Darling Ingredients Inc
NYSE:DAR
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Darling Ingredients Inc
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Good morning, everyone; and welcome to the Darling Ingredients Incorporated Conference Call to discuss the Company's Third Quarter 2018 Financial Results. On the call today are Mr. Randall Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Executive Vice President and Chief Financial Officer; and Melissa Gaither, Vice President of Investor Relations and Global Communications. After the speaker's opening remarks, there will be a question-and-answer period and instructions to ask a question will be given at that time. Today's call is being recorded.
I would now like to turn the call over to Melissa Gaither. Ms. Gaither, please go ahead.
Thank you, Danielle, and good morning, everyone. Thank you for joining us to discuss Darling Ingredients' earning results for the third quarter ended September 29, 2018. To augment management's formal presentation, please refer to the Presentations section of our IR website for the earnings slide presentation.
Randy Stuewe, our Chairman and CEO, will begin today's call with an overview of our third quarter operation and financial performances, focusing on year-over-year comparisons and will discuss some of the trends impacting our business. Brad Phillips, Executive Vice President and Chief Financial Officer, will then provide additional details about our financial results. Finally, Randy will conclude the prepared portion of the call with some general remarks about the business and the remainder of the year, and after which we'll be happy to answer your questions. Please see the full disclosure of our non-U.S. GAAP measures in both our earnings release and earnings slide presentation.
Now, for the Safe Harbor statement; this conference call will contain forward-looking statements regarding Darling Ingredients business opportunities and anticipated results of operations. Please bear in mind that forward-looking information is subject to many risks and uncertainties, and actual results may differ materially from what is projected. Many of these risks and uncertainties are described in Darling's Annual Report on the Form 10-K for the year ending December 30, 2017, our recent press release announced yesterday, and our filings with the SEC. Forward-looking statements in this conference call are based on our current expectations and beliefs, and we do not take any duty to update any of the forward-looking statements made in this conference call or otherwise.
Now I will turn the call over to Randy.
Thanks, Melissa. Good morning, everybody and thanks for joining us. As referenced in our press release last night, our third quarter dealt us many challenges. Specifically the third quarter was negatively influenced by our extended downtime at Diamond Green Diesel along with an unplanned catalyst replacement. In addition, our global feed segment fought margin pressure from declining finished product prices throughout the quarter along with our decision to revalue our plasma inventory in China due to African swine fever.
Finally, as many of you are aware, we ship a significant amount of our fat and used cooking oil to Diamond Green Diesel. The extended and unplanned downtime disrupted the supply chain significantly and forced us to move, sell and store product in nontraditional markets. As we've discussed in the past, each penny of discount or increase results in approximately $4 million to $5 million of annual EBITDA. In this case, we had to divert nearly a one month supply. So before we review the segment details, let me make some quick comments about Diamond Green.
As of October 1, post catalyst replacement in one of our reactors, the facility restarted and quickly ramped up the full capacity of 275 million gallons annually. The plant has operated well during October and we can say it produced in excess of 22 million gallons. Our Phase 3 Diamond Green Diesel expansion called Super Diamond adding a new parallel 400 million gallon plant and taking annual production to 675 million gallons of renewable diesel was approved by both Darling and Valero's boards. Estimated cost of the facility is around $1.1 billion and this new total includes a new 60 million gallon renewable Naphtha or green gasoline plant. We are clearing land as we speak, engineering and cost estimation is done and long lead equipment will be ordered shortly. We anticipate start up in the latter half of 2021.
Now let's go on to some segment specific items. In our feed segment, we dealt with a lower pricing environment for both fats and proteins as our raw material formulas chased markets lower throughout the quarter. Record slaughter levels drove around material volumes up 6.1% over last year and provided ample supplies. Trade disruptions with China, Mexico and others further disrupted global protein values and DGD being offline with other global players for most of the quarter, clearly influenced fat markets along with typical hot summer weather impacting our quality.
As mentioned earlier, earnings were also negatively impacted by a $7 million inventory write down in China, for African swine fever and our blood plasma business. While the true extent of ASF in China is still relatively unknown, we have instituted strict bio security protocols in our facilities and will continue to service our customers.
Traditionally, we see a seasonally stronger fourth quarter, where protein in prices improve the colder weather and fat prices should move higher with the DGD back online at its expanded rate. As we look to the fourth quarter, we also expect fat prices in the EU to strengthen when those markets address the cheap Argentinean biodiesel flooding their market and other bio players come back online.
On November 29th, we will celebrate the grand opening of Phase 1 of EnviroFlight, the largest and most sophisticated automated black soldier fly larvae production facility in North America, if not the world. Construction is nearing completion on the first phase of our potential for phase project. We expect Phase 1 to produce about 900 metric tons of new protein annually for the global market.
Now, let's move to the food segment. Food segment results improve sequentially and delivered consistent results year-over-year with much improved performance from Rousselot, our global collagen and gelatin platform. Globally, we continue to see growing demand for peptone, our specialty collagen product. We are on the leading edge of innovation and continue to work with customers to develop new applications for this higher margin nutrition and health focus product. Our two new peptone implants in Brazil and France are expected to come online during the first and early second quarter 2019. Our edible fats business delivered slightly lower earnings as it chased the global oil down namely palm oil, lower impacting our refining spread. CTH our casings business also reported lower earnings due to a lower sales price and lower volumes in China. Overall, the food segment should have a modestly improved fourth quarter.
Now, let's turn to the fuel segment. Strong volume supported consistent performance across Europe. Ecoson, our bio energy business leveraged strong demand and higher production capacity from both our New Belgium bio gas digester and the return of our Netherlands facility to full capacity after being curtailed last year. Rendac, our European disposal rendering business contributed stable earnings on strong volumes in both the Netherlands and Belgium. North American bio diesel results moderated in Canada, due to lower RIN pricing and the absence of the Blenders Tax Credit. However, we remain confident that the Blenders Tax Credit even in light of election results last. will be reinstated for 2018 most likely late in fourth quarter, which in case it is reinstate should add about $8 million and $9 million of earnings to the fuel segment and approximately $80 million to the Diamond Green Diesel joint venture.
As mentioned earlier, Diamond Green Diesel is now operating at its new capacity of 275 million gallons per year. With the DGD back on line, we expect to produce 65 million to 70 million gallons of renewable diesel in the fourth quarter and anticipate delivering over our targeted $1.25 per gallon EBITDA margin on that volume. Spot margins even remain more attractive around $1.35 a gallon as we discussed and we are seeing LCFS markets continue to open well beyond California and to Scandinavia, Switzerland and other European markets.
As also announced in the earnings release, our board approved an increase in the company's previously announced share repurchase program from 100 million to 200 million and extended the term of the program for an additional year out to August 2020 to be exercised depending on market conditions.
With that I'll now turn it over to Brad to discuss a little more highlights of the number and then come back before QA. Thanks Brad.
Thanks Randy. For the third quarter 2018, we reported consolidated net sales of $812.6 million, a decrease of 13.2% compared to the 2017 period. This was primarily driven by lower finished product pricing in the extended downtime at Diamond Green Diesel, the deconsolidation of the company's best hide subsidiary in 2018 built for a recorded and cost of sales in 2018 as compared to net sales 2017 and the divestiture of our industrial residuals business earlier this year.
We posted a net loss in Q3 of $6 million or negative $0.04 per diluted share compared to net income of $7.8 million or $0.05 per diluted share for the 2017 third quarter. The net loss reflects currently weaker prices for our finished products specifically in the feed segment, the write down of our China blood plasma as a result of the ASF outbreak and reduce production and higher expenses at Diamond Green Diesel.
SG&A was $67.4 million for the 2018 third quarter which was substantially lower than the $82.2 million for the 2017 third quarter. The decrease was primarily due to two business interruption settlements that provided a gain of $8.4 million on a combined basis, as well as lower performance based compensation expense and a general decrease in overall SG&A expenses.
Depreciation and amortization expense increased $1.6 in the third quarter of 2018 to $78.8 million as compared to the same period in 2017. The increase is primarily due to the increase in capital expenditures made for organic growth projects in 2017 and 2018.
Interest expense was $20.1 million during the three months ended September 29, 2018 compared to $22.5 million during the previous year quarter. The decrease of $2.4 million is primarily due to a decrease in the interest rate on the company's 5.15 million euro senior notes to 3.625% from 4.75% from the refinancing completed earlier this year and a decrease in the amortization of differed loan cost as compared to 2017.
Now I'll address our tax expense for the quarter. The company reported an income tax benefit of $1.4 for the three months ended September 29th, 2018. The effective tax rate is 21.5% which differ slightly from the federal statutory rate of 21% primarily due to the relative mix of earnings among jurisdictions with different tax rates including foreign withholding taxes and state income taxes, losses that provide a no tax benefit and discrete items. The company's effective tax rate excluding the impact of certain losses that provide no tax benefit another third quarter discrete items is 28.8% for the three months ended September 29th, 2018. The company also paid 11.5 million of income taxes in the third quarter.
For 2018, we are projecting an effective tax rate of 25% including our 50% of Diamond Green Diesel's 2017 biofuel tax refund. If the biofuel tax incentive is reenacted for fiscal 2018 before the end of this year, the effective tax rate is projected to be 15%. Finally, we are projecting cash taxes of approximately $5 million for the remainder of fiscal 2018.
The company reported an equity and net loss of one consolidate subsidiaries for the 2018 third quarter of negative $2.8 million as compared to income of $7.7 million for the 2017 third quarter. Decline is due to the extended downtime at the Diamond Green Diesel joint venture.
Moving to our balance sheet. Our cash position ended the quarter at $81.5 million and our leverage ratio for the third quarter 2018 was 3.37, which was improved from the 3.56 in the third quarter 2017. Our liquidity remains strong with approximately $954 million available under our revolving credit facility. We made additional improvements on working capital in the third quarter over the second quarter, but working capital remains higher than year and '17 levels primarily due to continued elevated inventories.
Debt payments for 2018 will be less than originally targeted, primarily due to the acquisitions executed this year, as well as the extended downtime at Diamond Green Diesel. However, we do anticipate a dividend from Diamond Green in the fourth quarter of 2018.
CapEx for the first nine months of 2018 totaled $213.7 million compared to $196.4 million for the 2017 nine months period.
With that I'll turn it back over to you, Randy.
Hey, thanks, Brad. It is at these times that our world of growth strategy demonstrates its value. From our vantage point and as we witness shifting global trade, changing dietary trends and expanded energy markets around the world, we're well positioned to leverage our multi continent portfolio businesses to adapt to an evolving demand and capitalize on growth opportunities. To that end on October 5th, we acquired substantially all the assets of Triple - T Foods, a wet pet food ingredient operation. This acquisition is immediately accretive and is an excellent strategic fit with our growing specialty pet food ingredients portfolio in Nebraska and Kentucky. Triple - T has a legacy of providing high quality proteins to leading pet food companies and we look forward to building on that reputation.
Additionally, I am pleased to announce that we just closed on an agreement to acquire an edible fab processing plant in Poland, while a small acquisition, it continues to build out our footprint in Poland's rapidly growing meat sector. And finally, we just signed an asset purchase agreement to acquire a feed mill in California. This facility will immediately be converted to an organic fertilizer production facility. That will be another step in growing our North American nature safe brand on the West Coast.
As we enter the fourth quarter, we see a lot of positive momentum. Diamond Green Diesel at its higher capacity level should help fat markets and protein prices will see a boost with seasonal increase in feed demand. Volumes in October globally where once again very strong. Our global collagen business remained strong and we are seeing increasing contributions from our specialty products. We expect to finish the year on strong footing and see good momentum into 2019 as we build the premium diversified portfolio of feed food and fuel ingredients.
Additionally, we're excited to see the progress being made on our commitment to corporate social responsibility disclosure. Our sustainability committee elected to elevate our sustainability reporting by adopting the Sustainability Accounting Standards Board or SASB framework as a structure for our CSR reporting. Going forward, we will report on Darling's impact on our three key pillars, clean air and water, safe food and feed and communities and workplaces. We don't have time today to talk in depth about the great work our teams are doing, but will share regular KPI updates on our websites, as well as success stories that highlight our commitment to social responsibility.
As always, I'd like to thank our shareholders, employees and customers for believing in the long term Darling story.
With that Danielle, let's go ahead and open up to questions.
We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Ken Zaslow of Bank of Montréal. Please go ahead.
Hey good morning, everyone.
Good morning, Ken.
Good morning, Ken.
A couple of questions. One is, for the last 12 and 24 months, how many shares have you guys purchased, can you remind us how many shares you guys have purchased?
We purchased $10.9 million.
This new program that you have, how's that going to defer in, will you celebrate it from the current levels?
You know Ken, what the board has opted to do, we put out our strategy long term as we move forward to continue to build out supply of fat around the world to support our low carbon fuel initiative which is our expansion of Diamond Green Diesel. As we reeled on our investment day, we wanted to add flexibility to our portfolio here and we view acquiring back or purchasing back our stock is one of the options for deploying capital as we go forward. As we said, we'll do that that if the market warrants it and we're not going to give any more detail about that today, but it is very much a tool within our arsenal that the board is authorized now as we go forward.
Okay. My second question is on the acquisition strategy, how much have you spent on acquisitions and when do you expect the return to be, and help us out with that?
You know this year, I want to say that we've spent would be around $110 million to date in addition to Greenfield capital build out. That capital is we've made promises to people as being deployed at a 15% to 20% return.
And my last question is, the election, obviously the midterm election yesterday, I think is the word you said is in spite of, but that's not exact terminology but...
In light of.
Oh, in light of, okay. Yeah, do you read the election is a positive or negative or neutral? And it just seems like it would be a positive maybe I'm missing something.
No, we share that. I don't see really the impact on what we're trying to do here and you know specifically to the Blenders Tax Credit was my comment and I still feel the momentum is there to once again move that forward in at least a multi-year fashion is the signals we're getting out of D.C.
Right, I'll leave it there. Thank you.
The next question comes from Heather Jones of Vertical Group. Please go ahead.
Good morning. Thanks for taking the question. So just a quick detail on Blenders Tax Credit, you're not - you are expected to be at least for '18 and '19 or could you elaborate on how many years you're expecting?
Heather, this is John Bullock. I think 2018 and 2019 is probably logical. I know that the industry requesting a longer term potentially up to 5 years. Typically in the past, we've seen this issue go into December and they usually go just a reset button on the existing Blenders Tax Credit for either a year or two year type of the timeframe. There might be enough pushed at this point in time to make it a longer term program, potentially three to five years and we would certainly hope the Congress would evaluate that alternative. But I think it's two to five years is probably a pretty good range estimate on what will happen.
Okay. Thank you. The food segment, Randy, you mentioned that it would be modestly improved in Q4, are you referring to year-on-year or sequentially?
I was referring more to that sequentially here. We just see better demand in the fourth quarter.
Okay. Then on the feed segment. So when I look at quoted fats prices, quoted meal prices, they've been this week before, and yet this is one of the weakest quarters we've ever seen in feed. So my thought is and I just was wondering if you could affirm this or give greater details, it sounds like that you had to place a fair amount of your fats at, for lack of a better word you had to dump some of it during the quarter because of issues that Diamond Green and so that you are placing product well, at prices well below quoted markets. So I was wondering if you could elaborate on that and when you expect Diamond Green to be back in the market meaningfully buying fats to start helping support that market?
Yeah, I know those are very, very fair questions. That's a large segment, fairly complicated, but simplify it down to everybody. You know the protein prices although we're lower and lots of volume there and we were just having to move protein to nontraditional markets, the real driver of the performance of that segment. If you look at Q1 versus Q3, most of that difference is the plasma write down and in China. But at the end of the day, the difference between Q2 and Q3 is remember Diamond Green was really down June, July and then most on reduced rates in August in the second half of August and the first half of September. So all-in-all we were down about 90 days.
When you think about the business in a simple sense here, every penny of discount that we had to take is worth $4 to $5 million of EBITDA annually. And so we producing in North America somewhere between 160 million and 170 million gallons a month. And so we were down three months and it just really that last month when the disruption there forced us to move product, additional freight, additional demerge, additional tank storage and discounting. You know you can say I would estimate to the tune somewhere between $10 million and $14 million that we moved the product around the country and tried to get it out of nontraditional markets. The challenge is Diamond Green Diesel has been operating at capacity and it's in all form of 160 million gallons for multiple years. We've raised the price or the chloric equivalent - above the chloric equivalent. So we had to buy our way back into nontraditional markets. And you said it well, we dumped it, somewhere around $0.03 a pound below nontraditional markets to get it moved. Unfortunately, this is a sell it or smell it business if you want to look at it that way, we carry little storage of any at any of our factories and it just really backed up on us and that's what flowed through the P&L.
Thank you for that clarity. My final question is just a detail one. So we've heard for some time that every penny is 45 million and annual EBITDA. At your Analyst Day, you mentioned $10 million, so my gut is…
Global.
Okay. So the 4 5 is just U.S.?
Right.
Okay. Perfect. Thank you so much.
The next question comes from Adam Samuelson of Goldman Sachs. Please go ahead.
Thanks. Good morning, everyone. Maybe just first Rand, I just wanting to understand on the bridge just gave on the feed segment on the quarter. So $10 million to $14 million from lower fat realizations given the Diamond Green down time plus there was $7 million or so of inventory write down in China on the plasma inventory. So ex-Diamond Green downtime and China, you would have been up a little bit at the EBITDA level quarter-on-quarter even with lower protein prices, is that the right way to think about it?
Yeah, I mean it would have been modestly similar quarter-to-quarter because of, at the end of the day, I mean fat prices were up on the index up about 7.7%, protein prices were down and we make a little more money on the fat than we do the protein as we've said in the past. And so yeah I mean that's a fair way of looking at it.
Okay. That's helpful. And then just Diamond Green in the quarter I know operationally is a lot of challenges. Just from the margin realization, kind of what was the kind of extra cost that was put into the system from the unplanned downtime and kind of the fixed costs under absorption that drove the margins up, quantify that piece a little bit?
Yeah, this is a John Bullock. I mean obviously the big issue there we had some extra catalyst a little over $5 million is where we had to replace that catalyst. The rest of it is essentially some additional expenses associated with a little bit of extra work around the turn around that we had to do to replace the catalyst, but most of it is just a lack of volume gone to the facility and that drives our per gallon cost up extremely high. And so once we get to return to producing like we are now then our costs go right back in the line. It was a cost issue driven by both some additional cost associated with the catalyst issue and the lack of production because we simply were not up and operational enough days in the quarter.
Okay. And then last one from me. Just on - as we think about 2019 in the base business a little over $100 million year-to-date deployed via M&As some Greenfield capital. I mean it is - were those talk about the earnings expectations from those acquisitions and kind of what the base kind of contribution from total growth investments would expected to be in 2019 as you go forward?
Yeah, I mean from the Triple - T, Kruger and then the organic feed business I mean, we were targeting somewhere a contribution there of a $15 million to $20 million of new EBITDA annual run rate next year, off of those off of the approximately $100 million of additional growth capital that's being deployed. That will be staged over the year as Grapeland Texas doesn't really come up until mid-first quarter and that will be a ramp up with the poultry supplier as they bring online. The new Wahoo facility has been now delayed a little bit as cost goes back to in Nebraska, is not going to complete as early as we thought it would and then several other projects that are out there. As we talked about the two big ones are the Peptan, spray dryer complexes for Peptan down in Brazil, and then in England, France those should be online March, April of next year and then have pretty nice run rates off of those, which would be very similar to our normal capital return.
Okay. Appreciate the color. I'll pass it on. Thanks.
And next question comes from Craig Irwin of ROTH Capital Partners. Please go ahead.
Hi. Good morning and thanks for taking my questions. So Randy, if we're in the camp that we're going to see a five to seven year reinstatement of BTC with a tail on it and we're firm believers that. It's going to have an impact on fats prices, right. Can you maybe discuss for us your Darling supply to Valero whether or not this is actually the impact pricing of fats potentially to the joint venture. And then what do you think the impact would be for core fats in your rendering operations, is this likely to drive up profitability given that a lot of third party guys buy from other vendors and from you, if you can find this out?
This is John Bullock. Yeah, I mean obviously with the Diamond Green Diesel now online at the expanded capacity and excellent LCFS demand, we anticipate the fat prices are going to go higher and we do believe that that will have a benefit. I think as we consistently said into our non-biofuel businesses, so we should see an improvement in profitability in those businesses as we move through the next couple of years. I'm not sure what the rest of the question, I don't know, I quite understood the rest of the question, but we do see fat prices moving higher.
Yeah, I'll take it from there a little bit Craig. I mean at the end of the day, we're going to - the marketplace has not seen the new 115 million gallon expansion that we added at Diamond Green Diesel, that's another 1 billion pounds, that's another 6% to 8% of U.S. supply that's now going to be diverted to Diamond Green Diesel. Along with I think there are some other demand that's happening, there is some co-processing going on in the Northwest United States now.
And all-in-all there is just a little bit more fat going into the markets now that should absorb the excess here. I mean if you look back over the last five years, we moved from caloric value to a $0.03 to $0.05 premium to caloric value. And I think it's safe to say as we go forward here that we're going to move that on up a couple more sense I suspect as we run fuller and fuller both here and over in Europe. And then when we bring Super Diamond on, I think that's anyone's bet as to how that all sorts out, but you probably won't see that impact until mid to late '21 when we start mine there, but that 675 million gallons, I mean you're about 6 billion pounds, you're one out of every 2.5, 3 pounds of North American fat have to end up in a half square mile in New Orleans.
So I suspect it'll make a pretty nice Harvard case study one day as to what dislocation of what markets happens and what the ultimate price of fat. It's driven by carbon intensity as you know and we've been very, very clear about that. There's a lot of fat in the world to use whether it's palm oil, soybean oil, canola oil, sunflower oil but it doesn't have the carbon intensity scores that the waste fats increases and the distillers corn oil has. So I think overall clearly we will chase that product in and if there's any other competition that comes out there they will too and the impact will be to drive that price up.
Great. Thank you for that. My second question is about the low carbon fuel standard. So I know this wasn't the cleanest quarter as far as being able to parse the impacts on the P&L, but it appears that you actually you did a better job capturing LCFS in Diamond Green in the quarter, you saw the benefit of some of the positive movements which we've seen on LCFS credits. Can you comment about mix going to California and where you see this mix heading over the next couple of quarters?
Yeah, this is John Bullock. Yeah, we move 100% of our product today to the Low Carbon Fuel Standard markets, whether it be California or the Rest of the World. And I think that's probably an under-reported part of the story. This story is just not California, there are tremendous LCFS markets around the world and we move some product to a lot of those markets today. We continue to get a greater percentage of the LCFS each and every single year as we contract our renewable diesel and that's going to continue now for the next couple of years. So we are receiving a greater share of the LCFS as we go forward. Our carbon intensity scores overtime have been coming down, so that increases the value of the product that we sell a lot of Diamonds Green Diesel as well. So we see the demand that are extremely robust. For the next several years, we can sell a lot more products and we can make. We're actually limiting customers on how much they can take.
Great. Thanks again for taking my questions.
Thanks Craig.
This concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Stuewe for closing remarks.
Thanks Danielle. Thanks again everyone for joining us. Hope everyone enjoys the upcoming holiday season and we look forward to report our fourth quarter and yearend performance early next year in March. Have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.