Darling Ingredients Inc. — Fiscal 2018 Form 10-K Summary
Reporting period: The provided filing is the annual report for the 52 weeks ended December 29, 2018, filed February 27, 2019. The request metadata references 2017 Q4, but the filing itself reports fiscal 2018 and compares it primarily with the 52 weeks ended December 30, 2017.
Business context
Darling is a global producer of sustainable ingredients derived from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. It operates across five continents through three segments: Feed Ingredients, Food Ingredients and Fuel Ingredients. Products serve feed, pet food, food, pharmaceutical, industrial, fertilizer, biodiesel, renewable diesel and bioenergy markets.
The Company operates more than 200 locations, including 144 production facilities, and employed approximately 9,800 people at year-end. Its principal renewable diesel investment is the 50%-owned Diamond Green Diesel Holdings LLC joint venture with Valero.
Key financial metrics
| Metric | Fiscal 2018 | Fiscal 2017 | Change |
|---|---|---|---|
| Net sales | $3.388 billion | $3.662 billion | (7.5%) |
| Operating income | $95.2 million | $141.2 million | (32.6%) |
| Net income attributable to Darling | $101.5 million | $128.5 million | (21.0%) |
| Diluted EPS | $0.60 | $0.77 | (22.1%) |
| Adjusted EBITDA | $431.4 million | $443.3 million | (2.7%) |
| Cash flow from operations | $398.6 million | $410.4 million | (2.9%) |
| Capital expenditures | $321.9 million | $274.2 million | 17.4% increase |
Consolidated gross margin was $740.6 million, or 21.9% of reported sales, versus $786.8 million, or 21.5%, in 2017. Operating margin declined to approximately 2.8% from 3.9%, while net margin attributable to Darling declined to approximately 3.0% from 3.5%.
- Feed Ingredients: Revenue was $1.953 billion, down from $2.239 billion. Raw material volume increased 4.4% to 8.60 million metric tons, but lower fat prices, reduced freight revenue under the new revenue standard, and the sale or deconsolidation of certain businesses reduced reported sales. Operating income declined to $82.8 million from $132.3 million.
- Food Ingredients: Revenue was $1.139 billion, down from $1.157 billion. Operating income decreased to $33.8 million from $56.9 million, reflecting weaker European collagen performance, lower edible fat prices, higher casing raw-material costs and $15.0 million of restructuring and impairment charges related primarily to the Hurlingham, Argentina plant shutdown.
- Fuel Ingredients: Revenue was $296.0 million, up from $265.8 million. Segment income including the Diamond Green Diesel joint venture increased to $195.1 million from $42.2 million, largely due to retroactively reinstated 2017 blenders tax credits and higher renewable diesel production.
Cash flow, liquidity and debt
- Year-end cash and cash equivalents were $107.3 million, with working capital of $357.4 million and a current ratio of 1.66, compared with $397.0 million and 1.71, respectively, in 2017.
- The revolving credit facility had approximately $929.8 million of availability after borrowings and letters of credit. Management stated that operating cash flow, cash on hand and available revolver capacity should cover working capital, scheduled debt service, taxes and planned capital expenditures for the next 12 months.
- Total debt carrying value was approximately $1.674 billion, excluding certain trade obligations. Principal debt included $500.0 million of 5.375% senior notes due 2022, €515.0 million of 3.625% senior notes due 2026, and term loans of approximately $563.1 million in aggregate.
- Fiscal 2018 included $23.5 million of debt extinguishment costs associated with refinancing the 4.75% senior notes. The Company reported compliance with its debt covenants.
- Operating cash flow exceeded capital expenditures by approximately $76.7 million before acquisitions and other investing activity. Investing cash use was $342.4 million, including $107.7 million for acquisitions. Financing cash use was $47.6 million.
- For fiscal 2019, management expected approximately $300 million of capital expenditures, including $233 million for maintenance and compliance and $67 million for new construction and expansions.
Material changes and unusual items
- Revenue comparability was affected by adoption of ASC Topic 606. Fiscal 2018 reported sales exclude billed freight from revenue; without the new standard, fiscal 2018 sales would have been approximately $3.565 billion. Prior-year amounts were not fully recast.
- The Diamond Green Diesel joint venture recorded approximately $160.4 million of retroactively reinstated 2017 blenders tax credits in fiscal 2018, with Darling’s 50% share contributing materially to equity income. The credits were not extended for 2018 or later periods and remain at risk.
- Diamond Green Diesel expanded annual renewable diesel capacity from 160 million gallons to 275 million gallons in August 2018. The partners approved a further expansion to 675 million gallons, estimated to cost approximately $1.1 billion and targeted for startup in the fourth quarter of 2021. Darling may need to fund its proportionate share of any cash-flow shortfall.
- The Company issued €515 million of 3.625% senior notes and retired the 4.75% senior notes during the second quarter of 2018.
- Acquisitions included Kruger Commodities for approximately $51.3 million and Triple-T Foods for approximately $49.2 million. The Company also sold its industrial residuals business for approximately $80.0 million and recorded a loss of approximately $15.6 million.
- The effective tax rate was 10.2% in 2018 versus a 107.7% benefit rate in 2017. The prior-year benefit primarily reflected U.S. tax reform and European tax-law changes. Excluding the 2017 biofuel incentive and tax-law changes, management reported a 2018 effective tax rate of 34.4%.
- The Company adopted the new lease standard on December 30, 2018 and estimated that approximately $130 million to $140 million of right-of-use assets and lease liabilities would be recognized.
Outlook, risks and contingencies
Management did not provide formal financial guidance, citing unpredictable commodity prices, energy costs, weather, raw-material volumes, government programs, foreign exchange and global demand. Key risks include volatility in fat, protein, oilseed and energy prices; competition for animal by-products and used cooking oil; dependence on significant suppliers and customers; animal diseases including African Swine Fever; food-safety, environmental and permitting requirements; international trade and currency risks; variable-rate debt; and execution risk related to the Diamond Green Diesel expansion and the Company’s ERP implementation.
Goodwill totaled approximately $1.229 billion. No material goodwill impairment was recorded, but six reporting units had less than 30% excess fair value over carrying value and one had less than 10% excess, leaving sensitivity to lower product prices, weaker margins or reduced supplier volumes.
Contingency reserves for insurance, environmental, litigation and tax matters were approximately $66.6 million at year-end. The Lower Passaic River matter remains unresolved; the Company’s potential liability cannot be determined, although management does not currently expect a material effect. Certain U.S. multiemployer pension plans are underfunded and could require material additional contributions or withdrawal liabilities.
The Company has not paid common-stock dividends since 1989 and did not expect to pay dividends in 2019. Its $200 million share-repurchase authorization remained available, although only approximately $10.9 million had been repurchased since inception.
Facts investors should verify
- Reconcile the reported 2018 revenue decline with the ASC 606 freight presentation and compare underlying volumes and pricing rather than reported sales alone.
- Assess the sustainability of 2018 Fuel Ingredients earnings, particularly the one-time or uncertain impact of reinstated blenders tax credits.
- Review Diamond Green Diesel production ramp-up, cash generation, expansion costs, financing and Darling’s potential funding obligation.
- Evaluate leverage, variable-rate exposure and debt maturities, including the $500 million of senior notes due in 2022 and the 2021 maturity of the revolving facility and Term Loan A.
- Monitor Feed Ingredients and Food Ingredients margins, commodity prices, raw-material availability and the effect of the Argentina plant shutdown.
- Review goodwill sensitivity, environmental and litigation contingencies, underfunded pension exposure and the expected balance-sheet effect of lease accounting.