Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: Quarterly period ended September 27, 2014; comparative periods ended September 28, 2013. The request metadata identifies “2013 Q3,” but the filing is the 2014 third-quarter Form 10-Q, filed November 6, 2014. Financial statements are unaudited.
Business Context and Reporting Period
Darling Ingredients develops sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients for food, feed, fuel, pharmaceutical and industrial markets. Operations span approximately 200 locations across five continents and are reported in Feed Ingredients, Food Ingredients and Fuel Ingredients.
The 2014 results include the VION Ingredients acquisition completed January 7, 2014, and the Rothsay acquisition completed October 28, 2013. Consequently, 2014 and 2013 results are not directly comparable. VION contributed $1.532 billion of revenue and an approximately $7.7 million loss during the first nine months of 2014.
Key Financial Metrics
| Metric | Three months ended September 27, 2014 | Three months ended September 28, 2013 | Nine months ended September 27, 2014 | Nine months ended September 28, 2013 |
|---|---|---|---|---|
| Net sales | $955.8 million | $425.8 million | $2.894 billion | $1.295 billion |
| Operating income | $49.9 million | $41.7 million | $124.8 million | $151.0 million |
| Net income attributable to Darling | $14.3 million | $27.7 million | $(5.7) million | $86.5 million |
| Diluted earnings per share | $0.09 | $0.23 | $(0.03) | $0.73 |
| Adjusted EBITDA | $117.2 million | $64.8 million | $325.3 million | $218.1 million |
| Pro forma Adjusted EBITDA | $122.3 million | $89.5 million | $419.4 million | $240.5 million |
| Gross margin percentage | 24.1% | 27.2% | 23.4% | 27.2% |
Adjusted EBITDA and Pro forma Adjusted EBITDA are non-GAAP measures. Management uses them for operating evaluation and debt covenant purposes, but they should not be viewed as substitutes for net income or operating cash flow.
Cash Flow, Liquidity and Debt
- Operating cash flow was $179.3 million in the first nine months of 2014, compared with $168.7 million in the prior-year period.
- Capital expenditures were $154.0 million, versus $85.7 million in the prior-year period. Management expected an additional $75 million to $100 million of capital expenditures during the remainder of fiscal 2014.
- Acquisitions used $2.076 billion of cash, primarily for VION. Net cash used in investing activities was $2.233 billion.
- Financing activities provided $1.370 billion, primarily from new term debt and revolving borrowings used to fund acquisitions and related transactions.
- Cash and cash equivalents declined to $193.4 million from $870.9 million at December 28, 2013.
- Working capital was $599.1 million, with a 2.1-to-1 current ratio, compared with $950.7 million and 6.4-to-1 at year-end 2013.
- Total debt was $2.283 billion, including $500.0 million of 5.375% notes due 2022, $1.573 billion of Term Loan A and B debt, and $178.2 million drawn on the revolver. Revolver availability was $786.9 million after borrowings and letters of credit.
- The company redeemed its $250.0 million 8.5% senior notes in February 2014 for $280.4 million, including a $27.3 million redemption premium and $3.1 million of accrued interest.
- Management stated that the company was in compliance with its credit agreement and note covenants and believed operating cash flow, cash and revolver availability would fund expected needs for the next twelve months.
Material Changes Versus the Prior Comparable Period
- Revenue more than doubled because of the VION and Rothsay acquisitions, but reported profitability declined because of acquisition-related costs, purchase-accounting effects, higher debt costs, foreign exchange losses and weaker operating conditions.
- Third-quarter operating income increased 20% to $49.9 million, but net income attributable to Darling fell 48% to $14.3 million. Nine-month operating income declined 17%, while the company reported a net loss compared with prior-year net income.
- The first nine months included a $49.8 million non-cash VION inventory step-up, including $34.8 million after tax, which reduced reported gross margin and earnings.
- Nine-month interest expense increased to $110.8 million from $16.6 million, primarily because of acquisition financing, the senior-note redemption premium and deferred loan-cost write-offs.
- Feed Ingredients operating income declined to $46.3 million in the third quarter from $58.8 million, driven by lower fat and used-cooking-oil prices, procurement formula timing, weaker biofuel demand and operating disruptions.
- Food Ingredients generated $14.0 million of third-quarter operating income but had no comparable prior-year segment because it was created through the VION acquisition.
- Fuel Ingredients segment income declined to $1.4 million from $12.3 million, primarily because of the expired blender’s tax credit and a fire-related shutdown at the Diamond Green Diesel facility.
- Foreign currency translation produced a $57.5 million after-tax loss in accumulated other comprehensive income during the first nine months. The company also recorded a $12.3 million operating foreign-currency loss, including a $12.6 million loss on a VION-related hedge transaction.
Guidance, Outlook, Risks and Unusual Items
- The company does not provide forward-looking financial or operating estimates because results are sensitive to commodity prices, weather, crop conditions, regulation, global demand and other factors.
- Management expected to complete implementation of its Oracle E Business Suite ERP system in 2015. Approximately $37.0 million had been spent through September 27, 2014, with expected total cash impact of $40 million to $42 million.
- The Diamond Green Diesel facility was shut down by a fire on August 3, 2014 and resumed operations on September 18, operating for approximately 52% of available third-quarter production days. The joint venture expected insurance coverage, with exposure generally limited to the deductible.
- Key risks include commodity-price and margin volatility, lower finished-product prices, raw-material availability, biofuel regulation and renewable-fuel credits, foreign exchange, variable-rate debt, acquisition integration, ERP implementation, food-safety and environmental regulation, disease outbreaks and pension or multiemployer-plan liabilities.
- Management identified potentially material withdrawal liabilities for certain underfunded multiemployer pension plans, although the current amount cannot be calculated. Approximately $2.0 million was accrued for scheduled withdrawal liability payments.
- Insurance, environmental and litigation reserves totaled approximately $55.3 million at September 27, 2014. Management considered the reserves reasonable but noted that final costs could exceed estimates.
- Off-balance-sheet commitments included approximately $47.5 million of commodity purchases and $28.8 million of operating lease obligations due during the next twelve months.
- Management stated that disclosure controls were effective. VION’s internal controls remained subject to integration and were excluded from management’s 2014 assessment as permitted by SEC rules.
Most Important Facts for Investors to Verify
- Reconcile reported earnings with adjusted results, particularly the $49.8 million VION inventory step-up, acquisition costs, debt-refinancing charges and foreign-currency hedge loss.
- Assess leverage, variable-rate exposure, debt maturities and compliance with maximum leverage, secured leverage and interest-coverage covenants.
- Evaluate whether VION and Rothsay integration synergies can offset weaker Feed Ingredients margins and higher corporate costs.
- Monitor Diamond Green Diesel’s post-fire operations, insurance recovery and exposure to renewable-fuel mandates, RIN prices and tax-credit changes.
- Review cash generation relative to scheduled debt service, planned capital expenditures, ERP spending and acquisition-related needs.
- Assess sensitivity to agricultural commodity prices, finished-product prices, raw-material volumes, foreign exchange and energy costs.
- Review unresolved environmental, litigation, pension, multiemployer-plan and permit contingencies, including matters where potential exposure is not currently estimable.