Darling Ingredients Inc (DAR) 2005 Q3 法說會逐字稿

Good morning everyone and welcome to the Darling International Conference Call to discuss the Company's Third Quarter Fiscal 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 of Administration and Finance. After the speaker's opening remarks there will be a question-and-answer period.

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

Thank you operator. Good morning ladies and gentlemen. Thank you for joining us for a review of Darling's Third Quarter Fiscal 2005 earnings results. Randy Stuewe, our Chairman and CEO will begin today's call with an overview of our third quarter financial performance and some of the trends that impacted our results.

John Muse, Executive Vice President Finance & Administration will then provide you with some additional details about our financial results. Randy will conclude the prepared portion of the call with some general remarks about the business after which time we will 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, 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 current events and are based on it's assessment of and are subject to a variety of risks and uncertainty beyond it's control including business and economic conditions in it's 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 & 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 now like to turn the call over to Randy.

Good morning everyone thanks Brad. It's a pleasure to be here this morning and let's get started with our third quarter results.

As mentioned earlier in our press release our results for the third quarter pretty much reflect the same challenges we've been facing throughout 2005. Historically high natural gas prices, high diesel fuel prices have had a direct influence on our results. We continue to experience lower finished product prices and they persisted throughout the quarter. Overall, meat and bone meal was down $37 a ton, about 18%. While callow and yellow grease were down 2 to 2.5%--$0.02 to $0.025 cents per pound respectively.

We continue to feel the effect of the closure of our export markets for meat and bone meal and callow. Our export locations in Tacoma, San Francisco, Los Angeles and Newark continue to ship their product inland versus traditionally finding offshore homes.

For the quarter cattle slaughter numbers were slightly improved, but year-over-year cattle kills remained lower and thus the raw material supplies to our plants continue to be lower year-over-year. Collectively, the reduced raw material volume together with lower finished product prices contributed to our year-over-year decline in both sales revenue and operating income. However, on the positive side our recovery of collection expenses has improved and it now includes an energy surcharge on over 75% of our customer base.

Additionally we have continued to make operating efficiency improvements and have included--including--and mainly in through the energy management area. On the raw materials side despite the good news out of Canada and more recently out of Japan we continue to see the closure of U.S. export markets for finished beef products and this continues to negatively impact our financial performance.

While the announcement that Japan's Food Safety Commission has declared that beef from certain young cattle is safe to be exported to Japan, final approval and resumption of trade still remains uncertain. Still, this marks an important and optimistic step forward in our operating environment and Darling is well positioned to benefit from any reopening of the border.

Meanwhile our key export markets for our meat, bone meal and tallow remain closed. Meat and bone meal which traditionally has found overseas homes is predominantly a domestic protein today. And with the uncertaintity attached to potential government regulations regarding SRM removals, specified risk materials, meat and bone meal continues to trade at a protein discount to its other competing ingredients.

Tallow on the other hand still has not resumed its historical export patterns, but is now finding homes in the non-traditional energy sector. Turning to energy prices which hit historical and unprecedented highs in the third quarter, I can tell you that this remains both a substantial cost and concern for Darling. During the third quarter Darling was well positioned and our natural gas ownership was favorable.

However, the series of hurricanes quickly forced us to seek alternative fuel sources for our boilers. To date Darling is operating the majority of its plants bio fuels and substantially all of the remaining plants which are still consuming natural gas have pricing mechanisms to absorb the cost increase. Make no mistake though, energy costs have doubled for Darling since 2002

On the diesel-fuel front we were less fortunate our plants have limited storage and as we felt the price volatility related to the hurricanes towards the end of the quarter. As we all know diesel is a substantial component of our collection cost and we were forced to react with monthly surcharges to offset this impact. This was a change from quarter two where we were using a quarterly indexing to calculate and quantify the impact, but have now moved our customers to a monthly surcharge basis.

New government regulations were proposed during third quarter. For nearly two years we have anticipated some type of government response to the first case of BSE in December of 2003. The initial rule, while 120-pages long, simply requests comments and can be summarized as follows, SRMs, specified risk materials will be removed from cattle 30-months and older entering the food chain. This will be limited too--estimated to be one to two pounds per animal. If you look at the number of animals slaughtered in this country over 30-months old, it's estimated to be five to six million animals a year. Thus the mathematics would say its six to ten million years of product.

Secondarily, the government has requested comments on removing the same SRMs, the brain and spinal cord, from all dead, non-ambulatory or diseased animals. Thirdly, tallow will be able to be sold with limited impurities or an impurity specification, even if it's made from SRM-grade tallow, or SRM-grade material.

Overall, we are not satisfied with the government's approach and will comment accordingly. We believe the rule is too lax and has too m any holes to become reasonably enforceable. The impact on the industry is difficult to quantify today and additionally it is not consistent with Canada's proposed rule which removes all SRMs. What ultimately comes out of the final government rules from these comments is unknown. And the timing or implementation is even a greater unknown.

Turning to our restaurant services segment, our grease Trap business continues to show good customer growth compared to both last year and last quarter. Our Cooking Oil Removal business, while growing, was negatively impacted by lower yellow grease prices and higher diesel prices to run the truck fleet. In our operations I want to point out that we have now received the construction and modernization permits necessary to begin and finalize construction in Fresno, California. I'm pleased to report that construction is underway and progressing on schedule and provided we get good weather this winter in California, we will be able to bring that plant on line in first quarter of 2006.

As a result, in addition to significantly boosting our operating efficiency on the West coast, we will also be able to substantially reduce our transportation costs up and down California. I'm also pleased to announce on November 10th, that Darling has acquired the grease trap pumping business of Southeastern Maintenance & Construction located in Alma, Georgia. This acquisition will continue to enhance the company's presence in Southern Georgia and our Northern Florida locations along the I95 corridor. We are excited about this and we are excited about our expanded presence and look forward to continuing our growth in the grease trap business.

In conclusion, traditionally third quarter is our most challenging quarter because of the summer temperature impact on our raw material quality. This year was no different and possibly more severe than in the past. Overall, our balance sheet remains strong and we continue to make the necessary operating adjustments to survive these difficult times.

For Darling, historically high energy prices for gas and diesel, closure of our traditional export markets for finished products and lower supplies of beef raw materials have made for a very challenging operating environment. Our organization has reacted and we have made the necessary modifications to continue to deliver profitability.

I would like to turn the call over to John now so he can provide some additional color on our financial results.

John?

Thanks Randy and good morning to everyone. For the third quarter of 2005 Darling reported net income of $2 million or $0.03 cents per share as compared to $4.6 million or $0.07 per share in the third quarter of 2004. The decrease in net income for the quarter was primarily due to a before-tax gain of $2.8 million we realized in the comparable period of 2004. This resulted from a settlement with past insurers.

The company also reported net sales of $79.3 million for the quarter ended October 01, 2005 as compared to $80 million for the third quarter of 2004. Operating income for the third quarter of 2005 was $4.2 million, a 55.3% decrease over last year's third quarter. Due primarily to lower finished product prices for meat and bone meal, tallow 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 and operating cost adjustments.

You will note that our SG&A expenses decreased $1.1 million for the third quarter of 2005 as compared to last year's period. This is primarily due to lower accruals for incentive compensation which is substantially based on the company's performance.

At the segment level, Rendering generated net sales of $49 million for the third quarter as compared to $51.6 million in the third quarter of 2004. The Restaurant Service business generated net sales of $30.4 million in the third quarter as compared to $28.5 million in the third quarter of 2004.

Turning to the nine months ended October 01, 2005 Darling reported net sales of $232 million as compared to $248.8 million for the comparable period of 2004. Decreases and raw material volumes and finished product prices accounted for the majority of this decline in net sales.

The company also reported net income of $5.7 million as compared to $13 million for the comparable period of 2004. Decreases in raw material volumes and finished product prices combined with increases in energy costs tin 2005 and the before tax insurance settlement gain of $2.8 million realized in the third quarter of 2004 accounted for the majority of the $7.3 million decline in net sales.

At the segment level for the nine months ended 2005 Rendering generated net sales of $146.5 million as compared to $159.4 million for the first nine month of 2004. Restaurant services generated net sales of $85.4 million for the first nine months as compared to $89.5 million for the comparable period of '04.

Looking at the balance sheet, capital expenditures during the first nine months of 2005 were $14.5 million compared to $7.7 million in the first nine months of 2004. The net increase of $6.8million is primarily due to major projects as Randy mentioned, in Fresno, California and our Wahoo, Nebraska facility.

Operating income for the nine months ended October 01, 2005 was $12.4 million a decrease of $14.7 million. This decrease was primarily attributable to the lower finished product goods prices, lower raw material volume, lower yields on production and the $2.8 million realized in the prior year from the settlement with past insurers. Again, this decrease was partially offset by improved recovery of collection expenses and lower SG&A expense.

Interest expense was $4.7 million during the first nine months of 2005 compared to $5.2 million during the first nine months of '04. A decrease of $500,000 was primarily reduced (call spend) on the preferred stock dividends and accretion in interest expense charged in the first nine months charged in the first nine months of '04 to interest expense as a result of an adoption of FAS 150 in the third quarter of '03.

As of October 01, 2005 Darling's cash and cash equivalents totalled $36.7 million as compared to $41.2 million on October 02, 2004. Working capital at the end of the third quarter was $35.4 million as compared to working capital of $39.6 million on January 01, 2005.

Net cash provided by continuing operations was $16.7 million as compared to $33.7 million for the nine months ended October 01, '05 and October 02, '04 respectively. A decrease of $17 million and this decrease was primarily due to lower income from continuing operations of $7.4 million, pension contributions of $4.8 million, non-cash expense items related to deferred taxes of $1.4 million and changes in operating assets and liabilities of $1.5 million.

I would now like to turn the call back over to Randy.

Thanks John. Before we open to questions here I would like to make a brief closing comment. 2005 has and continues to be a very challenging year. I'm pleased with our progress the organization has made and our ability to react to volatile energy and lower commodity markets. While we've worked diligently to move more and more customers to formula based pricing our work is not finished.

The commodity volatility we have experienced once again highlights our exposure and the work we must continue to complete. Let me say we are optimistic that the U.S. will see resumption of beef trade to Japan and other Far Eastern countries which should result in an increase in slaughter volumes during 2006.

I would like to conclude by saying we appreciate your support and your continued confidence in Darling.

John and I are now happy to take questions. India?

Thank you.

(OPERATOR INSTRUCTIONS)

Our first question is coming from George Gross (ph) of Joseph Gunnar (ph). Please go ahead, your line is live.

Yes, good morning gentlemen. Could you talk a little bit about the National Services Center, how many new you'd like to pick up this quarter and also have you begun seeing revenues from, I believe you had seven national service wins that you mentioned on the Q2 call?

Well the National Service Center, George this is Randy, it continues to grow for us. I would say at the--it's gone from a staff of one here to now a staff of--or a staff of four customer service people. And we continue to integrate the seven accounts that we talked about. I don't have any new disclosures of new victories in Q3 that I can disclose at this time.

But the service center is continuing to be a success for it and we're very pleased with it.

I mean you're saying--is that you had wins during Q3, but you just can't disclose them or?

There's nothing I want to disclose at this time.

I guess moving to the Grease Trap business did you get any new accounts during the quarter?

Yes, I mean we don't release that data, but the business continued to grow in that segment. But as you see in the Q, it's one that's impacted by two or three different processes. One being that it's when you--it receives--in the sales site it receives the downgrades from the grease production, yellow grease production from the hot summer temperatures, of the dead animals.

From the collections side in the restaurant side there we continued to grow. We're up year-over-year and near our plan on accounts. And it was offset though by a lot of increase in diesel fuel when diesel fuel hit an average price in the 320's here for the remaining 30 to 45 days of the quarter. And additionally we saw the prices decline substantially so that's how you're trying to reconcile that one.

I mean price, is that in terms of what you're getting from your customers, or is that pricing pressure or?

No, the yellow grease price, is the (moderate) price--.

Oh, okay, okay.

That I said, you know, it dropped $0.025 quarter-over-quarter.

Yes, yes, okay.

And if you remember that the yellow grease business is one that involves service charges to our customers or what we would describe as recovery of collection fees and the majority of that business is not on formula so you experience more volatility in that segment than you do in the traditional rendering segment.

Okay, last question on the--from me, before I go back in the queue. Were you able to add on like ancillary services in your Grease Trap, I know you've been, slowly but surely trying to tack on additional services there?

Nothing of any magnitude at this time. We've added some different speciality equipment around the country into different regions, but nothing of any magnitude.

Okay, thanks a lot I'll go back into the queue.

Thanks George.

The next question is coming from Jeff Gates of Gates Capital Management. Please go ahead, your line is live.

Yes can you--it looks like you've spent about $20 million on CapEx in the past 12 months can you break that down and talk about the capital projects that you've undertaken and the return on invested capital you expect to get from them, number one?

And number two, can you talk about the recent acquisition that you just made and what the economics are for the company?

I'll address the CapEx spending Jeff, the main increase in that area has been the Fresno project which as we, if you look at our credit agreement, did provide for up to $5 million for the period for that project and we're on target, on plan, for spending on that. We had to delay, from the standpoint of permitting, but the project--that is a major component of that overrun as well as compliance for waste disposal at the Wahoo facility, of water treatment.

And that was another major expenditure which really accounts for almost 5 to $6 million of that, over what has been normal CapEx.

What would you expect the CapEx plan be--to be going forward into '06?

In '06 I think if you look at our normal CapEx spending as we've had in the past we do not have, or have identified any, major projects other than the Wahoo and Fresno projects that we have outlined when we did our refinancing that we were looking at doing.

So we would be more back to normal CapEx, compliance, and then any technology money that we would be spending to lower any energy costs.

Okay, so you're saying that all the Fresno and the Nebraska, those projects will be finished by the end of '05?

Yes, Jeff, this is Randy. The--we--Wahoo is pretty much in the start-up phase right now. That was the installation of new boilers and a major waste-water treatment plant, to stay in business there essentially. That's under start-up right now and it'll be completed here by the 1st of December. And then the Fresno project will become a true revenue generator, hopefully sometime right after the first of the year. A major shutdown is planned there in early January and hopefully we'll have the bugs worked out throughout first quarter and be ready to roll.

And the recent acquisition?

That's a small company down in very Southern Georgia, along the I95 corridor. It services that Savannah to Jacksonville corridor. It's--I don't know what to--just--it's just small Jeff. It services less than 1,000 customers with four to five trucks and it just basically gives us a new business to provide in the South Georgia and helps us provide our (North Ford) operations.

We're you not in that market before?

No. We were over in Tampa and down in Fort Lauderdale and we were running some collection in the Jacksonville, Orlando area, but what the Alma, Georgia facility does to us, it's going to come with two properties. One in Alma, Georgia and one in Kingsland and it gives us processing and it's permitted processing capacity that will reduce our--once again allows us to expand in the Trap business with--but belief of what our core value is in that and that is controlling our disposal. And that's what that property brings to us that we didn't have before.

Okay, thank you.

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Gentlemen, I am not showing any further questions from the phone lines at this time.

All right, India. And thank you everybody and we'll talk to you after fourth quarter here.

Thank you. This does conclude today's Darling International Conference Call. You may now disconnect your lines and have a wonderful day.