Business Context and Reporting Period
Darling Ingredients Inc. filed this Form 10-K for the 52 weeks ended December 28, 2019. The request metadata references “2018 Q4,” but the provided filing is the fiscal 2019 annual report; quarterly data are included separately. Darling converts animal by-products, used cooking oil, bakery residuals and other bio-nutrients into feed, food, fuel, collagen, fats, proteins, bioenergy and related ingredients across five continents. Its reportable segments are Feed Ingredients, Food Ingredients and Fuel Ingredients.
Key Financial Metrics
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net sales | $3.364 billion | $3.388 billion | (0.7%) |
| Operating income | $475.8 million | $255.0 million | +86.6% |
| Net income attributable to Darling | $312.6 million | $101.5 million | +207.0% |
| Diluted EPS | $1.86 | $0.60 | +210.0% |
| Adjusted EBITDA | $436.9 million | $431.4 million | +1.3% |
| Net cash from operating activities | $362.6 million | $398.6 million | (9.0%) |
| Capital expenditures | $359.5 million | $321.9 million | +11.7% |
| Gross margin | 23.0% | 21.9% | +1.1 points |
Net income benefited materially from Diamond Green Diesel (“DGD”) earnings and retroactively reinstated biofuel blenders tax credits. FY2019 income included $364.5 million of equity income from DGD, compared with $159.8 million in FY2018. The FY2019 effective tax rate was 15.6%, versus 10.2% in FY2018; excluding the 2018 and 2019 biofuel incentive and tax-law effects, management reported a 27.4% FY2019 effective rate.
Segment Performance
- Feed Ingredients: Sales increased to $1.971 billion from $1.953 billion, but operating income declined to $54.7 million from $82.8 million. Gross margin declined to 22.9% from 23.3%, primarily due to lower protein prices and higher compensation and depreciation.
- Food Ingredients: Sales declined to $1.119 billion from $1.139 billion, while operating income rose to $90.6 million from $33.8 million. Gross margin increased to 22.7% from 19.4%, driven mainly by stronger collagen performance and the absence of FY2018 Argentina restructuring and impairment charges.
- Fuel Ingredients: Sales declined to $274.3 million from $296.0 million, but operating income increased to $398.8 million from $195.1 million. Results were significantly aided by the FY2018 and FY2019 blenders tax credits recorded in FY2019.
Liquidity, Debt and Capital Resources
- Cash and cash equivalents were $72.9 million at year-end, compared with $107.3 million in FY2018.
- Working capital was $228.9 million, down from $357.4 million; the working-capital ratio declined to 1.33 from 1.66.
- Total debt, including current and long-term debt, was approximately $1.649 billion on the balance sheet. Contractual debt obligations were reported at approximately $1.608 billion in the liquidity table, reflecting presentation differences.
- Revolving facility availability was approximately $911.9 million after borrowings, letters of credit and ancillary facilities.
- The company issued $500 million of 5.25% senior notes due 2027 and used the proceeds, together with cash, to refinance its 5.375% senior notes due 2022.
- Management stated that operating cash flow, unrestricted cash and available revolver capacity should be sufficient for expected working capital, scheduled debt service, maintenance capital expenditures and other needs over the next twelve months.
- FY2020 expected capital expenditures were approximately $306 million, including $236 million for maintenance and compliance and $70 million for new construction and expansions.
Material Changes Versus FY2018
- Operating income and reported net income increased sharply, primarily due to DGD’s stronger performance and retroactive biofuel tax credits, rather than comparable growth in consolidated sales.
- DGD’s annual renewable diesel capacity had increased to 275 million gallons after its 2018 expansion. A further parallel facility is planned to increase capacity to 675 million gallons, with estimated completion in the fourth quarter of 2021 and estimated project cost of approximately $1.1 billion.
- In February 2020, DGD entered terminaling agreements requiring Darling and Valero to guarantee up to $50 million each of specified DGD obligations; management considered payment under the guarantee remote and recorded no liability.
- The company adopted the new lease accounting standard on December 30, 2018, recognizing approximately $135.7 million of operating lease right-of-use assets and $134.4 million of operating lease liabilities.
- The company reclassified its DGD equity income into operating income for all periods presented because management determined DGD had become integral to the business.
- FY2019 raw material volumes increased 1.7% in Feed Ingredients and 7.2% in Fuel Ingredients, but declined 3.4% in Food Ingredients, partly because African swine fever diverted certain food-grade raw materials directly into Chinese food markets.
Guidance, Outlook, Risks and Unusual Items
- Management does not provide formal forward-looking financial or operating estimates because results are highly sensitive to commodity prices, energy costs, weather, raw-material availability, government policies and currency movements.
- DGD’s expansion and potential Port Arthur, Texas project provide substantial growth potential but require further engineering, permits and board approval. The proposed Port Arthur facility would target 400 million gallons of renewable diesel and 40 million gallons of renewable naphtha annually, with a potential 2024 start.
- Biofuel results depend materially on renewable-fuel mandates, low-carbon fuel standards and tax credits. Changes, legal challenges or non-enforcement could materially reduce demand and profitability.
- Major operating risks include commodity-price volatility, competition for animal by-products and used cooking oil, supplier and customer concentration, animal disease including African swine fever, food-safety and environmental regulation, severe weather, foreign-exchange movements, cybersecurity, labor actions and energy-price volatility.
- Goodwill was approximately $1.223 billion. No impairment was recorded, but four reporting units had less than 30% excess fair value over carrying value and Canada Feed had less than 10% excess fair value with approximately $178.6 million of goodwill. Management identified lower finished-product prices and weaker supplier economics as key impairment risks.
- Insurance, environmental, litigation and tax contingency reserves totaled approximately $70.5 million, partially offset by $26.2 million of insurance recovery receivables. The Lower Passaic River matter remained unresolved; Darling accepted a proposed $0.6 million EPA cash-out settlement subject to approval, while ultimate liability, if any, could not be determined.
- The company has not paid common-stock dividends since 1989 and did not expect to pay dividends in 2020. Approximately $180.8 million remained under the authorized $200 million share-repurchase program at year-end.
- The filing was audited by KPMG with unqualified opinions on the financial statements and internal control over financial reporting. Goodwill valuation was identified as the critical audit matter.
Most Important Facts to Verify
- Separate recurring operating performance from the approximately $430.6 million of DGD blenders tax credits recorded for FY2018 and FY2019 and Darling’s related 50% share.
- Confirm DGD’s construction budget, funding requirements, distributions and schedule for the planned 675-million-gallon facility.
- Review debt maturities, covenant headroom, variable-rate exposure and the $911.9 million of revolver availability.
- Assess sensitivity of Feed Ingredients earnings and goodwill valuation to protein, fat, energy and competing-commodity prices.
- Monitor African swine fever, coronavirus-related disruptions, food-safety restrictions and their effects on Asian raw-material volumes and demand.
- Review the Lower Passaic River settlement approval and any remaining CERCLA or environmental exposure.
- Reconcile quarterly results carefully: FY2019 fourth-quarter net income attributable to Darling was $242.6 million, including approximately $234.4 million of FY2018 and FY2019 blenders tax credits.