DARLING INGREDIENTS INC. quarterly report, Q2 FY2018

Darling Ingredients Inc. Form 10-Q Summary

Reporting period: The supplied filing is for the 13 and 26 weeks ended June 30, 2018, compared with July 1, 2017. Although the request metadata identifies “2017 Q2,” the filing itself clearly reports fiscal 2018 second-quarter results. The statements are unaudited. Darling operates in Feed Ingredients, Food Ingredients and Fuel Ingredients across more than 15 countries.

Key Financial Metrics

Metric	Three months ended June 30, 2018	Three months ended July 1, 2017	Six months ended June 30, 2018	Six months ended July 1, 2017
Net sales	$846.6 million	$894.9 million	$1.722 billion	$1.773 billion
Operating income	$21.7 million	$38.2 million	$53.4 million	$70.7 million
Net income attributable to Darling	$(30.4) million	$9.1 million	$66.9 million	$15.0 million
Diluted earnings per share	$(0.18)	$0.05	$0.40	$0.09
Adjusted EBITDA	$115.1 million	$111.2 million	$225.5 million	$214.8 million
Operating cash flow	Not separately provided	Not separately provided	$128.0 million	$197.5 million

Second-quarter gross margin was 22.9%, compared with 21.9% in the prior-year quarter. Six-month gross margin was 22.7%, compared with 21.8%.
Second-quarter operating income declined 43.2%; six-month operating income declined 12.8%.
Second-quarter results included $15.0 million of restructuring and impairment charges, $23.5 million of debt extinguishment costs and a $15.5 million loss on the TRS sale.
Equity income from unconsolidated subsidiaries was $15.2 million in the quarter and $112.4 million year to date, primarily reflecting the Diamond Green Diesel joint venture. The joint venture recorded approximately $160.4 million of reinstated 2017 biodiesel blender tax credits in the first six months.
Cash, cash equivalents and restricted cash were $104.3 million at June 30, 2018, including $104.1 million of unrestricted cash.
Total debt carrying value was $1.695 billion, including $1.688 billion of long-term debt. Working capital was $435.5 million, with a 1.90-to-1 current ratio.

Material Changes Versus the Prior Comparable Period

Net sales decreased 5.4% in the quarter and 2.9% for the first six months. The company attributed much of the reported decline to adoption of Topic 606, which moved billed freight out of revenue and cost of sales, and to the deconsolidation of a European cattle-hides operation.
Feed Ingredients quarterly sales declined 9.2%, while raw-material volume increased 5.6%. Segment operating income declined 6.0% to $37.3 million, primarily because of lower fat prices and higher depreciation.
Food Ingredients quarterly operating results shifted to a $5.7 million loss from $11.2 million of income. The decline reflected the Hurlingham, Argentina gelatin-plant shutdown, weaker European gelatin performance and lower edible-fat prices.
Fuel Ingredients quarterly segment income, including the joint venture, increased to $20.1 million from $10.3 million. Six-month segment income increased to $134.5 million from $14.4 million, primarily because of the reinstated 2017 blender tax credits.
The company acquired substantially all assets of Kruger Commodities for approximately $51.1 million in cash and sold its Terra Renewal Services industrial-residuals business for $80.0 million, recording a $15.5 million loss.
In May 2018, the company issued €515.0 million of 3.625% senior notes due 2026 and used the proceeds, together with revolver borrowings, to retire its €515.0 million 4.75% notes due 2022. The refinancing generated $23.5 million of extinguishment costs.
Other comprehensive loss attributable to Darling was $106.1 million in the quarter and reflected a $76.8 million after-tax foreign-currency translation loss.

Cash Flow, Capital Allocation and Liquidity

Six-month operating cash flow of $128.0 million was down $69.5 million year over year, principally because of less favorable changes in receivables, taxes, inventories, payables and accrued expenses.
Capital expenditures were $139.1 million in the first six months, compared with $127.8 million in the prior-year period. Management expects approximately $194.0 million of additional capital expenditures during the remainder of fiscal 2018, funded from operating cash flow.
Investing cash use was $110.7 million, including $139.1 million of capital expenditures and $51.1 million for the Kruger acquisition, partially offset by $82.8 million of proceeds from subsidiary investment sales.
The company had $950.4 million of unused revolving-credit capacity after borrowings and letters of credit. Management believes cash flow, cash on hand and available credit will fund working capital, scheduled debt service and planned expenditures for the next 12 months.
The share-repurchase authorization had approximately $100.0 million remaining at the reporting date; no material repurchase activity was reported in the supplied period.

Outlook, Commentary and Risks

Management does not provide formal forward-looking financial or operating estimates because results are sensitive to volatile commodity prices, energy costs, weather, crop conditions, government policies, raw-material volumes, foreign exchange and global demand.
The Diamond Green Diesel expansion from 160 million to 275 million gallons of annual capacity was nearing completion, with startup scheduled for August 2018. A further expansion to approximately 330–420 million gallons was under review, with a decision expected later in 2018.
Key risks include high leverage, variable interest rates, foreign-exchange movements, commodity and energy-price volatility, availability of rendering feedstock, regulatory changes affecting renewable fuels and tax credits, food-safety or animal-disease events, international trade restrictions and potential disruptions at the joint venture.
The company carries approximately $62.6 million of reserves for insurance, environmental, litigation and tax contingencies, supported by approximately $25.0 million of insurance recovery receivables.
The company is a defendant in litigation relating to the Lower Passaic River contamination site. Its ultimate liability cannot be determined, although management believes the matter is unlikely to materially affect financial position, results or cash flow.
Two multiemployer pension plans could create material withdrawal liabilities if a withdrawal or plan termination occurred. Accrued scheduled withdrawal liabilities totaled approximately $1.7 million, but potential additional liabilities cannot currently be calculated.
Unrecognized tax benefits were $2.2 million, plus $1.2 million of related interest and penalties. The company expects gross unrecognized benefits could decrease by up to $1.9 million within the following 12 months.

Important Facts for Investors to Verify

Confirm that the intended comparison is fiscal 2018 second quarter, not fiscal 2017, because the filing period is June 30, 2018.
Assess the sustainability of earnings excluding the $160.4 million of reinstated prior-year blender tax credits recognized through the Diamond Green Diesel joint venture.
Reconcile reported revenue trends for the impact of Topic 606 freight presentation and the European subsidiary deconsolidation.
Monitor leverage, refinancing savings, currency exposure and compliance with the company’s 5.50-to-1 total leverage and 3.00-to-1 interest-coverage covenants.
Evaluate the effect of the Hurlingham shutdown, TRS disposition, Kruger acquisition and proposed Diamond Green Diesel expansion on future margins and cash flow.
Review commodity-price sensitivity, especially fats, proteins, palm oil, soybean meal, corn, diesel and natural gas.
Track developments in the Passaic River litigation, multiemployer pension plans, tax-reform provisional accounting and other environmental or permitting matters.