Darling International Inc. — Form 10-Q Summary
Business context and reporting period
Darling International Inc. (now known as Darling Ingredients Inc.) filed this unaudited Form 10-Q for the 13 weeks ended April 2, 2011, compared with the 13 weeks ended April 3, 2010. The company renders animal by-products, recycles used cooking oil and bakery waste, and provides related collection services. Following the December 17, 2010 acquisition of Griffin Industries, operations were reported in two segments: Rendering and Bakery. The 2011 quarter includes a full quarter of Griffin results, while the comparable 2010 period does not.
Financial performance and liquidity
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net sales | $439.9 million | $162.8 million | +$277.1 million |
| Operating income | $88.1 million | $19.6 million | +$68.5 million |
| Net income | $46.6 million | $11.5 million | +$35.1 million |
| Diluted EPS | $0.43 | $0.14 | +$0.29 |
| Operating margin | 20.0% | 12.0% | Improved |
| Net margin | 10.6% | 7.1% | Improved |
| Cash flow from operations | $80.7 million | $14.8 million | +$65.9 million |
| Capital expenditures | $12.8 million | $4.6 million | +$8.2 million |
Revenue growth reflected $219.3 million from Griffin, $58.7 million from higher finished-product prices, and $0.9 million from higher raw-material volumes, partially offset by lower production yields and other sales declines. Rendering generated $371.6 million of sales and $89.0 million of segment profit; Bakery generated $68.3 million of sales and $15.0 million of segment profit.
Gross profitability benefited from stronger prices for fats, MBM and bakery by-products, although higher formula-based raw-material costs partly offset the benefit. Lower natural-gas costs were offset by higher diesel costs. Selling, general and administrative expense increased to $30.7 million from $15.8 million, while depreciation and amortization increased to $19.7 million from $7.0 million, primarily due to Griffin.
Interest expense increased to $14.2 million from $0.9 million, including approximately $4.2 million of deferred loan-cost write-offs related to debt repayment. The effective tax rate was 36.5%, compared with 36.7% in the prior-year quarter.
At April 2, 2011, the company had $38.0 million of unrestricted cash, $331.6 million of revolver availability, and working capital of $46.5 million. Debt consisted of $250.0 million of 8.5% senior notes due 2018, a $60.0 million term loan, and $60.0 million outstanding under the revolving facility. Total long-term debt was approximately $370.0 million. Management stated that the company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Griffin added a new Bakery segment and substantially expanded the Rendering business; reported year-over-year comparisons are not on an organic basis.
- Net sales increased approximately 170%, while operating income increased approximately 350% and net income increased approximately 306%.
- Cash from operations rose substantially, aided by higher earnings and an approximately $18.1 million increase in income taxes payable.
- The company issued 24.2 million common shares for approximately $292.7 million of net proceeds and used the proceeds to repay revolver borrowings and term debt.
- The term loan declined from $300.0 million at January 1, 2011 to $60.0 million at April 2, 2011; revolver borrowings declined from $160.0 million to $60.0 million.
- Revolver capacity was increased from $325.0 million to $415.0 million in March 2011.
Outlook, risks, contingencies and unusual items
The filing provides no formal earnings or revenue guidance. Management expects operating cash flow, cash on hand and revolver availability to fund working capital, maintenance and compliance capital expenditures, debt service, taxes, and planned joint-venture funding for the next twelve months.
Darling and Valero formed a 50/50 joint venture to develop a renewable diesel facility in Louisiana. Darling committed approximately $93.2 million of equity toward estimated total project costs of approximately $427.0 million. The project also involves a conditional DOE loan guarantee, completion-guarantee obligations, potential cost overruns, a required segregated cash balance of approximately $27 million subject to specified reductions, and required debt-facility availability. Darling had invested approximately $1.6 million as of April 2, 2011 and recorded no joint-venture earnings or losses.
- Commodity prices for fats, proteins and bakery products are volatile and directly affect revenue and earnings.
- Raw-material availability depends on meat, poultry and food-service volumes; higher feed costs could reduce supplier volumes.
- Diesel and natural-gas prices are significant operating costs, with diesel prices rising during the quarter.
- Demand and pricing may be affected by renewable-fuel mandates, biofuel tax credits, export restrictions, tariffs, animal disease and changes in food-safety regulations.
- Contingency reserves for insurance, environmental and litigation matters totaled approximately $28.9 million at April 2, 2011. The company was also involved in Lower Passaic River environmental litigation and related EPA matters, for which ultimate liability could not be determined.
- Underfunded multi-employer pension plans could require additional contributions; the filing states that potential amounts could be material.
- Off-balance-sheet commitments included approximately $17.6 million of commodity purchases and $14.2 million of operating lease obligations over the next twelve months.
- The company had $0.5 million of alternative-fuel credits recorded as deferred income pending further clarification.
Important facts for investors to verify
- Separate Griffin-related growth and pricing-driven growth from underlying organic operating performance.
- Assess whether elevated commodity prices and segment margins are sustainable and how formula-based raw-material costs may respond to price declines.
- Review debt covenants, floating-rate exposure, refinancing requirements and the effective availability of the revolving facility after letters of credit and joint-venture restrictions.
- Monitor the cash funding, completion-guarantee exposure and potential cost overruns associated with the renewable diesel joint venture.
- Evaluate environmental, food-safety, animal-disease, export-market and multi-employer pension risks, including whether existing reserves remain adequate.
- Confirm the effect of the substantial equity issuance and debt repayment on future diluted shares, interest expense and per-share results.
- Management concluded that disclosure controls were effective and that no material change in internal control over financial reporting occurred during the quarter, while Griffin integration controls remained under development.