Darling Ingredients Inc (DAR) 2007 Q1 法說會逐字稿

Good morning everyone, and welcome to the Darling International Conference Call to discuss the company's fiscal first quarter 2007 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)

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

Thank you, Henry. Good morning, ladies and gentlemen. Thank you for joining us to review Darling's first quarter 2007 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, 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, intend, anticipate, should, estimate, continue and other words referring to events to occur 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 risk 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 now like to turn the call over to Randy.

Thanks, Brad. Good morning everyone, and thanks for joining us. As noted in our press release yesterday, Darling's improved first quarter performance was a continuation of our strong performance in fourth quarter with some notable improvements.

There were several factors contributing to our strong operating performance during the quarter. First, the improved commodity prices for our finished products continued through the quarter.

While there was some price movement and improvement for tallow towards the end of the quarter, for the most part, prices remained flat from December.

Grease and fat prices continue to reflect the strong demand for feedstock globally for the production of biofuels.

Protein prices continued steady throughout most of the quarter, and we saw a significant improvement on the west coast as a result of the resumption of exports to Indonesia.

Second, extreme winter conditions in the Midwest increased our volume of deadstock. Heavy snows in western Kansas, eastern Colorado coupled with late-season snows in Iowa and Nebraska provided us some significant extra tonnage.

Additionally, as noted in our fourth quarter call, we continued to see heavy volumes of swine mortalities in the Midwest as a result of circovirus.

Third, we continued to benefit from the successful integration of national by-products and achievement of the resulting synergies.

Finally, as previously released, we received and were able to book a $2.2 million gain on the sale of a judgment for the damages related to the actions of a steam provider at our Newark, New Jersey plant.

It should be noted, however, that net of tax and litigation costs, the impact of -- on our net earnings was approximately $0.01 per share.

Overall, our first quarter earnings reflect improved raw material volumes, strong commodity prices and solid execution by our management team.

Additionally, there is another income source that is currently not reflected in our earnings at this time.

As we described last quarter, on October 1, 2006, the IRS approved the alternative fuel mixture tax credit. This credit is set to expire in September of 2009.

The credit is a tax rebate of $0.50 per gallon, or roughly $0.068 a pound for each gallon consumed in our boilers or trucks. This credit is available only when we choose to burn grease in the place of natural gas and the economics are favorable to do this.

With yellow grease prices currently averaging around $0.19 and natural gas in approximately the $8.00 range at most plants, it was pretty much a push during the first quarter with the exception of a couple of plants.

As of March 31, we have applied for over $1.1 million in credits and have received in excess of $500,000 to date.

Again, I must remind you that the IRS issues -- until the IRS issues specific guidance, we will reserve all our credits on the balance sheet and will not be recognizing it as income until proper guidance is published.

We are aware and want to communicate that both the Senate and House have articulated the technical corrections necessary for the IRS to issue guidance, and we are now awaiting final vote.

Hopefully, this will happen soon, however, we cannot predict the outcome or timeframe of a congressional vote.

While we are on the subject of biofuels, let me update you on our progress towards determining our future strategy in the area of renewable fuels.

As we commented last quarter, we are evaluating biodiesel production, synthetic fuel production or more recently redefined as renewable diesel and finally green electric generation.

We are continuing to define the scope of our participation with respect to these options and believe we have been making substantial progress on a number of fronts.

First, with respect to biodiesel production, we have completed the evaluation of potential technologies available to process our animal-based feedstock and have narrowed down the providers who possess the capability to process our feedstock.

Second, we are completing our diligence with our next steps focused on potential partners, site selection, and financing alternatives. We will update you as quickly as we can when we make our decisions.

On the electric generation front, as we see it, interest in green electricity is clearly growing in the U.S. There are increasing mandates for 20% of our electricity to come from green or renewable sources by 2020.

This can include wind, solar and stationary, fixed-power generation fueled by yellow grease.

While this opportunity may be limited to our coastal locations, the growing populations and resulting increases in electric demand, the mandates for green and the attractive governmental supports make this a highly attractive value addition for our yellow grease production.

The subsidy structure of only allowing yellow grease to receive $0.50 in gallon in biodiesel potentially makes this a superior alternative to classical biodiesel production with less capital, more attractive financing and ultimately, better returns.

With respect to renewable diesel, the IRS recently expanded their definitions to include petroleum-related processes known as hydrotreating to be used as a method to produce green or renewable diesel and receive the equivalent subsidy that has been available to the producers of biodiesel.

As you may recall and as recently seen, Conoco Phillips and Tyson quickly reacted and announced a strategic alliance to produce next-generation, renewable diesel fuel.

This is a significant breakthrough on the renewable energy front and one that we intend to fully understand before making our investment decisions.

Ultimately, Darling could find itself with a similar relationship with a petroleum refiner, allowing us to benefit from our significant feedstock position. This is an opportunity we are pursuing parallel with our other and already discussed alternatives.

With that, I'd like to turn the call over to John so he can provide some additional color on our financial results for the quarter.

After John concludes, I'd like to provide some closing remarks. And then, we'll open it up to questions and answers. John?

Thanks Randy, and good morning to everyone.

For the first quarter of 2007, Darling's net sales were $138.6 million as compared to $76.4 million for the first quarter of 2006.

The majority of the $62 million increase in sales is attributable to our May 15, 2006, acquisition of National By-Products.

Net income for the first quarter of 2007 increased to $9.6 million or $0.12 a share as compared to $400,000 or a penny a share for the comparable period of 2006.

As Randy mentioned, the $9.2 million increase in net income for the first quarter resulted primarily from improved prices for unfinished products, increased raw material volume, the integration of National By-Products and achievement of resulting synergies, and a $2.2 million gain on judgment for damages related to actions with a service provider.

Interest expense in the first quarter was $1.6 million compared to $1.5 million during the first quarter of 2006, an increase of $100,000, primarily due to the overall increase in debt outstanding as a result of the National acquisition.

Operating income increased to $17 million in the first quarter of 2007, a $15.1 million increase compared to the first quarter of 2006.

The principal factors contributing to the increase were the inclusion of the operations of National By-Products, higher finished product prices, and improved raw material volumes.

These increases were partially offset by a continuation of historical high energy prices for both natural gas and diesel fuel and higher raw material costs in the first quarter of 2007.

At that segment level, rendering generated net sales of $101.7 million for the first quarter as compared to $45.5 million in the first quarter of 2006. This reflects increased volume resulting from the National acquisition.

Restaurant services generated net sales of $36.9 million as compared to $30.9 million in the first quarter of 2006.

Additionally, Darling made capital expenditures of $2.4 million during the first three months of 2007 as compared to capital expenditures of $2.5 million in the first three months of 2006.

Capital expenditures related to compliance with environmental regulations were $400,000 during the three months ended 2007 compared to $100,000 for the three months ended April 1, 2006.

On March 31, Darling had working capital of $20.3 million or a working capital ratio of 1.34 to 1, compared to working capital of $17.9 million and a working capital ration of 1.31 to 1 on -- at December 31, 2006.

As of March 31, Darling had unrestricted cash of $5.3 million and funds available under the revolving credit facility of $82.1 million compared to unrestricted cash of $5.3 million and funds available of $71 million at December 31, '06.

Before I turn the call back to Randy, I'm pleased to say that during the first quarter, the company reduced its long-term debt by $11.75 million. I'd now like to turn the call back to Randy.

Thanks, John. Before we open for questions, I'd like to close with a few comments.

First quarter was significant milestone in performance in Darling's 125-year history. Our record performance was a result of solid execution by all of our employees.

We are continuing to reduce debt, and we most note that since the closing of the acquisition, we have reduced debt by over $30 million.

Our balance sheet is strong, and we are now in a better position to grow and invest in new businesses.

The momentum we began to see at the end of last year and now during the first quarter, appears to be continuing as we move forward into the second quarter. Global commodity markets continue to reflect tightness. Our core business remains strong, and Darling is poised to benefit.

That concludes our prepared remarks, and we'd like to now open it up to questions. John and I are happy to take questions now, Henry.

Thank you. (OPERATOR INSTRUCTIONS) Thank you. Your first question is coming from Brian Shore of Avondale Partners. Please go ahead.

Good morning guys, congratulations on a good quarter.

Thanks, Brian.

Once quick question, we noticed that year-over-year within SG&A, the corporate payroll seemed to increase more than in recent quarters. Is this due to some additional Sarbanes-Oxley type needs or something with the MPB acquisition?

Well Brian, the cost increases was -- is related to moving in the National SG&A costs into the company.

And we did have some continuing litigation cost during the first quarter. But, it's basically in line with what we had expected it to be in the -- with the acquisition of National.

Okay, great. And we noticed -- we've noticed so far that cattle kills in the second quarter seem to be down a little bit year-over-year. Are you guys concerned, especially with the good raw material volumes in the first quarter going into Q2, about volumes at all?

You know, this is Randy. I think the -- we saw in first quarter that the weekly cattle kills were up over '06 and '05, and we're a little bit still down from the pre-mad cow aside.

The -- coming into second quarter, the margins are still somewhat constricted out there for the slaughterhouses. They're -- they improve and are pretty volatile day to day.

Typically, you would see cattle volumes, year-over-year for the last five years, increase pretty substantially over first quarter during second. It looks like we're off to a little slow start.

Relative to our first quarter here, we did have some pretty extreme weather conditions that caused some pretty substantial mortalities throughout the Midwest on all fronts.

And so, with the weather moderating here in April, I think it's -- the mortalities were down a little bit. But, I think it's kind of too early yet to say, Brian, whether cattle kills will pick up for second quarter, as they traditionally do.

Okay, great. And then, just one more question, you mentioned that Tyson/Conoco Phillips arrangement.

What are -- I guess in particular, what are your guys thoughts on that? And what from that are you looking at as you analyze whether the renewable diesel or the other alternatives would be good for Darling?

Well, for Darling as -- we continue to believe that we've got a unique position in being one of the top five feedstock suppliers or providers in the country due to our scale and size of the different fats and greases.

The alternatives for Darling is as we kind of put them on the table with you here is we kind we of believe that we're positioned very nicely to participate in whichever one of these alternatives ends up being that lower risk and a better return, less capital.

And if the petroleum refiners want to come in as Conoco did and essentially buy animal fats to slide into their refineries into their hydrotreaters, it could be a significant opportunity for Darling to participate in biodiesel without having to take the risk of additional capital investment and timing as far as plant start-ups.

So, we look at it very positively. But, I'll also caution you to say that it's one that we haven't fully vented through and understand yet as to whether or not the petroleum guys can take Darling's kind of feedstock and whether it is ultimately the pure opportunity that Conoco and Tyson announced.

So, I think as I would ask and defer here is, give us a little time to vent through that. We look at it positively, but one way or another, it just goes into the investment opportunity mix that the company now faces.

Sure, and that's definitely understood. Thanks again guys, a great quarter.

Thank you. Your next question is coming from Tyson Bauer of Wealth Monitors. Please go ahead.

Great quarter gentlemen, on target and looks like a good Q2 starting out with pricing.

Randy, we're seeing cattle prices now approaching $0.27, $0.28, almost double a year-ago levels.

Is there a balance point that you've been able to work out as to where we start losing some interest from, say, some of the tire manufacturers, some of the [south] guys?

What is that balance point to, that influx of new demand for biofuels with your standard customers?

Yes, I think it's a great question, Tys. What we're seeing today is first of all, you've got to look and say, "What are the competing ingredients or alternatives that each one of those sectors can use."

And if you are following palm oil at all, I think Malaysian palm oil is now broken the $700 a metric ton mark here in the nearby on reduced production from the trees.

They've had record production the last couple of years, and there were seasonally strained by the weather conditions last year. And they're seeing lower output now. So all of a sudden, palm oil on an FOB Malaysia stand points in that $0.32, $0.33 range.

Soybean oil is in that $0.32, $0.33 range, and so animal fats, one could argue that are substitutable in the soap and chemical business, are now reacting to the price movement of the competing ingredients of palm oil.

On the feed side, I think you're beginning to look at the feeding economics. And the greases and fats have been fairly priced with where corn is and otherwise, and we're starting to see corn back off a little bit with the speculation of a significantly large crop here and pretty decent growing conditions.

So overall, we've not seen prices at all continue to back off. We're seeing lots of movement between the different feed and chemical sector.

The chemical sector's been trying to load up on volume as -- when you find yourself into bull markets like we've experienced here over the last six to nine months, you find people with -- shortening up their pipelines and supply.

And so, the chemical guys have now recently been coming in to buy additional animal fats in order to fill up their needs for this summer. So overall, business remains strong in those -- in both of those sectors.

Would you anticipate a fairly firm trading range then as we go through the summer off the current levels?

You know, it's hard to say. If palm oil stays in the 30s and soybean stays in the 30s and animal fats in the high 20s, those -- doesn't -- it's not overpriced or underpriced. It's historically and statistically pretty much in the money there.

The restaurant side of the business, are -- is there any risk of that stagnating on the volume side as you get a lot more of these smaller entities getting in and trying to capture some of those volumes from the restaurants?

Our restaurant business experiences the same -- it's a pretty predictable seasonality.

And it starts around when the baseball parks open and people eat out a little more in the spring and summer after dieting all winter. And we're seeing the same seasonal surge that we've seen historically there.

When grease prices move up to these levels, which are nearer their historical highs, you're going to see more competition on the street for people trying to compete for that grease. What most of them ultimately find out is that there's two phases to that business.

There's the collection and the processing piece, and they -- while they may enjoy the collection piece, they're not sure what to do with it once they get it.

So overall, our grease business has continued to grow, both volume and customer quantity. And it's right on track.

And the last question, and I'll get back in queue is, I'd say it's fair to say that you're fairly risk adverse here at the company as a aggregate term for the management there.

Does that lend itself to the propensity of more looking at an equity deal versus debt?

And then, the follow-up on that, is working with a petro company basically -- is that mutually exclusive from building your own facility? Or, would you like a partner in this endeavor to lower that risk profile?

And at the risk of being a market tease, when do you think a decision timeline at this point is reasonable where the company has been looking at this now for a year and a half that the market should expect, "Okay. They are setting some firm times to make decisions."

Well, I think first of all, I wouldn't -- I'm not sure if your risk adverse is a compliment or an insult to me, Tyson. But, that's okay.

(inaudible)

Yes. We -- as we do and historically have operated from a very conservative perspective, our balance sheet strength is something that we've worked hard on over the last year now.

And the balance sheet with the debt coming down and the pace of earnings that we have puts us in a different position than when we were -- where we were at a year ago.

While we do admit we've been studying this for a while, there's a lot to learn here and a lot to get up the curve. The most important thing to us was to make sure that we properly integrated and got the two companies put together.

And I feel good that that's happened, and the management teams are on board and focused.

As to where we go from here, I don't think that there's any mutual exclusivity on any one of the three strategies that we've talked about here.

And there's some mix and match that could or possibly happen here. As to whether it's equity or debt, the credit markets will ultimately turn that out.

What we know, as we've said before is that, we've got the pot of gold in the sense of the bucket of feedstock here. And we're trying to find the best value addition methodology that we can find.

As for timing, every day's a new day here in the sense that the phone rings with another person interested in something.

We're trying to ferret through those and understand the Conoco implication. And hopefully, when we get together by the next call, we can continue to articulate more and more progress in that area.

Thank you, gentlemen.

Thank you. Your next question is coming from Dean Haskell of Morgan Joseph. Please go ahead.

Hi. This is [Julie], actually, in for Dean. Can you hear me?

Yes.

Hello. Okay. Just a couple of follow-up questions, firstly just to follow-up on a previously asked question, would you say your outlook on commodity pricing for the remainder of 2007 remains pretty high?

And do you think these prices will be sustainable?

Well, the only thing that you can ever reference, Julie, against the business here is the Chicago Board of Trade.

And what's interesting, the commodity cycle that we're enjoying right now is that traditionally, commodity cycles in the rendering side of the business have been brought on by some type of supply issue, meaning either the weather was bad in that U.S. or the weather was bad in South America or the demand across the world was greater than anticipated.

So, what's interesting going on this year is if you reference the Chicago Board of Trade as your base point for both corn or soybean, soybean meal, soybean oil, the market's in a strong carrying charge market versus in inverted markets that we've typically seen when we've gone through these cycles.

So, without answering your question, it looks like, at least as the Board of Trade's predicting today, prices are steady to higher in the future right now, given the inputs that the market reads today with normalized weather and in anticipation that the global demand will continue for both ethanol and biofuels.

Okay, great. And then, can you provide a little more color on the fuel tax credit status and when you might actually recognize that income?

Well, the -- and I'll take a stab at it. We are awaiting the clarification from Washington that makes the language correct and that the IRS can issue proper guidance at which time, the accounting firm, KPMG, which takes care of Darling here, says that it can be brought into income.

And aside from any guidance that would ever be issued at -- ultimately, the -- what is the audit cycle, John?

Three years.

Three-year audit cycle would have to be achieved. That would be the ultimate extreme, but our read from Washington is, is that the technical correction has been articulated in both the House and the Senate, that it is now awaiting to be attached to some other bill or some bill that has to be run through.

And it has to be voted on, and once it's voted on, then the IRS will pick it up as guidance and issue it.

Now, whether that happens an hour after this call or before the end of the year, your guess is as good as mine.

Okay.

Congress seems to be focused on other things than this right now.

Do you suspect that it will occur before the end of 2007? Or, is this kind of further out?

Hard to say, Julie.

Okay, okay. And then lastly, just quickly, CapEx guidelines for the second quarter and the full year?

CapEx during the first quarter was our traditionally low CapEx period, mainly because through the Midwest, the weather conditions and so forth, it's very difficult for us to be working outside or be doing work on the plants.

Looking at the rest of the year, during our last call, we indicated that the CapEx that we ran during the fourth quarter was probably more representative of our annual rate, which was more in the 12 to 13 range for an annualized CapEx.

But, that's about all the guidance we can give on that.

Okay, great. Thank you, that's it.

Thank you. Your next question is coming from Jeff Feinberg of JLF Asset Management. Please go ahead.

Thank you very much. Most of the questions have been answered, nice job gentlemen.

The one follow-up I did have is just so we can have some perspective around this alternative energy opportunity, whether it be biodiesel, synthetic, or green electric generation, if -- just to make sure I'm thinking about the perspectives correctly.

If I'm not mistaken, you guys have around 1.5 billion pounds of fat and grease a year. Is that correct?

Well, we don't publish that number. But, it's not a bad guess.

Okay. And some of the metrics that came out of the Conoco thing that I had read was that it takes around 7.5 pounds to make a gallon of biodiesel.

So, depending on what the profit of that is, I'd seen various estimates in the industry, $0.50, $0.75, the like.

It seems like this could be an opportunity that has the potential to be $100 million plus of EBITDA, again depending on how those are shared and financed and the like. But, just in terms of scale of the opportunity, are we thinking about the opportunity correctly?

Yes. Jeff, that's the kind of the Excel spreadsheet hysteria that's here is that if you run the tonnage that we have, although not all of it is tributary to exactly going to those needs, but that's the equation that we're looking at here is saying that the -- that animal fats are still the cheapest feedstock for the production of biodiesel.

And compared to soybean oil today, they're anywhere from a $0.40 to a $0.50 a gallon cheaper feedstock to make the product.

Yellow grease, on the other hand, as we've talked about is that we think yellow grease, since it only has a $0.50 subsidy can actually work as well, if not better, with a -- with both a better capital structure and a risk management profile into electric generation.

Okay, thank you very much.

Thank you. Your next question is coming from [David McGruder] of [Longarden Management]. Please go ahead.

Hey guys, great quarter, thank you. Actually, a lot of my questions have been answered. But, there's a few that if you guys could help me out with?

Is -- there's three options you guys are looking at. Is one other option kind of doing nothing and selling into a spot market or maybe retaining that maybe 50%, creating a partnership or doing with a commodity?

Yes. I think when we said there's three options, I would call it there's three sectors that we're evaluating.

What we want to make sure, we've been approached by no less than probably 100 companies, it may be greater than that by now, that all want us to give them our feedstock.

Yes.

And what we're committed to doing is trying to find the best avenue for participating in the renewable fuels sector and getting the greatest return for that feedstock with the lowest risk profile attached to it.

And while that may be doing nothing, it could take the form of selling the product to somebody else and just swapping that for either an equity participation or some type of profitability -- profit-sharing premium to putting greenfield capital into the ground, whether it would be our -- standalone or with a partner.

That's all up in the air today and something that, as we said, we'll continue to try to update you on.

Okay. And Tyson said that in the fourth quarter, they would start pulling a supply out of the commodity market and Phillips would be -- Conoco Phillips would start producing biofuel.

Do you think the market has currently reacted to that news? Or, do you see that happening later this year when they actually start pulling supply?

Yes. I haven't seen the -- much reaction to it yet. And until the physical supplies move off the market, I -- tallow and -- is still pretty -- a short-term oriented market. It trades predominantly in a 30-day up to possibly a 90-day period.

My understanding is that sometime late summer, early fall, the Conoco arrangement will begin.

And then, I think you'll see a -- you'll see a significant portion of animal fats that were either going to U.S. customers or being exported move off the market. And that probably should bode well if all other of the inputs hold.

Okay, thank you.

Thank you. Your next question is coming from James Dickinson of Rice Hall James. Please go ahead.

Good morning. The comment about being risk adverse, I'd take as a compliment, especially if it's combined with a pro-profit philosophy.

But, your last answer on what you're doing in biodiesel sounds very good to us. You're taking your time. You're doing things right. I know the market is frothing for you to make a decision.

But, you're in this for the long term, and I'd counsel you to take your time. On a question, your recent acquisition, is it now fully integrated?

Yes. I -- we are fully integrated at the operating level. Administratively, we still are putting the companies together.

From day one, we cut checks, did payroll, did all of the -- closed the books, all the administrative functions -- we're now trying to put both companies on a common information system and become SarbOx compliant here by the end of the year.

So, that's kind of our last mode, no real significant capital involved in doing that, just people time to get it done right here.

Operationally, as we reported last quarter, it's all put together. And it's performing as expected, if not at a little better.

Super, is there anything new on the acquisition front? I know all these things seem to be family owned, but is there anything cooking?

Nothing cooking, the balance sheet's in better shape than it's been. So, we'll see when an opportunity comes by again.

Excellent, thank you very much.

You bet.

Thank you. There are no further questions at this time. This does conclude today's conference call. You may now disconnect your lines at time, and have a wonderful day.

See you everyone.