Darling Ingredients Inc (DAR) 2005 Q4 法說會逐字稿

Good morning everyone, and welcome to the Darling International conference call to discuss the company's fourth 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.

[OPERATOR INSTRUCTIONS]

This call is being recorded. Your participation implies consent to our recording this call. If you do not agree to these terms, simply drop off the line. I would now like to turn the call over to Mr. Brad Phillips, Treasurer of Darling International. Please go ahead, sir.

Thank you, Elsa. Good morning, ladies and gentlemen. Thank you for joining us to review Darling's fourth quarter and full fiscal 2005 earnings results. Randy Stuewe, our Chairman and CEO, will begin today's call with an overview of our fourth quarter financial performance, and some of the trends that impacted our results. John Muse, Executive Vice President Finance and 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", "expect", "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 its assessment of and are subject to a variety of risks and uncertainty beyond its control and 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 risks and uncertainties regarding Darling, its business, and the industry in which it operates, are referenced 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 for as the result of new information, future events, or otherwise.

With that, I would now like to turn the call over to Randy.

Thanks, Brad. Good morning, everybody. Thanks for joining us this morning. 2005 is now in the record books, and will be remembered as a year where we continued delivering profitability in spite of adverse operating conditions. Let me begin with a high-level overview of our financial results for both the quarter and the year. I'll then talk more generally about some of the factors that contributed to our performance in 2005, and provide you a brief update on where we are with respect to our pending acquisition of National By-Products. John will then conclude our prepared remarks with a detailed discussion of our earnings, and after that we'll open it up to your questions.

As noted in our press release, our fourth quarter results reflected small increases in both finished product prices and raw materials supplies. These improvements enabled us to generate 5.5 million, period over period, in increased sales growth. Despite significantly higher energy prices for both natural gas and diesel fuel, we were also able to realize a $1.2 million increase in net income for the quarter.

For the full fiscal year, however, our financial results were impacted by three key challenges; lower supplies of raw material as a result of the continued closure of U.S. export markets to U.S. beef products, significantly higher energy prices for both diesel and natural gas, and lower commodity prices for our finished goods. I'd like to provide you with a little bit of color around each of these factors.

Lower raw material volumes. For the first three quarters, weak cattle slaughter margins in the meat processing industry, along with continued export restrictions on U.S. beef products, contributed to a decline in our red meat raw material volumes. Darling was significantly impacted at four of its rendering locations by lower supply of raw material available from its primary suppliers. During the fourth quarter, supply volatility persisted with the announced opening of the Japanese border, but eventually slowed with the re-closing of that market. We saw increases in our raw materials supplies early on, but with eventual issues related to a veal supplier in New York, we saw slaughter margins collapse and ultimately slaughter volumes reduce.

Higher energy prices for both natural gas and diesel fuel persisted throughout fiscal 2005. As many of you already know, we actively attempt to manage natural gas price risk by entering into forward purchase agreements, and depending on market conditions, to purchase natural gas for future months when prices are low or attractive. We also have the ability to burn alternative fuels at various plant locations when it's economically feasible to do so.

All said, 2005 was a year of extremes. The late summer hurricane season cost substantial disruption in supplies for all energy products. During late third quarter and continuing on through fourth quarter, we decided to operate 18 of our 23 plants on alternative fuels. Additionally, helping us out in moving that number up, we received during the fourth quarter two additional permits to burn alternative fuels at our Dallas and Houston plant.

For finished product pricing, throughout most of the year, 2004 closure of foreign export markets to U.S. produced beef products, including meat and bone meal and tallow, continued to result in lower commodity prices throughout our system. Meat and bone meal competed domestically for its share in feed rations, but excessive global supplies of competing proteins, mainly soybean meal, held prices substantially reduced versus last year's. However, tallow and yellow grease prices benefited from the eventual switch over from natural gas to alternative bio-fuels during the fourth quarter.

Additionally, given the limited amount of exports experienced this year, our coastal plants located in Newark, LA Tacoma, San Francisco found themselves shipping product inland or inward versus garnering the normal and historical export premiums due to their close proximity to the water. These challenges were the primary contributors to our lower net income in 2005. As we have discussed before, our use of formula based pricing and our collection cost recovery model were quite effective in helping us manage our business and continue to deliver profitability in light of these volatile and very difficult markets.

On the government regulation front, the comment period for responding to proposed regulations on SRM removal to address and alleviate any concerns with mad cow disease has now passed. As we have commented before, very little progress has been made with respect to how the government will potentially treat the removal and monitoring of SRMs from dead animals. At this time, we do not anticipate these issues being finalized in the near future.

On the avian influenza front, we continue to monitor what is called the H5N1 Avian Influenza Virus. It continues to move across Asia and Europe. As most of you know, AI, or what's commonly called bird flu, is a highly contagious disease that affects primarily poultry, but can be passed from animal to human. AI is not new to the U.S. and was found in 2002 and 2004 in this country, although in a less dangerous strain form. No cases of avian influenza have been reported in the U.S. to date.

At this time, our plans and the plans that combat AI are being developed. As history has taught us, AI is quickly eradicated and managed through flock culling and the use of peat. While any impact to Darling is difficult to quantify today, we do believe that poultry meal exports could be impacted and ultimately have to fight for a larger share of the domestic rations, much as in the same way meat and bone meal did in 2004.

In our restaurant services segment, we continued to make progress in 2005. We continued to leverage our coast-to-coast presence and added several new large multi-state operators to our base. Accordingly, our national service center continues to expand and we now manage 3,700 locations and perform approximately 74,000 services annually for our customers. Collectively, our restaurant services segment experienced customer growth of approximately 7%.

The grease trap business continues to be a solid performer for us. Once again, we were able to grow at double-digit rates. Additionally, we increased our national footprint with the addition of two new processing and service locations -- one in Alma, Georgia, and a new modern facility in Detroit, Michigan. This brings our total service locations to 23, and makes Darling the largest grease trap service provider in the United States.

On the CapEx front, we completed several key projects during 2005. As mentioned, we completed the construction of a grease trap processing plant in Detroit, and in Wahoo, Nebraska, we completed the construction of a major waste treatment and boiler replacement project. In Fresno, which we've talked about in the past, after many delays resulting from permitting challenges we encountered throughout the last 18 months, we finally commenced construction of the modernization and the expansion of that facility.

As we speak today, the plant is in the final stages of construction, and we will hopefully start it up in the coming week. This has been a long and arduous process, but we are pleased that the end is in sight, and we will begin to feel the benefits of the improved efficiency and lower freight expense on the West Coast. Additionally, during 2005, high-energy markets made us focus on energy reduction like never before. Numerous efficiency projects were completed during the year that involved both equipment replacement and process changes.

I'd like to conclude my prepared remarks by giving you an update on the proposed acquisition of National By-Products. On December 20, 2005, we announced our acquisition of NBP, a leading independent renderer based in Des Moines, Iowa. As we said when we announced the transaction, combining National By-Products with us will give us a number of important strategic and financial benefits. The addition of NBP's 42 facilities located throughout the Midwest will strengthen Darling's regional capabilities, and diversify our raw material supply to include a sizable white meat component.

Additionally, National By-Products 14 large production facilities will complement our existing Midwestern location and provide us a platform for additional growth in the restaurant services segment for both used cooking oil collection and grease trap service. The companies combined nationwide network of facilities will have scale, industry expertise, and management talent to realize improved operating efficiencies and pursue new growth opportunities.

We have been working diligently to close this transaction, which we continue to expect will take place during the first half of 2006. To that end, on February 3rd, we announced that Darling was granted early termination of the Hart-Scott-Rodino review by the Federal Trade Commission. In early February, we filed the S-4 Proxy Statement to complete the transaction, and are awaiting final SEC signoff on this document, which will permit us to hold the necessary shareholder and unitholder meetings. We are excited about completing this transaction and will, of course, keep you apprised of any new developments.

I'd like to turn the call over to John now, so that we can provide some additional color and flavor on our financial results for both the fourth quarter and the full year. John?

Thanks Randy, and good morning to everyone. In spite of significantly higher energy prices for natural gas and diesel fuel, net income for the fourth quarter 2005 increased to 2.1 million, or $0.03 a share, as compared to net income of 0.9 million, or $0.01 a share for the 2004 comparable period. The company also reported net sales of 76.9 million for the quarter ended December 31, 2005, as compared to 71.4 million for the fourth quarter of 2004. Increases in finished product prices and raw material supplies accounted for the majority of the 5.5 million increase.

Operating income for the fourth quarter was 3.7 million, as compared to 3.5 million in the fourth quarter of 2004. As Randy mentioned, despite continued high-energy prices, our operating income in the fourth quarter was positively impacted by the increased availability of beef, raw material supplies, and higher commodity prices for finished products. At the segment level, rendering generated net sales of 45.8 million for the quarter, as compared to 41.8 million for the fourth quarter of 2004. This is an increase of 4 million.

The restaurant services area generated net sales of 31.1 million, as compared to 29.6 million in the fourth quarter of 2004. Profit in the restaurant services segment improved to 3.6 million, as compared to 3.3 million in the fourth quarter for 2004. Now, turning to the fiscal year ended December 31, Darling reported net income of 7.7 million, or $0.12 per share, as compared to net income of 13.9 million, or $0.22 per share, for the 2004 comparable period. The 6.2 million decrease in net income for 2005 resulted primarily from higher energy prices, lower availability of beef raw material supplies as a result of the continued closure of export markets to U.S. beef, and lower commodity prices for finished goods.

The company also realized a before tax gain of 2.8 million in 2004, resulting from a settlement with our past insurers. We also reported a decrease in net sales of 11.3 million to 3.8 million in fiscal 2005, compared to 302 million for fiscal 2004. Decreases in finished product prices and raw materials supplies accounted for the majority of the net sales decline.

Interest expense was 6.2 million during fiscal 2005, compared to 6.8 million for 2004, a decrease of 6.6 million, or 8.9%. The decrease in interest expense is partially due to reduced preferred stock dividends and accretion that was charged to interest expense in 2004 as a result of the application of SFAS 150, which was adopted in a first day of 2003's third quarter. The company's outstanding preferred stock has been redeemed in 2004.

Other income was 0.9 million in fiscal 2005, a 1.2 million increase in income from other expense of 0.3 million in 2004. This favorable variance is due to primarily from the increase in interest income of 0.7 million, and gains on the sale of assets of 0.25 million, that was the sale of our Tyler, Texas and our Sunnyvale, Washington transfer stations. At the segment level, rendering generated net sales of 192.3 million as compared to 201 million in 2004, a decrease of 8.8 million. Restaurant services generated net sales of 116.5 million for 2005, as compared to 119.1 million for 2004, a decrease of 2.6 million.

As for the balance sheet, as of December 31, 2005, Darling's cash and cash equivalents totaled 36 million, versus 37.2 million at the end of 2004. On December 31, 2005, the company had working capital of 40.4 million, as compared to working capital of 39.6 million on January of 2005. Capital expenditures of 21.4 million were made during fiscal 2005, as compared to 13.3 million in 2004. This was an increase of 8.1 million. The fiscal 2005 increase is primarily due to major projects at Fresno, California and Wahoo, Nebraska that were identified over normal maintenance and compliance expenditures.

As Randy mentioned earlier, we expect to realize significant benefits, both strategic and financial through our combination with National By-Products. We believe this transaction represents and excellent investment of our excess cash, and it will optimize our capital structure by enhancing our asset and debt mix. As we told you in December, the cash component of this transaction will be financed through a combination of cash on hand and debt financing. I am pleased to report that Darling is in the final stages of discussion with our prospective lenders to secure financing for the cash component of the transaction, and expects to have a definitive agreement in place prior to closing the acquisition. We look forward to updating you on this as we proceed with the transaction.

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

Thanks, John. Before we open it up for questions, I'd like to make a couple of comments on one final item noted in our 10-K and our press release. As a result of our internal review over internal controls over financial reporting, management identified a material weakness related to our state income taxes for 2005. In late 2004, we hired a professional consultant to conduct an extensive review of state tax credits available to Darling. Our consultant conducted a thorough review of the specific state tax law, and determined that the company was entitled to substantial tax credits related to its operations for the years 2000 through 2004. Prior to recording these credits and during the fourth quarter, we asked our outside tax advisor, a Big Four firm, to review the work.

Upon review, our outside tax advisor concluded that the calculations, computations, and documentation were correct and we made the necessary entries to our preliminary 2005 statements. Subsequently, in reviewing this entry and prior to finalizing our year-end financial statements, management determined that additional documentation should have been required to better substantiate the potential tax benefits. From this, we must declare that a material weakness existed. Approximately 565,000 had been inappropriately credited against our tax liability for 2005. We believe adequate changes to our controls will be made to correct this problem.

In closing, I'd like to say that while 2005 was clearly a challenging year for Darling, I'm very proud of the hard work and dedication we saw from all employees as we work to deliver continued profitability. Going forward, you can be sure that we will continue to make every effort to position the company for improved growth and profitability. Our National By-Products acquisition, in particular, represents a major step forward in our strategy to deliver value to stockholders by growing our top line, diversifying our raw materials supply, and creating additional growth opportunities in our restaurant services segment. I'd like to conclude by saying we appreciate your support, and we look forward to your continued confidence in Darling.

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

Thank you. The floor is now open for questions.

[OPERATOR INSTRUCTIONS]

Our first question is coming from Tyson Bauer with Wealth Monitors. Please go ahead.

Good morning, gentlemen.

Good morning, Tyson.

Good morning.

Quick question. It would appear one of the big risk factors entering '06 is avian flu, which you've already touched on. Can you explain, or help us understand, what contingencies or mitigation plans you would have for a direct impact of the avian flu if it were on U.S. soil? Or in general, your impact is somewhat indirectly just by having it in Europe and Asia because of it holds down the soy complex, and soy meal, that that would hold down some MBM prices, what are some things that the company can try to do to mitigate should those instances occur?

Tyson, this is Randy. I'll take a stab at this, but them I'm trying to stay away from purely speculative comments here. First of all, AI is not 100% new to the country. As we said, this strain is highly contagious, and so the government and the poultry industry are working diligently, as we've been made aware, to create plans to combat it. Now, those plans that I've reviewed or seen snippets of, pretty much the target is to contain it regionally within the flock or the location, and then from an export standpoint, to pretty much make that region a somewhat embargoed from exporting product. So, overall the goal by the poultry industry is to regionally contain it.

Now, from our perspective, and knowing our BSE, or mad cow experience, and what's happened in the rest of the world, I think it's probably fair to say that the poultry exports and poultry meal exports would probably be impacted as countries say, "We don't want that product in our country." When you look at this and then much as any other, it's a consumer perception issue on these finished products as the product or the disease is quickly heat eradicated.

So, I think you can only then draw a conclusion that would say, I would suspect that poultry meal would start to, I don't want to use the word back up, but would have to displace competing protein in the United States that could be exported. And you can only come back full circle and say that would impact then the soy complex and displace soy protein, because until the margins turn so negative in the poultry business or we stop eating it, then they're going to continue to process birds and sell protein.

So, in my long or short view here, is as you will see a similar displacement or potentially see a similar displacement that you saw in the meat and bone meal domestic displacement that happened in '04, it's not insurmountable. It's one of those things that ultimately, when as you know, in feed rations, it's a price computation for least cost formulation. And, overall, the margin structural shakeout and the right protein will stay in the formulation.

Speaking of processing, what kind of [kill all] do you have? Obviously, beginning in '06 the feedlot placements are up dramatically, given the conditions in the southern cattle belt, I guess if that's a region -- you classify it? And, how do you stand as far as supplementing some of your raw materials with poultry material?

That's a double-edged question there. First thing is, during late third quarter, fourth quarter, as the optimism grew as Japan was going to open, and then it eventually did open, the market place did hit an upturn in the cattle cycle, and also the slaughter volumes increased a little bit in fourth quarter, I think about 2% over the prior year. So, we did see that upturn, and as we said, we saw it quickly shut off as margins returned negative and freezers filled up with finished product as Japan closed the border there.

Relative to poultry and Darling, poultry is somewhat of a small component of our mix today. It's a limited, I guess I'd hesitate to comment more than that, other than to just say it's a small component of our mix.

Two quick, both keeping, and I'll get back in queue. One, what do you anticipate adoption or equity compensation costs for '06? And then, two, for modeling purposes, if you do go forward with the early prepayment June 1st, which would seem likely, what kind of early prepayment expense would there be associated with that?

Tyson, on the subordinated debt, there is a 5.5% penalty for early prepayment on the 35 million, so that's 1.9 million prepayment penalty that would be taken at the time that the sub-debt would be replaced.

Okay. And now that we're expensing options, will you anticipate that for '06?

I don't think right now -- as you can see in the equity portion of the balance sheet, there is a classification of unrecorded compensation cost of 1.2 million, and that's about as much as we can discuss at this time.

Okay. Thank you, gentlemen.

Thank you. Our next question is coming from [Ed Secton] with Portfolio Logic.

Yes. Hi. I was just wondering if you could clarify the tax rate as compared to 2004, and also noting the Q4 tax rate number and how low that was?

The tax rate was down as it relates to prior periods because we did identify some credits that we did go after, and were approved and signed off on. So, we were able to take those during the period. We also got closure from the IRS on our 2002 tax return, and there were reserves that were against that in case the government had questioned any provisions that we had taken in that tax return. So, the impact of the credits that we had applied for and took those, and then -- but one of the larger impacts was the approval or sign off by the IRS on the 2002 return, and those reserves basically come back and flow right into the tax rate.

Got it. Thank you, very much.

Thank you. At this time, I'd like to turn the floor back over to you.

All right. If there's no other questions, I guess we'll go ahead and wrap up. I just wanted to thank everybody for their support, and we look forward to bringing you up to speed on any additional events that happen as we approach the National By-Products closing, and look forward to talking to you after first quarter here. Thanks and have a great weekend.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.