Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 weeks ended April 2, 2016, with comparison to the 13 weeks ended April 4, 2015. Although the request identifies 2015 Q1, the filing is for fiscal 2016 Q1. The financial statements are unaudited and prepared under U.S. GAAP.
Business Context
Darling operates globally across Feed Ingredients, Food Ingredients and Fuel Ingredients. Its businesses collect and process animal by-products, used cooking oil, bakery residuals and other bio-nutrients into fats, proteins, gelatin, collagen, casings, fuels, renewable energy and related specialty ingredients. The company also owns a 50% interest in the Diamond Green Diesel joint venture with Valero.
Key Financial Metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net sales | $779.6 million | $874.7 million | Down $95.1 million |
| Operating income | $26.7 million | $31.8 million | Down $5.1 million |
| Net income | $2.7 million | $1.8 million | Up $0.8 million |
| Net income attributable to Darling | $1.1 million | $0.1 million | Up $1.0 million |
| Diluted EPS | $0.01 | $0.00 | Improved |
| Adjusted EBITDA | $98.9 million | $98.2 million | Up $0.7 million |
| Pro forma Adjusted EBITDA | $99.3 million | $103.5 million | Down $4.2 million |
| Operating cash flow | $45.0 million | $59.2 million | Down $14.2 million |
| Capital expenditures | $53.4 million | $50.8 million | Up $2.6 million |
Gross margin increased to 23.2% from 21.7%. The effective tax rate was 41.2%, compared with 53.7% in the prior-year quarter. Interest expense increased to $23.9 million from $23.1 million.
Segment Performance
| Segment | Q1 2016 Sales | Q1 2016 Operating Income | Prior-Year Operating Income |
|---|---|---|---|
| Feed Ingredients | $476.2 million | $13.9 million | $35.4 million |
| Food Ingredients | $247.9 million | $21.9 million | $10.8 million |
| Fuel Ingredients | $55.6 million | $6.1 million | $2.5 million |
- Feed Ingredients: Sales declined primarily because of lower prices for proteins, fats and used cooking oil. Higher raw-material volumes partly offset pricing pressure.
- Food Ingredients: Profitability improved substantially, led by stronger gelatin operations, improved margins and production efficiencies.
- Fuel Ingredients: Operating performance improved at Canadian biodiesel and European operations. Including the DGD equity contribution, segment income increased to $11.7 million from $0.3 million, principally because of biodiesel blenders tax credits.
- Raw materials processed increased 3.5% year over year to 2.52 million metric tons, excluding DGD joint venture volumes.
Liquidity, Debt and Capital Resources
At April 2, 2016, the company had $147.3 million of unrestricted cash, working capital of $508.4 million and a current ratio of 2.13 to 1. Revolver availability was $944.2 million after considering $22.0 million of borrowings and $33.8 million of letters of credit.
| Debt item | Carrying value |
|---|---|
| Total debt, including current portion | $1.971 billion |
| 5.375% senior notes due 2022 | $491.4 million |
| 4.75% senior notes due 2022 | $577.2 million |
| Term Loan A | $276.2 million |
| Term Loan B | $580.6 million |
Management stated that it expects operating cash flow, cash on hand and available revolver capacity to fund working capital, maintenance and compliance capital expenditures, scheduled debt service, taxes and other needs for the next 12 months. The company expects approximately $177.0 million of additional capital expenditures during the remainder of fiscal 2016, including ongoing ERP implementation costs.
Material Changes and Unusual Items
- Foreign currency translation produced a $57.5 million other comprehensive gain, compared with a $93.3 million loss in the prior-year quarter; this materially affected equity but not operating income.
- Acquisition and integration costs fell to $0.3 million from $5.3 million, primarily because prior-year costs related to VION integration and internal-control implementation had largely ended.
- The DGD joint venture recorded $11.1 million of net income versus a $4.5 million net loss in the prior-year quarter. The improvement primarily reflected inclusion of biodiesel blenders tax credits.
- Subsequent to quarter-end, DGD received $156.4 million of 2015 blenders tax credits, repaid approximately $54.7 million of debt and distributed $25.0 million to each partner.
- DGD announced a planned capacity expansion from 160 million to 275 million gallons annually, targeted for completion in the fourth quarter of 2017, subject to final engineering and cost analysis.
- The company repurchased approximately $5.0 million of common stock during the quarter, leaving approximately $89.1 million authorized under its share-repurchase program.
- The company adopted accounting changes concerning debt issuance costs and deferred-tax classification. Management reported no material impact on the financial statements.
Outlook, Risks and Contingencies
The company does not provide formal forward-looking financial or operational estimates because results are highly sensitive to commodity prices, raw-material volumes, energy costs, weather, government policies and currency movements.
- Lower prices for fats, proteins and other commodities could continue to pressure Feed Ingredients margins and liquidity.
- The company is highly leveraged and exposed to variable interest rates, refinancing requirements and debt covenant compliance. Management stated that it was in compliance with applicable financial and other debt covenants at April 2, 2016.
- Foreign exchange movements affect reported results, debt balances and the ability of subsidiaries to transfer cash to the parent.
- Biofuel tax credits, renewable-fuel standards, RIN values and low-carbon fuel policies materially affect DGD and other fuel operations.
- The company reported $54.9 million of reserves for insurance, environmental, litigation and tax contingencies, partially offset by $12.2 million of insurance recovery receivables.
- The company remains a potentially responsible party in the Lower Passaic River environmental matter. EPA estimated the selected remedy at $1.38 billion, but has made no demand on Darling; the company stated that its ultimate liability cannot currently be determined and does not expect the matter to be material based on available information.
- Potential withdrawal liabilities under underfunded multiemployer pension plans could be material. Accrued liability for two notified plans was approximately $1.9 million.
- Unrecognized tax benefits were $3.8 million, with $2.0 million of related interest and penalties; up to $2.3 million of gross benefits could decrease within the next 12 months.
- The company had $66.8 million of commodity purchase commitments, $36.9 million of expected operating lease payments and $43.4 million of letters of credit and foreign bank guarantees over the disclosed periods.
Investor Verification Priorities
- Verify whether Feed Ingredients pricing and margins recover from the significant year-over-year commodity-price decline.
- Monitor DGD’s receipt and use of tax credits, debt reduction, partner distributions and the proposed capacity expansion.
- Reconcile reported net income and Adjusted EBITDA, including the effect of foreign exchange, tax credits and other non-GAAP adjustments.
- Assess leverage, variable-rate exposure, debt maturities and continued compliance with credit-facility covenants.
- Track cash conversion as capital expenditures and ERP spending remain elevated.
- Review developments in the Lower Passaic River matter, multiemployer pension plans, environmental claims and other contingencies.
- Evaluate the impact of commodity prices, energy costs, foreign exchange, biofuel policies, food-safety regulation and animal-disease outbreaks on future results.