Darling Ingredients Inc (DAR) 2015 Q3 法說會逐字稿

Good morning, everyone, and welcome to the Darling Ingredients Incorporated conference call to discuss the Company's fiscal third-quarter 2015 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 agree to these terms, simply drop off the line.

I would now like to turn the call over Melissa Gaither, Director of Investor Relations for Darling Ingredients. Please go ahead.

Thank you, Allison. Good morning. Thank you for joining us to review Darling's earnings results for the third quarter 2015 ended October 3, 2015. To augment Management's formal presentation, please refer to the presentation section of our IR website for the third quarter earnings slide deck.

Randall Stuewe, our Chairman and CEO, will begin today's call with an overview of our third 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 at 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.

And 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 in 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 now like to turn the call over to Randy.

Thanks, Melissa. Good morning, everyone. Thanks for joining us today to review our financial results for the third quarter that ended on October 3.

Overall, we are encouraged with our third quarter performance, highlighted by sequential EBITDA growth, as we continued to aggressively execute operational and financial improvements intended to stabilize and grow profitability. Our business continues to experience the impacts of a deflationary cycle within the agriculture sector. Operating within these cycles is something Darling has done for over 130 years, and we are confident in our ability to manage and adjust the business as needed.

Before we get into our operating units, I would like to talk about our broader ongoing strategy. From one quarter to the next, our strategy is clear and consistent, delever and grow the business.

In Q3, we paid down debt by $16.3 million, and year-to-date have paid down $75.8 million. We are on track to pay down in excess of $100 million in 2015, and have set a target of $125 million to $150 million debt paydown for 2016. Additionally, we modified our credit agreements to provide us the necessary head room to both operate in a deflationary and unpredictable environment, and ultimately to retain the option to grow as we see fit.

On the growth front, our international operations continue to provide a growth platform. Our international operations continued to deliver as predicted, and the opportunities we see to grow are countless. Domestically, we have three new plants in commissioning stages, two wet pet food plants and one bakery plant.

Additionally, we are in the ramp up stage of our Dubuque gelatin expansion. Whiles slightly delayed due to a wet spring, we are on schedule with the two new US rendering plants that will start up during third and fourth quarter of 2016. Total capital deployed for these projects will be around $60 million, and it's projected to provide us a 40%-plus return.

And overall, we continue to focus on improving margins, reducing headcount, lowering global plant operating costs, and frankly, managing all controllable expenses. Regardless of the current macro operating conditions, we are executing our strategy, which ultimately positions us to grow and build shareholder value.

Now let's take a look at each of the segments. Starting with our global feed ingredient segment. This is primarily a spread management business, and during the quarter we saw sequential EBITDA improvement. The improvement in margin was driven by a solid quarter of strong volumes and stable earnings within our global rendering business.

Our USA restaurant services business continues to make adjustments, but showed margin improvement in light of lower selling prices. Our USA bakery feeds business showed nice improvement, as our supply chain smoothed out quarter-over-quarter. Our global blood processing business enjoyed its typical seasonal pick-up and improved results in China.

Globally, our rendering continued to deliver predictable and strong volumes. European rendering continued to see strong volumes and stable fat prices, but is starting to feel the pressure of a growing protein surplus due to strong global slaughter, and robust world grain and oil seed supplies. USA rendering continued to deliver solid performance on strong volumes, and we continue to make the necessary adjustments to our pricing formulas to offset the lower selling prices of our finished products.

Canada rendering came in slightly lower in Q3 versus Q2. This was largely a result of the finished product prices moving sharply lower in June, and our raw material prices being locked in for the calendar quarter. We're making adjustments and should see these flow through in fourth 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 we look for it to be fairly consistent in Q4. Our bakery feeds business showed solid earnings with stable corn prices during the quarter.

Volumes were strong, and we have been able to strengthen our margins in several geographies as we renew our raw material agreements. Our new Bryan, Texas facility was commissioned recently, and should take a little pressure off our system and improve earnings. We expect a fairly consistent Q4.

As we've noted in the past, we utilize derivatives to margin this business. And as noted in our 10-Q, we had a favorable hedge position on for Q3, and we'll have a similar position on for Q4. We have managed to margin approximately 75% of our anticipated production in the first six months of 2016.

Our specialty protein areas, made up of our wet pet food and pet food blending business, along with our organic and natural fertilizer business, continues its solid performance. Our new wet pet food plants in Paducah, Kentucky and Ravenna, Nebraska are now completed, are in the process of receiving the necessary certifications to service our global pet food customers.

Nature Safe, our organic fertilizer business continues to grow, and will become a more relevant part of our platform in 2016. Terra Renewal Services, our industrial residuals business also delivered its best performance of the year, and it appears to be back on track. In addition, FSMA or the Food Safety Modernization Act should create some new opportunities for this business unit in 2016 and 2017.

Lastly, in the feed segment, our restaurant services business continues to improve its spreads, but pricing pressure continues as we have noted in prior quarters. This business delivers very nice returns to our shareholders, but is also one that has low barriers to entry and the most commodity exposure.

Our volumes have returned nicely to the pre-biofuels era, and the related theft levels have diminished, and we've made significant changes in our model by lowering our raw material procurement cost, reducing our head counts and in some cases reinstating collection charges where it makes sense. We have more work to do, but I am pleased to say we are on track to deliver the $10 million of promised improvement.

Now let's turn to the food ingredients segment. The food ingredients segment sequentially was modestly lower. However, this is easily explained by the three major and planned turnarounds at our Angouleme, France, Wenzhou, China and Peabody, Massachusetts gelatin factories. For the quarter, these three shutdowns hit the P&L for approximately $4 million to $5 million.

While the third quarter is typically and seasonally lower, Rousselot, a global leader in gelatin and functional protein production continues to perform nicely, with year-over-year increases in both volume and earnings. Rousselot is a four continent operating unit, and produces a variety of products for pharmaceutical, food and industrial sectors.

Geographically, China continues to deliver nicely for Rousselot. Margins in Brazil continue to improve, however, Argentina continues to face challenges related to the strong peso. Europe continues to enjoy the benefits of lower raw material costs and a weak euro for exporting, while the USA is phasing in the expansion of our Dubuque, Iowa gelatin plant. We anticipate full production at Dubuque, and sales from this expansion to accelerate by year end.

In Europe, we operate one of the largest edible animal fat refining businesses. Sonac, as we refer to it, has benefited from increased quantities of raw material due to the border closure with Russia. While volumes grew, selling prices were pressured as we moved the product to market.

Sonac is a spread business, but ultimately this product competes with food grade palm oil. Selling prices have remained steady since the second quarter, and margins have widened back to their historical averages.

CTH, our global casings and meat byproducts business showed modest improvement this quarter after facing challenges in second quarter. While a very small contributor to the food segment, it returned to profitability in this quarter, as the Chinese embargo of our specialty finished products was lifted.

For the fourth quarter, we anticipate the food segment returning to more normalized earnings. And finally, in the fuel ingredients segment, Rendac, our European disposal rendering business continued its solid performance, and volumes were strong for the quarter.

Ecoson, our European bioenergy business, delivered modestly lower results, as it faced some operational challenges during the quarter that have now been resolved. Canada biodiesel operated at a $1.9 million EBITDA loss due to the collapse in US RINs and lower ULSD selling prices, 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. This unit is critical to balancing the supply and demand of fats in Canada, as trade barriers still exist for moving products across the border. Overall, adjusting for the anticipated Blenders Tax Credit, our fuel segment once again turned in a predictable and consistent return.

Now let's look at Diamond Green Diesel. As we've discussed in the past, this is an unconsolidated subsidiary and a joint venture with Valero. DGD faced a very challenging operating environment in the third quarter, with RINs collapsing, ultra low sulfur diesel prices retreating, and feed stock input prices only slightly offsetting these declines.

On an entity operating basis, Diamond Green had an EBITDA loss of $16.6 million. Keep in mind, this was impacted by a $10.9 million charge related to LIFO, our inventory method. DGD continued its track record of strong volumes, producing more than 41 million gallons of renewable diesel in the quarter.

While the operating environment was severe in Q3, we now have seen RINs strengthen, and our long-lead supply chain adjust for a more favorable margin environment. We're optimistic that the $1 a gallon Blenders Tax Credit will be adopted retroactively in 2015 and taking this into account, the third quarter EBITDA for Darling's share of Diamond Green would have been approximately $11.7 million. We expect the tax credit to be reinstated in mid-December, and this will help deliver full year EBITDA earnings of around $75 million to $80 million for Darling's share.

DGD continues to be one of our top performing investments, as it provides a counter cyclical hedge, and manufactures one of the cleanest fuels in the world. As I've discussed in the past, we are currently undergoing an intensive engineering study to expand this facility to 18,000 barrels a day, this is a 50% increase from its current operating rates. We intend to comment further on this expansion later in the year, as the EPA publishes the RVO here in November.

Now going forward, we're focused on deleveraging the balance sheet, and continuing to pursue profitable growth. In regard to executing on operational and financial improvements to enhance profitability, we remain focused on right-sizing the business, and managing our cash flows and CapEx. With that, I'll turn the call over to John, who will give a little more detail on the initiatives, and a financial [view].

And after John's done, we'll open it up to Q&A as usual. John?

Thanks, Randy. Following up on the initiatives that Randy mentioned, we're primarily focused on the following areas, and have achieved solid results.

As Randy stated, we're focused on debt repayment and deleveraging. We intend to repay in excess of $100 million of debt this year. In the third quarter, we've repaid $16.3 million of debt, with our year-to-date total now at $75.8 million.

We continue to focus on EBITDA margins in all three business segments and cost reductions, while commodity prices have all declined. As we have stated in the past, we have reduced headcount at corporate by over 10% since January 1, and we are on track to deliver the $10 million of planned reductions this year. This is evidenced again, by the SG&A reduction of $33.8 million year-over-year.

We have committed to reducing working capital utilized in the business. This is a primary focus of our operating groups. Sequentially, we improved our working capital, and this was done by lowering inventories, managing payables, and being better stewards of our receivables.

We have spent $162.3 million year-to-date on CapEx versus $154 million last year. Our 2015 plan that called for CapEx deployment of approximately $275 million this year, however, given the operating environment we have scaled back, and anticipate spending an approximately $225 million in 2015.

As we reported in the 10-Q during the third quarter, the Company repurchased $5.9 million worth of common stock in the open market. This was directed under the share repurchase program approved by the Company's Board of Directors.

Now I will go through some of our financial results for the third quarter. For the third quarter 2015, the Company reported net sales of $853 million, as compared to net sales of $979 million for the third quarter 2014. The $125 million decrease in net sales is primarily attributable to lower finished product prices primarily in the global fat markets, and by $37.7 million from the foreign exchange rate impact of the weak euro and Canadian dollar. Overall, global raw material volumes were stronger year-over-year.

The net loss for the third quarter was $9.9 million or $0.06 per diluted share, compared to net income of $14.3 million or $0.09 per diluted share in 2014 third quarter. This decrease is attributable to the impact of foreign exchange rates as a function of the strengthening US dollar, as compared mainly to the euro and Canadian dollar, and the impacts of tax expense which included discrete items that have no direct relationship to the premixed earnings, which was partially offset by improvements in operations.

If the extenders legislation is passed this year, which is the same or similar to last year's package including the bio tax credit and the look-through rule, we expect the effective tax rate for the end of the year, which would be about the same as last year or 16%. Interest expense decreased by $500,000 in the third quarter over the prior year.

Sequentially, adjusted EBITDA for the third quarter 2015 improved to $106.1 million, compared to $105.5 million in the second quarter of 2015, an increase of $0.6 million. This increase is largely due to lower raw material prices and cost reductions. So now moving onto our operating segments.

A sequential quarter result breakdown of each of these operating segments is included in the slide deck, that we have out there for your review. On a sequential quarter basis, segment operating income was $38.8 million in the third quarter, versus $39.3 million for the second quarter of 2015, basically unchanged quarter-over-quarter. The feed segment operating income was $35.6 million in the third quarter, versus $35.4 million in the second quarter.

Feed sales were down $4.2 million, but operating costs and SG&A were down to offset the reduction in sales. The food segment, operating income was $11.6 million in the third quarter, versus $15.5 million in the second quarter of 2015, a reduction of $2.9 million in operating income. Sales were down $14.1 million quarter-over-quarter.

This reduction in operating income and sales were due to as Randy mentioned earlier by the three planned turnarounds at Angouleme, France, and in China and in Massachusetts Rousselot facilities. The fuel segment operating income was down $1.8 million, due to the Canadian biodiesel losses, and operating challenges at our Ecoson bioenergy facility in Europe. Now I would like to cover a couple of balance sheet, and then tax expense highlights for the quarter.

As mentioned, we continue to manage tightly our working capital resources, and have fortified our balance sheet to maintain solid long-term liquidity. We continue to enhance our capital structure to provide stability and financial flexibility to meet our long-term growth goals, and we are fully compliant with our bank covenant ratios at the end of the third quarter of 2015. Our total debt to EBITDA ratio was 4.36, compared to our covenant of 5.5, and the secured debt ratio was 1.99, compared to our covenant of 3.75.

Now let's take a little deeper look into our effective tax rate. The income tax expense for the third quarter or three months ended was $7.9 million. The quarterly income tax expense is based upon the Company's estimate of its expected tax rate for the full year, and any discrete items recognized during the period, discrete items being one-time.

Most of the expense was due to $1.8 million write-down of certain tax assets, and the US taxation of certain payments between foreign subsidiaries. A significant portion of the payments mentioned are dividends from our China -- Chinese joint ventures which were 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 were included in the tax extenders package.

The impact of changes in the annual tax rate and discrete items do not have a direct relationship with the almost breakeven pretax earnings for the three months ended October 3. If the extenders legislation is passed this year, which is the same or similar to last year's package including the biofuel tax credit and the look-through rule, we expect the effective tax rate for the year to be about the same as it was last year or 16%.

Finally, I want to mention briefly about our cash taxes. For the first nine months, the Company paid net of refunds $4 million to the taxing authorities. Cash taxes decreased from the last quarter, as we received a net tax refund of $7 million during the quarter.

Now I'd like to turn the call back over to Randy.

Thanks, John. As we move forward here, we'll open it up and start to answer some questions and answers here. Allison?

Thank you.

(Operator Instructions)

And our first question will come from Heather Jones of BB&T Capital Markets. Please go ahead.

Good morning.

Good morning, Heather.

I have a few questions, but first a detail-ish one. SG&A came in lower than we were expecting for the quarter. And I understand it's been headcounts and all, but was there any nonrecurring items in that quarter-over-quarter reduction?

There was some small nonrecurring, but the biggest impact that we outlined in the Q, Heather, was on benefits or really incentive comp.

We've been accruing about a -- between $1.5 million and $1.750 million a quarter. That was reversed. That $3 million to $3.5 million was reversed from what we booked in the first and second quarter. We didn't book that in the third quarter, so that brings you up to about $4.5 million to $5 million, and then we will not be booking that into the fourth quarter.

The other things were just some cost reductions and some true-ups. We do some actuarial reports that come in, to true-up our healthcare and our workers' comp and auto and so forth. So that kind of flows through a little bit in the third quarter, but that is pretty standard comparisons. We would expect fourth quarter SG&A to be back more in that -- between that [$82 million] to [$83.5 million], [$84 million] range in the fourth quarter.

Okay. Because you won't have the reversals and all in that quarter?

No, we won't have that $4.5 million, as you kindly saw flow through, but we won't have the $1.5 million accrual that we had been doing. That's correct.

And another detail-ish question, on working capital, these improvements you're making in payables, receivables, et cetera, are those sustainable? So should we consider -- continue like going into 2016, 2017, have you reached a new level of working capital management that we should expect going forward?

If you look at the cash flow schedule, and just focusing on the receivables, you really need to look at the cash flow, not necessarily the balance sheet, because the [fat] cash flow schedule truly takes into account non-FX related items that flow through. We showed at the end of last year, those accounts receivable, inventory prepaids, accounts payable, accrued expenses, we, last year as I had said earlier, we were at about minus $55 million for the year. First quarter we're negative. We're back to a positive, at the end of second and third quarter on those.

We expect that to improve through the end of the year, to get most of that back. And then, we should see our working capital move no more than the $10 million to $20 million in any one year. But we think we've still got some opportunities next year in working capital, and we'd like to get another $20 million to $25 million out.

Okay. Thank you. Okay, I wanted to talk about the LCFS. So first, if you look at [carbs] charts about the different fuels and their carbon intensity, biodiesel and renewable diesel made from waste feedstocks have among the best. So you would think -- and I mean, and based upon their studies, there's estimates out there that renewable diesel and biodiesel will become much larger components of that market. And honestly, it seems like they're counting on those two items to get them a lot of the way to the 10% reduction.

So I was wondering if you could help us think about how that benefits -- should benefit your core business? I'm not talking about Diamond Green, but like your tallow pricing, your UCO pricing, how should we be thinking about that in 2016 and going forward?

Heather, this is Randy. I'll try to take a stab at it. It's a pretty broad question here, but the -- there's a lot of moving parts within the whole biofuel and feedstock arena now. Obviously, the carbon intensity issue favors used cooking oil and animal fats, recycled animal fats, and renewable diesel. So I mean, when you look at it on the surface, it looks a pretty neat opportunity.

You start to try to take a guess, at a 5% blend within to the California system. And then, you can quickly get a couple hundred million gallons, maybe more so. And then, when you start to then also dive off, and look at whether it ends up being a blenders tax credit or a producers tax credit, it sends -- just nominally, a very friendly price signal for our fats and oils to make fuels next year.

I mean, when you look at the S&D that's out there, whether it's for waste fats and greases or even soybean oil, as we start to creep up inclusion of the LCFS, even without a producers tax credit, saying that it would have to be made in America here, you start to -- and then with the advanced biofuel growth next year, you start to come up with potentially another couple billion pounds of fat demand. And given the carbon intensity numbers on our products, it's very favorable for not only our West Coast fats, but all the way back to the Midwest. I mean, that kind of helps us think through strategically, both expanding Diamond Green Diesel, and looking at a West Coast production facility as we go forward.

So we're very friendly moving forward. I mean, fats and oils that we produce today, relative to soybean oil are at their near historical low on a percentage basis. You start to look at the inclusion of fats and oils -- and even on the European continent, we've already seen fats and oils come back and improve or stabilize from where they were, as they start to balance their carbon needs over there. So hope that answers your question.

It does. And then speaking to Diamond Green, I understand the expansion and all, and I understand the infrastructure is not in place right now, for you to do rail to California. But given where the credits are at this point, where do they need to go, where it would make sense for you, to get out there and charter ships, et cetera, to start taking volumes to California now? Or do you need to wait until you expanded, and to put in rail infrastructure?

Well, we're lucky enough to have John Bullock here. John, you want to take a shot at that?

We're currently evaluating the various alternatives. Vessel is clearly one of them. However, we have to go US flagged, if we go from a US point to a US point, and US flagged vessel freight's a little more expensive, than traditional international freight.

Having said that, there are some US flagged vessels that are currently under construction. So we may look at going vessel, and we're evaluating various rail alternatives, as a way to move out to California as well. So the design phase for all that is under way now, and we will work that simultaneously, and in conjunction with our expansion of the facility.

Okay. And my final question is on ForEx. And it seems like you guys have demonstrated strongly that you can stabilize this business in a falling commodity price environment. There's a number of positive indicators out -- on the horizon for your renewables business, but a key uncertainty remains ForEx. And so, I was wondering if you could share with us, updated philosophy on that?

I know it can be expensive, but we've covered companies that have been in bankruptcy before, and buy out-of-the-money puts, and sell calls for a low cost option. So I was just wondering what your thoughts are on putting a floor in on that ForEx risk?

It's a timely question, Heather. As we wrapped up a Board meeting this week, and John Muse put on a pretty interesting presentation on that, and we evaluated it at the Board level. I mean, I think it's clear and safe to always put on your 20/20 hindsight glasses, and say it would have made a lot of sense when the euro was 1.36, 1.38, at 1.07 this morning. The exposure that we see is fairly limited down maybe to parity.

What's even more important, though, is you've got to keep in mind, that while we've talked about the European earnings of being in that EUR180 million to EUR200 million range, on the EUR1.6 billion purchase price, only about a half, of 55%, maybe 60% of that is really European euro-based earnings. The rest are Renmimbi, Brazilian reals, Argentine pesos. So at the end of the day, you're really only hedging say, $100 million to $120 million of exposure. So on a 5 or 7 point move to parity, that's only about $1 million to $1.5 million a quarter of US dollar translation. And the price to do it -- we looked at it, it just wasn't compelling enough to put that one-time expense on the balance sheet.

Now if our you view is, that it's going to go to 90, which it isn't today, then that's a different story. So I would tell you -- not only, and I think it's a good general discussion. We look at -- and our bakery business, we do use derivatives and collars, and we hedge that, and we've locked in, as I said a significant portion of our margins there. But when you start talking currencies, you've got to go back then, and look at the related.

If you've got a view on corn or soybean meal or palm oil, you can then move into that arena too. Which we've chosen not to do for the simple reason that, that the relationships that exist on the basis levels or there aren't really that strong at times. Just like we've seen some of our fats and oils [trank] down into the low teens against $0.27, $0.28 bean oil right now. So I hope that helps there.

It's very helpful. Thank you.

Our next question will come from Dan Mannes from Avondale Partners. Please go ahead with your question.

Thanks. Good morning everyone, and nice quarter.

Thanks, Dan.

So first question, and I want to follow back to you on your last comment about fat prices, and even to a lesser extent, meat and bone meal. Based on our math, both fats and meat and bone meal are trading at pretty significant discounts to their competing products, particularly into animal feed. And I am wondering if you could just give us a little color? I mean, we've seen this happen before, but usually for short periods of time.

Can you maybe walk us through some of the current supply demand dynamics that are driving that? And maybe walk us through how that fixes itself -- now obviously, including your commentary on the potential demand from biofuels, because it just seems a little incongruous, given some of your commentary?

Yes, and let me -- I'll take a stab at it here. I mean, what we're seeing -- and then I'm going to speak both domestically, and then even over to the continent. I mean, what you're seeing on the pressure on fats, typically in the USA, you do see some seasonality that happens, as the biodiesel industry ramps down, and they don't have the inclusion. You've had fats being pressured by the biodiesel industry's lack of profitability because of the imports.

But more importantly, the fats have been pressured because of just the strong slaughter that we've seen predominantly in the poultry side. Every one of our poultry-related facilities is at or near capacity, or was running at and above capacity, during the third quarter here. We're continuing to see big animals come to market, especially in the poultry side, and there's ample amounts of poultry fat on the market. You just haven't seen the winter seasonal feeding patterns kick in.

We're below the value, the caloric value of corn, so yes, I'll call a floor on that. And so at the end of the day, I think it's pretty temporary. We're already seeing the poultry guys start to scale back a little bit. Cattle slaughter's been a little stronger than I would have thought it would have been, and the pork guys have been doing pretty well with their profitability.

So overall, you've got a couple things happening. Slow biodiesel, driven by the import infrastructure right now, and the unknowns of the credit structure. Two, a very strong dollar making exports really hard to do. And three, just really a strong slaughter there, especially on the poultry side.

When we look to Europe then, we've already seen fat prices come back and stabilize to their normal relationships to palm oil. But on the protein side, in Europe, we're seeing the same pressure with the strong poultry slaughter over there.

So protein prices are also being driven both here and in Europe, a lot by the amount of chicken material that's hitting the market. And that's always -- there's all kinds of different things that go into that protein demand. But predominantly, it's related right now to both the slaughter and the lack of winter feeding that's not started yet.

Got it. And then, just moving on real quick, and just closing the loop on your LCF -- on low carbon fuel standard. Is it fair to say once, is it fair to say that the prices in California are now high enough that the window is open, meaning if you could get the infrastructure in place, is there a substantial margin? Our guess is yes, but I'd like to hear you say it.

Hey, Dan, this is John Bullock. Yes, it is open, and a point of fact, we are shipping to California now.

Well, I'm sorry, I guess, in your prior question, I thought you said, you didn't really have rail access or ship -- or access to (multiple speakers)

We have vessel access. We always have.

(multiple speakers) Okay.

There's limited amounts of vessels. I mean, I think Dan, you've been in the business long enough to know who owns those vessels, because they have to be Jones Act. And so, at the end of the day, yes, we're moving product there. I think I saw the carbon number's up to about $1 a gallon.

It is -- number one, and I'll stop here, and give you a little more color on it. Diamond Green Diesel was built on the pipeline to domestically supply the pipeline, and it's been doing that. So the majority, a super high percentage of our sales are committed out there, are pipeline or barge sales within the region and infrastructure.

As the expansion is contemplated here, it's not only to meet the demands of our growing customer base on the pipeline, but to be able to service California. We have been able to move now product -- as John was trying to allude to, we are moving product to California. It is a premium to these sales, but it's not a significant portion of our mix today until we expand.

Got it. And then my last question -- this is more of a broader question. One of the benefits of the VION transaction, is that it kind of gives you a world view, particularly into China and Brazil. And I'm just wondering if you could talk more broadly, maybe what you're seeing on the ground level, since you're able to get some visibility on things like consumer demand and things like that in some of those countries What does your intel tell you about how the rest of the world is acting?

We've had a pretty good year in China, and it's driven by Rousselot's performance there. They're running at capacity, and sales are up year-over-year, and prices have improved over in China. Our blood business, we expanded our Zhejiang plant to be probably the largest in China, and one of the larger ones in the world today. It's doing quite well, as the aqua culture season picks up over there.

So from our perspective, on both consumer and feed demand in China, pretty solid at the food level or food and feed. Now the offset to that is, we run a very large rendering hides business, which means the hides that are pulled from fallen stock or deadstock, both here in the US and in Europe. And we've seen a pretty significant slowdown in the low end upholstery and gloves and boot liner business then that -- and let me kind of put it in contrast. In 2008, during the CDO crisis, we had numerous containers of hides inbound to China that were simply cancelled and defaulted on, millions of dollars.

Right now, what we've seen, is we've seen a Chinese renegotiation of price. So prices of rendering hides have moved down tremendously in China due to the factory slowdown. Really nothing real new there, to the point where we're not even pulling hides in some of our plants now in the US, where we can just -- we just grind them up and render them.

So that's a view of China. It feels pretty solid going into next year for us. I don't see anything on the horizon for the feed or food. We're contemplating additional expansions in both right now, in China.

Move to South America, the South America profitability -- and when I say South America, you've got to break it down to Brazil and Argentina. Brazil electricity prices went through the roof, because of the drought in the southern part of Brazil. Hopefully, we'll get some relief there this year but -- and we've seen the real devalue. But the economy is very challenging domestically in Brazil. But we're having pretty good earnings out of Brazil, because raw material costs have now come in line, with the normal margin structure down there.

We had to run raw material costs up, and you can say, what are raw materials? Well, we make gelatin out of cattle hides or bovine hides down there. And if you think through the cycle, and like you said, we get to see what no one else sees. As the USA's cattle slaughter numbers came down, because of availability and high price, the Brazilians brought their cattle to market.

And so, we had a surge of hides that came to market. And then as the Brazilians have now had to shutter a lot of their slaughter plants, because of cattle availability and margin pressure. So hide prices moved rapidly up, which compressed our margins in gelatin, but have now, we've been able to raise prices in Brazil to re-establish those margins. So Brazil is a little bumpy, but it's okay from an earnings perspective. Argentina, the best years are still ahead for it, as it figures out who its next President, and who's going to devalue down there.

Move to Europe for you a little bit. We've got strong raw material availability, lots of animals still coming to market. The consumer meat markets are starting to find new homes if you will. Back to China, as the Russian border closure backed up some products that typically shouldn't be in the rendering truck or rendering barrel have now started to move back to their normal markets. And we've seen pretty strong demand all across the pet food and fuel markets for our products in Europe.

So overall, we see a pretty robust 2016 coming on. I don't know that we'll see raw material volumes as strong as they were this year. But when I say not as strong, I'm not talking a 5% or10% down, I'm talking probably back to normalized population growth. So that's kind of our view.

Sounds great. Thanks, Randy.

Our next question will come from Adam Samuelson from Goldman Sachs. Please go ahead.

Yes, thanks. Good morning everyone. Maybe first, going back to this question on fat prices, Randy, and the large discount that you're seeing on used cooking oil and tallow, relative to bean oil and other vegetable oil prices. Thinking about the blenders credit coming up, the RVO coming up, I mean, how much do you think that can narrow? If the credit and the RVO go the way you think it does, and over what time frame, obviously, seasonally, it's a tougher period for biodiesel. So just trying to think about magnitude of reversion on fat pricing?

Well, I mean, we're -- I'll try to answer it with a couple different directions here. One, fat prices, remember that a lot -- a significant amount of our used cooking oil ends up down in Diamond Green Diesel, so we're going to get the benefit on the other side of the margin structure there.

The portion that is located on the coastal plants, primarily on the East Coast, there is a very strong biofuel business in Europe that we're certified to service out of the Newark plant. Those are some pretty nice premiums to the domestic market right now, and the future values there, we're seeing prices up against the Jacobson of anywhere from $0.03 to $0.07 a pound. So you're at a bottom here, from the standpoint of fat prices.

So I mean, if you get an RVO that's even what we think it's going to be, or what was submitted, it's friendly to fat prices. It has to be. You're going to see -- remember, you can't use a lot of poultry fat into the biofuel arena. It just doesn't work for numerous reasons.

And so then, you got cattle slaughter, pretty similar next year. Poultry should -- fat's going to have to move back into animal feed, and that leaves people chasing our used cooking oil into the biofuel arena. So from our perspective, Adam, if you had to ask me to predict where we're going to be right now, we're at $0.11, at least Jacobson, the Board of Trade discount, it brings back at least 50% of that next year.

That's very helpful. And then maybe, along those lines, in the quarter, the used cooking oil business, and you saw the price -- your price in used cooking oil went down 6% year-over-year. I think if you looked at yellow grease, it was down 20% or so. Is that export opportunity out of the East Coast, a big driver of that kind of price improvement relative to the market?

Not sure I understand your question, Adam.

Used cooking oil, in the disclosures that you gave on the revenue kind of waterfalls, your price mix in used cooking oil was down 6%. Yellow grease on the Jacobson was down 25% year-over-year. So is the export of used cooking oil off the East Coast kind of helping you keep the top line in UCO steady?

Yes, and I think -- we put the Jacobson out there as a barometer, as an index of where the market is. That is the -- if you will from our perspective, that isn't necessarily representative of what we're selling at times in the different markets around the world.

That's the value of the Darling system. Yes, there's some plants that are selling at that price or very near it, and there's plants that are selling quite a bit over that, because of their location. But yes, that's the right explanation.

Okay. And then just on the SG&A reductions -- and so, I think the incentive comp accruals explains a good amount of the quarter variance. But as we think about next year, I think you'd be again accruing for that incentive compensation. So can you help us think about our run rate on SG&A in 2016? Obviously, think 3Q might understate it a little bit.

Oh yes, third quarter, yes, is definitely understated. As I said earlier, we feel fourth quarter will be in that [$82.5 million] to [$84 million] range, and we think that would carry over into early 2016, as we continue to look at cost reductions, and how we're doing business. We'll have a continued reduction target in 2016. But I think it's best to look at that [$82.5 million] to [$84 million range] for fourth quarter, and maybe on the low side of that going into 2016.

All right. Great. That's very helpful. I'll pass it along.

Our next question will come from Ken Zaslow from BMO Capital Markets. Please go ahead.

Hey, good morning, everyone.

Good morning, Ken.

So a couple questions, just follow-ups. One is on the restaurant side, you said that you were able to expand margins despite lower yellow grease prices. Can you talk about that?

Yes, remember, the market -- and I'm going to try to rewind the movie a little bit, because it's one of those things. That business model changed radically in the 2012, 2013, as the people, as you had all of the biofuel theft and RIN fraud and everything. You can remember if you go back, there were news stories on the web, calling it liquid gold.

And we got into a position, Ken, where we were chasing customers to preserve both our volume and our relationship and our legacy, and all that stuff that goes on and says, I got to pay more to keep the volume. So we went out there, built an organization, and to do that. What we've done internally is, as I said, we reduced the headcount substantially. We've returned to the headcount that we pretty much had, when we doubled the size of that business in 2008, 2009.

And then secondly, we've been able to return our volumes now to greater than they were in 2010. So we've recovered all the theft. And then the third piece that's happened is, is that when we talk about margins -- remember, there's a selling price, and there's the purchase price, and then there's a small piece of charging that happens for the service where we can. So really at the end of the day, as prices have come down, we've stopped paying in all markets for used cooking oil. We're kind of at that threshold, where we may have to reinstitute charges in our larger metropolitan high cost areas, and frankly, we're in process of doing that.

Okay. Great. Thank you. And then in terms of your return, of getting 40% on your CapEx spending, that's only on the $60 million, is that first -- is that fair? And then how quickly will you get that 40% return?

Yes. Now the -- as we come in, let's talk about all the facilities that make up that number. You've got the two wet pet food plants that are essentially completed. They're in wrap-up stage, as I said in my comments. It was critical for us to have them done by the first of October, so the large pet food companies could come in, and do their audits, give us the certifications. We're in that process right now. I think those plants are ready to run.

They are producing product in Ravenna. We're getting ready to ramp up in Paducah here. We have made product in both. Paducah and Ravenna will be online, full speed on Jan 1.

Ravenna, remember is both a replacement of our Platte River plant. So we have a base load of sales in there, with an opportunity to grow or double its size. Paducah, Kentucky is a brand-new plant that is geared at taking predominantly chicken products and putting them into the pet food market. We've got a very nice sales ledger there going into 2016. So both of those should be at those run rates.

Bryan, Texas was just commissioned here a couple weeks ago. It is making product. It is ready to run. The beauty of Bryan, Texas is that it was built to shut down Caldwell, Texas, which we leased from Custom Blenders when we did that acquisition last year. As we've noted before, we were leaving a lot of money on the table logistically there, when that plant wasn't able to run at the capacity that we needed it to. So the bakery in Bryan, Texas will be online. So all three of those will be online full speed Jan 1.

Dubuque, Iowa will be online with its new major customer. As always, that customer had a little extra inventory they had to work through, but it should come online. The two rendering plants, the one in Winesburg, Ohio should be online by the end of -- in third quarter next year, and then up to full speed there shortly thereafter, meaning within the quarter. And then the Peco plant in Pocahontas, Arkansas should be online in fourth quarter.

Both plants are under major construction right now. The buildings are up. I want to say that we took possession of on December 1, or will take possession of the building on December 1 in Winesburg to start setting our equipment in January 1, on Pocahontas, Arkansas to start setting our equipment, so the burden is on us. The sooner we get it done, the sooner they can run. So what I -- so full year for three plants, plus the gelatin, and then a -- basically a quarter for the two rendering plants.

Great. And then just to make sure, the update on your cost savings program, where are we, and how much have you actually realized, and what is the expectation for 2016?

Well, number one, cost savings for us was driven off -- as John noted in his comments, a 10% reduction of corporate headcount. We've got some more people that will come out of the system, as we finish up our integrations of the business. And ultimately, as everyone knows, we've got an ERP system installed that's still going on. We're still getting lots of help there.

Ultimately, as part of the Rothsay acquisition, we set up a transition services agreement. We're on an SAP in Canada. We're due to install Oracle up there in first quarter of next year. We can't make changes and implementations in fourth quarter for SOX control reasons. So that will roll off, and that's a couple million dollars ultimately that comes out of the system there.

So additional headcount, little bit there. We're on -- we set a goal internally of taking $10 million out. We've accomplished that, a little more to go next year.

At the plants, USA plants, believe it or not, those plants are down 50 to 60 people this year out of -- that's a 2% or 3% reduction. We've seen similar reductions out of Europe. And then ultimately, it's just really when I said, all controllable expenses, we're taking expenses a little bit out of everywhere. And it's really hard to quantify, because remember, in the business your volumes go up and down. And otherwise -- so when you say a real number, but those costs are coming out.

And then, ultimately as John said, the big opportunity has been really reducing inventories, extending payables and getting receivables, and getting the working capital down. We set a goal to have a $20 million positive there. At the end of last year, we were minus [$55 million]. So we've really -- that's the big one.

Restaurant services, John Bullock, has stepped forward, and taken out headcount, has also taken out a lot of the raw material costs. We set a $10 million margin improvement goal. We will hit that. So overall, we're right on target.

Great. I appreciate it. Thank you.

Our next question will come from Chip Moore from Canaccord Genuity. Please go ahead.

Yes, thanks, Randy and John. Maybe we can talk a little bit more about leverage. You laid out plans to pay down $150 million or so by the end of next year, and obviously you've got more than a full turn now, versus the covenant. I guess, where do you see that ratio going next year, and when might you start to think about accelerating some of these growth plans that have been dialed back?

Well, I'll let John answer the leverage. I want to comment a little bit about our credit approach, and really you've seen us move our credit agreement around. I know the markets at times have said, that's a bad signal that's saying, that you have a negative view on an outlook. We absolutely don't.

The time to manage your credit agreement is when you understand your business, and understand what it can do, before anything happens out there. I mean, so at the end of the day, you saw us move to a 5. And then we went out an issued the euro bonds, and it became fairly obvious to move the secured to unsecured. And then we were able, once we moved to that, and got it to, [once] again, then move it on up to 5.5. So we gave ourselves the head room.

As John says, it gives our operations team the necessary ability to run the business, without us telling them what they can spend or not spend, to keep all these assets running. So at the end of the day, John said we would -- as we did early on, when we gave our forecast for third quarter. And John you want to comment a little bit?

As I reported, we're at 4.36. So we had said, and by the end of third and fourth quarter, we would be at a maximum at 4.5. We'll be more in the [4.45] range probably at the end of the year. And for the end of 2016, we're targeting about a 4.1. And then at the end of 2017, we're going to be at about 3.5 to 3.6 [of that]. We'll get there, with the debt reduction levels that we've been talking about.

And we take a very conservative approach. As John said, when we look at that, guys, what we're doing is we're saying -- John and I have operated together for 13, 14 years. We control what we can control.

And what we do is, we look and says, okay, if the business doesn't get any better than it is right now, can we pay down? And that's typically what we've done is, set a CapEx number out there, because we thought that had a good return, and we were spending shareholder money effectively. And then we would back into what we could pay down. Next year we're setting a target of $125 million to $150 million paydown. And then, we're backing into what we can spend next year. So ultimately, what I'm trying to say here is, is we're looking at this thing and say, if it doesn't get any better than it has here in the last three quarters, we can still deploy capital, a couple hundred million dollars next year, pay down $150 million debt, and continue to reduce the leverage ratio.

We have plenty of head room. You will see us continue to acquire bolt-on plants within geographies around the world that make sense. You will see us continue to deploy capital to build additional rendering plants where it makes sense. So really at the of the day, we don't see any giant deals out there that are begging for us to do.

We've seen a lot of businesses come through -- for sale out there right now. And at the end of the day, we're still a buyer, we're still a grower. But we're going to focus, as I said on delever first, and then grow. So I think by mid next year -- and at the end of the day, if as Adam says or as Dan says, if we get an improvement, and Heather and the LCFS, and the biofuels, and fat prices, it only accelerates from where we're at right now. So we've built the platform. We've delevered it now. We've got a strategy for both cost management and growing the Company again, and we're set for the next move. And from there, we'll keep growing the business as we have for the last 13, 14 years.

That makes perfect sense. Appreciate the color. And then, I think you mentioned mid-December, it looked like you're pretty confident the blenders gets retroactively passed. Do you have a ballpark for the cash you'd get from that? Thanks.

Well, we'll comment quickly. I did spend yesterday with John Bullock on Capital Hill, once again making my rounds, making sure as I talk to you today, that I could confidently say what I heard, or report what I heard. And I felt a high level of confidence that we would have a retroactive tax credit that would be passed here, mid-December at the -- most likely. There's a potential, I would say a 50% chance, it will go for multiple years, for two years.

The producers tax credit was on everybody's agenda, and everybody openly talked about it. There's still some basic issues that are hidden in it, that are trying to be reconciled right now -- would throw that out there as potentially 50/50 too right now. The question is, it's DC, what can they truly get done? But I think you can sleep at night, knowing you'll have a blenders tax credit coming forth here in December as part of the tax extenders package.

As John talked about, and ultimately when you saw our profit before tax, and then you see our tax expense, that tax extenders package is very critical -- not only for blenders tax credit but for the look-through tax, extender piece that is in there for reconciling our taxes back to a normal rate. So we're not the only company out there that, that is part of that tax extenders package that needs a lot of different pieces to go. As we've talked about in the past, there's 50 or 60 items in there. It will get done. They'd love to make a lot of them permanent, but as we heard yesterday -- but I don't know that they have the time or the ability to make that happen.

As far as coming back, we expect Diamond Green to produce this year somewhere around 155 million gallons for the year. So that $1 a gallon will come back to the entity there. We'll pull a dividend as necessary and available, when we can.

Ultimately, up in Canada, we did have the fire, shutdown and explosion at the plant, that kept us running at about 50% capacity for the most part of the first half of the year. But we expect about CAD8 million to come back into there on that. And then we've got the Butler, Kentucky, the 2 million gallon plant there. So that's pretty much the math underneath, that's going into fourth quarter.

Very helpful. Thanks, guys.

All right. Thanks everybody. I want to just close, and say we finished the first three quarters on a strong operational footing. The third quarter had its normal seasonal challenges, along with continued pricing pressures from the increasing global supplies of grains and oil seeds. Our management team continues to be focused, and has endured commodity cycles many, many times in the past. We talked about the FX headwinds, and they'll continue, but we remain optimistic in the long-term viability of our model.

Globally, we're positioned. We're one of a kind, and we're very proud of it. The efficiencies, both operating and financial are beginning to come home. Working capital is being improved. The cost reductions are solid, and the CapEx spending is being managed on the outflow basis.

We'll continue to focus on our strategy of delevering and growing, and we'll talk to you here, when the end of the fourth quarter comes. Thanks again. Be safe. Have a great holiday season.

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