Darling Ingredients Inc. — Form 10-Q Summary
Reporting period: The filing covers the 13 and 26 weeks ended July 1, 2017, compared with July 2, 2016. The request metadata identifies “2016 Q2,” but the filing is for the second quarter of fiscal 2017. Financial statements are unaudited and presented in U.S. dollars unless otherwise stated.
Business Context
Darling Ingredients develops and produces sustainable ingredients from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Operations span Feed Ingredients, Food Ingredients and Fuel Ingredients across more than 15 countries. The company also owns 50% of Diamond Green Diesel Holdings LLC, a renewable diesel joint venture with Valero.
Key Financial Metrics
| Metric | Q2 2017 | Q2 2016 | First six months 2017 | First six months 2016 |
|---|---|---|---|---|
| Net sales | $896.3 million | $877.3 million | $1,776.4 million | $1,657.0 million |
| Operating income | $37.1 million | $54.5 million | $68.5 million | $81.2 million |
| Net income attributable to Darling | $9.1 million | $32.0 million | $15.0 million | $33.1 million |
| Diluted EPS | $0.05 | $0.19 | $0.09 | $0.20 |
| Operating margin | 4.1% | 6.2% | 3.9% | 4.9% |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $197.5 million | $168.2 million |
| Adjusted EBITDA | $110.1 million | $124.0 million | $212.6 million | $222.9 million |
Gross margin was $195.6 million, or 21.8%, in Q2 2017 versus $200.2 million, or 22.8%, in Q2 2016. For the first six months, gross margin was $386.0 million, or 21.7%, versus $381.0 million, or 23.0%.
At July 1, 2017, cash and cash equivalents were $124.8 million, working capital was $435.9 million and the current ratio was 1.89 to 1. Total debt was $1.75 billion, including $1.73 billion of long-term debt net of current maturities. The company had $968.7 million of unused revolving-credit capacity after borrowings and letters of credit.
Capital expenditures were $127.8 million in the first six months, up from $109.4 million in the comparable period. Management expects approximately $111.2 million of additional capital expenditures during the remainder of fiscal 2017.
Material Changes Versus the Prior Comparable Period
- Quarterly sales increased 2.2%, while first-half sales increased 7.2%, primarily reflecting higher volumes and prices in Feed Ingredients.
- Quarterly operating income declined 31.9%; first-half operating income declined 15.6%.
- Feed Ingredients quarterly operating income decreased 5.8% to $39.0 million, principally due to higher depreciation from new facilities. First-half operating income increased 26.4% to $69.9 million.
- Food Ingredients quarterly operating income fell 44.2% to $11.0 million, and first-half operating income fell 39.3% to $25.2 million. Higher raw-material costs, particularly in South American gelatin, compressed margins.
- Fuel Ingredients segment income, including the DGD joint venture, decreased to $10.2 million from $20.2 million in Q2 and to $14.3 million from $31.9 million for the first six months. The primary factor was the absence of biodiesel blenders tax credits in 2017.
- Equity income from unconsolidated subsidiaries decreased to $8.3 million in Q2 and $9.0 million for the first six months, versus $13.9 million and $19.5 million, respectively, largely because DGD no longer recorded the blenders tax credit.
- Interest expense declined to $22.4 million in Q2 and $44.1 million for the first six months, reflecting lower debt balances.
- Foreign currency translation generated $64.8 million of other comprehensive income in the first six months, increasing accumulated other comprehensive loss attributable to Darling from $340.0 million at year-end to $272.7 million.
Liquidity, Debt and Cash Flow
- Operating cash flow of $197.5 million exceeded capital expenditures of $127.8 million, but investing activities used $140.2 million and financing activities used $58.4 million. Cash increased by $10.3 million during the first six months.
- Debt consisted primarily of $500.0 million of 5.375% senior notes due 2022, €515.0 million of 4.75% senior notes due 2022, a $540.5 million Term Loan B, a $115.4 million Term Loan A and $5.0 million of revolver borrowings.
- The company stated that it was in compliance with its financial and other debt covenants as of July 1, 2017.
- Management believes operating cash flows, cash on hand and available revolver capacity will meet working-capital needs, scheduled debt and interest payments, taxes and planned capital expenditures for the next twelve months.
Outlook, Risks and Unusual Items
The company does not provide forward-looking financial or operating estimates because results are highly sensitive to commodity prices, weather, raw-material volumes, energy costs, government policies and global demand.
- The DGD joint venture is expanding annual renewable diesel capacity from 160 million to 275 million gallons. Estimated construction costs are $190 million, with completion and commissioning expected in the second quarter of 2018. The joint venture made a $25.0 million distribution to each partner during the first six months.
- Key risks include volatility in fats, proteins, corn, palm oil and soybean meal prices; availability of animal by-products and used cooking oil; natural gas and diesel costs; foreign exchange movements; variable-rate debt; renewable-fuel policy and tax-credit changes; animal diseases; regulatory and permitting requirements; and execution of the DGD expansion.
- The company had approximately $53.2 million of reserves for insurance, environmental, litigation and tax contingencies, partially offset by $15.9 million of insurance recovery receivables.
- The company remains a potentially responsible party in the Lower Passaic River environmental matter. Its ultimate liability cannot be determined, although management does not currently expect a material impact.
- A Fresno facility permit lawsuit remains subject to mediation. A non-binding letter of intent contemplates relocation, contingent on incentives and settlement of the litigation.
- Potentially material multiemployer pension withdrawal liabilities cannot currently be quantified; $1.8 million was accrued for scheduled payments under two plans.
- Off-balance-sheet commitments included $80.3 million of commodity purchases, $39.8 million of operating lease payments expected during the next twelve months, and $37.9 million of letters of credit and foreign bank guarantees.
Most Important Facts to Verify
- Confirm that the applicable period is Q2 fiscal 2017, not Q2 2016, and reconcile the request metadata with the filing date and period.
- Assess whether lower Food Ingredients and Fuel Ingredients profitability, including the loss of blenders tax credits, is temporary or structural.
- Monitor leverage, mandatory debt amortization, variable interest rates and the company’s ability to refinance or repay debt due in 2021 and 2022.
- Evaluate the required funding and execution risk for the $190 million DGD expansion and the sustainability of joint-venture distributions.
- Review commodity-price, foreign-exchange and derivative exposures, including the $267.0 million notional amount of foreign-currency contracts.
- Track environmental, permitting, litigation and multiemployer-pension contingencies, particularly matters whose ultimate exposure is not yet determinable.
- Reconcile management’s Adjusted EBITDA presentation with GAAP cash flow and verify the company-specific covenant definitions before using the metric for valuation or leverage analysis.