+8.0%
Operating income	$136.8 million	$152.1 million	-10.1%
Net income	$133.4 million	$107.2 million	+24.4%
Net income attributable to Darling	$128.5 million	$102.3 million	+25.6%
Diluted EPS	$0.77	$0.62	+24.2%
Adjusted EBITDA	$438.9 million	$442.0 million	-0.7%
Net cash from operating activities	$410.6 million	$391.0 million	+$19.6 million
Capital expenditures	$274.2 million	$243.5 million	+12.6%

Reported net income benefited materially from a $69.2 million income-tax benefit, including approximately $75.0 million related to U.S. tax reform and $13.9 million from European tax-law changes. Excluding U.S. and European tax-law changes, the 2017 effective tax rate was 30.8%; the reported effective tax rate was negative 107.7%.

Net sales increased in all three segments. Feed Ingredients sales rose to $2.239 billion from $2.089 billion, while operating income increased to $129.7 million from $115.8 million. Food Ingredients sales rose to $1.157 billion from $1.056 billion, but operating income declined to $56.4 million from $61.2 million. Fuel Ingredients sales increased to $265.8 million from $247.1 million, while segment operating income excluding the DGD joint venture declined to $13.8 million from $29.2 million.

Margins, cash flow, debt and liquidity

Consolidated gross margin declined to 21.5% from 22.3%.
Feed Ingredients gross margin was 22.1%, versus 22.2% in 2016.
Food Ingredients gross margin was 20.4%, versus 21.5%, primarily due to South American gelatin inefficiencies and macroeconomic conditions.
Fuel Ingredients gross margin excluding the DGD joint venture was 20.8%, versus 26.1%, principally because 2017 did not include U.S. blenders tax credits and Ecoson operations were curtailed for regulatory work.
Cash and cash equivalents were $106.8 million; working capital was $397.0 million, with a 1.71-to-1 current ratio.
Revolving-credit availability was $976.0 million after outstanding letters of credit.
Total debt carrying value was approximately $1.714 billion, including $500.0 million of 5.375% senior notes, €515.0 million of 4.75% senior notes and term loans.
Management stated that cash flow, cash on hand and revolver availability should be sufficient for working capital, scheduled debt service and planned capital needs over the next 12 months.

Material changes versus FY2016

Raw-material volumes increased approximately 3.4% in Feed Ingredients, 2.9% in Food Ingredients and 0.5% in Fuel Ingredients.
Operating income declined despite higher sales, reflecting weaker Food and Fuel Ingredients performance and higher corporate costs.
DGD joint-venture equity income fell to $28.5 million from $70.4 million because 2017 did not include the prior-year blenders tax credits.
Foreign-currency losses increased to $6.9 million from $1.9 million, although foreign-currency translation produced a $121.8 million gain in other comprehensive income.
The Company amended its credit agreement in December 2017, refinancing Term Loan B with new loans maturing December 18, 2024.
Goodwill increased to $1.301 billion from $1.226 billion, largely reflecting foreign-currency translation. No goodwill impairment was recorded, but six of nine reporting units had fair value less than 30% above carrying value.

Guidance, outlook and unusual items

The Company does not provide formal forward-looking financial or operating estimates because results are highly sensitive to commodity prices, raw-material volumes, energy costs, weather, currencies and government policies.
For fiscal 2018, management expected approximately $219 million of regular capital expenditures and $114 million of new construction and expansion spending, or approximately $333 million in total, funded primarily from operating cash flow.
The DGD joint venture was expanding annual renewable-diesel capacity from 160 million gallons to 275 million gallons, with expected completion and commissioning in the second quarter of 2018. A further expansion to 550 million gallons remained under review.
U.S. blenders tax credits for calendar 2017 were retroactively reinstated in February 2018. Darling expected approximately $12.6 million of related Fuel Ingredients credits and the DGD joint venture expected approximately $160.4 million.
Blenders tax credits had not been extended for 2018 and beyond, creating regulatory and earnings uncertainty.
Management identified significant exposure to commodity-price volatility, raw-material supply competition, energy costs, foreign exchange, food and animal disease, environmental regulation, cybersecurity, labor disruptions and international operations.

Legal, regulatory and other contingencies

Reserves for insurance, environmental, litigation and tax contingencies were approximately $61.4 million at year-end, compared with $51.9 million in 2016; related insurance recovery receivables were $25.0 million.
The Company remains a potentially responsible party in the Lower Passaic River environmental matter. The estimated remedy cost for the broader site was $1.38 billion, but the Company’s ultimate liability could not be determined and management did not expect a material impact based on information available.
A Fresno facility permitting lawsuit remained subject to mediation and a non-binding relocation proposal; management did not expect a material financial impact.
Defined-benefit pension obligations were underfunded by approximately $54.2 million. Expected fiscal 2018 domestic and foreign pension funding was approximately $5.0 million, excluding potentially material future exposure from underfunded multiemployer plans.

Important facts for investors to verify

Whether operating margins recover after the 2017 decline, particularly in Food Ingredients and Fuel Ingredients.
The sustainability of earnings excluding the one-time tax benefits from U.S. and European tax-law changes.
The timing, cost and operating performance of the DGD expansion and the status of any additional expansion to 550 million gallons.
The availability and future renewal of biofuel tax credits, renewable-fuel mandates and low-carbon fuel programs.
Debt maturities, covenant headroom, variable-rate exposure and the ability to refinance or repay the approximately $1.7 billion debt balance.
Progress on the planned $333 million of fiscal 2018 capital spending and its effect on free cash flow.
Potential goodwill impairment, given approximately $1.3 billion of goodwill and limited valuation cushions at several reporting units.
Final outcomes and potential costs of environmental, permitting, litigation and underfunded multiemployer pension matters.