Darling Ingredients Inc (DAR) 2015 Q2 法說會逐字稿

Good morning everyone, and welcome to the Darling Ingredients, Inc. conference call to discuss the Company's second-quarter FY15 financial results. With us today are Mr. Randall Stuewe, Chairman and Chief Executive Officer of Darling Ingredients, and Mr. John Muse, Executive Vice President and Chief Financial Officer.

(Operator Instructions)

This call is being recorded, and your participation implies consent to our recording this call. If you do not you agree to these terms, simply drop off the line. I would now like to turn the call over to Melissa Gaither, Director of Investor Relations for Darling Ingredients. Please go ahead.

Thank you, Emily. Good morning, and thank you for joining us to review Darling's earnings results for the second quarter 2015, ended July 4, 2015. To augment management's formal presentation, please refer to the presentation section of our IR website for the second-quarter earnings slide deck.

Randall Stuewe, our Chairman and CEO, will begin today's call with an overview of our second-quarter financial performance and discuss some of the trends that impacted the quarter. John Muse, Executive Vice President and Chief Financial Officer, will then provide you with additional details about our financial results. Please see the full disclosure of our non-US GAAP measures in both our earnings release and the end of the earnings slide presentation. Finally, 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 your questions.

Now, for the Safe Harbor statement. This conference call will contain forward-looking statements regarding Darling Ingredients' business opportunities and anticipated results of operations. Please bear in mind that forward-looking information is subject to many risks and uncertainties, and actual results may differ materially from what is projected. Many of these risks and uncertainties are described in Darling's annual report on Form 10-K for the year ending January 3, 2015, our recent press release announced yesterday, and our other filings with the SEC. Forward-looking statements on this conference call are based on our current expectations and beliefs, and we do not undertake any duty to update any of the forward-looking statements made in this conference call or otherwise.

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

Thanks, Melissa. Good morning everyone. Thanks for joining us.

First, as Melissa noted, we continue to strive for greater transparency in reporting our quarterly results, and our earnings slide deck is out on our website. This quarter, we provided a breakdown of facts isolating used cooking oil to help you better track our progress being delivered in our legacy USA restaurant services businesses.

For the quarter, earnings improved sequentially on an adjusted basis to $105.5 million, a 7.4% increase from the $98.2 million reported in the first quarter. Pro forma adjusted earnings increased to $107.7 million sequentially, when you take into account the FX changes versus the first quarter, in addition to the acquisition and integration-related expenses that are now simply limited to the transition services agreement in Canada, and SOX implementation consultants, mainly within our international group. Most importantly, for the third quarter in a row, we showed EBITDA margin improvements in all three segments, which is now a testament to our business model adjusting to the deflationary cycle within the agriculture sector.

So let's take a closer look at our operating performance. Starting with our feed ingredients segment, which is comprised of our global rendering business, our USA restaurant services business, along with our USA bakery feeds business and our global blood processing business. Once again, we face declining finished product prices, as the world wrestles with significantly larger grain and oil seed supplies. As we have discussed before, this is a spread management business. EBITDA modestly improved in light of a significantly lower finished product prices. Most notably, we saw a 50 basis point improvement in our margins as we made procurement adjustments globally.

USA rendering turned in a steady performance, making the necessary adjustments to our pricing formulas, to offset the lower selling prices of our finished product. This was accomplished even with seasonally lower volumes. Canada rendering came in slightly lower to Q1 2015. This was largely a result of finished product prices moving sharply lower in June, and our raw material prices being locked for the calendar quarter. Margin adjustments have been made, and we expect to see improvement in the third quarter.

Europe rendering delivered an improved performance versus Q1. Volumes remained strong, and prices for many of our finished products remained steady during the quarter.

Our global blood business showed strong growth, both sequentially and year-over-year. This is a highly seasonal business operated on four continents, and should show additional improvement in Q3.

Our bakery feeds business showed improved operational performance versus Q1. Volumes were strong, and we have been able to widen margins in several geographies as we renew raw material agreements. We eagerly await the startup of our new Bryan, Texas facility this fall, that will finally take pressure off our system and improve earnings. We expect improved results in Q3, due to many of the adjustments that have been initiated in the second quarter.

Our specialty protein areas, made up of wet pet food and the pet food blending business, continues to deliver solid results. Our new plants in Paducah, Kentucky and Ravenna, Nebraska are on target to be completed in the fourth quarter. Nature Safe, our organic fertilizer business, is contributing nicely and starting to become more relevant. Terra Renewal Services also delivered its best performance in the year, and appears to be back on track.

Lastly, in the feed segment, our restaurant services business delivered improved results over the first quarter, in both volume and margin. As we noted in the prior quarter, this business delivers very nice returns to our shareholders, but is also one that has the most commodity exposure. We have made significant changes to our model by lowering raw material procurement costs, lower headcounts, and in some cases, reinstating charges. We have more work to do, but I am pleased to say we are on track to deliver the $10 million of annual improvements we promised.

Now, let's turn to the food ingredient segments. The food ingredient segment delivered an exceptional second quarter, anchored by solid momentum from Rousselot, a global leader in gelatin and functional proteins. Rousselot is a four-continent operating unit, and produces a variety of products for the pharmaceutical, food, and industrial sectors. For the quarter, EBITDA improved 15% sequentially, and EBITDA margins improved by 100 basis points. The performance was led in Rousselot by China. Margins in South America have normalized, and in Europe, is enjoying the benefits of a lower euro and their ability to export. The USA continues to prepare our Dubuque, Iowa gelatin factory for expansion, and the inclusion of our new major global food customer.

In Europe, we also operate one of the largest edible animal fats business. Sonac, as we refer to it, benefited from the increased quantities of raw material, due to the border closure with Russia. While volumes grew, selling prices declined, as the product competes with food grade palm oil. Selling price is steady during the quarter, and we were able to make the adjustments to return margins to more historical levels.

CTH, our casings and edible offal business, faced challenges this quarter. While a very small contributor to the food segment, it operated in the red due to a Chinese embargo of our specialty finished products. Adjustments have been made, and we expect to see some improvements in the third quarter.

And finally, our fuel ingredients segment was slightly down for the quarter. EBITDA was slightly lower, but adjustments in other units allowed us to improve EBITDA margins. Canadian bio-diesel operated at a $1.6 million EBITDA loss. However, we expect this to be more than offset by the reinstatement of the blenders tax credit. Netted, we would have enjoyed a positive performance. Most notably, this unit is critical to balancing the supply and demand of fats and oils in Canada, as trade barriers still exist for moving products across the US border.

Rendac, our European disposal rendering business, delivered as usual, and volumes were stronger for the quarter. Ecoson, our European bio-energy business also continued to be a reliable contributor to the fuel segment. Overall, excluding the Canadian bio-diesel shortfall, fuel segment earnings improved sequentially, and margins expanded.

Now, let's turn to Diamond Green Diesel. Diamond Green Diesel continued a strong track record over the last three quarters and executed well, producing more than 41 million gallons of renewable diesel in the second quarter. This unit continues to provide the counter-cyclical hedge to our USA rendering, restaurant service, and bakery feeds businesses. Margins were volatile in the quarter, with RINs, feed stock and ULSD all bouncing around.

For the quarter, the entity turned in $15.8 million of EBITDA. This was slightly lower than the $18 million to $20 million we predicted in Q1, and was largely a result of the June volatility in RINs and heating oil, and the net hedge positions we had on versus our supply chain. We are optimistic that $1 a gallon Blenders Tax Credit will be adopted retroactively in 2015, and taking this into account, the second quarter EBITDA for Darling's share of Diamond Green Diesel would have been approximately $30.2 million. This is reflective of the 44.5 million gallons of renewable diesel we shipped in Q2. We expect the tax credit to deliver between $80 million and $85 million of additional earnings, when it is reinstated later this year.

Overall, we are encouraged with our second-quarter performance, but we take seriously the need to continue to aggressively execute operational and financial improvements to enhance our profitability. Let me outline several areas of focus. First, we continue to focus on returning EBITDA margins to more historical levels. This should be obvious, given the three quarters of continuous improvement across all segments. As noted, this has been while commodities and related prices have all declined.

Intertwined in these segments, we continue to focus on the restaurant services segment, where quarter-over-quarter improvements were executed, and delivered in excess of $3 million. We still believe that the $10 million of improvements we promised are feasible by year-end. Terra Renewal services had its best quarter. We have finally opened a closed market in the Carolinas, and we feel optimistic about its future performance. In addition, the Food Safety and Modernization Act, or FSMA, as we have referred to it, should create new opportunities for this unit. Our bakery feeds business, which has struggled with its supply chain, has clearly turned the corner, and should return to more reasonable annual EBITDA run rate of around $30 million.

Secondly, we have reduced headcount at corporate by 10% since January 1, and are on track to deliver $10 million of the planned reduction this year. This is evidenced again by the SG&A reduction quarter-over-quarter and year-over-year.

Third, we have committed to reducing working capital utilized in our businesses. This is primarily focused on our international ingredients group. Sequentially, we saw a $34 million improvement, essentially bringing us back to unchanged versus last year. This was done by lowering inventories, stretching payables, and just being better stewards of our receivables. We aren't done yet, and have targeted a $50 million improvement for the fiscal year.

Fourth, we have spent $98 million year-to-date on CapEx versus $103.5 million last year. Our plan called for CapEx deployment of around $275 million this year. However, given the environment we are in, we have scaled that back and anticipate spending around $225 million this year.

Fifth, we are focused on debt repayment and deleveraging. We intend to repay in excess of $100 million of debt this year. For the quarter, we repaid nearly $70 million. This does not include any additional dividend from Diamond Green Diesel in 2015. If operating conditions improve, a second dividend may happen. For 2016, we're targeting now $150 million debt reduction.

Sixth, Diamond Green Diesel continues to be one of our top performing investments. It provides the counter cyclical hedge we have promised, and manufactures one of the cleanest fuels in the world. We are working with our partner Valero to modernize its capital structure. As many of you know, Valero stepped in when we were unable to reach agreement with the Department of Energy to provide initial construction financing. We are grateful for Valero's backstop, and now think the business has proven itself to the point where it can find third-party financing on more favorable terms to all parties. As I discussed in the past, we are currently undergoing an intensive engineering study to expand this facility to 18,000 barrels per day. This is a 50% increase from current operating rates. We intend to comment further on this expansion opportunity, later in the year.

Seventh, construction continues on our five new facilities in the USA. The two new rendering plants were slightly delayed by the spring late rains, but are now working to catch up. Completion is expected in early to mid-2016. Our two new wet pet food plants are in the final stages of completion, and we expect them to contribute for the full year of 2016. Our Bryan, Texas bakery feeds plants should begin processing in the fourth quarter of 2015, and Dubuque, our gelatin factory in the Midwest, will begin increasing capacity in the fourth quarter as well.

And finally, last night we announced $100 million common stock repurchase program. As noted in the press release, we will opportunistically purchase stock on the open markets from time to time.

With that, I'd like to turn the call over to John for his normal financial review, and after John concludes, we'll open it up to Q&A. John?

Thanks, Randy. I want to point out that in our slide deck, we have further delineated our segment reporting by breaking out our used cooking oil sales from fats and our feed segment. This should provide additional segment detail, and the impact on the segment to price changes. We further outlined the EBITDA bridge from the first quarter of 2015 to the second quarter ended July 4, which we believe is helpful in reviewing segment results. Historical segment data is also provided in the slide deck. As you know, we regularly monitor Jacobsen Index for finished product pricing for our feed ingredient segment in the US, and in Europe we monitor Thomson Reuters to track competing commodities in palm oil and soy meal. To that end, slide 10 details average monthly prices, finished product prices for the first half of 2015.

Now for the quarter financial review. For the second quarter of 2015, the Company reported net sales of $859 million as compared to net sales of $1.031 billion for the second quarter 2014. The $172 million decrease in net sales is attributable to lower finished product prices, primarily in global fat markets, and by $113 million for a foreign exchange rate impact of a weaker euro and Canadian dollar. Overall, global raw material volumes were stronger year over year. Net income for the second quarter was $3.1 million or $0.02 per diluted share, compared to net income of $32 million or $0.20 per diluted share in 2014 second quarter.

Without the after-tax related costs, related to the acquisition and integration expenses, and deferred loan cost write-off or the euro bond, per share earnings would have been $9.6 million or $0.06 per share respectively for the 2015 second quarter, as compared to $39.2 million or $0.24 per diluted share respectively for the second quarter ended June 28, 2014, when adjusted for the non-cash inventory step-up and acquisition and integration cost. Our interest expense increased by $10.6 million in the second quarter, due to the write-off of the deferred loan cost associated with the retirement of the euro term B loan. This was an impact on an after-tax basis of $5.8 million to net income. Sequentially, adjusted EBITDA in the second quarter of 2015 improved to $10.5 million compared to $98.2 million in the first quarter of 2015, an increase of $7.3 million. This increase is largely due to lower raw material prices, lower acquisition and integration expenses, and cost reductions.

Moving to our operating segments, on a sequential basis, which you'll find in our slide deck. Sequentially, feed ingredient businesses stabilized with improved margins resulting from our actions to adjust raw material pricing dynamics in our global rendering, US restaurant services, and bakery business. The feed segment is the largest of our three platforms, and is anchored by North American business, and as Randy says, we operate this as a margin management business, which includes the largest commodity exposure. Noted on slide 7 for the feed segment, you will see that our rendering business formulas adjusted our raw material cost down, within cost of sales, to adjust for lower finished product values.

Overall, larger price declines were in the feed grade to pet food meal spread. Both Europe and Canada remained steady, while we're still challenged by weaknesses in bakery finished products. However, this business contributed a slight improvement in the quarter, as did our restaurant services business. Rousselot led our European food specialty ingredients business, and continues to be a steady and stable contributor with increased demand globally, especially in China. Strong volumes across this platform and necessary adjustments made in the edible fats refining business delivered a solid sequential improvement, and strong margins.

Favorable raw material prices benefited our European operations. However, our casings business struggled, due to the Asian border closure. Food segment was the most impacted by foreign currency exposure of approximately $8.2 million, while using our prior-year average exchange rates. The fuel ingredients business performance was down, due to the $1.6 million loss incurred in our Canadian bio-diesel facility, due to operating breakdown issues, and lower RIN values and low crude oil prices. The European Rendac and Sonac Ecoson business delivered stable earnings.

Now, a few balance sheet highlights. As Randy mentioned we're tightening our working capital resources and fortifying our balance sheet through maintaining solid liquidity long-term. On June 3, 2015, we closed on our follow-on offering for the euro bond 4.75% unsecured notes, to refinance our euro portion of our term B notes, locking in fixed rates for the next several years, and reducing the amount of our secured debt under the credit agreement. We improved our net working capital, during the second quarter ended July 4. Working capital improved by $33 million within the second quarter. With this, we have also resecured our debt.

With working capital improvements and the $25 million dividend from Diamond Green Diesel, we repaid nearly $70 million of debt in the second quarter. We believe we have greatly enhanced our capital structure to provide stability and financial flexibility, to meet our long-term growth goals. We're fully confident, compliant with our bank covenant ratios, our total debt to EBITDA ratio is currently at the end of the second quarter, 4.3 compared to our covenant of 5.0, and our secured debt ratio is 1.99 compared to the covenant of 3.75. Capital spending through the second quarter was $98.7 million, compared to $103 million in the comparable period of 2014. We expect to incur additional CapEx, between $110 million and $130 million for the remainder of 2015, which includes planned investments in the five new processing plants, and normal CapEx.

With respect to our foreign exchange exposure and the strength of the US dollar, both the euro and the Canadian dollar, if we use actual results for the first six months of 2015, and compare that to the first six months of the 2014 FX averages, operating income in 2015 would have increased by $27.1 million. On a sequential basis, first-quarter 2015 actual results would have increased by approximately $1 million. I want to point out, our European and Canadian debt is aligned to the functional currencies used by our non-domestic operations.

Now, let's take a look at our effective tax rate. During the second quarter, it was 48.6%, which is higher than the US statutory rate of 35%, due to US taxation of certain payments from foreign subsidiaries. A significant portion of the payments are dividends from Chinese joint ventures, which are currently taxable in the US, even though there is no actual repatriation of earnings to the US. Last year, these payments were not taxed due to the reenactment of the look-through rule, which was included in the tax extenders package. If the extenders legislation is passed this year, that is the same as, or similar to last year's package, including the bio-fuel tax credit and the look-through rule, we expect our effective tax rate to decrease significantly to approximately 25% for the year 2015.

And finally, I want to briefly mention cash taxes. For the first six months, the Company has paid $11.4 million of taxes, most of which was related to our international operations. We anticipate income tax payments of $15 million to $20 million in the second half of 2015 for a total tax in 2015 of approximately $30 million.

I will now turn the call back over to Randy.

Thanks, John. We closed the first half on a strong operational footing. Third quarter has its normal seasonal challenges, along with what appears to be continued pricing pressures from the increasing global supplies of grains and oil seeds. Our management teams globally have endured commodity cycles before, and know exactly what adjustments need to be made.

Foreign exchange headwinds will continue, and we remain optimistic in the long-term viability of our model. Our positioning globally is one of a kind, and we are proud of it. Operational efficiencies, working capital improvements, cost reduction, and managed CapEx spending will allow us to more quickly delever and grow Darling's shareholder value.

With that, let's open it up to Q&A. Thank you.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Our first question is from Adam Samuelson of Goldman Sachs. Please go ahead.

To start, Randy, you went through a long litany of actions, in terms of cost improvement targets and growth projects that you're working through. I'm hoping you could maybe try to wrap those all together a little bit, as you think about the back half of the year, or annualized and into 2016, how big those actions, in terms of the growth projects, the EBITDA contribution you think for 2016 the full-on impact of the cost action in 2016, if they're sustainable, particularly as we -- looks like we're going to stay in a pretty deflationary commodity price environment and a strong US dollar environment for the near term.

Fair question, Adam. To aggregate's a little difficult but I will try to speak a little more to them. First off, I mean, deflationary environment we're in right now is, obviously, we saw the WASD come out with a massive grain supply increase this week and there's pressuring in, essentially, fats and oils globally again. But at the end of the day, as we said, our July prices were pretty much unchanged to June.

There's some pressure there. But we'll just have to make the adjustments that we've made three quarters in a row now, to offset some of the pressure that's happening there. So that's always hard to quantify, but the model proves that it does work.

The headcount reductions that I take near and dear, there are several more to be made here by the year-end. As we said, we would deliver a $10 million SG&A reduction that we're well on the way, and I think we're probably 70%, 75% of the way there for the year.

The working capital is clearly a chief focus among the entire team. It's always difficult in deflationary environments while everybody believes that if prices go down 30% your working capital should go down 30%. The reality of it is, remember, you're buying the raw material, and it went down, too. So it's a spread management business. You recapture part of that.

As we said, we had a $34 million movement quarter-over-quarter, that essentially brings us back to even year-over-year, and we're setting a target out of there of $50 million by year-end. And then from that point on, we anticipate, and we'll structure to attempt to hold that going forward. The capital spending plan, I know we'll get a lot of questions on. Are we just deferring, or what are we doing?

There's always projects in our portfolio that compete, that are somewhat profit adding, but can be delayed, or we think there's a better use for capital. And in this case, we think a better use for capital is deleveraging, and then having the opportunistic share repurchase program out there.

So ultimately, our CapEx plan is one that we're just going to manage around, and return essentially $50 million to the cigar box here, for uses, or better uses, or other uses. And those are really the main drivers out there's as we go forward, Adam. To quantify anymore than that would be difficult, but they are sustainable, and they are real.

Okay. And in the last part of that answer you alluded to my next question. Can you help us think about the CapEx program coming down? What programs or actions or projects are maybe deferred or slowed?

How should we think about that pace of CapEx going into 2016, and related, how do you think about your leverage over the next two years? What's a comfort level, especially given the repurchase authorization you put in place last night?

I'll take part of this and I'll let John take the other part. From a capital standpoint, we've always said between the global businesses and North American businesses, that we need around $175 million to support the business. That's the -- as I call, that's maintenance, safety, environmental and replacement capital, to keep the plants operating efficiently. After that, it's really competition for profit-adding projects.

So as John said, we spent $98 million year-to-date, or through June, anticipate out somewhere around the $2.25 million for the year. That $50 million is going towards profit adding, and the majority of that is going toward Bryan, Texas, the Paducah and Ravenna plants that are all due to start up and be in position to contribute for the full year of 2016.

The two rendering plants are up and out of the ground. They were delayed a little bit by the heavy rains we had in the Midwest this spring and early summer, and those will be coming online here in 2016. So some of that spending was moved to 2016, but not a whole lot of it, as it moves if you will, into that $50 million bucket as we set for next year. $200 million to $225 million is the target spend for next year once again in capital. As we said, deleveraging is key to us. John, you want to comment about leverage rates and where you think we're going?

Adam, on the leverage ratio, as we said, we were at 4.30 compared to the bank covenant of 5.0. Looking forward, with what Randy outlined and less CapEx spending, improving our working capital by $50 million by the end of the year, we're going to be very comfortable with our leverage ratios, because we still can reduce the debt down, even with the repurchase of the stock over the next 24 months, as was indicated in the release, and we're in good shape. We're keeping more than that half turn that we've always said as a Company was our buffer that we would not exceed going above that 4.5.

Okay. And maybe just a final quick one on the CapEx deferrals. Randy, would it be fair to assume or imply that given the deflationary environment we're in, lower commodity prices, some of the projects you had on the table might not -- the return kind of opportunities over the next few years, might not look as attractive as you thought 18 or 24 months ago? That's driven some of the slowdown in capital spending, or is that the wrong inference?

There's a little bit of that, Adam. Really I don't like the word deferral. Essentially, there's a little bit of rain delay. We've had a couple projects in the feed area, in the Sonac blood area, the margins haven't looked as attractive as the original business case did, and that was pretty good spending. Those are going -- those were in the 2015 plan. Those will probably move to 2016, but they once again compete with other projects that we have around the world.

The other thing that steps down in 2016 versus 2015 is, we've made significant investments in our global gelatin business, both from a capacity expansion and from a waste water and environmental compliance area. Those investments are beginning to scale back, and that's the reason you're going to see the more normalized CapEx.

Okay. That's very helpful. Thanks.

Our next question is from Heather Jones of BB&T Capital Markets. Please go ahead.

Thanks for all the color on the call. First, simplistically, I just was wondering if you could walk through something with me. So setting aside Diamond Green, which will clearly fluctuate quarter to quarter, could you help us understand whether you believe adjusted EBITDA bottomed in Q1, given the changes that you've made in the core business? Is that a fair assessment of the business?

Are you including, Heather, Diamond Green in that or not?

No, excluding Diamond Green, your other businesses.

I always hate to give guidance like that, to be wrong, as I've proven myself to be wrong in the past at times. I think we've made a lot of the changes. It feels like from a margin management perspective, that we are seeing the bottoms here, but the challenge we have in Q3, as we've always said to people, is that's when the heat's pretty intensive around the country right now. The quality of the finished product we make in the fats and oils takes some discounts, so that's always been a challenge.

For the European and the global businesses, the European manufacturing industry slows down in August, for what appears to be lots of holidays. And so seasonally, you're going to get some impact here in Q3. As I look back over 2013 and 2014, and with the seasonality in the business, there's always a little bit of a seasonality moderation that happens within the business.

Now, offsetting that is, we've got a lot of good things going on in bakery, restaurant services, Terra Renewal, and in our protein rendering businesses that come back into play here. So I mean, I think overall, as we start to look forward, we've got a lot of positive momentum heading forward here.

So barring something unforeseen, it sounds like you feel comfortable that -- and excluding Diamond Green, that Q1 was a bottom, given what you can foresee?

Given what I can foresee at this time, as long as fats and oil prices don't fall out of bed, and take us lower.

Okay. My second question, comment is that what we found is, despite how depressed your stock has been, some investors are still wary of touching it, because of the level of debt, and 4.3 is more comfortable from a covenant perspective but it's still fairly high, particularly given the earnings volatility of the business. So was wondering given that, do you believe that all of your free cash flow would be best deployed to debt reduction, and secondly, has there been any consideration by you or the Board to potentially dispose of some assets?

Well, I think, let me answer that in two or three different pieces. Number one, we are constantly doing a benchmarking exercise within the Company, where we use financial measures on capital employed within assets, and, yes, we have identified assets that are either going to be fixed or rationalized. So that's always part of our business model that's out there. And then we share that with the Board constantly, and inform them of what we're working on in that area.

From a leverage ratio, I think the beauty of this company, and there's no doubt the stock's been under pressure, and there's no doubt that was the reason for putting the share repurchase announcement out there, is that we do believe in the Company, and that is clearly something that we want to make sure that people understand. We believe in our model as a strong cash flow generator, and we also believe that given the strong cash flow we can fund the organic capital expansion that we've talked about, along with maintaining the business, not going into a capital starvation mode.

I mean, by no means, do we, as a management team, and I think I can speak for the Board, view any type of stress here. It's a cycle we've been through. We're going to look at what we call strong return projects, deleveraging and also share repurchase, all as investment opportunities, and we'll make the decision on how those go.

Right now, our intent is obviously to delever the best and the most we can. As you know, part of the stress that appears to be -- that happens to us here, is the disruption of the Diamond Green Diesel cash flows, meaning the ability to pull dividends and the unknown as to the timing on the tax credit. And so, what we're optimistic, and that's the reason we stepped out with the additional debt repayment in 2015 or 2016, was that we believed that the tax credit will be made retro, and it will be put in place for 2016, which will then help, if you will, I don't like the word smooth, but make more predictable the cash flows and the dividends that can be used for both financing the business, paying down debt, growing the business, and share repurchases, as we go from time to time.

You mentioned that you have a benchmark as far as assets that will be either fixed or rationalized. Can you share with us what that benchmark is? What is your internal ROA target, before you consider disposing of an asset?

As Randy said, every quarter, when we meet with the Board, we update them on projects within each of the business segments. We've been going through that. There are a number of single site plants that we're looking at, that are below our 15% threshold that we like to see on a return, and we look to see what we're going to need to do there.

A lot of the times, it's just a capital infusion to take out cost or re-look at how the market pricing has done against the raw material, at times. We do a deep dive into that. We have a group that spends a lot of time looking at that, and they're pretty easy to point out, when you do a benchmarking against all the rest of the facilities, and we line them up as really green, yellow, and red, and if you fall into the red category, you're under scrutiny, and we look at those, and determine how to fix those, and bring those up to the standard that the other plants are running at.

And quietly, Heather, it's just not something we openly talk about out there. We have shut down our trading business in New Orleans in the quarter, and we're in the process of exiting one of our facilities in Memphis right now, that doesn't make sense anymore, in the bakery feeds area. So those are things that we go through, as we look around.

I wouldn't tell you there's a hard line in the sand, but we're also very honest with ourselves as to the viability and whether or not those assets are -- there isn't a long list of them, so I'd ask you not to spend much time thinking about that, because I think we're pretty well positioned out there.

Okay. Thank you.

Our next question is from Dan Mannes of Avondale Partners. Please go ahead.

First, congratulations on being able to expand EBITDA sequentially, even in a tough pricing environment. But I guess, I'm going to extend the prior group of questions. Given we've seen, what, another 10% decline in yellow grease prices in the last month, month and a half, I'm wondering are there more costs you can take out? Are there more things you can do to kind of offset that, given some of the sensitivity at both restaurant services and bakery?

I don't want to isolate it to one product there, because at the end of the day -- as I look around the world, and really when you look at that, you're predominantly talking about the feed segment. And the feed segment, the core drivers are Canadian rendering, European rendering, and USA rendering, restaurant and bakery.

So if we start in Canada, Canada, as we've talked before, fixes its raw material procurement formulas with its suppliers on a look-forward basis 90 days out. We had some massive volatility, if you will, in June, both up and down, that then brought prices lower in Canada in June, below our raw material, or what we call our atypical margins that we expect and anticipate out there. So our management team has had to go back for the third quarter and reprice that. That should help us improve there.

In Europe, it's about a 60 day look-forward as we do, and I think we're in pretty good shape there, with pretty steady earnings, depending on volumes within that business. They seem to be holding in there quite a bit from what we planned, and a little bit over last year. And then in the USA rendering, in Q2, we felt a little bit of pressure of the fats, but we also had pressure in the proteins from the standpoint that a significant portion of our rendering portfolio is poultry-driven.

We saw some of the pet food grade and aquaculture grade premium proteins, the premium collapsed quite a bit, especially in the month of June. We've seen that return or a portion of it return in July. And so from a USA rendering standpoint, I'm trying to be optimistic that the protein price rebound will offset the fat price pressure that you referred to.

In the restaurant services, we have made significant raw material price changes. At this point, we haven't lost any volume, so it's always when you're looking at price and volume, you say okay, there's more to go. We are now not paying for used cooking oil in most of our markets around the country right now.

And then in the bakery feeds business, the supply chain had gotten screwed up, if you will, pardon my English on that, from the standpoint of the acquisition and too much tonnage for a system that was running at or near capacity, and we had to shut down the Caldwell, Texas plant. That tonnage is still being moved around the country, spending about a half million a month moving that stuff around.

So we're trying to get Bryan, Texas up as quick as we can. We've also made some formulaic changes, both in the product that we make and you how we procure it, that should be supportive there.

So fats and oils, Dan, long answer to your question, pressure. I mean, there's no doubt with crude oil down to where it's at, the world is putting less fat into the fossil fuel mix around the world. That's making palm oil feel a little light. That's also making soybean oil feel a little light. At the end of the day, there is fats and oils pressure. I'm hoping we can offset that with the proteins here in the feed segment.

Let me try a little bit differently. You've laid out some pretty interesting cost plans, certainly both headquarters at food and also at restaurant services. Have you looked at anything more holistic? I don't know if you've considered bringing a third party to look at overall cost, given you're such a bigger enterprise now than you were 12, 18 months ago. And I'm wondering if now, with some time passed since the acquisitions, there's an opportunity to find some broader cost reductions?

That's something, we use an you array of consultants within the Company, and at the end of the day, a lot of those were in the SG&A trying to help us figure out how to put the new global platform together. For the most part, they're all out of here and we are -- what you're seeing is the result of the recommendations, as we put things together. So the answer is yes and no. I mean, I think you're seeing the results of our plans right now.

Okay. And then switching over real quickly to the commodity side. Given the RFS2 proposal, what looked like attractive volumes, given fairly decent production from a biodiesel perspective, are you a little surprised that grease prices hasn't traded better? Are you seeing another factor besides the lower price of corn that's maybe on grease, in light of what's been fairly decent industry-wide biodiesel production?

I think there's a couple things. As we met with our Board here this week, and we always put a slide up that shows what we thought would happen for Q2, versus what happened. And the slide itself said, we thought that the RFS volumes that would be announced would be supportive of fats and oil prices for the quarter, and going forward, and I couldn't have been more wrong.

What you see is that there continues to be a significant amount of renewable diesel from Neste, and bio diesel being imported into the country from Argentina, from Germany, that comes into the country, given the weak currency positions or the strong dollar on the offset there. Cheaper freight rates and lower fats and oils prices around the world that are coming in here. So that's tempering.

We saw RINs go from 86 to 67. The industry appears to be running, at least the biodiesel industry, appears to be running for the tax credit, as we talked to you. Our Canada plant is running red. But when you net out the tax credit, it's about breakeven or slightly above.

Diamond Green Diesel continues to run profitable at the EBITDA level right now, even with the prices. What you've seen is ULSD come down hard. RINs come down because of the imports, and then feedstock not come down.

Feedstock's coming down a little bit here and I guess the answer to you is yes, I'm a little surprised. I'm trying to think that will turn. But it doesn't feel like it, in the short term here.

Okay. My final question, before I step off. We have seen some movement in California on LCFS. Looks like that's going to get reproposed and finalized later this year. Talk about your positioning for that market, and how you view it at this point, and if it is attractive for you.

Dan, that is a -- it's a very interesting and a very complicated discussion. You're probably more skilled at it even than me. We continue to look at moving product to California. Obviously renewable diesel and biodiesel made from waste fats and greases will qualify and are very, very much going to be part of that LCFS.

We've seen the premiums of that market come up very significantly here. It is one that within our long-term strategic plan, says that we need to figure out how to move Diamond Green Diesel product to California. I would also say that the LCFS is going in place in British Columbia, and also Ontario. And we're starting to see some pretty abnormal and premium moves that support Diamond Green Diesel. It also supports for Darling the evaluation of a future investment in biodiesel within California, or nearby.

The challenge with building renewable diesel in California is simply the permitting, and the time line to construct. So that's what you're seeing as we talk about expanding Diamond Green Diesel. It would be for either a rail or a water move into California.

Between the complexity of moving to a blenders tax credit or a blenders to a producers tax credit in LCFS, I think there's a very, very bright future, and I think our Board does too, in the view of what kind of support that biofuels can bring to this business model long-term in the USA.

Sounds good. Thanks a lot.

Our next question is from Carla Casella of JPMorgan. Please go ahead.

I have a question on the border closures that you mentioned. Is there any outlook on how long that should continue, or how are you mitigating it?

Yes. CTH is -- there's a couple border closures I referred to, Carla. One was still the low grade cuts of meats are coming, still back-flowing back into Europe, and we're making edible fats and edible products for the sausage industry. I don't see much change happening there.

Obviously the meat producers in Europe, they're struggling a little bit. They're looking for better homes for their product, and I suspect they'll ultimately find it. Within the food segment, we referred to CTH, which is comprised of our casings business, and then we shipped some stomach packages and other products to the Asian markets.

China closed the border on some of those products here during the quarter. It wasn't a material impact to earnings, but it was something that was notable for us within the food segment. It is not open yet.

Once again, those are products that are purchased on formula, and it just takes a 60-day lag to where you have to reprice them. And right now, there's still premiums in the world for those products, not going either back into pet food or into the sausage business. So we're continuing to move that. But that was just a notable item in the quarter for us.

Okay. And then the currency movement in China, does that have any impact?

Well, the devaluation, the good news is all our raw material is basically bought in China and our finished products are sold in China. So from that standpoint, it's not like we're shipping products out of the country. But when you do convert at the end of a period, the earnings back to US dollars, there will be an impact there. The day-to-day business in China would not be impacted.

Okay. Great. Thank you.

Our next question is from Ken Zaslow of BMO Capital Markets. Please go ahead.

Hi. Good morning. This is Patrick for Ken.

Just quick question. What do you see for supply and demand in terms of biodiesel for 2016, especially in light of the potential change from the blenders' credit going into producers' credit? And also the $1 per gallon biodiesel tax credit.

Well, here's what we see going on out there. As you know, once again, a step-up in the mandate. Two, the Grassley legislation that's out there is moving it to a producers' credit, versus a blenders'. Obviously, we'd like to see that be a NAFTA inclusion, to take care of our Canadian facility. And then you have got the low carbon fuel standard.

And ultimately if you step back and where you can really get excited and I mean excitement with a capital E here, is if you go to a producers credit, then that can hopefully shut down these imports, which not only changes the profitability of our bio-fuel business and the industry's in the US, but it creates new and additional feedstock demand in the form of 2 billion, 2.5 billion pounds of new feedstock demand from our industry.

As we go into 2016, we're incredibly optimistic right now from what we see out there of the tax extenders package being made, if you will, taken out of play in an election year, meaning, made when it's brought retro this fall. 2016 is then put it at $1 a gallon. We think the blenders credit will go into place, and then as the LCFS steps in, it could make for some really interesting times in 2016.

Great. Just a quick follow-up. How fast would that accelerate your DGD expansion, if both legislations get passed through?

I'd love to tell you can expand that on a dime. The soonest the expansion, if Valero and the Board or Darling approves it, we would have to take some time down in early 2017 to bring it on. So it's a year out, year plus out, right now.

Thank you.

Our next question is from Craig Irwin of ROTH Capital Partners. Please go ahead.

Randy, just to touch on the blenders credit again. Lots of questions already. You've been very clear. 25 for Diamond Green, once reinstated, that your operations in Canada, maybe a small loss, becoming profitable or expected to be profitable, depending on the actual structure of the way this gets passed.

Just to step back a little bit, looking across the industry, a lot of plants are actually running today just like your Canadian facility, at a loss, running with the expectation that they'll more than make up that loss on the retroactive reinstatement of the blenders' credit. And one thing that a lot of them are saying is that psychology is also finding its way into feedstock pricing, basically around a third of the blenders' credit is being pulled away for the rendered fats that are being supplied into these facilities.

Can you discuss whether or not this is something that maybe helped you at the tail end of the quarter, once we did get the RVOs? Is it something that you expect to come in over the back half of the year, or potentially benefit the profitability of fat sales into the bio-fuel market?

Yes, I think, Craig, I think you got a pretty good feel for it. I mean, Canada's a little different for us, because as I tried to allude to in the script, there's a fence up there. Many people don't want to refer to it that way, but it's not as easy to move products over and across the border in the fats and oils area, as it probably should be.

We're working on that such that we're not married to our, if you will, our finishing capacity, which is our Quebec biodiesel plant. Right now that's a way for us to both add value and to sell our fats and oils in Canada, versus trying to load them on a boat and put them on the global fats and oils market. The reality is, up there is, we didn't anticipate RINs backing off as far as they have, and feed demand from the perspective, while we talk about bio-fuels, feed demand for fats has been very, very strong this summer.

And so ultimately in the USA, there's been a strong pull from the feed industry. We continue to see -- if you say big chickens, big hogs and big cows going to market, so there's a lot of fat still moving into those markets too. So while the industry runs for the biodiesel or the tax credit today, even with that, it's really not a very good business. It's a breakeven to marginally better business.

From our perspective, I see feed demand remaining strong. It was hard to believe it was this strong, given as warm a summer as we've seen, but animal numbers are strong, and still coming back. And then we'll see what the fourth quarter brings, and what kind of -- what happens with the LCFS, do we get the $1 a gallon for 2016, and is the industry successful in moving it towards the blenders credit. If that happens, then the psychology of that is probably supportive.

Great. Thank you for that.

Then just a follow-on about Diamond Green. I guess I should say first, congratulations for another production record at that facility in the quarter.

So revenue production was strong. It look like you're able to monetize naphtha and some of the other byproducts out of the facility. When we look at the feedstock costs and conversion costs, they seem to be close to the high end of the range; that's where you've been historically.

I was wondering if there was anything in the quarter that maybe impacted your conversion posture, feedstock costs, and whether or not you would expect to trend towards market prices for things like choice white grease and yellow grease as costs in the next couple quarters. And then as a second part of that question, can you maybe discuss the associated CapEx going to $18,000 a day?

Yes.

I mean, number one, remember as I've always said, the Diamond Green is the largest fat consuming point or entity in the United States at any given time, and its supply chain is fairly complex and fairly long, given the railroad delivery times that are out there today. So you roughly have 60 days out there either in the tank or in transit at any given time.

So when you get into a deflationary cycle, they've always been, no matter how good they purchase, they've always been lagging on the way down. We've also been able to pull the supply chain down a little bit there, to take advantage, and I think you'll see a little more of that flow through. I mean, the amazing thing with that facility is it does run in excess of 12,000 barrels a day, and it is profitable at the EBITDA line without the tax credit. So it is performing quite nicely.

As far as the CapEx to go, that is something that's being developed right now. We're simply in the phase 2 or engineering study right now of a very complex of sophisticated engineering and gated process that we should have those answers here, I would hope, by the November call, as to what the number is there. And I can tell you on an incremental basis it will still make sense.

Our next question is from John Quealy of Canaccord Genuity. Please go ahead.

Thanks, good morning, folks for putting me on.

Real quick, just on Diamond Green, Randy, I'm sorry if the you said this already, the cash flow expectations from blenders, if we get retroactive in 2015, what it would be? Second, can you ballpark either on a basis point perspective, or cost perspective what a recap and expansion of Diamond could bring to you in savings?

And then lastly, maybe for John, I know you talked about raising pricing across the complex, mostly on used cooking oil and some of the restaurant services business. I understand formulas lag, but can you just give an update on how that progress has gone? Thank you.

Thanks. No, I think first off in Diamond Green, what was the question?

You want me to come back at you for Diamond?

You gave us three.

I tried to be quick for you. Anyway, so Diamond Green number one, what's the blenders cash flow to you for Diamond, retroactive for 2015?

You got it.

Diamond Green is on a target to run 160 million gallons. So $80 million there, as long as we get it shipped out. Then you've also got our Butler plant up in Butler, Kentucky and then our Quebec plant to qualify there too. So around -- if everything works out right, about $85 million would come in, $80 million to $85 million, $80 million to $85 million for the year.

The other one was the recap of the plant itself plus the expansion, what sort of basis point or interest cost savings can you ballpark, you think you can get off it?

Number one, that credit agreement is confidential, at the request of Valero. They stepped in and we're so ever grateful when the Department of Energy negotiations became too complicated for us. So as we look at it, what we're working with our partner and trying to do is to say, we couldn't finance this on the outside or third party at the start, because it was unproven technology.

It's proven now. It's more than proven. And we would like to begin to look at taking it to a third-party financing, to lower the interest rate which I can't share with you. You could back into it.

Most importantly, then, to have better access to the dividends. Just as we've said in Q1, there's a pretty steep waterfall here, that's aimed at deleveraging the loan. And Valero stepped in, that's the good news, and the good news is, at the current run rates, it will be paid off in three years.

That's probably not the right way to run this business long term. And then to have the ability as we go forward with a major expansion to continue to not only finance that, but also finance the working capital that would be required to go forward.

I mean, to not refinance it is not a terrible deal. We would like to improve it. So I just want to be clear about that. We're not unhappy with what we have. We're just -- we look at things opportunistically, and say that's the right thing to do.

From your last question, which was the restaurant services, we've set a target for $10 million of improvement in that business. As I said before, it's still one of our best return on asset businesses that we have out there, but it has a lot of commodity exposure.

It's coming under pressure right now, and the only ways that you can really improve that business in deflationary is to either lower your raw material costs, or institute charges. Instituting charges is a long-term proposition that does yield some viability. But the number-one thing is that we are taking our raw material costs down as quickly as we can, in that business.

Great. Thanks, folks.

Thank you. We have reached the allotted time for questions, so this will conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Stuewe for any closing remarks.

Thanks, everyone. We appreciate all the questions today, and we look forward to talking to you here in November.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.