Darling International Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 and 39 weeks ended October 1, 2011, with comparisons to October 2, 2010. Although the request metadata identifies “2010 Q3,” the filing itself is a third-quarter 2011 report, filed November 10, 2011.
Business context
Darling provides rendering, cooking-oil and bakery-waste recycling, recovery and grease-trap services. It operates more than 125 U.S. processing and transfer facilities and sells fats, proteins, hides, bakery by-products and related products to animal-feed, pet-food, fertilizer, biofuel and industrial customers.
The December 2010 acquisition of Griffin Industries materially expanded the company and resulted in two reportable segments: Rendering and Bakery. The 2011 results include 13 weeks of Griffin contribution in the quarter and 39 weeks in the nine-month period, while the 2010 reported results did not include Griffin. Management cautions that year-over-year comparisons are therefore not fully comparable; pro forma 2010 information is provided in the filing.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $455.9 million | $168.7 million | $1,366.4 million | $497.7 million |
| Operating income | $74.8 million | $19.3 million | $255.1 million | $57.8 million |
| Operating margin | 16.4% | 11.5% | 18.7% | 11.6% |
| Net income | $41.1 million | $11.4 million | $139.9 million | $34.2 million |
| Net margin | 9.0% | 6.7% | 10.2% | 6.9% |
| Diluted EPS | $0.35 | $0.14 | $1.22 | $0.41 |
Reported sales increased approximately 170% in the quarter and 175% for the nine months, while net income increased approximately 261% and 309%, respectively. The filing attributes the increases primarily to Griffin, higher finished-product commodity prices and favorable segment contributions.
Segment performance
- Rendering: Q3 sales were $376.3 million and segment profit was $77.3 million. Nine-month sales were $1,140.6 million and segment profit was $259.6 million.
- Bakery: Q3 sales were $79.5 million and segment profit was $17.1 million. Nine-month sales were $225.8 million and segment profit was $50.6 million. The segment was acquired through Griffin and had no reported sales in the 2010 comparison.
- Q3 commodity-price increases included higher average prices for MBM, feed-grade and pet-food protein, BFT, poultry grease, yellow grease and bakery by-products. These gains were partly offset by formula-linked raw-material costs, lower yields and product-quality downgrades.
Cash flow, liquidity and debt
- Cash provided by operating activities was $174.2 million for the first nine months of 2011, compared with $48.1 million in 2010.
- Cash used in investing activities was $57.4 million, including $44.0 million of capital expenditures and $14.2 million invested in the Diamond Green Diesel joint venture.
- Cash used in financing activities was $107.4 million, reflecting $240.0 million of term-debt repayments, $160.0 million of revolver repayment and $293.2 million of common-stock issuance proceeds.
- Cash and cash equivalents were $28.6 million at October 1, 2011, versus $19.2 million at January 1, 2011. Working capital was $76.4 million, with a 1.52-to-1 current ratio.
- Total long-term debt was $310.0 million, consisting primarily of $250.0 million of 8.5% senior notes due 2018 and a $60.0 million term loan. The revolving facility had no borrowings, $23.4 million of letters of credit and $391.6 million of remaining availability.
- Management stated that the company was in compliance with its debt covenants and expected operating cash flow, cash and revolver availability to fund working capital, capital expenditures, debt service, taxes and planned joint-venture funding for at least the next 12 months.
Material changes versus the prior comparable period
- Griffin transformed the scale and mix of the business, adding the Bakery segment and substantially increasing Rendering operations.
- Operating income rose by $55.5 million in Q3 and $197.3 million for the first nine months.
- Interest expense increased to $7.4 million in Q3 and $29.4 million for the nine months, primarily because of Griffin-related acquisition debt; nine-month interest expense also included approximately $4.2 million of deferred-loan-cost write-off.
- Depreciation and amortization increased to $19.0 million in Q3 and $57.7 million for the nine months, primarily due to acquired Griffin assets and intangibles.
- Capital expenditures increased to $44.0 million from $15.9 million in the prior-year nine-month period. Management expects elevated maintenance capital spending following the Griffin acquisition.
- Debt declined substantially from January 1, 2011, when long-term debt was $707.0 million, following the equity offering and debt repayments.
Outlook, risks, contingencies and unusual items
- Extreme Midwest summer temperatures reduced raw-material quality, yields and finished-product value during Q3 and increased processing challenges. Management noted that Q3 performance may not be indicative of future results.
- The business is exposed to volatile commodity prices, raw-material availability, natural-gas and diesel costs, foreign trade conditions, biofuel policies and general economic conditions. Formula pricing can cause higher finished-product prices to increase raw-material costs.
- Darling and Valero are constructing the Diamond Green Diesel facility, designed for approximately 9,300 barrels per day of renewable diesel production. Darling committed approximately $93.2 million toward estimated project costs of $407.7 million, had contributed $14.2 million by October 1, 2011, and must fund 50% of cost overruns.
- Off-balance-sheet commitments included approximately $27.8 million of commodity purchases over the next 12 months and approximately $14.4 million of operating lease obligations. The company also had $11.2 million accrued for self-insurance obligations due within 12 months and expected approximately $2.2 million of pension contributions.
- Environmental, litigation and insurance reserves were approximately $27.6 million. The Lower Passaic River litigation and related EPA matters remain unresolved, and ultimate liability cannot currently be determined.
- Multiemployer pension plans are underfunded, and potential future withdrawal or funding obligations could be material, although the company cannot currently calculate the full exposure.
- The company authorized changes to its defined-benefit plans effective January 1, 2012, including closing plans to new participants and freezing service and wage accruals as of December 31, 2011.
- Management identified risks related to BSE, animal and feed safety, product recalls, FDA and FSMA requirements, export restrictions, disease outbreaks, permits, integration of Griffin and possible renewable-diesel project cost overruns.
Facts investors should verify
- Determine the extent to which reported growth reflects Griffin acquisition accounting versus organic volume, pricing and yield changes.
- Monitor commodity prices, formula-linked raw-material costs, product quality and yields, particularly after the adverse weather effects described for Q3.
- Verify continuing debt reduction, revolver availability, covenant compliance and cash generation relative to interest and capital requirements.
- Track the remaining $79.0 million commitment to the Diamond Green Diesel project and exposure to construction cost overruns.
- Assess potential liabilities from environmental litigation, multiemployer pension plans, self-insurance and regulatory compliance.
- Review the sustainability of earnings given higher interest, depreciation, integration costs and the volatility of fats, proteins, bakery products and energy prices.