Darling Ingredients Inc (DAR) 2006 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Darling International conference call to discuss the Company's first-quarter fiscal 2006 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. (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, Toni. Good morning, ladies and gentlemen. Thank you for joining us to review Darling's first-quarter 2006 earnings results. Randy Stuewe, our Chairman and CEO, will begin today's call with an overview of our first-quarter financial performance and some of the trends that impacted our results. John Muse, the Executive Vice President of 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, 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, 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 will now like to turn the call over to Randy.

Thanks, Brad. Good morning, everyone. Thanks for joining us this morning. I would like to begin my remarks by reviewing our first-quarter earnings and some of the trends that have impacted our performance. The environment we operated in during the first quarter remained difficult. Our key performance drivers -- raw material supply, finished product prices, and energy cost -- continued to influence our earnings. I would like to provide some additional color on these points as well as on some other factors that impacted our first-quarter earnings.

First, let's talk about raw material supplies. As we entered the first quarter, the beef processing industry felt encouraged that the Japanese market and other Pac-Rim countries reopened their borders to US beef in mid December. For Darling, raw material supplies began to improve, as beef inventories were built in anticipation of resumed shipments. On January 20, this abruptly ended as the borders were reclosed due to an errant shipment of veal from a processor in the Northeast. The borders remain closed today, and our raw material supplies have returned to pre-opening levels.

Finished product pricing was mixed during the quarter. Prices for grease and fat declined, both year over year and quarter over quarter. This was due to growing inventories of soybean oil; mild winter weather, which affected the consumption for animal feeding; and finally, reduced usage within the energy sector. On the positive side, however, protein prices improved across most of the US. The only exception to this trend was the West Coast, where a glut of material resulting from export limitations continued to keep prices lower than in the rest of the country.

Rising energy costs remained our number one challenge. Energy is a significant input in both our factories and our fleet. While Darling attempts to manage these costs through forward purchases, formula pricing, and surcharges to our customers, our ability to recover these significantly higher costs remains a challenge. As we discussed on previous calls, our plan is to attempt to mitigate the impact of these cost increases by arbitraging between natural gas and biofuel whenever economically feasible for them to do so. For the first quarter, the majority of our plants ran on biofuel and we have received permits in Dallas and Houston that allow us the flexibility to burn gas or biofuel as necessary.

While the three drivers discussed were significant to our performance, there were two additional items which contributed to our reduced earnings in first quarter. We discussed these briefly in our press release, but I thought I would like to provide additional detail on both. First, during the month of March, we shut down our plant in Fresno to complete our long-awaited modernization of the facility. As previously discussed, we experienced significant delays in permitting this plant. Ultimately, we were forced to operate the plant at reduced capacity for most of the quarter. While operating at lower throughput rates, we redirected our raw material to other Darling locations. These transportation costs became burdensome and grew even more challenging as fuel prices rose. Additionally, we experienced a substantial increase in plant repair costs for Fresno prior to the shutdown. Going forward, freight savings, lower plant repairs and increased operating efficiencies will provide substantial benefits for our shareholders.

On the legal front, while we don't traditionally comment on ongoing litigation, I would like to provide a brief dialogue of two legal actions that were reflected in our increased expenses during first quarter. First, in Newark, New Jersey, we are seeking affirmative relief in a contract default on behalf of a utility, which used to supply steam to our plant there. Second, in California, we are seeking affirmative relief in a property dispute. While it's difficult to predict the timing or the outcome of these actions, we will keep you informed as appropriate. Collectively, these were the main drivers of our performance during first quarter.

Now, let me discuss several other areas of interest. Avian influenza continues to make media headlines daily. From newspapers to television, the general public's awareness continues to grow. While high-pathogen AI does not exist on US soil, there are many preparations being made at the federal state and local levels to respond to an outbreak here, should one occur. At Darling, we have assembled an internal response plant and will continue to work with the respective government agencies to be prepared for any response which may be necessary.

On the restaurant services front, our growth continues and we are on target with our business plan. While we do not release key accounts for competitive reasons, we did reach an agreement with a major supermarket chain during the first quarter to provide nation-wide services for rendering cooking oil removal and grease trap maintenance service. This was a big win and an exciting one for all of us at Darling. It is also a good example of the excellent progress our team is making by leveraging Darling's national footprint to enhance the services we're able of providing to our customers within all 50 states.

I would like to conclude my prepared remarks by giving you an update on our proposed acquisition of National By-Products, which we announced on December 20, 2005. We have been working diligently to complete the transaction and have scheduled a special shareholder vote for Monday, May 15 with an anticipated closing shortly thereafter. As many of you are aware, on April 10, we announced that Darling had entered into a new credit agreement with lenders that would provide us with the liquidity and the financial flexibility necessary to complete the NBP acquisition. John will discuss that in greater detail momentarily. We are very excited about completing this transaction and will of course be issuing a formal announcement when we do so.

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

Thanks, Randy, and good morning to everyone. For the first quarter 2006, Darling's net sales were 76.4 million as compared to 71.4 million for the first quarter of 2005. Increases in raw material supplies and a higher volume of purchased finished product for resale accounted for the majority of the $5 million increase. Net income for the first quarter 2006 declined 2.4 million or $0.01 per share as compared to income of 0.9 million or $0.01 per share for 2005 comparable period.

As Randy mentioned, the 0.5 million decrease in net income for the first quarter 2006 resulted primarily from higher energy prices of natural gas and diesel fuel, increases in operating expenses related to the modernization of the Fresno project, and higher legal expenses. Interest expense in the first quarter of 2006 was 1.5 million compared to 1.6 million during the first quarter of 2005, a decrease of 0.1 million, primarily due to capitalization of interest in 2006. Operating income decreased by 0.9 million in the first quarter of 2006, which was a 32.1% decrease over the first quarter of 2005, caused primarily by lower finished product prices, higher natural gas and diesel fuel expenses, higher plant repair and maintenance expenses, and higher legal expense. These decreases were partially offset by improved recovery of collection expenses and higher raw material volumes at the segment level, rendering generated net sales of 45.5 million for the first quarter as compared to 44.4 million in the first quarter of 2005. The restaurant services business generated net sales of 30.9 million as compared to 27 million in the first quarter of 2005.

Additionally, Darling made capital expenditures of 2.5 million during the first quarter of '06 compared to capital expenditures of 3.1 million in the first quarter of 2005. This was a net decrease of 0.6 million. Capital expenditures related to compliance with environmental regulations were less than 100,000 during the first quarter of '06 compared to 400,000 for the first three months of '05. On April 1, the Company had working capital of 42.1 million compared to working capital of 40.4 million at December 2005. As of April 1, 2006, Darling had an unrestricted cash of 37.2 million compared to unrestricted cash of 36 million as of December 31, 2005.

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 an excellent investment of our excess cash and will optimize our capital structure by enhancing our asset and debt mix. As we told you back in December, the cash component of this transaction will be financed through a combination of cash on-hand and debt financing.

On April 10, Darling announced that we entered into a new credit agreement with new lenders effective April 7, 2006. This refinancing replaces a prior credit agreement executed in April 2004 and provides for 175 million in financing facilities, including a 50 million term loan facility which will be amortized at 5 million a year over a six-year term and a 125 million revolver facility for a five-year term, which provides for a 35 million letter of credit sub facility. With this refinancing, Darling repaid the balance on our term loan facility under the senior credit agreement in the second quarter of '06 and incurred a write-off of deferred financing costs of approximately 1.5 million. Additionally, in the second quarter of 2006, we plan on retiring the senior subordinated debts notes using money available under the credit agreement and will incur charges of approximately 1.9 million for prepayment fees and approximately 1.1 million in write-off the deferred loan cost.

The refinancing provides Darling with increased liquidity and financial flexibility to complete our acquisition of National By-Products as well as to retire senior subordinated notes. Additionally, we expect to realize significant benefits from the refinancing, incurring lower interest rates, an extended term, fewer restrictions on investments, and improved flexibility for paying dividends or repurchasing stock -- all of which are subject to the terms of the new facility.

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

Thanks, John. The progress demonstrated in the first quarter 2006 represents solid execution of our strategic plan. Despite the challenges of rising energy costs, we continue to work hard to deliver continued profitability. We are very excited about all of the compelling benefits of our acquisition of National By-Products. And we look forward to growing our top line, diversifying our raw material supplies and creating additional growth opportunities for our restaurant services segment -- all of which will ultimately deliver significant value to our shareholders. I would like to conclude by saying we appreciate your support and look forward to your continued confidence in Darling. John and I will now take questions. Toni?

(Operator Instructions). Tyson Bauer, Wealth Monitors.

A couple of quick questions. Can you quantify the non-recurring aspects of the expenses incurred in Fresno and also their legal expenses?

Yes, let me give you a little color on the Fresno thing. I don't know that I can break it out specifically for you. But, predominantly, that plant operated at about 50% of capacity and we were moving nominally the other half out by truck at around $800 a load every day for the first half -- or the first quarter of the year. So, there is a substantial amount of money there between freight. Between the operating costs, we were forced to send the material to plants that have higher operating costs, both in San Francisco and Los Angeles. Then, additionally, as we awaited the permits to build that plant, the plant continued to basically disintegrate and we had higher repair costs to keep it together during first quarter. So, I think it's fair to say that you'll see those savings come in, Tyson. I know that doesn't answer your question specifically, but I don't really want to put a number on it and give that away.

But, you would say it's a material improvement expected for Q2?

Yes, I think that's a fair statement.

You also -- obviously, we have had an extended engagement period with National By-Products thanks to the FTC. Has this better prepared you for -- once the acquisition is completed, I'm sure there's a lot of things that you wish you could have done earlier. Would we expect to see those benefits from the merger happen more quickly?

I don't know that I will put a timeframe on it. I will tell you that since December to May, it seems like it's been about 10 years for John and I. But, we have spent a lot of time now -- if you will, the thoroughness of the due diligence done makes us very comfortable on what we are acquiring or merging with here. I think we have had adequate time now to study and to start the execution here after Monday on bringing home the synergies.

Okay, and two quick ones and I will get off and back in queue. Obviously, questions people are wanting to know -- one is, your status -- we've talked about this repeatedly on conference calls -- as far as an alternative fuel play for the Company. Then, secondly, is there any poultry pressures? Obviously, we're looking at the manufacturers and the difficulties they've gone through. Has that had any kind of ancillary effect on your business?

First of all, on the alternative or the renewable fuels area, it's an area of great interest for the Company. It's one that we feel that once we get the two companies put together, we will even have more of a substantial footing into potentially entering that business. It's one that the Board continues to, if you will listen, to us as we present the opportunities and get smarter about it. You know, as we've discussed all along -- animal -- if we were to enter the business, it would be based on animal fats, as we have a substantial position there. It's one that we have to get comfortable that the technology available out there is one that can help us do it right the first time. So, I think where I would like to leave that right now is it is one we are studying with great interest and stay tuned.

On the poultry side, obviously, if you have been following the poultry issues in the country, there's been numerous things that have happened around the country. While I don't profess to be a poultry expert, we've seen Russia basically slow down their purchasing of poultry products for various reasons that they want to produce their own or otherwise. That has started to back up a poultry glut into the -- back into the United States. We've seen leg quarters pretty much go to zero value or a low value, even historically speaking. We've seen the chicken guys basically have to back down a little bit with their margin structure. Additional exports are being influenced by any of the countries that have experienced any type of avian influenza. Overall, the poultry situation in the US, at least as far as feeding demand for us, remains strong.

Has it reduced the overall yellow grease price though because of the extra dark meat on the market?

You've seen a little bit of poultry fat come onto the market, and I think that's fair to say that there's probably some relationship there. Additionally, you've seen the drop in natural gas prices. While still historically high, they've backed off from the 10, 11, $12 in MMBtu down to the 7 to $8 range, which puts -- basically what you've got is yellow grease -- is mirroring the price of the fuel substitutes. So if you use a nominal conversion of 60% on Btus, if you've got $0.12 yellow grease, that's $7.20 natural gas, which is pretty close to where it's at today.

So, as we saw natural gas come down, we saw yellow grease prices come down. Also, with that, you've seen a little bit of the rendering of the leg quarters putting a little more poultry fat onto the market. So, you know the issue out here is one overall of commodities. As the government reported today, you're seeing corn stocks are a little smaller than they thought they would be. So, you've got corn up substantially, now headed towards the $3 mark. Then, you've got the soybean stronger and the soybean oil complex headed back up to $0.25 to $0.27 between three months and a year out. So, historically, the rendering products of animal fats and the greases are lagging substantially to, if you will, the grain complex right now.

Jeff Gates, Gates Capital Management.

Yes, I know you've done a lot of work over the last couple of years to make the Company less sensitive to commodity prices, and it looks like your -- the growth spread was actually positive because your input costs fell more than the negative effects of pricing. I guess the question is where are you in that process? How much further do you have to go? Should we expect to see significantly less sensitivity to commodity prices in this Company going forward?

You know, it's something, Jeff, and I appreciate you pointing it out. It's something we've worked hard on. There is a couple phenomenons that hit us in first quarter. You pointed out that our spread has improved. Our margin structure on the top end improved. Our recovery of collection costs improved as we charged more for our services out there and tried to recover the energy piece. Really, when you net it out, the two things that hit us in first quarter were the legal expenses and the Fresno additional trucking.

Now, from a risk management standpoint, the other piece that is not on formula to as great a degree as maybe we would like it is the restaurant services segment. That piece is a lower percentage of our overall piece. It's one where we've -- we don't have -- well, we have very little on formula. We saw the prices in first quarter from quarter over quarter decline about 12%. So, as we bring some of the larger chains like the supermarket chain on and some of those others with our national accounts program, we are trying to move more and more of that to some type of formula to give us some reduced volatility there.

Secondly, what would the CapEx -- what is the CapEx budget for '06 for the Darling stand-alone business?

Jeff, this is John. We would expect -- if you remember in '05, we did have two large projects for CapEx in both Fresno and Wahoo get pushed back -- our CapEx dollars up to around 21 million. We would expect this year to be back in the realm of the 10 to 12 range that we've had in prior years without those major projects unless we do identify another plant to look at modernization for.

George Grose, Joseph Gunnar.

Could you talk about the -- like what would have been like the pro forma numbers for Q1 if you had included the National By-Products?

George, we will be putting pro forma numbers out after in an 8-K for their results for the first quarter as we go forward. Until that is done, I really would prefer not to discuss that at this time. But, that will be going out in an 8-K after the transaction is closed. So, everyone will be able to see those pro forma numbers.

Then, I guess next question -- now that you've had more time to study the National By-Products -- I know initially, you talked about synergies of 1 to 3 million. Could you -- would you care to venture out and give us a number of what you think now that you can get after having further reviewed the Company?

George, I'm not going to step out and speculate on that. But, I will comment that we've had adequate -- and I don't know if the word is ample -- but a great amount of time studying, working with the parties now and confirming the assumptions. We're very comfortable with what we're getting and how it's going to go together.

Okay. I guess my other question here is -- now that you are going to be like a larger entity, I mean can you talk a little bit about price increases on the restaurant services side of the business, both grease trap and oil collection?

George, that's not even remotely on our radar screen. I mean, the business we are acquiring and merging with -- with National By-Products -- is largely a rendering business, based and platformed in the Midwest. We have very limited overlap with that Company in every place other than a little bit in Omaha, where our business models are significantly different. The restaurant services side for that business, they have a strong presence in the Denver market. And the rest of the locations are somewhat regional to smaller metropolitan areas. We believe that we can work to grow those businesses in Wichita; Indianapolis; Clinton, Iowa; Des Moines, Iowa. We also believe between -- with our experience operating in the grease trap business that we will have a chance -- I believe they operate in Wichita and Des Moines today in the grease trap business -- to continue to leverage our platform there and expand that business.

I guess my last question here before I get back into the queue -- in terms of -- I know you did a pretty nice job on the improved recovery of collection expenses. How much of that was tied to I guess price increases that you've -- or the fuel surcharge?

You know, I mean, it's a combination of three or four things. One, it's new customers coming in. Two, it's price increases that we put on annually in our grease trap maintenance business. Three, it's fuel surcharges for diesel, for our grease collection business. And then, four, it's natural gas surcharges that we've put onto our rendering formula customers.

So, I guess that the customers are -- they are not really complaining then. You are able to pass that on along then (multiple speakers)?

Well, I would not say we are not complaining. But I think the point in time here is it's the new world that we all live in now. Run that to a degree, our ability to manage our collection routes now and with $3 diesel fuel has been nevermore challenging for us.

Okay and I guess the last here -- like on the supermarket win there, like the large contract, when could we expect to see some -- or that program to start to kick in there?

It's a nation-wide agreement. It's already underway, being integrated. I think completion or a substantial portion of the rollout is to be completed in May here. So we will probably have some benefit here in second, but I think you'll see it in third.

Okay, and in terms of size, how -- what kind of contract is that in terms of magnitude to your revenues?

I don't want to say about that yet. We're kind of coming out here, even telling you that we landed it, but it doesn't seem like it's a great secret out there.

[Mike Henney], Benchmark Capital.

I just want to get an idea on natural gas prices just to you. Are you guys significantly hedged out in 2Q? Or are we going to see some reduction in the price you've seen in the commodity market?

The two pieces of energy that we use obviously are natural gas and diesel fuel. Implicit underneath this business is a natural hedge for natural gas. What I mean by that is, I want to say today, around 20 to 21 of our facilities can burn yellow grease or alternative fuels versus natural gas. So, essentially, we do a monthly calculation, a quarterly calculation -- whatever our view is on the market -- and say we're either going to burn yellow grease or we're going to burn natural gas. What we found ourselves doing here in the last 45 days is having some pretty favorable ownership in natural gas. When natural gas runs up, we have arbitraged backwards to yellow grease as those prices came down. So, you know, for third quarter, fourth quarter with natural gas, we are at that. And grease prices where they are at, we are -- to a degree, you can say we're hedged their.

So, net-net, like diesel prices have gone up pretty much since the first quarter into 2Q. Gas prices have come down and whatever that hedge is you have with the grease, the fuel price probably in general going up for you guys. Is that a fair statement?

Yes. I guess a second data point to help you to connect the dots here is, I think the number is -- around 90% of our customers have a collection charge on them today. And, in that, we have put an indexed energy surcharge. That is the good news. The bad news is that it's a 30 day lag on some customers and a quarterly lag on others. So, as diesel fuel has escalated, where we could have ownership -- meaning we have got large tanks and have taken positions there -- that's one thing. Where we're just passing it through to our customers, we are experiencing a little bit of a lag there.

Chris Reynolds, Neuberger Berman.

A very general question about your restaurant services business. Can you articulate a strategy there in terms of growth and sales reps and how you would expect to grow this business from a revenue standpoint over the next few years?

Chris, this is Randy Stuewe. You know, the two segments that the Darling operates in today are the rendering and the restaurant services segment. The restaurant services segment is made up of three components -- one being the grease collection, two being the grease trap maintenance and the third piece being the equipment sales piece. Traditionally, what we've done is competed on the street day in/day out for used cooking oil accounts in the grease collection business.

The grease trap business has been one that we have been launching new facilities, adding additional trucking equipment and personnel and sales reps to sell. We've experienced double-digit growth for the last three to four years in that business. We believe that the environmental regulations relative to public waste management systems is only going to increase in making us or a reputable supplier that's like ourselves more valuable to the customer. The third piece of the strategy can be summarized with the word bundling. About 1.5 years ago, we hired a seasoned sales executive and brought him on to Darling in order to help us assimilate the offering to the customers. You know, where we might have been calling on the small one restaurant, two restaurant operator up and down Main Street or Broadway, we said really, the value offering that Darling brings to the marketplace is its ability to leverage its 40 locations across the United States and to package that into the larger customers.

Where we kind of have a general rule, where we are greater than 50% of a chain's needs, we will go to them and say, Darling can service over half of your needs and we can also outsource or manage the non-Darling locations. That's where we launched the national service center here approximately about a year ago. The national service center now I believe is going to handle after starting up after -- the supermarket chain will have over 5,000 or 6,000 customer locations managing 80,000 plus services. So, the platform we continue to offer is the cooking oil, the grease trap and the national service bundling. We added quite a bit of expense over the last couple of years getting this in position to bring to market. I think we are starting to feel pretty good now that we've strategically made the right move.

Michael Christodolou, Inwood Capital.

I have a high-level protein substitution question. Would the proliferation of ethanol plants generating more DDG as a co-product, what might the impact be on meat and bone meal and soybean meal?

Well, there's clearly -- I won't profess to be an expert in that. I did grow up a little bit in the ethanol business here during the lower operating years. DDG has predominantly been an export product for many, many years. As these ethanol plants continue to be built, some with drying capacity, meaning they can turn it into dryers or some that aren't spending money on drying, more and more of those DDGs are coming to market. Now, if they are not dried, meaning they are wet, obviously, transportation becomes prohibitive other than servicing the animals within a local region. That product can only be used in limited applications for -- mainly for I believe cattle feed. It doesn't work well because of the fiber in poultry and swine feeds.

So, I think clearly, we are all going to be competing more and more for a share of the protein diet going forward. I think there's additional arguments where the DDGs are taking fat out or they are defatted DDGs that will actually require more corn and more fat to substitute them in rations. So, I guess the way I would leave it with you is that it's an evolving share of the stomach here for the ruminant animal here, which we don't compete at all for the ruminant animal, at least with our meat and bone meal.

Thank you. There appears to be no further questions. At this time, I would like to turn the floor back over to Mr. Stuewe for any further or closing remarks.

Okay, I would like to thank everybody for coming and listening today. As we get the transaction closed here, we will be putting out some additional press releases as that happens. Hopefully, we look forward to talking to you at the end of second quarter and bringing you news of the integration and the progress we're making on putting National and Darling together. Thanks for joining us today.

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