Darling Ingredients Inc. — Fiscal 2016 Form 10-K Summary
Reporting period: The provided filing is the annual report for the 52 weeks ended December 31, 2016, not a 2015 Q4 filing. Prior comparable periods are the 52 weeks ended January 2, 2016 and January 3, 2015.
Business context
Darling Ingredients is a global processor of animal by-products, used cooking oil and food residuals into feed, food, fuel, bioenergy, fertilizer, gelatin, collagen, fats, proteins, natural casings, hides and related specialty ingredients. The company operates more than 200 locations across five continents through three reportable segments: Feed Ingredients, Food Ingredients and Fuel Ingredients.
- Fiscal 2016 revenue was generated primarily by Feed Ingredients, which represented 61.5% of sales, followed by Food Ingredients at 31.2% and Fuel Ingredients at 7.3%.
- The company employed approximately 10,000 people as of December 31, 2016.
- Darling owns a 50% interest in Diamond Green Diesel Holdings LLC, a renewable diesel joint venture with Valero Energy Corporation.
Financial performance and key metrics
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Net sales | $3.398 billion | $3.397 billion | Approximately flat |
| Operating income | $152.1 million | $142.6 million | Up $9.4 million |
| Net income | $107.2 million | $85.3 million | Up $21.9 million |
| Net income attributable to Darling | $102.3 million | $78.5 million | Up 30.3% |
| Diluted EPS | $0.62 | $0.48 | Up $0.14 |
| Adjusted EBITDA | $442.0 million | $412.5 million | Up 7.1% |
| Gross margin | 22.3% | 21.9% | Up 0.4 percentage points |
| Net cash from operating activities | $391.0 million | $421.0 million | Down $30.0 million |
| Capital expenditures | $243.5 million | $229.8 million | Up 6.0% |
Net income attributable to Darling benefited from lower interest expense, reduced acquisition and integration costs, improved Fuel Ingredients performance and a $5.6 million after-tax insurance settlement gain. Adjusted EBITDA is a non-GAAP measure and is not equivalent to cash flow or GAAP operating income.
Segment performance
| Segment | 2016 sales | 2015 sales | 2016 operating income | 2015 operating income |
|---|---|---|---|---|
| Feed Ingredients | $2.089 billion | $2.074 billion | $115.8 million | $116.5 million |
| Food Ingredients | $1.062 billion | $1.095 billion | $61.2 million | $61.2 million |
| Fuel Ingredients | $247.1 million | $228.2 million | $29.2 million | $17.2 million |
- Feed Ingredients sales increased modestly as higher volumes and fat prices offset materially lower protein prices. Raw material volumes in the segment increased 7.0%.
- Food Ingredients sales declined because of lower sales prices and volumes in China, although improved gelatin, edible fat and casing performance preserved operating income.
- Fuel Ingredients operating income excluding the joint venture improved by $12.0 million, driven by better Rendac and Ecoson results, Canadian biodiesel productivity and higher renewable identification number values.
- Darling’s equity income from unconsolidated subsidiaries was $70.4 million, primarily reflecting its share of Diamond Green Diesel earnings, compared with $73.4 million in 2015.
Liquidity, debt and capital resources
- Cash and cash equivalents were $114.6 million at December 31, 2016, compared with $156.9 million at January 2, 2016.
- Working capital was $441.5 million, with a current ratio of 1.98 to 1.
- Total debt carrying value was approximately $1.751 billion, including $500.0 million of 5.375% senior notes, $543.8 million of 4.75% euro-denominated senior notes, $120.1 million of Term Loan A and $583.5 million of Term Loan B.
- Revolving credit availability was $968.1 million after $5.3 million of borrowings and $26.6 million of letters of credit.
- The December 2016 credit agreement amendment extended Term Loan A and revolving facility maturities to December 2021, subject to a springing maturity provision tied to Term Loan B. It also established a maximum total leverage ratio of 5.50 to 1.00 and minimum interest coverage ratio of 3.00 to 1.00. Management stated that the company was in compliance with applicable covenants at year-end.
- Management expects approximately $239.0 million of fiscal 2017 capital expenditures. Approximately $39.9 million had been spent on the Oracle E Business Suite ERP project, with total expected cash costs of approximately $41.0 million to $42.0 million.
- Management believes operating cash flow, unrestricted cash and available revolver capacity will fund working capital, maintenance and compliance capital expenditures, debt service and other needs over the next twelve months.
Material changes versus the prior comparable period
- Revenue was essentially unchanged, but net income attributable to Darling rose from $78.5 million to $102.3 million.
- Adjusted EBITDA increased $29.4 million, supported by higher raw material volumes, higher fat prices, cost reductions and lower acquisition-related expenses.
- Overall gross margin increased to 22.3% from 21.9%; Fuel Ingredients margin increased to 26.1% from 22.4%, while Feed Ingredients margin remained 22.2%.
- Operating cash flow declined despite higher earnings, primarily because of changes in operating assets and liabilities and foreign currency hedge balances.
- Debt declined from approximately $1.931 billion at January 2, 2016 to approximately $1.751 billion at December 31, 2016.
- Fiscal 2016 included only $0.4 million of acquisition and integration costs versus $8.3 million in fiscal 2015. Fiscal 2015 also included a $10.6 million deferred loan cost write-off.
- Raw material processed increased 5.6% to 10.24 million metric tons.
Guidance, outlook, risks and unusual items
- The company does not provide formal forward-looking financial or operating estimates because results are highly sensitive to commodity prices, energy costs, weather, raw material volumes, currency movements and government policies.
- Diamond Green Diesel plans to expand annual renewable diesel capacity from 160 million gallons to 275 million gallons. Estimated construction cost is $190 million, funded from joint venture cash flow, with expected completion and commissioning in the second quarter of 2018.
- The $1.00-per-gallon federal blenders tax credit expired December 31, 2016. Diamond Green Diesel recorded approximately $160.6 million of credits in 2016, of which Darling’s share was 50%. Non-extension could materially affect future earnings and the effective tax rate.
- Key risks include volatile prices for proteins, fats, grains, energy and renewable fuel credits; competition for animal by-products and used cooking oil; supplier and customer concentration; foreign exchange and international regulatory exposure; high leverage and variable interest rates; environmental, food-safety and permitting requirements; pension and multiemployer plan obligations; ERP implementation; goodwill impairment; and operational risks at the Diamond Green Diesel joint venture.
- Goodwill was approximately $1.226 billion. No impairment was recorded, but six of nine reporting units had less than 30% excess fair value over carrying value and one had approximately 8% excess fair value, creating sensitivity to lower product prices, weaker margins or reduced supplier volumes.
- The company is a potentially responsible party in the Lower Passaic River environmental matter. The EPA-selected remedy is estimated at $1.38 billion, but no demand has been made on Darling and the company cannot determine its ultimate liability.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $51.9 million at year-end. Management believes the reserves are adequate and that additional liabilities are unlikely to be material, although final costs could exceed estimates.
- The company has not paid common-stock dividends since 1989 and does not expect to pay cash dividends in 2017. A share repurchase authorization of up to $100 million had approximately $89.1 million remaining at year-end.
Most important facts for investors to verify
- Reconcile reported net income and adjusted EBITDA to the audited financial statements and assess the effect of the Diamond Green Diesel tax credits.
- Review debt maturities, covenant calculations, variable-rate exposure and the December 2016 credit agreement amendment.
- Assess whether expected capital expenditures and the Diamond Green Diesel expansion can be funded from operating and joint venture cash flow.
- Monitor protein, fat, gelatin, renewable diesel, RIN, grain, natural gas and diesel prices, as well as raw material availability and volumes.
- Evaluate goodwill sensitivity, particularly the ERS Feed reporting unit and the six reporting units with limited valuation headroom.
- Review the potential impact of the Lower Passaic River matter, environmental compliance, product recalls, food-safety rules and multiemployer pension liabilities.
- Confirm the filing period: the supplied document reports fiscal 2016 results, although the request metadata identifies 2015 Q4.