DARLING INGREDIENTS INC. quarterly report, Q1 FY2014

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Darling Ingredients Inc. Form 10-Q Summary

Reporting period: The filing covers the 13 weeks ended March 29, 2014, compared with the 13 weeks ended March 30, 2013. Although the request metadata states “2013 Q1,” the filing is a first-quarter 2014 report. The company changed its name from Darling International Inc. to Darling Ingredients Inc. effective May 7, 2014.

Business Context

Darling is a global producer of sustainable ingredients derived from animal by-products, used cooking oil, bakery residuals and other bio-nutrients. Following the Rothsay acquisition in October 2013 and the VION Ingredients acquisition in January 2014, operations spanned more than 200 locations across five continents and were organized into Feed Ingredients, Food Ingredients and Fuel Ingredients.

Financial Performance and Position

  • Net sales: $931.4 million, up from $445.4 million in the prior-year quarter, primarily due to the acquired VION and Rothsay operations.
  • Operating income: $(0.6) million versus $58.6 million. Results included $44.8 million of non-cash inventory step-up expense related to the VION acquisition and $15.9 million of acquisition costs.
  • Net loss attributable to Darling: $(52.8) million, or $(0.32) per diluted share, versus net income of $32.4 million, or $0.27 per diluted share.
  • Adjusted EBITDA: $65.1 million versus $80.4 million. Pro forma Adjusted EBITDA, including acquisition-related adjustments and a full comparable period for acquired businesses, was $139.1 million versus $79.2 million.
  • Gross margin: 18.9% versus 27.6%. Excluding the VION inventory step-up, management reported an adjusted gross margin of 23.7%.
  • Operating cash flow: $(30.5) million versus $59.5 million of cash provided in the prior-year quarter.
  • Capital expenditures: $51.4 million versus $26.4 million.
  • Cash used in investing: $2.14 billion, including $2.08 billion for acquisitions.
  • Cash from financing: $1.44 billion, primarily from acquisition-related debt financing.
  • Cash and equivalents: $143.4 million at March 29, 2014, compared with $870.9 million at December 28, 2013.
  • Debt: $2.39 billion of total debt, including $333.96 million of Term Loan A, $1.30 billion of Term Loan B, $219.0 million drawn on the revolver and $500.0 million of 5.375% senior notes due 2022.
  • Liquidity: $748.3 million of revolving-credit availability, after borrowings and letters of credit. Working capital was $568.7 million, with a 2.07-to-1 current ratio.
  • Tax: The company recorded an $18.3 million tax benefit versus $20.4 million of tax expense in the prior-year quarter. The reported effective tax rate was 26.4%.

Material Changes Versus the Prior Comparable Period

  • Revenue more than doubled because the quarter included 12 weeks of VION operations and a full quarter of Rothsay operations; neither acquisition contributed to the first-quarter 2013 results.
  • The VION acquisition added $489.6 million of revenue but contributed an approximate $19.9 million net loss to the quarter, including purchase-accounting effects.
  • Feed Ingredients operating income declined to $35.8 million from $68.0 million, reflecting lower selling prices, weaker bakery-residual margins and severe North American winter weather. Excluding the VION inventory step-up, Feed Ingredients operating income was $48.5 million.
  • Food Ingredients generated $271.1 million of revenue and $(8.5) million of operating income; there was no comparable prior-year segment because the business was acquired with VION.
  • Fuel Ingredients operating income was $2.2 million excluding the DGD joint venture, and segment income was $6.9 million including the joint venture. The DGD venture began production in June 2013 and contributed approximately $4.7 million of equity income.
  • Interest expense rose to $58.9 million from $5.6 million, due to acquisition-related borrowings, the $27.3 million premium for redeeming the 8.5% senior notes and a $4.3 million deferred-loan-cost write-off.
  • Foreign-currency losses were $13.8 million, including approximately $12.6 million from euro forward contracts related to the VION closing.
  • The company redeemed its $250.0 million of 8.5% senior notes on February 7, 2014, for $280.4 million including premium and accrued interest.

Guidance, Outlook, Risks and Unusual Items

  • Management does not provide forward-looking financial or operating estimates because results are highly sensitive to commodity prices, weather, energy costs, raw-material volumes, government policies and global demand.
  • Management stated that cash flows from operations, unrestricted cash and available revolver capacity should be sufficient for working capital, maintenance capital expenditures, scheduled debt service, taxes and other needs over the next 12 months.
  • Key risks include substantial leverage, variable interest rates, foreign-exchange movements, restrictions on upstreaming cash from subsidiaries, acquisition integration costs, ERP implementation, volatile agricultural and finished-product prices, raw-material availability, renewable-fuel regulation, disease outbreaks, environmental and permit requirements, product recalls and pension or multiemployer-plan funding obligations.
  • The company had $104.7 million of off-balance-sheet commodity purchase commitments and expects $26.4 million of operating lease payments over the next 12 months.
  • Insurance, environmental and litigation reserves totaled approximately $76.2 million at March 29, 2014. Management considered the reserves adequate but noted that final costs could exceed estimates.
  • VION purchase-accounting values remained provisional and could be retrospectively adjusted, including goodwill and potentially earnings.
  • The company reported effective disclosure controls and procedures. Controls for the recently acquired VION business were excluded from management’s fiscal 2014 assessment as permitted by SEC rules while integration continues.

Investor Verification Checklist

  • Verify the effect of the VION inventory step-up, acquisition costs, debt-redemption costs, hedge losses and discrete tax items on reported versus adjusted earnings.
  • Reconcile the company’s non-GAAP Adjusted EBITDA and pro forma Adjusted EBITDA to GAAP results and review the differing covenant definitions.
  • Assess post-acquisition debt reduction, interest expense, leverage ratios and compliance with financial covenants, which first became effective for the quarter ending June 28, 2014.
  • Monitor integration of VION and Rothsay, including expected synergies, ERP costs and the finalization of provisional purchase accounting.
  • Evaluate exposure to commodity prices, raw-material volumes, energy costs, foreign exchange, renewable-fuel policy and severe weather.
  • Review environmental, litigation, pension and multiemployer-plan contingencies, including potentially material withdrawal liabilities that the company cannot currently quantify.