Darling Ingredients Inc (DAR) 2005 Q2 法說會逐字稿

Good Morning everyone and welcome to the Darling International Conference Call to discuss the Company's second quarter 2005 financial results. With us today are Mr. Randall Stuewe, Chairman and Chief Executive Officer of Darling International and Mr. John Muse, Executive Vice President Administration and Finance. After the speaker's opening remarks, there will be a question and answer period.

[Operator's Instructions].

I would now like to turn over the call to Mr. Brad Phillips, Treasurer of Darling International. Please go ahead sir.

Thank you Holly. Good morning ladies and gentlemen. Thank you for joining us for our review of Darling's second quarter 2005 earnings results. With me on the call today are Randy Stuewe, our Chairman and CEO and John Muse, Executive Vice President Finance and Administration. Randy will begin today's call with an overview of our second quarter financial performance, and some of the trends that impacted our results. John will then provide additional details about our financial results. Randy will conclude the prepared portion of the call with some general remarks on the business, after which time we'll be happy to answer any questions you may have.

Before we begin I need to remind everyone that this conference call will contain certain forward looking statements regarding the business operations of Darling, and the industry in which it operates. These statements are identified by words such as may, will, expect, believe, intend, anticipate, should, estimate, continue and other words referring to events or circumstances to occur in the future.

These statements reflect Darling's current view of future events and are based on its assessment of and are subject to a variety of risks and uncertainty beyond its control including business and economic conditions in its existing markets that could cause actual results to differ materially from those contained in such forward looking statements.

Other risk and uncertainties regarding Darling, its business and the industry in which it operates are referenced from time to time in the Company's filings with the Securities and Exchange Commission. Darling is under no obligation to and expressly disclaims any such obligations, to update or alter its forward looking statements, whether as a result of new information, future events or otherwise. With that I would like to now turn the call over to Randy.

Thanks Brad, good morning everyone, it's great to be here this morning to discuss the second quarter with you and talk about some of our financial results and some of the trends that have impacted our performance. As we talked about in our press release, our second quarter earnings improved significantly when compared to the first quarter but many challenges remain. Our results continue to be impacted by reduced raw materials supplies, increasing prices for both diesel and natural gas, low finished product prices and uncertainty regarding second case of BSE found in the United States on June 24th.

For the second quarter, raw materials supplies were lower for rendering materials when compared to both first quarter and last year. But in our restaurant services segments, performance improved. Year over year, cattle kills remain lower, and when you look at it on a 5 year basis they are significantly lower. However, when compared to first quarter, seasonality adjusted for the cattle kill it improved, but our suppliers' tributary to the Darling System, chose not to participate because of weak margins and no export market has been reopened for the US beef products at this time.

In our restaurant services segment, our cooking oil removal and grease trap service business, saw both volume and margin improvements during the quarter when compared to both last year and last quarter. This was primarily attributable to customer growth initiatives and seasonal improvements in our grease collection business. Relative to finished product prices, year over year, they trended lower.

For the second quarter though, prices reacted sharply versus first quarter as hot weather, lower rainfalls, a smaller South American crop for soybeans became the market focus. For the second quarter, we saw meat and bone meal prices increase nearly $50 a ton, but relative to last year in 2004 they were off by almost 12%. Tallow increased $0.025 a pound in second quarter and yellow grease improved slightly less than a penny. But relative to last year, they were collectively off 3%.

Overall, the combination of lower raw material supplies and lower finished product prices contributed to nearly all of our reduction in sales revenue when compared year over year. Energy, a substantial component of Darling's cost, persisted and grew even higher during the second quarter. Overall, operating income was lower when compared year over year due to raw materials and finished product prices, but was up nearly 40% when compared to first quarter and an improvement even over fourth quarter 2004.

Let me talk about the drivers of our business for a minute. We continue to be impacted by the closure of export markets for US produced finished beef. There's been little, if any change, in Japan's stance towards reopening the market to US beef. And this once again took another setback when the second case of BSE was found on June 24th of this year.

Our export markets for Darling's meat and bone meal and tallow remain closed. We got some break in March when Indonesia resumed its import of non pork meat and bone meal, but it closed its border simultaneously with the second case of BSE. Overall, the continued closure of export markets for rendering by products continued to weigh on our ability to capture price premiums for our export oriented plants.

Energy, as we talked about, remains a substantial cost for Darling. Both diesel and natural gas escalated through out the quarter and the first 6 months of the year for us. While most of our raw material formulas give as the ability to pasture energy costs, we have found it necessary to initiate an energy surcharge program in our restaurant services segment.

Nearly two-thirds of our customer base now is paying an energy surcharge which is indexed to both natural gas and diesel fuel. In addition, when it's economically favorable and feasible, Darling will burn alternative fuels at its plants. We will continue to manage our energy cost and attempt to minimize these expenses, but we expect energy prices to remain high for the foreseeable future.

In our restaurant services segment, we showed a nice improvement during the quarter. Improved recovery of collection cost, coupled with the growing customer base were the primary reasons. Our national service center and our national account sales team have now added 7 new large accounts during the quarter.

Integration of these accounts is going to take some time, but overall we are on target to continue our double digit account growth this year. Our balance sheet, it remained strong and it remained strong during the second quarter, while our cash balance declined slightly during the quarter as we funded both CapEx and made our annual pension contributions, we are pretty much online where we thought we would be.

Let me comment a minute about our capital projects underway. In prior calls we've talked about a modernization of our Fresno California plant. In second quarter, we received the environmental operating clearance to begin the construction and modernization of the plant. The environment was difficult and it took nearly 21 months for the permitting to be complete. We expect to complete this project and bring it online during fourth quarter and ultimately finish the project in first quarter 2006. This will boost our operating efficiency on the West Coast and allow us to reduce our freight bills substantially out there.

In Wahoo Nebraska, we are two-thirds complete now with our modernization and expansion of a wastewater treatment plan. This is going to provide us an opportunity to both expand and define some more operating efficiencies in our Nebraska and Iowa plants. Additionally, we have completed and brought online a grease trap processing expansion in our Detroit facility. Also, we have completed numerous energy reduction and efficiency programs during the first half of the year.

Id like to turn the call over now to John, let him take you through a little more detailed analysis of our quarterly performance and when John's finished I'll make a few comments and then open it up to questions. John?

Thanks Randy and good morning to everyone. For the second quarter 2005, Darling's net sales were 81.3 million as compared to 91.3 million for the second quarter of 2004. Lower raw material supplies and finished product prices accounted for a majority of the 10 million decrease in net sales. Net income for the second quarter was 2.7 million or $0.04 per share as compared to net income of 4.5 million or $0.07 per share for the 2004 comparable period. The 1.8 million decrease in net income year over year was primarily due to lower raw material supplies and finished product prices.

As Randy mentioned earlier, the second quarter did reflect a 1.8 million increase in net income over the first quarter of 2005. The increase in other income in the second quarter of 2005 was due to a gain on the sale of property equipment of approximately 0.3 million which included the sale of 2 of the Company's properties; that being in Tyler (ph) Texas and Sunnyside Washington. The 2004 second quarter included a charge of 1.7 million and other expenses related to the early redemption of preferred stock in 2004.

Operating income for the second quarter of 2005 was 5.4 million, which was a 50.9% decrease over last year's second quarter, caused primarily by a decrease in raw material volumes, lower finished product prices for meat and bone meal and yellow grease, and continued high prices for diesel fuel and natural gas.

As Randy mentioned, these decreases were somewhat offset by improved recovery of collection expenses, operating cost improvements and higher finished product prices for tallow. At the segment level, rendering generated net sales of 53.2 million for the second quarter as compared to 58.4 million in the second quarter of 2004. This decrease of 5.2 million was largely due to lower raw material volumes.

The restaurant services business generated net sales of 28.1 million in the second quarter as compared to 32.7 million in the second quarter of 2004. The decrease of 4.6 million is primarily attributable to lower grease prices. Turning to the 6 month ended July 2nd 2005, Darling reported net sales of 152.6 million, as compared to 168.8 million for the 2004 period. The Company also reported net income of 3.7 million, as compared to 8.4 million for the comparable period of 2004.

Decreases in raw material volumes and finished product prices also accounted for the majority of this decline. Capital expenditures during the first 6 months of 2005 were 7.5 million compared to 4.4 million in the first 6 months of 2004, for a net increase of 3.1 million and this was primarily due to the efficiency enhancement at our Fresno California and Wahoo Nebraska facilities.

Operating income for the 6 month ended July 2nd was 8.2 million, a decrease of 9.5 million or 53.7%. Now this increase was primarily from lower raw material volume which accounted for 6.4 million of the decrease, lower raw material prices which accounted for 2.7 million and higher energy cost of 2.4 million, which was partially off set by improved recovery of collection expenses of 3.1 million.

Interest expense was 3.2 million for the first 6 months of 2005 compared to 3.5 million during the first 6 months of 2004. The decrease of 400,000 was primarily due to reduced preferred stock dividends and accretion in interest expense charged in the first 6 months of 2004, the interest expense that was a result of the accounting treatment in the third quarter 2003.

At the segment level, rendering generated net sales of 97.6 million, as compared to 107.8 million for the comparable period of 2004. Restaurant services generated net sales of 55 million as compared to 61 million in the 6 months ended July 3rd 2004. Additionally beginning in 2005, Darling increased the allocation of plant operating expenses in both plant and corporate administrative expenses to restaurant services, which resulted in additional expense of 300,000 allocated to this segment during the 3 months and 1.4 million allocated to this segment during the 6 months ended July 2nd 2005.

As of July 2nd, Darling's cash and cash equivalent totaled 32.4 million as compared to 37.2 million on January 1st 2005. Working capital at the end of the second quarter was 37.2 million as compared to working capital of 39.6 million on January 1, 2005. At the end of the second quarter long term debt was reduced by 3.8 million.

Net cash provided by continuing operations was 5.5 million as compared to 23.1 million for the 6 months ended July 2nd and July 3rd of '04 respectively, a decrease of 17.6 million. This decrease was primarily due to the lowered net income of approximately 4.7 million, pension (ph) contributions of 5.6 million and changes in operating assets and liabilities of 6 million. With that I would like to turn the call back over to Randy.

Thanks John, before we move ahead with questions let me make a few brief closing comments. Reduced raw materials volumes, mainly beef, declining commodity prices, the continued closure in export restrictions, high energy prices will continue to challenge us. Overall, I believe we are well positioned with our formula agreements and pricing mechanisms to offset the majority of the commodity risk we are enduring brought on by the lower finished product prices and high energy prices. But the balance of the year is going to continue to be challenged in an extremely difficult operating environment brought on by these components.

With that we appreciate your support and your continued confidence in Darling and we'll open it up to questions at this time. Holly?

Thank you the floor is now open for questions.

[Operator Instructions].

Thank you, your first question is coming from Jeff Gates from Gates Capital Management.

Yes a couple of questions. First of all can you talk about what's going on with the yield? I see that cost you money in both the first and the second quarter. Secondly can you talk about what's happening in both the acquisition and the regulatory environment?

Sure Jeff, good morning this is Randy. From the yield perspective as we talked about the primary reduction of raw material has been in the beef end as the margins have been some what challenged and the people that supply us raw material have chosen not to run their plants because of -- essentially there is very little customer base for exports that exist for them out there. With that as a known for us we have been in the process of filling up the plants where we can with poultry material which naturally yields less than beef raw material so that's mainly -- that is the rationale for that true up.

The acquisition front, obviously the environment we're talking about is challenging. We've built the war chest as we've talked about in the past and I don't think there's very little that I can say at this time about that, other than we'll continue to review it and look for bolt ons and abilities to grow our company. I think we have a favorable view at this time that this environment will give us that opportunity now.

Do you think that's more than likely that that acquisition happens on the rendering side or on the grease trap side?

Can't really say right now, we're open to both. I guess is the way I'd answer that

But the other expenses of $1 million that looks like were mostly on the rendering side so was that legal or due diligence or -- can you tell us what that $1 million of extra expenses was during the quarter?

I don't know Jeff I'll -- I'm not being able to figure that one out right now so -.

And what about the regulatory environment?

The regulatory environment I guess the best way to summarize that would say the regulatory environment is very quiet right now. Everybody has read in the press the June 24th event, and then there was another animal that was positive under initial testing that came back negative. There continues to be discussion now at the FDA level, they have appointed Dr. Lester Crawford as the head, so they at least are back to somewhat full staff now in the regulatory environment.

Its interesting when you step back and look at the issues that the government is facing and you watch the dynamic, they have been over the course now of about 18 to 19 months we've now what I would summarize to say decoupled SRMs or the removal of risk materials out of the cattle feed chain from the opening of the Japanese border. There has been no decision on either, the Japanese are still asking us to test all the animals before we ship them to them, and we've had no movement on that and then as far as whether or not we are going to remove some materials from the feed chain, there has been very little movement on that.

There are rumors now and it has been printed into several media placements that they believe they are close to articulating an improvement in the feed rule, but its not going to come in the form of essentially a regulatory action immediately, it will come in the form of once again basically a proposed rule, and there will be a comment period and then an indefinite implementation time. So, I guess longwinded answer to say there has been very little movement on either fronts at this time.

Okay, thank you.

Thank you, your next question is coming from Tyson Bauer from Wells Monitors.

Good morning Gentlemen.

Morning, Tyson.

Could you characterize, you talked about 7 new large contracts on the restaurants services side, characterize what you mean by large contracts if you could in a dollar range national scope? Give us a little more detail on that.

Well, Tyson as we said we protect that information pretty -- very much, and the flavor I wanted to leave was that we are growing that business when we call a large store I would say they are multi store, multi state, multi chain operators, and we would say we protect that information, they are brands that you and I eat at probably a lot, so that's where I would like to leave that.

That's fine. Could you then, if you have this characterization on what a large contract is, how many current large contracts do you have in your portfolio that these 7 are added to?

We don't break that information out Tyson, I don't know how to answer that one. So -.

I tried.

I know, nice try.

Could you comment obviously commodity prices have dipped fairly significantly at the start of July and have continued to do so, any kind of feedback you could provide on any rationale in industry why that has occurred?

Well, I think if we trace back to the first of the year, we saw prices kind of dip off in the first quarter, or trail off as the large US crop was being harvested and digested of both soybeans and corn. Towards the end of the 1st quarter we started to see prices rebound in the soybean and corn complex as the crop and the anticipation of the crop both in South America and the US got smaller.

And so, we saw the soy complex move from $6.00 or $5.00 hike by a $6.00 soybean went up into the 7s and saw the oil complex move back from the low 20s to the mid 20s and soybean meal moved from 160 into the low 2s, 200s a ton. We then enjoyed part of that price appreciation in the second quarter, and towards the end of the second quarter here the cattle kills at some of the locations continued to improve for some of the big packing houses as if you will, as seasonality adjusted meaning barbecue season hit. And then that coincided still with no exports of our product around the world that would be for meat and bone meal and tallow.

And then also we saw a number of US fatty acids splitting plans here, that make fatty acids chemicals, olio chemicals for the cosmetic and industrial industry take an extended summer down time. So, we've seen a kind of a reduction in domestic demand for the products here that have backed off the prices some what during the second quarter and on into the third here as reported by the different trade publications.

Historically, the price spreads of tallow and yellow grease to soybean oil are extremely wide right now. And so, while I can't sit here and tell you where prices are going to go, I can also tell you that they're extremely wide. We're seeing the fatty acid demand pick up, and we're starting to see export interest renewed in that area. So, kind of a seasonal dip here.

Okay. You filed an 8-K yesterday. In regard to going through the trouble of getting amendment -- or your credit facility to free up $10 million for availability, repurchases, dividends or other use, but yet you had no actual plan put in place. What is the intent of the board in regard to doing this?

First of all, I'm glad you read the last line there for me, which was that there has been no determination of what we're going to do there. First of all, we listened to the shareholders, we've been talking to you about the war chest that we have on our balance sheet, and then when we reviewed our credit agreement that was put in place a year plus ago, we had limited flexibility at the time to issue a dividend.

And the language if you pulled up the credit agreement said we could use an aggregate amount not in excess of 25% of the excess cash flow, and we had 60 days to make that determination post to filing of the 10-K. We wanted to increase our flexibility and have that option to do either a dividend or a stock buy back and give ourselves a year to make those decisions as we review either acquisition opportunities, or look at what -- if government is going to do any new regulation on us. It's just another piece of flexibility in our war chest right now, going forward.

Okay. And the final 2 questions following up on Gates Capital question. It would seem the prospects for possibly losing competitors in the industry, or even packers looking to farm out the rendering as the commodity prices are low and the volumes are low, seems to be ripe and in a good position for somebody like yourselves with the war chest available. Could you comment on both the packers' side, and some of your smaller competitors? And then the last question, any impact of Canada if any?

Okay. The Canadian -- I'll start in reverse order there. The Canadian situation is some what of a fascinating kind of macro-economic study. That border remained closed for almost 18 months. You've seen enough -- a series of announcements of the Canadian based slaughtering industry increasing their capacity, and essentially, the Canadians are sending very few cattle over our way. So, the anticipated influx of Canadian born cattle into this country has been slow to develop, and so it's had limited impact on supplies for the packing industry.

Relative to the packer industry I can't really comment about that because I'm really not close enough to it. As far as acquisition opportunities as I answered Jeff's question for you, this is probably one of the strangest and toughest environments that both the packing and the rendering industry has gone through for sometime. With the closure of the export market, the reduced customer base because of that and then you put on the natural gas and diesel fuel at where they are at and it's -- I'm not sure that there's been a time in recent history that's put as many -- as much wind in the face of both industries as we're enduring right now.

So with that as we talk about before, was that was one of the reasons that we built the war chest within the last year and a half was to be ready to endure any type of commodity cycle that came at us and that's the reason that we made the adjustments to our raw material formulas was to handle the lower peaks and valleys if you will of the pricing. So, I guess we are poised and ready to participate it's just a matter of time and we'll evaluate them as the opportunities come up.

Thank you.

Thank you.

[Operator Instructions].

Your next question is coming from George Growth (ph) from Joseph Gunner (ph).

Hi good after -- good morning George Growth here. With respect to the prospect of the Asian ban being lifted, I guess we've seen the tide shifting some what positively like during the last while or so. I mean -- a couple of -- last week small markets -- Philippines reopened their market to US beef and then last month on its earnings call Tyson foods indicated that it could see the Asian ban South Korea and Japan being lifted in the November, December time frame. Bearing any other cases of mad cow being discovered -- when do you think that the Asian ban could be lifted?

I think George -- this is Randy. I think you probably summarized it real well. I don't know, I really don't know. Is the environment right for it to be opening? I think it is, and just because so much time has elapsed and obviously Tyson would be in more in the drivers seat and aware than we would have been, but right now we are just going to operate this business cautiously until it does open up.

Do you see that positive decision happening in the fall or early next year or early next year or -?

We are as hopeful as you are and that's about all I can say about that. I'm not aware of any information that says there's a date that has been chosen to open, and I'm kind of at the same mercy you are from reading the newspapers and listening to the Tyson calls and I hope that the US government and the large packing industry do the necessary things to get the border open again.

I guess since like the reopening of the US border to Canadian cattle, that was just a couple of weeks ago, do you see slaughter volumes picking up, because it has only been a couple of weeks so -- and like the trend is kind of hard to pin point at this point in time. But would you see the slaughter volumes picking up because of that?

You know I think it would be safe to think that they possibly will. I mean what if -- the US slaughter volume to put it in perspective was roughly 35, 36 million animals a year. I think the Canadians were bringing in somewhere north of 1.5 into this country, a combination of those being young animals and old animals. The Canadian packing industry has expanded.

I can't tell you how much but a significant amount such that I know over the last 3 or 4 weeks where you would expect I think the numbers used to be around 30,000 head a week coming into this country, are running about 10,000 head right now. So, will it pick up momentum? Probably but it hasn't yet. There is still the issue, George, of age and I think that's what they've still got to work through, they are still not allowing older animals into this country yet.

Okay. And with respect to commodity prices, I guess as the previous caller indicated they dipped a little bit in July. How do you see commodity prices like for the rest of the year? Like for meat and bone meal, tallow and yellow grease?

I try not to give guidance in that in area because I am really not very good at it, but what I would point to for the investor group is to look at the historical relationships and we're pretty much on the low side. And if the domestic demand comes back, which we anticipate it will, I think it's safe to say there are probably some improvement, and we've already seen improvement here in third quarter from some of the lows that we thought saw towards the end of the second quarter.

Okay. And I guess with respect to like your credit amendment file I mean, if you were to -- which gives you more flexibility; if you were to rank in like an order of importance the possible options that you have being -- buying back stock, dividend, acquisitions, where would you place those?

Boy, I don't -- I think it'd be evaluated on a case by case basis, I think obviously our -- we're going try to make the best investment for the shareholder base that we can, and hopefully we can -- our goal would be to grow the business and I think that would be the primary driver and after that we'll evaluate the best way to return shareholder value whether it'd be a buy back or a dividend.

Okay, and in terms of acquisitions like what's, I guess, preventing you from pulling the trigger. I mean, have you done anything subsequent to the quarter end in terms of acquisitions or -?

No, I mean, largely the industry we operate in is a privately owned base where we are the only public company out here. So number 1, I can't say anything, of who we're talking to and what we're talking about. But as we all know, acquisitions and relationship development are the key drivers in acquisitions and they take time. And this is an industry that has enjoyed 3 to 4 years of good times here and only now is it starting to feel some of the pain of the raw materials, the energy prices, and the commodity cycle to determine whether they want to stay in the business or not.

And that will take time, as we said, 6 months and 9 months ago to create the opportunity. The management team and the board of this company is not going to repeat the mistakes that it's made in the past of over paying, and so we're going sit back find the right opportunity and when that exists, we'll bring it to the shareholders.

I mean is it a question of you guys waiting a little bit more until for some of your weaker competitors keep struggling or is that what you're intent on doing or -- and secondly are you -- have you currently looked at some potential candidates acquisition targets now?

George I'd love to comment on it but I just can't. I mean, obviously it takes 2 people to show up at a dance to dance, and so we'll just leave it at that.

Okay. I'll head back into the queue, thanks.

Thank you.

Thank you. There appears to be no other questions I would like turn the call back over to Mr. Randall Stuewe for any closing remarks.

Thanks Holly. I want to thank everybody for joining us today and we look forward to talking to you at the end of third quarter. Thanks and see everybody later.

Thank you ladies and gentlemen this does conclude today's teleconference. You may disconnect your line at this time and have a wonderful day.