Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: The supplied filing is for the 13 and 39 weeks ended September 26, 2020, compared with September 28, 2019. Although the request metadata states “2019 Q3,” the filing itself is a third-quarter 2020 Form 10-Q, filed November 3, 2020.
Business context and reporting period
Darling operates globally in Feed Ingredients, Food Ingredients and Fuel Ingredients, converting animal by-products, used cooking oil, bakery residuals and other bio-nutrients into fats, proteins, collagen, renewable fuels, bioenergy and specialty ingredients. The company also owns 50% of the Diamond Green Diesel Holdings LLC joint venture with Valero.
The financial statements are unaudited and prepared under U.S. GAAP for a 52/53-week fiscal year. Management stated that all facilities remained operational during COVID-19 and that the company had not experienced a material negative effect on operations through September 26, 2020.
Financial performance and key metrics
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Net sales | $850.6 million | $842.0 million | 1.0% increase |
| Operating income | $127.5 million | $59.9 million | 112.9% increase |
| Net income attributable to Darling | $101.1 million | $25.7 million | 293.2% increase |
| Diluted earnings per share | $0.61 | $0.15 | Increase |
| Adjusted EBITDA | $122.1 million | $108.2 million | 12.8% increase |
| Adjusted EBITDA including Darling’s DGD share | $218.5 million | $147.8 million | 47.9% increase |
| Metric | First nine months 2020 | First nine months 2019 | Change |
|---|---|---|---|
| Net sales | $2.552 billion | $2.504 billion | 1.9% increase |
| Operating income | $356.6 million | $182.5 million | 95.4% increase |
| Net income attributable to Darling | $252.1 million | $70.0 million | 260.1% increase |
| Diluted earnings per share | $1.51 | $0.42 | Increase |
| Adjusted EBITDA | $357.9 million | $327.2 million | 9.4% increase |
| Adjusted EBITDA including Darling’s DGD share | $627.0 million | $440.5 million | 42.4% increase |
Margins: Consolidated gross margin was 24.9% for the first nine months of 2020 versus 22.2% in the prior-year period. Q3 segment gross margins were 25.1% for Feed Ingredients, 22.3% for Food Ingredients and 33.9% for Fuel Ingredients. The filing does not present a consolidated net margin percentage.
Segment trends: Q3 Feed Ingredients sales declined 2.8% to $483.0 million and operating income declined 16.3% to $18.5 million. Food Ingredients sales increased to $291.8 million and operating income rose 8.2% to $21.1 million. Fuel Ingredients operating income increased 209.6% to $103.1 million, primarily because of stronger DGD results and the inclusion of renewable-fuel blender tax credits.
Cash flow, liquidity and debt
- Operating cash flow for the first nine months was $470.4 million, compared with $262.7 million in the prior-year period.
- Capital expenditures were $184.9 million, down from $245.1 million. Management temporarily reduced non-essential capital spending because of COVID-19 uncertainty.
- Net cash used in financing activities was $287.5 million, including $171.6 million of long-term debt repayments, $55.0 million of share repurchases and $8.8 million to acquire the remaining interest in EnviroFlight.
- Cash, cash equivalents and restricted cash totaled $66.0 million at September 26, 2020, including unrestricted cash of $65.8 million.
- Working capital was $307.6 million, with a 1.49-to-1 working-capital ratio.
- Debt carrying value was $1.474 billion, including $345.3 million of Term Loan B, $494.1 million of 5.25% senior notes due 2027, $592.5 million of 3.625% euro-denominated senior notes due 2026 and $15.0 million drawn on the revolving facility.
- Revolver availability was $934.3 million after borrowings, ancillary facilities and letters of credit. Management stated that the company was in compliance with its debt covenants.
Material changes versus the prior comparable period
- DGD equity income increased to $91.1 million in Q3 and $252.4 million for the first nine months, versus $32.0 million and $94.4 million, respectively. The 2020 results included approximately $79.9 million of Q3 and $232.1 million of nine-month blender tax credits; the comparable 2019 periods included none.
- Net income and operating income increased substantially despite relatively flat sales, reflecting higher DGD earnings, improved Fuel Ingredients margins and lower interest expense.
- Interest expense decreased to $55.8 million for the first nine months from $60.1 million, while 2019 included $12.1 million of debt extinguishment costs that did not recur in 2020.
- The company repurchased approximately $55.0 million of common stock during the first quarter and had approximately $200.0 million remaining under its repurchase authorization at September 26, 2020.
- On September 18, 2020, the company amended its credit agreement, extending the revolver maturity to September 18, 2025 and modifying leverage thresholds, covenants and collateral provisions.
- In October 2020, after the reporting date, a subsidiary acquired a Belgium rendering group for approximately $29.4 million.
Guidance, outlook, commentary and risks
- Management did not provide forward-looking financial or operating estimates, citing volatility in commodity prices, energy costs, weather, agricultural markets, government policies and global demand.
- Management expected operating cash flow, cash on hand and revolver availability to be sufficient for working capital, maintenance and compliance capital expenditures, scheduled debt service, taxes and other needs for the next twelve months.
- COVID-19 had not materially affected operations through the reporting date, but management warned of potential future disruptions to raw-material supply, logistics, customers and fuel demand. Specialty collagen and gelatin disruptions experienced in the second quarter had largely normalized in the third quarter.
- The DGD expansion is expected to increase annual renewable diesel capacity from 275 million gallons to approximately 675 million gallons, with estimated completion and startup in the fourth quarter of 2021. Estimated project cost is approximately $1.1 billion, and additional partner funding could be required if DGD cash falls below specified levels.
- Key risks include volatile finished-product and agricultural commodity prices, raw-material availability, renewable-fuel policies and tax credits, energy prices, foreign exchange, COVID-19, animal diseases, regulatory and environmental obligations, high leverage, pension and multiemployer plan liabilities, and potential goodwill impairment.
- Contingency reserves for insurance, environmental, litigation and tax matters were approximately $64.4 million at September 26, 2020. The company also disclosed potentially material but currently unquantifiable exposure related to underfunded multiemployer pension plans.
- The company had $102.9 million of commitments to purchase commodity products over the next two years, plus $38.9 million of letters of credit and bank guarantees.
Most important facts for investors to verify
- Determine how much of the 2020 earnings improvement was driven by temporary or policy-dependent DGD blender tax credits versus recurring operating performance.
- Review DGD expansion costs, funding requirements, construction timing and the company’s potential share of additional capital contributions or guarantees.
- Monitor leverage, Term Loan B maturity in December 2024, interest-rate exposure and the company’s ability to upstream cash from subsidiaries.
- Assess sensitivity to commodity prices, raw-material volumes, renewable-fuel mandates, tax credits and foreign exchange.
- Evaluate COVID-19 impacts on supply chains, collagen and gelatin demand, fuel demand and customer credit quality.
- Review goodwill at-risk reporting units, especially the Canada Feed unit and the approximately $511.8 million of goodwill allocated to reporting units with limited valuation cushion.
- Reconcile non-GAAP Adjusted EBITDA with GAAP results and note that DGD share-of-Adjusted EBITDA is presented separately rather than included in Darling’s Adjusted EBITDA.