Darling Ingredients Inc. Form 10-Q Summary
Reporting period: The filing is for the 13 and 26 weeks ended June 29, 2019, compared with June 30, 2018. Although the request metadata identifies “2018 Q2,” the filing itself is a second-quarter 2019 Form 10-Q, filed August 7, 2019.
Business Context
Darling Ingredients develops and produces sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Its three operating segments are Feed Ingredients, Food Ingredients and Fuel Ingredients. The company operates internationally and has a significant 50% investment in the Diamond Green Diesel Holdings LLC joint venture with Valero.
Key Financial Metrics
| Metric | Three months ended June 29, 2019 | Three months ended June 30, 2018 | Six months ended June 29, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Net sales | $827.3 million | $846.6 million | $1.662 billion | $1.722 billion |
| Operating income | $36.0 million | $21.7 million | $60.3 million | $53.4 million |
| Net income attributable to Darling | $26.3 million | $(30.4) million | $44.3 million | $66.9 million |
| Diluted EPS | $0.16 | $(0.18) | $0.26 | $0.40 |
| Net cash from operating activities | Not separately provided | Not separately provided | $154.3 million | $128.0 million |
| Adjusted EBITDA | $115.5 million | $115.1 million | $219.0 million | $225.5 million |
Second-quarter gross margin was $182.6 million, or 22.1% of sales, compared with $194.4 million, or 23.0%, in the prior-year quarter. Six-month gross margin was $366.8 million, or 22.1%, compared with $391.2 million, or 22.7%.
At June 29, 2019, cash and cash equivalents were $87.0 million, working capital was $300.8 million and the working-capital ratio was 1.53 to 1. Total debt carrying value was $1.676 billion, including $1.640 billion of long-term debt. Revolving-credit availability was approximately $913.0 million.
Capital expenditures were $167.9 million in the first six months, up from $139.1 million in the comparable period. Management expected approximately $132.0 million of additional capital expenditures for the remainder of fiscal 2019.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales declined 2.3%, while six-month sales declined 3.5%, primarily reflecting lower protein, edible-fat and bioenergy pricing and the absence of certain prior-year revenue items.
- Second-quarter operating income increased 65.9% to $36.0 million. The comparison benefited from the absence of the $15.0 million prior-year restructuring and impairment charge and a $13.9 million gain on asset sales in 2019.
- Second-quarter net income attributable to Darling improved from a $30.4 million loss to $26.3 million of income. The prior-year quarter included $23.5 million of debt-extinguishment costs and a $15.5 million loss on disposal of a subsidiary.
- Six-month net income attributable to Darling fell to $44.3 million from $66.9 million. The prior-year period benefited from approximately $160.4 million of reinstated 2017 biodiesel blenders tax credits recorded by the DGD joint venture.
- Feed Ingredients operating income declined to $15.8 million in the quarter and $31.0 million year to date, mainly due to lower protein prices, lower poultry pet-grade spreads and higher costs from new facilities.
- Food Ingredients operating income improved to $30.5 million in the quarter and $54.1 million year to date, driven by improved collagen results, a gain on the sale of land in China and the absence of prior-year impairment and restructuring charges.
- Fuel Ingredients operating income excluding DGD declined, but DGD equity income increased to $38.1 million in the quarter from $15.2 million. Six-month DGD equity income decreased to $62.4 million from $112.3 million because of the prior-year blenders tax credits.
- Net cash from operations increased $26.3 million year to date despite lower net income. Investing cash use increased to $162.8 million, primarily because the prior-year period included $82.8 million of proceeds from a subsidiary disposition.
- On April 3, 2019, the company issued $500.0 million of 5.25% senior notes due 2027 and used the proceeds, together with cash, to retire the 5.375% senior notes due 2022. The refinancing generated $12.1 million of debt-extinguishment costs.
- The company adopted the new lease standard and recognized approximately $135.7 million of operating lease right-of-use assets and $134.4 million of additional operating lease liabilities at adoption.
Guidance, Outlook and Management Commentary
- Management did not provide formal financial or operational estimates, citing volatility in commodity prices, energy costs, weather, crop harvests, government policies, currency movements and global demand.
- Management believes operating cash flow, unrestricted cash and revolver availability will be sufficient for working capital, maintenance and compliance capital expenditures, scheduled debt and interest payments, taxes and other needs over the next twelve months.
- The DGD joint venture expects its new parallel facility to begin operations in the fourth quarter of 2021. The project is expected to increase annual renewable diesel capacity by approximately 400 million gallons, from 275 million to 675 million gallons, at an estimated total cost of approximately $1.1 billion.
- The DGD joint venture distributed approximately $17.7 million to Darling during the first six months and approximately $37.8 million in July 2019. The joint venture partners may be required to provide additional capital or loans if available cash falls below specified thresholds during construction.
Risks, Contingencies and Unusual Items
- African Swine Fever reduced pig slaughter volumes and raw-material availability in China and temporarily affected demand for porcine plasma products. The plasma-use ban had been lifted subject to new guidelines.
- Commodity exposure is significant. Lower protein, palm oil and soy meal prices affected results, while fats and used cooking oil prices were comparatively stronger. Rapid price changes can compress margins because raw-material procurement and finished-product sales occur at different times.
- The company is highly leveraged and exposed to variable interest rates, foreign currency movements and reliance on cash distributions from subsidiaries, including non-guarantor subsidiaries.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $69.4 million at June 29, 2019, offset by approximately $26.1 million of insurance recovery receivables.
- The Lower Passaic River matter and Fresno facility permit litigation remain unresolved. Management stated that potential material effects could not be determined for the Passaic River matter, although it did not currently expect a material impact.
- Two multiemployer pension plans could create material withdrawal liabilities under certain circumstances. Recorded withdrawal-liability accruals were approximately $1.6 million, but potential additional liabilities cannot be calculated.
- Off-balance-sheet commodity purchase commitments totaled approximately $98.4 million over the next two years. Standby letters of credit and foreign bank guarantees totaled approximately $35.7 million.
- Goodwill impairment risk remains concentrated in several reporting units. Approximately $817.4 million of goodwill was allocated to six reporting units with limited valuation cushion; no triggering event was identified at quarter-end.
Most Important Facts for Investors to Verify
- Confirm that the relevant period is second-quarter 2019, not second-quarter 2018.
- Assess the sustainability of earnings excluding prior-year blenders tax credits, asset-sale gains, restructuring comparisons and other unusual items.
- Evaluate DGD’s contribution, planned $1.1 billion expansion, required funding obligations and dependence on renewable-fuel policy and low-carbon fuel markets.
- Monitor leverage, debt maturities, variable-rate exposure and the company’s reliance on subsidiary distributions to service parent-level obligations.
- Track protein, fat, used-cooking-oil, energy and renewable-fuel credit prices, as well as raw-material volumes and African Swine Fever developments.
- Review the Passaic River, Fresno permit, pension, environmental and insurance contingencies for changes in estimated exposure.
- Reconcile management’s non-GAAP Adjusted EBITDA with GAAP earnings and cash flow; Adjusted EBITDA excludes or adjusts for several material items and is not a liquidity measure.