Darling International Inc. — Form 10-Q Summary
Reporting period: The filing is for the 13 and 26 weeks ended June 29, 2013, compared with June 30, 2012. The request metadata identifies “2012 Q2,” but the filing itself is the second-quarter 2013 report. Results are unaudited and presented in thousands except per-share data.
Business context
Darling operates more than 120 U.S. processing and transfer facilities and provides rendering, used cooking oil collection, bakery residual recycling, grease-trap cleaning and related recovery services. Its products include fats, proteins, hides and bakery by-products sold primarily into animal feed, pet food, fertilizer, biofuel and industrial markets. Operations are reported in Rendering and Bakery segments.
Diamond Green Diesel Holdings LLC, the 50%-owned joint venture with Valero Energy, reached mechanical completion and began producing renewable diesel in late June 2013. The facility is designed for approximately 9,300 barrels per day.
Financial performance
| Metric | Three months ended June 29, 2013 | Three months ended June 30, 2012 | Six months ended June 29, 2013 | Six months ended June 30, 2012 |
|---|---|---|---|---|
| Net sales | $423.6 million | $436.7 million | $869.0 million | $823.8 million |
| Operating income | $50.8 million | $64.0 million | $109.4 million | $116.5 million |
| Net income | $26.4 million | $36.2 million | $58.8 million | $64.8 million |
| Diluted EPS | $0.22 | $0.31 | $0.50 | $0.55 |
| Operating margin | 12.0% | 14.6% | 12.6% | 14.1% |
| Net margin | 6.2% | 8.3% | 6.8% | 7.9% |
Second-quarter sales decreased 3.0% year over year, operating income declined 20.6%, and net income declined 27.1%. For the first six months, sales increased 5.5%, while operating income fell 6.1% and net income fell 9.2%.
- Segment sales: Second-quarter Rendering sales were $350.6 million versus $371.5 million; Bakery sales were $73.0 million versus $65.2 million. Six-month Rendering sales were $717.8 million versus $693.8 million; Bakery sales were $151.2 million versus $130.0 million.
- Segment profit: Second-quarter Rendering profit declined to $60.2 million from $73.1 million, while Bakery profit increased to $13.7 million from $13.1 million. Six-month Rendering profit declined to $131.9 million from $137.6 million, while Bakery profit increased to $28.2 million from $24.1 million.
- Cash flow: Six-month operating cash flow was $129.2 million versus $142.0 million. Capital expenditures were $54.7 million versus $53.5 million, and investing cash use was $97.0 million versus $77.6 million, including $45.0 million invested in the joint venture. Ending cash was $133.6 million versus $72.3 million at the prior-year period end.
- Balance sheet: Total assets were $1.642 billion and stockholders’ equity was $1.127 billion at June 29, 2013. Working capital was $189.0 million, with a current ratio of 2.41 to 1.
- Debt and liquidity: Long-term debt was $250.1 million, consisting principally of $250.0 million of 8.5% Senior Notes due 2018. The term loan was fully repaid, the revolving facility had no borrowings, and availability was $382.2 million after $32.8 million of letters of credit.
Material changes versus the prior comparable period
- Second-quarter results were pressured by lower prices for MBM, pet-food poultry meal, BFT, poultry grease and yellow grease, lower Rendering yield, higher payroll and benefit costs, and higher natural gas and diesel costs.
- Second-quarter Rendering sales declined by approximately $21.0 million, primarily from a $23.1 million negative finished-product price impact and a $5.3 million yield impact, partly offset by higher raw-material volumes and other sales.
- Bakery sales increased by approximately $7.9 million, supported by higher corn-linked product prices, improved yield and increased raw-material volumes.
- For the first six months, higher protein and corn prices and greater poultry and pork volumes increased sales, but lower fat prices, weaker Rendering yield, higher costs and higher SG&A reduced profitability.
- SG&A increased 10.6% in the quarter and 11.8% year to date, primarily due to payroll, incentive-related benefits and other corporate expenses.
- Interest expense declined to $11.3 million for the first six months from $12.7 million, primarily because prior-year term debt repayments reduced outstanding debt and the prior year included deferred loan-cost write-offs.
- The equity-method loss from Diamond Green Diesel increased to $3.2 million for the first six months from $0.9 million, principally due to construction-phase expenses. The Company’s investment was approximately $104.3 million at June 29, 2013, after total contributions of approximately $111.7 million.
Outlook, risks and unusual items
Management stated that Diamond Green Diesel was operating at or near nameplate capacity in July 2013, with anticipated production of approximately 9,300 barrels per day, but cautioned that start-up disruptions remain possible. Profit on certain feedstock shipments to the joint venture is deferred until the resulting fuel is sold, typically creating an approximately 30-day lag.
Management expects operating cash flow, cash on hand and revolving-credit availability to fund working capital, maintenance and compliance capital expenditures, debt service, taxes and other needs for the next twelve months. The ongoing Oracle E Business Suite ERP project had incurred approximately $24.7 million of costs and was expected to require total cash expenditures of $36.0 million to $40.0 million.
- Commodity prices for fats, proteins, bakery products and competing commodities are volatile and materially affect revenue, raw-material costs and liquidity.
- Natural gas and diesel prices, raw-material availability, slaughter volumes, product yields and export demand remain important operating risks.
- Renewable-fuel mandates and tax credits may support demand, while changes to those policies could reduce demand and pricing.
- Export restrictions related to BSE, animal disease, tariffs or other trade barriers could affect product volumes and prices. Indonesia reopened its market for U.S.-origin beef MBM in July 2013, but USDA approval and import requirements remained pending as of the filing date.
- Insurance, environmental and litigation reserves totaled approximately $38.1 million at June 29, 2013, with $9.3 million of related insurance recovery receivables.
- The Company had approximately $10.5 million accrued for self-insurance obligations expected to become due over the next twelve months and expected approximately $0.5 million of pension contributions.
- Potential multiemployer pension withdrawal liabilities could be material, although the current amount cannot be calculated.
- Off-balance-sheet commitments included approximately $18.1 million of commodity purchases and $18.8 million of operating lease obligations due over the next twelve months.
- The Company committed to a proposed $195,000 settlement relating to the Lower Passaic River litigation, subject to court approval. A separate Fresno facility permitting and nuisance case was scheduled for trial in February 2014; management did not expect either matter to have a material financial effect.
- On August 6, 2013, after quarter-end, the Company agreed to acquire Terra Renewal Services’ industrial residuals and used cooking oil operations. Closing was expected by the end of August 2013, and management did not consider the acquisition material.
Important facts for investors to verify
- Whether Diamond Green Diesel sustains near-nameplate production, achieves expected yields and generates positive earnings and cash flow without material disruption or additional funding.
- The effect of fat, protein, corn, natural gas and diesel price movements on margins during the balance of fiscal 2013.
- Whether higher raw-material volumes and the reopening of Indonesian MBM exports offset weaker fat pricing and continued yield pressure.
- Progress, final cost and execution risk of the ERP implementation, including the remaining expected cash investment.
- Compliance with the Credit Agreement and Senior Notes covenants and continued availability under the revolving facility.
- Potential exposure from multiemployer pension plans, environmental and litigation matters, self-insurance claims and regulatory requirements.
- The impact of food-safety, BSE, animal-disease, export, renewable-fuel and other government-policy changes on product demand and operating costs.