UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
DC 20549
FORM
10-Q
(Mark
One)
/X/
QUARTERLY
REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE
ACT
OF 1934
For
the quarterly period ended March 31, 2007
OR
/
/
TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE
ACT
OF 1934
For
the
transition period from _______ to _______
Commission
File Number 0-24620
DARLING
INTERNATIONAL INC.
(Exact
name of registrant as specified in its charter)
Delaware |
36-2495346 |
(State or other jurisdiction |
(I.R.S.
Employer |
of incorporation or
organization) |
Identification Number) |
|
|
251 O'Connor Ridge Blvd.,
Suite
300 |
|
Irving,
Texas |
75038 |
(Address of principal executive
offices) |
(Zip
Code) |
Registrant's
telephone number, including area
code: (972)
717-0300
Indicate
by
check mark whether the Registrant (1) has filed all reports required
to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the Registrant was
required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days. Yes X
No
____
Indicate
by
check mark whether the Registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and
large accelerated filer” in Rule 12b-2 of the Exchange Act (check
one).
Large
accelerated filer ____ Accelerated
filer X Non-accelerated
filer ____
Indicate
by
check mark whether the Registrant is a shell company (as defined in Rule
12b-2
of the Exchange Act). Yes
No
X
There
were
80,863,582 shares of common stock, $0.01 par value, outstanding at May
3,
2007.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
FORM
10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2007
TABLE
OF CONTENTS
|
|
Page
No.
|
|
PART
I: FINANCIAL INFORMATION
|
|
|
|
|
Item
1.
|
FINANCIAL
STATEMENTS
|
|
|
Consolidated
Balance Sheets
|
3
|
|
March
31, 2007 (unaudited) and December 30, 2006
|
|
|
|
|
|
Consolidated
Statements of Operations (unaudited)
|
4
|
|
Three
months
ended March 31, 2007 and April 1, 2006
|
|
|
|
|
|
Consolidated
Statements of Stockholders’ Equity (unaudited)
|
5
|
|
Year
ended December 30, 2006 and three months ended March 31,
2007
|
|
|
|
|
|
Consolidated
Statements of Cash Flows (unaudited)
|
6
|
|
Three
months ended March 31, 2007 and April 1, 2006
|
|
|
|
|
|
Notes
to Consolidated Financial Statements (unaudited)
|
7
|
|
|
|
Item
2.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
|
|
|
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
|
16
|
|
|
|
Item
3.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES
|
|
|
ABOUT
MARKET RISK
|
29
|
|
|
|
Item
4.
|
CONTROLS
AND PROCEDURES
|
30
|
|
|
|
|
PART
II: OTHER INFORMATION
|
|
|
|
|
Item
6.
|
EXHIBITS
|
32
|
|
|
|
|
Signatures
|
33
|
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
March
31,
2007 and December 30, 2006
(in
thousands, except shares and per share data)
|
|
|
|
|
December
30,
2006
|
|
ASSETS
|
|
(unaudited
|
)
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
5,271
|
|
$
|
5,281
|
|
Restricted cash
|
|
458
|
|
|
480
|
|
Accounts receivable
|
|
44,616
|
|
|
42,381
|
|
Inventories
|
|
18,248
|
|
|
14,562
|
|
Other current assets
|
|
3,861
|
|
|
5,036
|
|
Deferred income taxes
|
|
8,317
|
|
|
6,921
|
|
Total
current assets
|
|
80,771
|
|
|
74,661
|
|
Property,
plant and equipment, less accumulated depreciation of
$187,841 at March 31, 2007 and $184,061 at December 30,
2006
|
|
130,015
|
|
|
132,149
|
|
Intangible
assets, less accumulated amortization of
$38,817 at March 31, 2007 and $37,599 at December 30, 2006
|
|
32,440
|
|
|
33,657
|
|
Goodwill
|
|
71,856
|
|
|
71,856
|
|
Other
assets
|
|
6,603
|
|
|
6,683
|
|
Deferred
income taxes
|
|
1,923
|
|
|
1,800
|
|
|
$
|
323,608
|
|
$
|
320,806
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
Current portion of long-term debt
|
$
|
5,000
|
|
$
|
5,004
|
|
Accounts payable, principally trade
|
|
16,390
|
|
|
17,473
|
|
Accrued expenses
|
|
39,091
|
|
|
34,319
|
|
Total
current liabilities
|
|
60,481
|
|
|
56,796
|
|
|
|
|
|
|
|
|
Long-term
debt, net
|
|
66,250
|
|
|
78,000
|
|
Other
non-current liabilities
|
|
35,378
|
|
|
34,685
|
|
Total
liabilities
|
|
162,109
|
|
|
169,481
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
Common stock, $0.01 par value; 100,000,000 shares authorized;
80,931,035 and 80,875,453 shares issued at March 31, 2007
and at December 30, 2006 respectively
|
|
809
|
|
|
809
|
|
Additional paid-in capital
|
|
150,606
|
|
|
150,045
|
|
Treasury stock, at cost; 59,136 and 21,000 shares at
March 31, 2007 and December 30 2006, respectively
|
|
(378
|
)
|
|
(172
|
)
|
Accumulated other comprehensive loss
|
|
(11,635
|
)
|
|
(11,733
|
)
|
Retained earnings
|
|
22,097
|
|
|
12,376
|
|
Total
stockholders’ equity
|
|
161,499
|
|
|
151,325
|
|
|
$
|
323,608
|
|
$
|
320,806
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
Three
months ended March 31, 2007 and April 1, 2006
(in
thousands, except per share data)
(unaudited)
|
|
|
|
March
31, 2007
|
|
|
April
1, 2006
|
|
|
Net
sales
|
|
$
|
138,612
|
|
$
|
76,400
|
|
|
Costs
and expenses:
|
|
|
|
|
|
|
|
|
Cost
of sales and operating expenses
|
|
|
103,244
|
|
|
60,681
|
|
|
Selling,
general and administrative expenses
|
|
|
12,581
|
|
|
9,687
|
|
|
Depreciation
and amortization
|
|
|
5,744
|
|
|
4,133
|
|
|
Total
costs and expenses
|
|
|
121,569
|
|
|
74,501
|
|
|
Operating
income
|
|
|
17,043
|
|
|
1,899
|
|
|
|
|
|
|
|
|
|
|
|
Other
income/(expense):
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
(1,633
|
)
|
|
(1,542
|
)
|
|
Other,
net
|
|
|
(429
|
)
|
|
231
|
|
|
Total
other income/(expense)
|
|
|
(2,062
|
)
|
|
(1,311
|
)
|
|
|
|
|
|
|
|
|
|
|
Income
from operations before income taxes
|
|
|
14,981
|
|
|
588
|
|
|
Income
taxes
|
|
|
5,401
|
|
|
222
|
|
|
Net
income
|
|
$
|
9,580
|
|
$
|
366
|
|
|
|
|
|
|
|
|
|
|
|
Basic
income per share
|
|
$
|
0.12
|
|
$
|
0.01
|
|
|
Diluted
income per share
|
|
$
|
0.12
|
|
$
|
0.01
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
Year
ended December 30, 2006 and three months ended March 31, 2007
(in
thousands, except share data)
(unaudited)
|
Number
of Outstanding
Shares
|
$.01 par Value
|
Additional
Paid-In
Capital
|
Treasury Stock
|
Accumulated
Other Comprehensive Loss
|
Retained
Earnings
(Accumulated
Deficit)
|
Unearned
Compen- sation
|
Total
Stockholders’
Equity/ (Deficit)
|
Balances
at December 31, 2005
|
64,437,410
|
$
644
|
$79,370
|
$
(172)
|
$
(9,282)
|
$
4,447
|
$
(1,327)
|
$73,680
|
Net
income
|
-
|
-
|
-
|
-
|
-
|
5,107
|
-
|
5,107
|
Minimum
pension liability
adjustment, net of tax (revised)
|
-
|
-
|
-
|
-
|
2,415
|
-
|
-
|
2,415
|
Interest
rate swap derivative
adjustment, net of tax
|
-
|
-
|
-
|
-
|
(408)
|
-
|
-
|
(408)
|
Total
comprehensive income
(revised)
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
7,114
|
Adjustment
to initially apply FASB
Statement No. 158, net of
tax (revised)
|
-
|
-
|
-
|
-
|
(4,458)
|
-
|
-
|
(4,458)
|
Adjustment
to opening
stockholders’ equity
|
-
|
-
|
-
|
-
|
-
|
2,822
|
-
|
2,822
|
Adjustment
to initially apply SFAS
No. 123R
|
-
|
-
|
(1,327)
|
-
|
-
|
-
|
1,327
|
-
|
Stock-based
compensation
|
-
|
-
|
1,488
|
-
|
-
|
-
|
-
|
1,488
|
Excess
tax benefits associated
with stock-based compensation
|
-
|
-
|
50
|
-
|
-
|
-
|
-
|
50
|
Issuance
of common stock
|
16,417,043
|
165
|
70,464
|
-
|
-
|
-
|
-
|
70,629
|
Balances
at December 30, 2006
|
80,854,453
|
$
809
|
$150,045
|
$
(172)
|
$(11,733)
|
$
12,376
|
$ -
-
|
$151,325
|
Net
income
|
-
|
-
|
-
|
-
|
-
|
9,580
|
-
|
9,580
|
Pension
liability adjustment,
net of tax
|
-
|
-
|
-
|
-
|
194
|
-
|
-
|
194
|
Interest
rate swap derivative
adjustment, net of tax
|
-
|
-
|
-
|
-
|
(96)
|
-
|
-
|
(96)
|
Total
comprehensive income
|
-
|
-
|
-
|
-
|
-
|
-
|
-
|
9,678
|
Adjustment
to initially apply FIN
48
|
-
|
-
|
-
|
-
|
-
|
141
|
-
|
141
|
Stock-based
compensation
|
-
|
-
|
265
|
-
|
-
|
-
|
-
|
265
|
Excess
tax benefits associated with
stock-based compensation
|
-
|
-
|
89
|
-
|
-
|
-
|
-
|
89
|
Treasury
stock
|
(38,136)
|
-
|
-
|
(206)
|
-
|
-
|
-
|
(206)
|
Issuance
of common stock
|
55,582
|
-
|
207
|
-
|
-
|
-
|
-
|
207
|
Balances
at March 31, 2007
|
80,871,899
|
$
809
|
$150,606
|
$
(378)
|
$(11,635)
|
$
22,097
|
$
-
|
$161,499
|
The
accompanying notes are an integral part of these consolidated financial
statements.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
Three
months ended March 31, 2007 and April 1, 2006
(in
thousands)
(unaudited)
|
|
March
31, 2007
|
|
|
April
1,
2006
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income
|
$
|
9,580
|
|
$
|
366
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
5,744
|
|
|
4,133
|
|
Gain
on disposal of property, plant, equipment and other
assets
|
|
(39
|
)
|
|
(25
|
)
|
Deferred
taxes
|
|
(1,519
|
)
|
|
(1,170
|
)
|
Stock-based
compensation expense
|
|
540
|
|
|
424
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
Restricted
cash
|
|
22
|
|
|
11
|
|
Accounts
receivable
|
|
(2,235
|
)
|
|
3,418
|
|
Inventories
and prepaid expenses
|
|
(2,582
|
)
|
|
277
|
|
Accounts
payable and accrued expenses
|
|
3,534
|
|
|
(3,561
|
)
|
Other
|
|
1,110
|
|
|
1,035
|
|
Net
cash provided by operating activities
|
|
14,155
|
|
|
4,908
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
Capital
expenditures
|
|
(2,385
|
)
|
|
(2,503
|
)
|
Gross
proceeds from disposal of property, plant and equipment and
other assets
|
|
57
|
|
|
57
|
|
Net
cash used by investing activities
|
|
(2,328
|
)
|
|
(2,446
|
)
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
Proceeds
from debt
|
|
5,500
|
|
|
-
|
|
Payments
on debt
|
|
(17,254
|
)
|
|
(1,256
|
)
|
Deferred
loan costs
|
|
(16
|
)
|
|
-
|
|
Contract
payments
|
|
(37
|
)
|
|
(33
|
)
|
Issuance
of common stock
|
|
87
|
|
|
11
|
|
Minimum
withholding taxes paid on stock awards
|
|
(206
|
)
|
|
-
|
|
Excess
tax benefits from stock-based compensation
|
|
89
|
|
|
4
|
|
Net
cash used by financing activities
|
|
(11,837
|
)
|
|
(1,274
|
)
|
Net
(decrease)/increase in cash and cash equivalents
|
|
(10
|
)
|
|
1,188
|
|
Cash
and cash equivalents at beginning of period
|
|
5,281
|
|
|
36,000
|
|
Cash
and cash equivalents at end of period
|
$
|
5,271
|
|
$
|
37,188
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
Cash
paid during the period for:
|
|
|
|
|
|
|
Interest
|
$
|
1,634
|
|
$
|
1,403
|
|
Income
taxes, net of refunds
|
$
|
3,631
|
|
$
|
1,326
|
|
The
accompanying notes are an integral part of these consolidated financial
statements.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
March
31,
2007
(unaudited)
|
The
accompanying consolidated financial statements for the three
month periods
ended March 31, 2007 and April 1, 2006 have been prepared in
accordance
with generally accepted accounting principles in the United
States of
America by Darling International Inc. (“Darling”) and its subsidiaries
(Darling and its subsidiaries are collectively referred to
herein as the
“Company”) without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (“SEC”). The information furnished
herein reflects all adjustments (consisting only of normal
recurring
accruals) that are, in the opinion of management, necessary
to present a
fair statement of the financial position and operating results
of the
Company as of and for the respective periods. However, these
operating
results are not necessarily indicative of the results expected
for a full
fiscal year. Certain information and footnote disclosures normally
included in annual financial statements prepared in accordance
with
generally accepted accounting principles have been omitted
pursuant to
such rules and regulations. However, management of the Company
believes,
to the best of their knowledge, that the disclosures herein
are adequate
to make the information presented not misleading. The accompanying
consolidated financial statements should be read in conjunction
with the
audited consolidated financial statements contained in the
Company’s Form
10-K for the fiscal year ended December 30,
2006.
|
(2) Summary
of Significant Accounting Policies
|
(a)
|
Basis
of Presentation
|
The
consolidated financial statements include the accounts of Darling and
its
subsidiaries. All significant intercompany balances and transactions
have been
eliminated in consolidation.
|
The
Company has a 52/53 week fiscal year ending on the Saturday
nearest
December 31. Fiscal periods for the consolidated financial
statements
included herein are as of March 31, 2007, and include the 13
weeks ended
March 31, 2007, and the 13 weeks ended April 1,
2006.
|
|
(c)
|
Statement
of Stockholders’ Equity
|
The
consolidated statement of stockholders’ equity for the year ended December 30,
2006, included an incorrect presentation of the adoption impact of FASB
Statement No. 158. That presentation included a $4.5 million reduction
in
stockholders’ equity resulting from the adoption of FASB Statement No. 158 as a
component of fiscal 2006 comprehensive income, rather than displaying
the impact
of the adoption as an adjustment of the ending balance of accumulated
other
comprehensive loss.
This
Form
10-Q includes a revised consolidated statement of stockholders’ equity for the
year ended December 30, 2006. The immaterial corrections include presentation
of
the $4.5 million impact of the adoption of FASB Statement No. 158 as
an
adjustment of the ending balance of accumulated other comprehensive loss
and a
corresponding increase to fiscal 2006 comprehensive income. The revisions
did
not change net income, total accumulated comprehensive loss or cash flows
for
the year ended December 30, 2006.
|
Basic
income per common share is computed by dividing net income
by the weighted
average number of common shares outstanding during the period.
Diluted
income per common share is computed by dividing net income
by the weighted
average number of common shares outstanding during the period
increased by
dilutive common equivalent shares determined using the treasury
stock
method.
|
|
Net
Income per Common Share (in thousands, except per share
data)
|
|
Three
Months Ended
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
|
|
Shares
|
|
Per
Share
|
|
|
Income
|
|
|
Shares
|
|
Per
Share
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
$
9,580
|
|
80,429
|
|
$ 0.12
|
|
|
$ 366
|
|
|
63,952
|
|
$
0.01
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect
of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Add:
Option shares in the money
and
dilutive effect
of restricted stock
|
—
|
|
2,075
|
|
—
|
|
|
—
|
|
|
1,894
|
|
—
|
|
Less:
Pro forma treasury
shares
|
—
|
|
(857
|
)
|
—
|
|
|
—
|
|
|
(1,074
|
)
|
—
|
|
Net
income
|
$
9,580
|
|
81,647
|
|
$
0.12
|
|
|
$
366
|
|
|
64,772
|
|
$
0.01
|
|
For
the
three months ended March 31, 2007 and April 1, 2006, respectively, 4,862
and
45,000 outstanding stock options were excluded from diluted income per
common
share as the effect was antidilutive. For the three months ended March
31, 2007
and April 1, 2006, respectively, 158,305 and 300,022 shares of non-vested
stock
and restricted stock were excluded from diluted income per common share
as the
effect was antidilutive. For the three months ended March 31, 2007 and
April 1,
2006, respectively, 105,082 and zero shares of contingent issuable stock
were
excluded from diluted income per common share as the effect was
antidilutive.
(3) Acquisition
On
May
15, 2006, Darling, through its wholly-owned subsidiary Darling
National LLC (“Darling National”), a Delaware limited liability company,
completed the acquisition of substantially all of the assets (the “Transaction”)
of National By-Products, LLC (“NBP”), an Iowa limited liability company.
The
following table presents selected pro forma information, for comparative
purposes, assuming the Transaction had occurred on January 1, 2006 for
the
periods presented (unaudited) (in thousands, except per share
data):
The
selected unaudited pro forma information is not necessarily indicative
of the
consolidated results of operations for future periods or the results
of
operations that would have been realized had the Transaction actually
occurred
on January 1, 2006.
|
April
1,
2006
|
Net
sales
|
$127,124
|
Income
from continuing operations
|
3,576
|
Net
income
|
3,576
|
Earnings
per share
|
|
Basic and diluted
|
$
0.04
|
The
purchase price for the Transaction totaled $150.7 million, which included
the
issuance
of approximately 16.3
million shares of Darling common stock valued at $70.5 million. The asset
purchase agreement contains a true-up adjustment in which additional
shares
(“Contingent Shares”) may be issuable to NBP based on Darling’s stock price for
an average of 90 days ending on June 30, 2007 (the “True-up Market Price”). To
the extent the True-up Market Price exceeds $4.31, no Contingent Shares
will be
issuable. If the True-up Market Price is less than $4.31, the number
of
Contingent Shares issuable is determined by dividing the “Value Gap” by the
greater of $3.60 and the True-up Market Price.
The
Value
Gap is determined by multiplying the number of shares issued at closing
by the
excess of (i) $4.31 over (ii) the greater of the True-up Market Price
and $3.60.
Only holders of shares that were issued at closing and have not been
transferred
(except by gift or into trust) as of the date used to calculate the True-up
Market Price will be eligible to receive Contingent Shares. However,
the Value
Gap used to calculate the Contingent Shares will not be known until the
True-up
Market Price is determined. In accordance with Emerging Issues Task Force
97-15,
Accounting
for Contingency Arrangements Based on Security Prices in a Purchase Business
Combination,
the
value of the Contingent Shares issued, if any, will be recorded in stockholders’
equity.
(4) Contingencies
LITIGATION
The
Company is a party to several lawsuits, claims and loss contingencies
arising in
the ordinary course of its business, including assertions by certain
regulatory
agencies related to air, wastewater and storm water discharges from the
Company’s processing facilities.
The
Company’s workers’ compensation, auto and general liability policies contain
significant deductibles or self-insured retentions. The Company estimates
and
accrues its expected ultimate claim costs related to accidents occurring
during
each fiscal year and carries this accrual as a reserve until such claims
are
paid by the Company.
As
a
result of the matters discussed above, the Company has established loss
reserves
for insurance, environmental and litigation matters. At March 31, 2007
and
December 30, 2006, the reserves for insurance, environmental and litigation
contingencies reflected on the balance sheet in accrued expenses and
other
non-current liabilities were approximately $22.5 million and $21.5 million,
respectively. Management of the Company believes these reserves for
contingencies are reasonable and sufficient based upon present governmental
regulations and information currently available to management; however,
there
can be no assurance that final costs related to these matters will not
exceed
current estimates. The Company believes that the likelihood is remote
that any
additional liability from such lawsuits and claims that may not be covered
by
insurance would have a material effect on the financial statements.
In
June
2006, the Company was awarded damages of approximately $7.4 million
as a result
of a service provider’s failure to provide steam under a service agreement to
one of the Company’s plants. At the time the damages were awarded,
collectibility of such damages was uncertain; however on October 12,
2006, the
Company entered into an agreement to sell its rights to such damages
to a third
party for $2.2 million in cash. The agreement was made subject to certain
conditions that were satisfied on March 1, 2007. On March 8, 2007,
the Company
received $2.2 million and transferred its damage award to the third
party. The
Company has recorded a gain with the receipt of the $2.2 million in
proceeds in
the first quarter of 2007.
The
Company sells its products domestically and internationally and operates
within
two industry segments: Rendering and Restaurant Services. The measure
of segment
profit (loss) includes all revenues, operating expenses (excluding certain
amortization of intangibles), and selling, general and administrative
expenses
incurred at all operating locations and excludes general corporate
expenses.
Included
in corporate activities are general corporate expenses and the amortization
of
intangibles. Assets of corporate activities include cash, unallocated
prepaid
expenses, deferred tax assets, prepaid pension and miscellaneous other
assets.
The acquisition of substantially
all of the assets of NBP
is
reflected primarily in the Rendering segment.
Rendering
Rendering
consists of the collection and processing of animal by-products, including
hides, from butcher shops, grocery stores, food service establishments
and meat
and poultry processors, and converting these into useable oils and proteins
principally utilized by the agricultural, leather and oleo-chemical industries
and in the production of bio-diesel.
Restaurant
Services
Restaurant
Services consists of the collection of used cooking oils from food service
establishments and recycling them into similar products used as high-energy
animal feed ingredients, industrial oils and in the production of bio-diesel.
Restaurant Services also provides grease trap servicing. The National
Service
Center (“NSC”) is included in Restaurant Services. The NSC contracts for and
schedules services such as fat and bone and used cooking oil collection
as well
as trap cleaning for contracted customers using the Company’s resources or third
party providers.
As
discussed above, the Company received proceeds of $2.2 million during
the first
quarter of fiscal 2007 as a result of a service provider’s failure to provide
steam under a service agreement to one of the Company’s plants. The Company
recorded approximately $1.2 million of the proceeds as a reduction of
cost of
sales in the Company’s rendering segment and approximately $1.0 million as a
reduction of selling and general and administrative costs in the corporate
segment.
|
Business
Segment Net Sales (in thousands):
|
|
Three
Months Ended
|
|
|
March
31,
2007
|
|
|
April
1,
2006
|
|
Rendering:
|
|
|
|
|
|
|
Trade
|
$
|
101,665
|
|
$
|
45,502
|
|
Intersegment
|
|
8,831
|
|
|
7,252
|
|
|
|
110,496
|
|
|
52,754
|
|
Restaurant
Services:
|
|
|
|
|
|
|
Trade
|
|
36,947
|
|
|
30,898
|
|
Intersegment
|
|
1,060
|
|
|
1,037
|
|
|
|
38,007
|
|
|
31,935
|
|
Eliminations
|
|
(9,891
|
)
|
|
(8,289
|
)
|
Total
|
$
|
138,612
|
|
$
|
76,400
|
|
Business
Segment Profit/(Loss) (in thousands):
|
|
Three
Months Ended
|
|
|
|
|
March
31,
2007
|
|
|
April
1,
2006
|
|
Rendering
|
|
$
|
17,908
|
|
$
|
4,388
|
|
Restaurant
Services
|
|
|
7,363
|
|
|
3,098
|
|
Corporate
|
|
|
(14,058
|
)
|
|
(5,578
|
)
|
Interest
expense
|
|
|
(1,633
|
)
|
|
(1,542
|
)
|
Income from continuing operations
|
|
$
|
9,580
|
|
$
|
366
|
|
Certain
assets are not attributable to a single operating segment but instead
relate to
multiple operating segments operating out of individual locations. These
assets
are utilized by both the Rendering and Restaurant Services business segments
and
are identified in the category called Combined Rendering/Restaurant Services.
Depreciation of Combined Rendering/Restaurant Services assets is allocated
based
upon management’s estimate of the percentage of corresponding activity
attributed to each segment.
Business
Segment Assets (in thousands):
|
|
March
31, 2007
|
|
|
December
30,
2006
|
|
Rendering
|
$
|
155,776
|
|
$
|
153,798
|
|
Restaurant
Services
|
|
39,185
|
|
|
36,359
|
|
Combined
Rendering/Restaurant Services
|
|
104,230
|
|
|
105,402
|
|
Corporate
|
|
24,417
|
|
|
25,247
|
|
Total
|
$
|
323,608
|
|
$
|
320,806
|
|
The
Company has provided income taxes for the three-month period ended March
31,
2007 and April 1, 2006, based on its estimate of the effective tax rate
for the
entire 2007 and 2006 fiscal years.
In determining whether its deferred tax assets are more likely than not
to be
recoverable, the Company considers all positive and negative evidence
currently
available to support projections of future taxable income. The Company
is unable
to carryback any of its net operating losses and recent favorable operating
results do provide sufficient historical evidence at this time of sustained
future profitability sufficient to result in taxable income against which
certain net operating losses can be carried forward and utilized.
In
2006,
the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No.
48, Accounting
for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109
(“FIN
48”), which prescribes accounting for and disclosure of uncertainty in tax
positions. This interpretation defines the criteria that must be met
for the
benefits of a tax position to be recognized in the financial statements
and the
measurement of tax benefits recognized. Effective December 31, 2006 the
Company
adopted the provisions of FIN 48 resulting in a reduction in the Company’s
existing reserves for uncertain state and federal income tax positions
of
approximately $0.1 million. This reduction was recorded as a cumulative
effect
adjustment to retained earnings. At the adoption date of December 31,
2006, the
Company had $0.6 million of unrecognized tax benefits and a related deferred
tax
asset of $0.1 million. If the Company recognized such tax benefits, the
net
impact on the Company’s effective tax rate would be $0.5 million, which includes
the effect of the reversal of the $0.1 million deferred tax asset. Additionally,
at December 31, 2006, the Company had an accrual for interest and penalties
of
$0.1 million. The Company recognizes interest and penalties related to
uncertain
tax positions in income tax expense.
Federal
examinations for years 2002 and 2004 have been completed. For federal
income tax
purposes, open tax years include 2003 and subsequent years. The statute
for most
state returns filed for the year 2002 will expire in the third quarter
of 2007.
Statute of limitations are generally three to four years from the due
date of
the return, including extensions, depending upon the jurisdiction. The
Company’s
state tax returns for 2003, 2004 and 2005 are still open. Additionally,
it is
expected that the amount of unrecognized tax benefits will change over
the
next 12
months, but the Company does not expect the change to have a significant
impact
on its results of operations or financial position.
The
Company entered into a new $175 million credit agreement (the “Credit
Agreement”) with new lenders on April 7, 2006 that replaced the former senior
credit agreement executed in April 2004. The
Credit Agreement provides for a total of $175.0 million in financing
facilities,
consisting of a $50.0 million term loan facility and a $125.0 million
revolver
facility, which includes a $35.0 million letter of credit
sub-facility.
As of
March 31, 2007, the Company has borrowed all $50.0 million under the
term loan
facility, which provides for quarterly scheduled amortization payments
of $1.25
million over a six-year term ending April 7, 2012; at that point, the
remaining
balance of $22.5 million will be payable in full. The revolving credit
facility
has a five-year term ending April 7, 2011. The proceeds of the revolving
credit
facility may be used for: (i) the payment of fees and expenses payable
in
connection with the Credit Agreement, acquisitions and the repayment
of
indebtedness; (ii) financing the working capital needs of the Company;
and (iii)
other general corporate purposes. The proceeds of the term loan facility
and a
portion of the revolving credit facility were used to pay a portion of
the
consideration for the acquisition of the assets of NBP. See Note 3 for
further
discussion regarding the acquisition of substantially all of the assets
of
NBP.
The
Credit Agreement allows for borrowings at per annum rates based on the
following
loan types. Alternate base rate loans under the Credit Agreement will
bear
interest at a rate per annum based on the greater of (a) the prime rate
and (b)
the federal funds effective rate (as defined in the Credit Agreement)
plus 1/2
of 1% plus, in each case, a margin determined by reference to a pricing
grid and
adjusted according to the Company’s adjusted leverage ratio. Eurodollar loans
will bear interest at a rate per annum based on the then applicable London
Inter-Bank Offer Rate ("LIBOR") multiplied by the statutory reserve rate
plus a
margin determined by reference to a pricing grid and adjusted according
to the
Company’s adjusted leverage ratio. At
March
31, 2007 under the Credit Agreement, the interest rate for the $46.25
million
term loan that was outstanding was based on LIBOR plus a margin of 1.50%
per
annum for a total of 6.875% per annum. The interest rate for $25.0 million
of
the revolving loan amount outstanding was based on LIBOR plus a margin
of 1.50%
per annum for a total of 6.875%.
The
Credit Agreement contains certain restrictive covenants that are customary
for
similar credit arrangements and requires the maintenance of certain minimum
financial ratios. The Credit Agreement also requires the Company to make
certain
mandatory prepayments of outstanding indebtedness using the net cash
proceeds
received from certain dispositions of property, casualty or condemnation,
any
sale or issuance of equity interests in a public offering or in a private
placement, unpermitted additional indebtedness incurred by the Company,
and
excess cash flow under certain circumstances.
The
Credit Agreement consisted of the following elements at March 31, 2007
and
December 30, 2006, respectively (in thousands):
|
|
March
31,
2007
|
|
December
30,
2006
|
Term
Loan
|
|
$
|
46,250
|
|
$
|
47,500
|
Revolving
Credit Facility:
|
|
|
|
|
|
|
Maximum availability
|
|
$
|
125,000
|
|
$
|
125,000
|
Borrowings outstanding
|
|
|
25,000
|
|
|
35,500
|
Letters of credit issued
|
|
|
17,896
|
|
|
18,391
|
Availability
|
|
$
|
82,104
|
|
$
|
71,109
|
The
obligations under the Credit Agreement are guaranteed by Darling National
and
are secured by substantially all of the property of the Company, including
a
pledge of all equity interests in Darling National. As of March 31, 2007,
the
Company was in compliance with all the covenants contained in the Credit
Agreement. At March 31, 2007, the Company had unrestricted cash of $5.3
million,
compared to unrestricted cash of $5.3 million at December 30, 2006 and
$37.2
million at April 1, 2006.
(8) |
Derivative
Instruments
|
The
Company makes limited use of derivative instruments to manage cash flow
risks
related to interest and natural gas expense. Interest rate swaps are
entered
into with the intent of managing overall borrowing costs by reducing
the
potential impact of increases in interest rates on floating-rate long-term
debt.
The Company does not use derivative instruments for trading
purposes.
Under
Statement of Financial
Accounting Standards No. 133, Accounting
for Derivative Instruments and Hedging Activities (“SFAS
133”),
entities are required to report all derivative instruments in the statement
of
financial position at fair value. The accounting for changes in the fair
value
(i.e., gains or losses) of a derivative instrument depends on whether
it has
been designated and qualifies as part of a hedging relationship and,
if so, on
the reason for holding the instrument. If certain conditions are met,
entities
may elect to designate a derivative instrument as a hedge of exposures
to
changes in fair value, cash flows or foreign currencies. If the hedged
exposure
is a cash flow exposure, the effective portion of the gain or loss on
the
derivative instrument is reported initially as a component of other
comprehensive income (outside of earnings) and is subsequently reclassified
into
earnings when the forecasted transaction affects earnings. Any amounts
excluded
from the assessment of hedge effectiveness as well as the ineffective
portion of
the gain or loss are reported in earnings immediately. If the derivative
instrument is not designated as a hedge, the gain or loss is recognized
in
earnings in the period of change.
On
May
19, 2006, the Company entered into two interest rate swap agreements
that are
considered cash flow hedges according to SFAS 133. Under the terms of
these swap
agreements, beginning June 30, 2006, the cash flows from the Company’s $50.0
million floating-rate term loan facility under the Credit Agreement have
been
exchanged for fixed-rate contracts that bear interest, payable quarterly.
The
first swap agreement for $25.0 million matures April 7, 2012 and bears
interest
at 5.42%, which does not include the borrowing spread per the Credit
Agreement,
with amortizing payments that mirror the term loan facility. The second
swap
agreement for $25.0 million matures April 7, 2012 and bears interest
at 5.415%,
which does not include the borrowing spread per the Credit Agreement,
with
amortizing payments that mirror the term loan facility. The Company’s receive
rate on each swap agreement is based on three-month LIBOR. At March 31,
2007,
the fair value of these interest swap agreements was $0.8 million and
is
included in non-current other liabilities on the balance sheet, with
the offset
recorded to accumulated other comprehensive loss.
A
summary
of the derivative adjustments recorded to accumulated other comprehensive
income, the net change arising from hedging transactions and the amounts
recognized in earnings during the three months ended March 31, 2007 is
as
follows (in thousands):
|
|
March
31,
2007
|
|
Derivative
adjustment included in accumulated other comprehensive loss/(gain)
at beginning of period
|
$
|
408
|
|
Net change arising from current period hedging
transactions (a)
|
|
103
|
|
Reclassifications into earnings
|
|
(6
|
)
|
Accumulated other comprehensive loss
|
|
505
|
|
(a)
|
Reported
as accumulated other comprehensive loss of approximately $0.2
million
recorded net of taxes of approximately $0.1 million for the
three months
ended March 31, 2007.
|
A
summary
of the gains and losses recognized in earnings during the three months
ended
March 31, 2007 is as follows (in thousands):
|
|
|
|
Loss/(gain) to interest expense related to interest rate
swap agreements
(effective portion)
|
$
|
6
|
|
Loss/(gain) to other expenses related to net change arising
from current
period hedging transactions
|
|
-
|
|
Total reclassifications into earnings
|
$
|
6
|
|
At
March
31, 2007, the Company has forward purchase agreements in place for purchases
of
approximately $2.0 million of natural gas for the month of April 2007.
These
forward purchase agreements have no net settlement provisions and the
Company
intends to take physical delivery. Accordingly, the forward purchase
agreements
are not subject to the requirements of SFAS 133 because they qualify
as normal
purchases as defined in the standard.
The
Company recognizes revenue on sales when products are shipped and the
customer
takes ownership and assumes risk of loss. Collection fees are recognized
in the
month the service is provided.
(10) |
Employee
Benefit Plans
|
The
Company has retirement and pension plans covering substantially all of
its
employees. Most retirement benefits are provided by the Company under
separate
final-pay noncontributory and contributory defined benefit and defined
contribution plans for all salaried and hourly employees (excluding those
covered by union-sponsored plans) who meet service and age requirements.
Defined
benefits are based principally on length of service and earnings patterns
during
the five years preceding retirement.
Net
pension cost for the three months ended March 31, 2007 and April 1, 2006
includes the following components (in thousands):
|
|
March
31,
2007
|
|
|
April
1,
2006
|
|
Service cost
|
$
|
582
|
|
$
|
564
|
|
Interest
cost
|
|
1,253
|
|
|
1,114
|
|
Expected
return on plan assets
|
|
(1,409
|
)
|
|
(1,242
|
)
|
Amortization
of prior service cost
|
|
29
|
|
|
35
|
|
Amortization
of net loss
|
|
288
|
|
|
413
|
|
Net
pension cost
|
$
|
743
|
|
$
|
884
|
|
Contributions
The
Company's funding policy for employee benefit pension plans is to contribute
annually not less than the minimum amount required nor more than the
maximum
amount that can be deducted for federal income tax purposes. Contributions
are
intended to provide not only for benefits attributed to service to date,
but
also for those expected to be earned in the future. Based on actuarial
estimates
at March 31, 2007, the Company expects to make contributions of $0.5
million to
meet funding requirements for its pension plans during the next twelve
months.
(11) |
New
Accounting Pronouncements
|
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157,
Fair
Value Measurements
(“SFAS
157”),
which
defines fair value, establishes a framework for measuring fair value,
and
expands disclosures about fair value measurements. The provisions of
SFAS 157
are effective as of the beginning of fiscal year 2008. The Company is
currently
evaluating the impact of adopting SFAS 157 on the consolidated financial
statements.
In
February 2007, the FASB issued Statement of Financial Accounting Standards
No.
159,
The
Fair Value Option for Financial Assets and Financial
Liabilities
(“SFAS
159”),
which
allows entities to choose to measure financial instruments and certain
other
items at fair value. This statement is effective for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the impact
of
adopting SFAS 159 on the consolidated financial statements.
Item
2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations contains forward-looking statements that involve
risks and
uncertainties. The Company’s actual results could differ materially from those
anticipated in these forward-looking statements as a result of certain
factors,
including those set forth below under the heading “Forward Looking Statements”
and elsewhere in this report, and under the heading “Risk Factors” in the
Company’s Annual Report on Form 10-K for the year ended December 30, 2006, and
in the Company’s other public filings with the SEC.
The
following discussion should be read in conjunction with the historical
consolidated financial statements and notes thereto.
Overview
The
Company is a leading provider of rendering, recycling and recovery solutions
to
the nation’s food industry. The Company collects and recycles animal by-products
and used cooking oil from food service establishments and provides grease
trap
cleaning services to many of the same establishments. The Company’s operations
are organized into two segments: Rendering and Restaurant Services. With
the May
15, 2006 acquisition of substantially
all of the assets of NBP
(the
“Transaction”), the Company now processes raw materials at 39 facilities located
throughout the U.S. into finished products such as protein (primarily
meat and
bone meal, “MBM”), tallow (primarily bleachable fancy tallow, “BFT”), yellow
grease (“YG”) and hides. The Company sells these products nationally and
internationally, primarily to producers of livestock feed, oleo-chemicals,
soaps, leather goods, bio-fuels and pet foods, for use as ingredients
in their
products or for further processing As a result of the Transaction, the
Company’s
first quarter 2007 results include a full quarter of contribution of
assets
acquired in the Transaction, as compared to no contribution from these
assets in
the first quarter of 2006. The accompanying consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements
contained in the Company’s Form 10-K for the fiscal year ended December 30,
2006.
During
the first quarter of fiscal 2007 the Company saw a significant increase
in
finished product prices that favorably impacted earnings. Raw material
volumes
improved modestly during the quarter, but export markets in some foreign
counties for U.S.-produced finished beef products and cattle by-products
remained closed. The Company continues to face major challenges relating
to the
continuation of historically high energy costs. Additionally,
the Company has substantially integrated the facilities acquired in the
Transaction into the Company’s infrastructure and operations and has realized
achievement of resulting synergies.
Operating
income increased by $15.1 million in the first quarter of fiscal 2007
compared
to the first quarter of fiscal 2006. The challenges faced by the Company
indicate there can be no assurance that operating results achieved by
the
Company in the first quarter of fiscal 2007 are indicative of future
operating
performance of the Company.
Summary
of Critical Issues Faced by the Company During the First Quarter of
2007
· |
Higher
finished product commodity prices were experienced in the first
quarter of
fiscal 2007 as a result of a global tightening of feed grains
and oils
from a growing global demand for bio-fuels. Higher finished product
prices
were favorable to the Company’s sales revenue, but this favorable result
was partially offset by the negative impact on raw material cost,
due to
the Company’s formula pricing arrangements with raw material suppliers,
which index raw material cost to the prices of finished product
derived
from the raw material. The financial impact of finished goods
prices on
sales revenue and raw material cost is summarized below in Results
of
Operations. Comparative sales price information from the Jacobsen
index,
an established trading exchange publisher used by management,
is listed
below in Summary of Key Indicators.
|
· |
The
Company has the ability to burn alternative fuels, including
its fats and
greases, at a majority of its plants as a way to help manage
the Company’s
exposure to high natural gas prices. Beginning
October 1, 2006, the federal government effected a program which
will
provide Federal tax credits under certain circumstances for commercial
use
of alternative fuels in lieu of fossil-based fuels. Beginning
in the
fourth quarter of 2006, the Company filed documentation with
the Internal
Revenue Service (“IRS”) to recover these Alternative Fuel Mixture Credits
as a result of its use of fats and greases to fuel boilers at
its plants.
The Company has received approval from the IRS to apply for these
credits.
However, the Federal regulations relating to the Alternative
Fuel Mixture
Credits are complex and further clarification is needed by the
Company
prior to recognition of any tax credits received. The Company
has not
recorded these credits as income due to pending clarification
of the
federal regulations. The Company is in the process of pursuing
clarification and eligibility to receive the Alternative Fuel
Mixture
Credits. As of March 31, 2007, the Company has applied for approximately
$1.1 million in Alternative Fuel Mixture Credits and has received
approximately $0.4 million from the IRS relating to these credits,
which
are included in current liabilities on the balance sheet as deferred
income. The
Company expects to continue to burn alternative fuels at its
plants in
future periods as long as the price of natural gas remains
high.
|
· |
Higher
raw material volumes were collected from suppliers during the
first
quarter of 2007 as compared to fiscal 2006. Extreme winter conditions,
Midwest swine diseases and strong West Coast production contributed
to the
Company’s increase in raw material volumes. The financial impact of higher
raw material volumes on sales revenue and raw material cost is
summarized
below in Results of Operations.
|
Summary
of Critical Issues and Known Trends Faced by the Company in 2007 and
Thereafter
· |
Energy
prices for natural gas and diesel fuel are expected to remain
relatively
high in fiscal 2007. The Company consumes significant volumes
of natural
gas to operate boilers in its plants, which generate steam to
heat raw
material. High natural gas prices represent a significant cost
of factory
operation included in cost of sales. The Company also consumes
significant
volumes of diesel fuel to operate its fleet of tractors and trucks
used to
collect raw material. High diesel fuel prices represent a significant
component of cost of collection expenses included in cost of
sales. Though
the Company will continue to manage these costs and attempt to
minimize
these expenses, prices remained relatively high in the first
quarter of
2007 and represent an ongoing challenge to the Company’s operating results
for future periods.
|
· |
Avian
influenza (“H5N1”), or Bird Flu, a highly contagious disease that affects
chickens and other poultry species, has spread throughout Asia
and Europe.
The H5N1 strain is highly pathogenic, which has caused concern
that a
pandemic could occur if the disease migrates from birds to humans.
This
highly pathogenic strain has not been detected in North or South
America
as of April 30, 2007, but low pathogenic strains that are not
a threat to
human health have been reported in the U.S. The USDA has developed
safeguards to protect the U.S. poultry industry from the H5N1
strain of
Bird Flu. These safeguards are based on import restrictions,
disease
surveillance and a response plan for isolating and depopulating
infected
flocks if the disease is detected. Notwithstanding these safeguards,
any
significant outbreak of Bird Flu in the U.S. could have a negative
impact
on the Company’s business by reducing demand for
MBM.
|
· |
Expenses
related to compliance with requirements of Section 404 of the
Sarbanes-Oxley Act of 2002 (the “Sarbanes Act”) are expected to continue
throughout 2007 and thereafter. The Company expects recurring
compliance
costs related to the required updating of documentation and the
testing
and auditing of the Company’s system of internal control over financial
reporting, as required by the Sarbanes Act. Additionally, the
Company
expects to incur higher costs related to the Sarbanes Act in
fiscal 2007
over the previous year due to the inclusion of NBP in the internal
control
documentation and testing process.
|
· |
In
fiscal 2007, the integration of information systems used by NBP
into the
Company’s information systems could have a significant impact on the
Company’s operations. Additionally, continued attention to integration
activities, particularly as they relate to systems integration
and
internal control integration, may distract Company management
from
operating issues.
|
Recent
Developments Regarding Federal Regulations:
· |
In
March 2007, U.S. federal and state regulatory authorities put
increased
emphasis on pet and livestock food safety as a result of the
discovery of
adulterated imported pet and livestock food additives. It is
unclear
whether, or to what extent, any increased regulatory attention
on animal
food safety will impact the Company.
|
· |
As
a result of the first case of bovine spongiform encephalopathy
(“BSE”), on
October 6, 2005, the FDA proposed to amend the agency’s regulations to
prohibit certain cattle origin materials in the food or feed
of all
animals (“Proposed Rule”). The materials that were proposed to be banned
include: 1) the brain and spinal cord from cattle 30 months and
older that
are inspected and passed for human consumption; 2) the brain
and spinal
cord from cattle of any age not inspected and passed for human
consumption; and 3) the entire carcass of cattle not inspected
and passed
for human consumption if the brains and spinal cords have not
been
removed. In addition, the Proposed Rule provides that tallow
containing
more than 0.15% insoluble impurities also be banned from all
animal food
and feed if this tallow is derived from the proposed prohibited
materials.
As of April 30, 2007, the FDA has not finalized the Proposed
Rule and no
new regulations affecting animal feed or modifying the Proposed
Rule have
been issued. The Company’s management will continue to monitor this and
other regulatory issues.
|
Results
of Operations
Three
Months Ended March 31, 2007 Compared to Three Months Ended April 1,
2006
Summary
of Key Factors Impacting First Quarter 2007 Results:
Principal
factors which contributed to a $15.1 million (794.7%) increase in operating
income, which are discussed in greater detail in the following section,
were:
·
|
The
inclusion of the operations of NBP,
|
·
|
Higher
finished product prices,
|
·
|
$2.2
million received for sale of judgment, and
|
·
|
Higher
raw material volume.
|
These
increases were partially offset by:
·
|
Higher
raw material prices.
|
Summary
of Key Indicators of 2007 Performance:
Principal
indicators which management routinely monitors and compares to previous
periods
as an indicator of problems or improvements in operating results
include:
·
|
Finished
product commodity prices (quoted on the Jacobsen
index),
|
·
|
Raw
material volume,
|
·
|
Production
volume and related yield of finished product, and
|
·
|
Collection
fees and collection operating
expense.
|
These
indicators and their importance are discussed below in greater
detail.
Prices
for finished product commodities that the Company produces are quoted
each
business day on the Jacobsen index, an established trading exchange price
publisher. These finished products are MBM, BFT and YG. The prices quoted
are
for delivery of the finished product at a specified location. These prices
are
relevant because they provide an indication of a component of revenue
and
achievement of business plan benchmarks on a daily basis. The Company’s actual
sales prices for its finished products may vary significantly from the
Jacobsen
index because the Company’s finished products are delivered to multiple
locations in different geographic regions which utilize different price
indexes.
Average Jacobsen prices (at the specified delivery point) for the first
quarter
of
fiscal 2007 compared to average Jacobsen prices for the first
quarter
of
fiscal 2006 follow:
|
Avg.
Price
1st
Quarter
2007
|
Avg.
Price
1st
Quarter
2006
|
Increase/
(Decrease)
|
%
Increase/
(Decrease)
|
MBM
(Illinois)
|
$203.73
/ton
|
$169.40
/ton
|
$34.33
/ton
|
20.3%
|
MBM
(California)
|
$201.48
/ton
|
$114.73
/ton
|
$86.75
/ton
|
75.6%
|
BFT
(Chicago)
|
$
21.52 /cwt
|
$
16.43 /cwt
|
$5.09
/cwt
|
31.0%
|
YG
(Illinois)
|
$
18.65 /cwt
|
$
12.71 /cwt
|
$5.94
/cwt
|
46.7%
|
The
increases in average price of the finished products the Company sells
had a
favorable impact on revenue that was partially offset by a negative impact
to
the Company’s raw material cost resulting from formula pricing arrangements,
which compute raw material cost based upon the price of finished product.
Additionally, some U.S. exports of MBM from the West Coast of the U.S.
resumed
in the first quarter of 2007. As a result, the MBM prices for the West
Coast
have increased significantly as indicated above.
Raw
material volume represents the quantity (pounds) of raw material collected
from
suppliers, including beef, pork, poultry and used cooking oils. Raw material
volumes provide an indication of future production of finished products
available for sale and are a component of potential future revenue.
Finished
product production volumes are the end result of the Company’s production
processes, and directly impact goods available for sale and thus become
an
important component of sales revenue. Yield on production is a ratio
of
production volume (pounds) divided by raw material volume (pounds), and
provides
an indication of effectiveness of the Company’s production process. Factors
impacting yield on production include quality of raw material and warm
weather
during summer months, which rapidly degrades raw material.
The
Company charges collection fees, which are included in net sales in order
to
offset a portion of the expense incurred in collecting raw material.
Each month
the Company monitors both the collection fee charged to suppliers, which
is
included in net sales, and collection expense, which is included in cost
of
sales. The monitoring of collection fees and collection expense provides
management an indication of the achievement of the Company’s business
plan.
Net
Sales. The
Company collects and processes animal by-products (fat, bones and offal),
including hides, and used restaurant cooking oil to produce finished
products of
MBM, BFT and YG and hides. Sales are significantly affected by finished
goods
prices, quality and mix of raw material, and volume of raw material.
Net sales
include the sales of produced finished goods, collection fees, fees for
grease
trap services and finished goods purchased for resale.
During
the first
quarter
of
fiscal 2007, net sales increased by $62.2 million (81.4%) to $138.6 million
as
compared to $76.4 million during the first
quarter
of
fiscal 2006. The increase in net sales was primarily due to the following
(in
millions of dollars):
|
Rendering
|
|
Restaurant Services
|
|
Corporate
|
|
Total
|
|
Net
sales due to contribution from NBP assets
|
$
52.0
|
|
$
3.9
|
|
$
-
|
|
$
55.9
|
|
Higher
finished goods prices
|
6.9
|
|
2.7
|
|
-
|
|
9.6
|
|
Other
sales increase
|
1.6
|
|
(1.0
|
)
|
-
|
|
0.6
|
|
Purchase
of finished product for resale
|
(2.7
|
)
|
(1.2
|
)
|
-
|
|
(3.9
|
)
|
Product
transfers
|
(1.6
|
)
|
1.6
|
|
-
|
|
-
|
|
|
$
56.2
|
|
$
6.0
|
|
$
-
|
|
$
62.2
|
|
Cost
of Sales and Operating Expenses.
Cost of
sales and operating expenses include cost of raw material, the cost of
product
purchased for resale and the cost to collect raw material, which includes
diesel
fuel and processing costs including natural gas. The Company utilizes
both fixed
and formula pricing methods for the purchase of raw materials. Fixed
prices are
adjusted where possible for changes in competition and significant changes
in
finished goods market conditions, while raw materials purchased under
formula
prices are correlated with specific finished goods prices. Energy costs,
particularly diesel fuel and natural gas, are significant components
of the
Company’s cost structure. The Company has the ability to burn alternative fuels
at a majority of its plants to help manage the Company’s price exposure to
volatile energy markets.
During
the first
quarter
of
fiscal 2007, cost of sales and operating expenses increased $42.5 million
(70.0%) to $103.2 million as compared to $60.7 million during the first
quarter
of
fiscal 2006. The increase in cost of sales and operating expenses was
primarily
due to the following (in millions of dollars):
|
Rendering
|
|
Restaurant
Services
|
|
Corporate
|
|
Total
|
|
Cost
of sales and operating expenses related
to NBP
assets
|
$
40.8
|
|
$
1.5
|
|
$
-
|
|
$
42.3
|
|
Higher
raw material prices
|
4.2
|
|
0.4
|
|
-
|
|
4.6
|
|
Other
expenses
|
0.8
|
|
(0.5
|
)
|
0.4
|
|
0.7
|
|
Purchases
of finished product for resale
|
(2.7
|
)
|
(1.2
|
)
|
-
|
|
(3.9
|
)
|
Sale
of judgment
|
(1.2
|
)
|
-
|
|
-
|
|
(1.2
|
)
|
Product
transfers
|
(1.6
|
)
|
1.6
|
|
-
|
|
-
|
|
|
$
40.3
|
|
$
1.8
|
|
$
0.4
|
|
$
42.5
|
|
Selling,
General and Administrative Expenses. Selling,
general and administrative expenses were $12.6 million during the first
quarter
of
fiscal 2007, a $2.9 million increase (29.9%) from $9.7 million during
the
first
quarter
of
fiscal 2006. The increase was primarily due to the following (in millions
of
dollars):
|
Rendering
|
|
Restaurant
Services
|
|
Corporate
|
|
Total
|
|
Selling, general and administrative expenses
related to NBP assets
|
$
1.2
|
|
$
0.2
|
|
$
0.8
|
|
$
2.2
|
|
Payroll and related expense
|
(0.1
|
)
|
-
|
|
1.7
|
|
1.6
|
|
Other expense increase
|
-
|
|
(0.1
|
)
|
0.2
|
|
0.1
|
|
Sale of judgment
|
-
|
|
-
|
|
(1.0
|
)
|
(1.0
|
)
|
|
$
1.1
|
|
$
0.1
|
|
$
1.7
|
|
$
2.9
|
|
Depreciation
and Amortization. Depreciation
and amortization charges increased $1.6 million (39.0%) to $5.7 million
during
the first quarter of fiscal 2007 as compared to $4.1 million during the
first
quarter of fiscal 2006. The increase is primarily due to depreciation
of the
assets acquired in the Transaction.
Interest
Expense.
Interest
expense was $1.6 million during the first
quarter
of
fiscal 2007 compared to $1.5 million during the first
quarter
of
fiscal 2006, an increase of $0.1 million, primarily due to the overall
increase
in debt outstanding as a result of the Transaction.
Other
Income/Expense.
Other
expense was $0.4 million in the first
quarter
of
fiscal 2007, compared to other income of $0.2 million during the first
quarter
of fiscal 2006. The increase in other expense is primarily due to reduced
interest income as a result of less cash investment on the balance sheet
and
increases in other non-operating expenses.
Income
Taxes.
The
Company recorded income tax expense of $5.4 million for the first quarter
of
fiscal 2007, compared to income tax expense of $0.2 million recorded
in the
first quarter
of
fiscal 2006, an increase of $5.2 million, primarily due to the increased
pre-tax
earnings of the Company in fiscal 2007. The
effective tax rate for fiscal 2007 is 36.1% and differs from the statutory
rate
of 35.0% primarily due to state income taxes and qualified production
deductions. The effective tax rate for fiscal 2006 of 37.8% differs from
the
statutory rate of 35.0% primarily due to state income taxes.
FINANCING,
LIQUIDITY AND CAPITAL RESOURCES
On
April
7, 2006, the Company entered into a new $175 million credit agreement
(the
“Credit Agreement”) with new lenders that replaced the senior credit agreement
executed in April 2004. The principal components of the Credit Agreement
consist
of the following.
· |
The
Credit Agreement provides for a total of $175.0 million in financing
facilities, consisting of a $50.0 million term loan facility
and a $125.0
million revolving credit facility, which includes a $35.0 million
letter
of credit sub-facility.
|
· |
The
$125.0 million revolving credit facility has a term of five years
and
matures on April 7, 2011.
|
· |
As
of March 31, 2007, the Company has borrowed all $50.0 million
under the
term loan facility, which provides for scheduled quarterly amortization
payments of $1.25 million over a six-year term ending April 7,
2012. The
Company has reduced the term loan facility by quarterly payments
totaling
$3.75 million, for an aggregate of $46.25 million principal outstanding
under the term loan facility at March 31,
2007.
|
· |
Alternative
base rate loans under the Credit Agreement bear interest at a
rate per
annum based on the greater of (a) the prime rate and (b) the
federal funds
effective rate (as defined in the Credit Agreement) plus ½ of 1% plus, in
each case, a margin determined by reference to a pricing grid
and adjusted
according to the Company’s adjusted leverage ratio. Eurodollar
loans bear interest at a rate per annum based on the then-applicable
LIBOR
multiplied by the statutory reserve rate plus a margin determined
by
reference to a pricing grid and adjusted according to the Company’s
adjusted leverage ratio.
|
· |
The
Credit Agreement provided sufficient liquidity to complete the
Transaction
and to retire the Company’s senior subordinated notes in the aggregate
amount of $37.6 million in principal, accrued interest and fees
on June 1,
2006. Additionally, the Credit Agreement has an extended term,
lower
interest rates, fewer restrictions on investments, and improved
flexibility for paying dividends or repurchasing Company stock
(all of
which are subject to the terms of the Credit Agreement) than
the Company’s
prior credit facility.
|
· |
The
Credit Agreement contains restrictive covenants that are customary
for
similar credit arrangements and requires the
maintenance of certain minimum financial ratios. The Credit Agreement
also
requires the Company to make certain mandatory prepayments of
outstanding
indebtedness using the net cash proceeds received from certain
dispositions of property, casualty or condemnation, any sale
or issuance
of equity interests in a public offering or in a private placement,
unpermitted additional indebtedness incurred by the Company and
excess
cash flow under certain circumstances.
|
The
Credit Agreement consisted of the following elements at March 31, 2007
(in
thousands):
Credit
Agreement:
|
|
Term
Loan
|
$
46,250
|
Revolving
Credit Facility:
|
|
Maximum
availability
|
$
125,000
|
Borrowings
outstanding
|
25,000
|
Letters
of credit issued
|
17,896
|
Availability
|
$
82,104
|
The
obligations under the Credit Agreement are guaranteed by Darling National
LLC
(“Darling National”) and are secured by substantially all of the property of the
Company, including a pledge of all equity interests in Darling National.
As of
March 31, 2007, the Company was in compliance with all of the covenants
contained in the Credit Agreement.
The
classification of long-term debt in the accompanying March 31, 2007 consolidated
balance sheet is based on the contractual repayment terms of the debt
issued
under the Credit Agreement.
On
March
31, 2007, the Company had working capital of $20.3 million and its working
capital ratio was 1.34 to 1 compared to working capital of $17.9 million
and a
working capital ratio of 1.31 to 1 on December 30, 2006. At March 31,
2007, the
Company had unrestricted cash of $5.3 million and funds available under
the
revolving credit facility of $82.1 million, compared to unrestricted
cash of
$5.3 million and funds available under the revolving credit facility
of $71.1
million at December 30, 2006.
Net
cash
provided by operating activities was $14.2 million and $4.9 million for the
first three months
ended
March
31, 2007 and April 1, 2006, respectively, an increase of 9.3 million,
primarily
due to an increase in net income of approximately $9.2 million. Cash
used by
investing activities was $2.3 million for the first three months of fiscal
2007,
compared to $2.4 million for the first three
months
of
fiscal 2006, a decrease of $0.1 million, primarily due to lower capital
investment in the first three months of fiscal 2007. Net cash used by
financing
activities was $11.8 million and $1.3 million for the first three months
ended
March 31, 2007 and April 1, 2006, respectively, an increase of $10.5
million,
principally due to debt payments on the Credit Agreement.
The
Company made capital expenditures of $2.4 million during the first
three months
of
fiscal 2007, compared to capital expenditures of $2.5 million in the
first three
months of fiscal 2006. Capital expenditures related to compliance with
environmental regulations were $0.4 million during the three months ended
March
31, 2007 compared to $0.1 million for the three months ended April 1,
2006.
Based
upon the annual actuarial estimate, current accruals and claims paid
during the
first three months of fiscal 2007, the Company has accrued approximately
$6.6
million it expects will become due during the next twelve months in order
to
meet obligations related to the Company’s self insurance reserves and accrued
insurance, which are included in current accrued expenses at March 31,
2007. The
self insurance reserve is composed of estimated liability for claims
arising for
workers’ compensation, and for auto liability and general liability claims. The
self insurance reserve liability is determined annually, based upon a
third
party actuarial estimate. The actuarial estimate may vary from year to
year due
to changes in cost of health care, the pending number of claims or other
factors
beyond the control of management of the Company. No assurance can be
given that
the Company’s funding obligations under its self insurance reserve will not
increase in the future.
Based
upon current actuarial estimates, the Company expects to make $0.5 million
in
payments in order to meet minimum pension funding requirements during
the next
twelve months, which will reduce current accrued compensation and benefit
expenses. The minimum pension funding requirements are determined annually,
based upon a third party actuarial estimate. The actuarial estimate may
vary
from year to year due to fluctuations in return on investments or other
factors
beyond the control of management of the Company or the administrator
of the
Company’s pension funds. No assurance can be given that the minimum pension
funding requirements will not increase in the future.
In
August
2006, the Pension Protection Act of 2006 (“PPA”) was signed into law and goes
into effect in January 2008. The stated goal of the PPA is to improve
the
funding of pension plans. Plans in an under-funded status will be required
to
increase employer contributions to improve the funding level within PPA
timelines. The Company participates in several multi-employer pension
plans that
provide defined benefits to certain employees covered by labor contracts.
These
plans are not administered by the Company and contributions are determined
in
accordance with provisions of negotiated labor contracts. Current information
with respect to the Company’s proportionate share of the over- and under-funded
status of all actuarially computed value of vested benefits over these
pension
plans’ net assets is not available. The Company knows that three of these
multi-employer plans were under-funded as of the latest available information,
some of which is over a year old. The Company has no ability to compel
the plan
trustees to provide more current information. While we have no ability
to
calculate a possible current liability for under-funded multi-employer
plans
that could terminate or could require additional funding under the PPA,
the
amounts could be material.
The
Company has the ability to burn alternative fuels, including its fats
and
greases, at a majority of its plants as a way to help manage the Company’s
exposure to high natural gas prices. Beginning October 1, 2006, the federal
government effected a program which will provide federal tax credits
under
certain circumstances for commercial use of alternative fuels in lieu
of
fossil-based fuels. Beginning in the fourth quarter of 2006, the Company
filed
documentation with the Internal Revenue Service (“IRS”) to recover these
Alternative Fuel Mixture Credits as a result of its use of fats and greases
to
fuel boilers at its plants. The Company has received approval from the
IRS to
apply for these credits. However, the federal regulations relating to
the
Alternative Fuel Mixture Credits are complex and further clarification
is needed
by the Company prior to recognition of any tax credits received. The
Company has
not recorded these credits as income due to pending clarification of
the federal
regulations. The Company is in the process of pursuing clarification
and
eligibility to receive the Alternative Fuel Mixture Credits. As of March
31,
2007, the Company has applied for approximately $1.1 million in Alternative
Fuel
Mixture Credits and has received approximately $0.4 million from the
IRS
relating to these credits, which are included in current liabilities
on the
balance sheet as deferred income. The Company expects to continue to
burn
alternative fuels at its plants in future periods as long as the price
of
natural gas remains high. Depending on the natural gas prices and market
price
of fats, the amount of Alternative Fuel Mixture Credits the Company applies
for
and receives could be material.
The
Company’s management believes that cash flows from operating activities
consistent with the level generated in the first quarter of fiscal 2007,
unrestricted cash and funds available under the Credit Agreement will
be
sufficient to meet the Company’s working capital needs and maintenance and
compliance-related capital expenditures through the next twelve months.
Numerous factors could have adverse consequences to the Company that
cannot be estimated at this time, such as: a reduction in finished product
prices; possible product recall resulting from developments relating
to the discovery of unauthorized adulterations to food additives; the
occurrence of Bird Flu in the U.S.; any additional occurrence of BSE in
the U.S. or elsewhere; reductions in raw material volumes available to the
Company due to weak margins in the meat processing industry or otherwise;
unforeseen new U.S. or foreign regulations affecting the rendering industry
(including new or modified animal feed, Bird Flu or BSE regulations);
increased
contributions to the Company’s multi-employer defined benefit pension plans as
required by the PPA; and/or unfavorable export markets. These factors,
coupled
with high prices for natural gas and diesel fuel, among others, could
either
positively or negatively impact the Company’s results of operations in fiscal
2007 and thereafter. The Company cannot provide assurance that the cash
flows
from operating activities generated in the first quarter of fiscal 2007
are
indicative of the future cash flows from operating activities that will
be
generated by the Company’s operations. The Company reviews the appropriate use
of unrestricted cash periodically. Although no decision has been made
as to
non-ordinary course cash usages at this time, potential usages could
include:
opportunistic capital expenditures and/or acquisitions; investments relating
to
growing interest in bio-diesel; investments in response to governmental
regulations relating to BSE or other regulations; cash requirements necessary
to
address unforeseen problems relating to the integration of NBP, including
increased expenses related to the Sarbanes Act; and paying dividends
or
repurchasing stock, subject to limitations under the Credit Agreement,
as well
as suitable cash conservation to withstand adverse commodity
cycles.
The
current economic environment in the Company’s markets has the potential to
adversely impact its liquidity in a variety of ways, including through
reduced
finished product prices, reduced sales, potential inventory buildup,
and/or
higher operating costs.
The
principal products that the Company sells are commodities, the prices
of which
are based on established commodity markets and are subject to volatile
changes.
Any decline in these prices has the potential to adversely impact the
Company’s
liquidity. Any of a further disruption in international sales, a decline
in
commodities prices, further increases in energy prices resulting from
the
ongoing war in Iraq and subsequent political instability and uncertainty,
and
the impact of the PPA has the potential to adversely impact the Company’s
liquidity. A decline in commodities prices, a rise in energy prices,
a slowdown
in the U.S. or international economy, or other factors, including political
instability in the Middle East or elsewhere, and the macroeconomic effects
of
these events, could cause the Company to fail to meet management’s expectations
or could cause liquidity concerns.
OFF
BALANCE SHEET OBLIGATIONS
Based
upon the underlying purchase agreements, the Company has commitments
to purchase
$3.4 million of finished products and natural gas during the next twelve
months,
which are not included in liabilities on the Company’s balance sheet at March
31, 2007. These purchase agreements are entered into in the normal course
of the
Company’s business and are not subject to derivative accounting. The commitments
will be recorded on the balance sheet of the Company when delivery of
these
commodities occurs and ownership passes to the Company during fiscal
2007, in
accordance with accounting principles generally accepted in the
U.S.
Based
upon the underlying lease agreements, the Company expects to pay approximately
$8.5 million in operating lease obligations during the next twelve months,
which
are not included in liabilities on the Company’s balance sheet at March 31,
2007. These lease obligations are included in cost of sales or selling,
general,
and administrative expense as the underlying lease obligation comes due,
in
accordance with accounting principles generally accepted in the
U.S.
CRITICAL
ACCOUNTING POLICIES
The
Company follows certain significant accounting policies when preparing
its
consolidated financial statements. A complete summary of these policies
is
included in Note 1 to the Consolidated Financial Statements included
in the
Company’s Form 10-K for fiscal year ended December 30, 2006.
Certain of the policies require management to make significant and subjective
estimates or assumptions that may deviate from actual results. In particular,
management makes estimates regarding valuation of inventories, estimates
of
useful life of long-lived assets related to depreciation and amortization
expense, estimates regarding fair value of the Company’s reporting units and
future cash flows with respect to assessing potential impairment of both
long-lived assets and goodwill, self-insurance, environmental and litigation
reserves, pension liability, estimates of income tax expense, and estimates
of
pro-forma expense related to stock options granted. Each of these estimates
is
discussed in greater detail in the following discussion.
Inventories
The
Company’s inventories are valued at the lower of cost or market. Finished
product manufacturing cost is calculated using the first-in, first-out
(FIFO)
method, based upon the Company’s raw material costs, collection and factory
production operating expenses, and depreciation expense on collection
and
factory assets. Market values of inventory are estimated at each plant
location,
based upon either the backlog of unfilled sales orders at the balance
sheet
date, or for unsold inventory, calculated based upon regional finished
product
prices quoted in the Jacobsen index at the balance sheet date. Estimates
of
market value, based upon the backlog of unfilled sales orders or upon
the
Jacobsen index, assume that the inventory held by the Company at the
balance
sheet date will be sold at the estimated market finished product sales
price,
subsequent to the balance sheet date. Actual sales prices received on
future
sales of inventory held at the end of a period may vary from either the
backlog
unfilled sales order price or the Jacobsen index quotation at the balance
sheet
date. These variances could cause actual sales prices realized on future
sales
of inventory to be different than the estimate of market value of inventory
at
the end of the period. Inventories were approximately $18.2 million and
$14.6
million at March 31, 2007 and December 30, 2006, respectively.
Long-Lived
Assets Depreciation and Amortization Expense and Valuation
The
Company’s property, plant and equipment are recorded at cost when acquired.
Depreciation expense is computed on property, plant and equipment based
upon a
straight line method over the estimated useful life of the assets, which
is
based upon a standard classification of the asset group. Buildings and
improvements are depreciated over a useful life of 15 to 30 years, machinery
and
equipment are depreciated over a useful life of 3 to 10 years and vehicles
are
depreciated over a life of 2 to 6 years. These useful life estimates
have been
developed based upon the Company’s historical experience of asset life utility,
and whether the asset is new or used when placed in service. The actual
life and
utility of the asset may vary from this estimated life. Useful lives
of the
assets may be modified from time to time when the future utility or life
of the
asset is deemed to change from that originally estimated when the asset
was
placed in service. Depreciation expense was approximately $4.5 million
and $3.1
million for the three months ended March 31, 2007 and April 1, 2006,
respectively. The increase in depreciation expense as compared to historical
amounts is primarily due to the Transaction.
The
Company’s intangible assets, including permits, routes and non-compete
agreements are recorded at fair value when acquired. Amortization expense
is
computed on these intangible assets based upon a straight line method
over the
estimated useful life of the assets, which is based upon a standard
classification of the asset group. Collection routes are amortized over
a useful
life of 8 to 20 years; non-compete agreements are amortized over a useful
life
of 3 to 10 years; and permits are amortized over a useful life of 20
years. The
actual economic life and utility of the asset may vary from this estimated
life.
Useful lives of the assets may be modified from time to time when the
future
utility or life of the asset is deemed to change from that originally
estimated
when the asset was placed in service. Intangible asset amortization expense
was
approximately $1.2 million and $1.0 million for the three months ended
March 31,
2007 and April 1, 2006, respectively. The increase in intangible amortization
expense as compared to historical amounts is primarily due to the
Transaction.
The
Company reviews the carrying value of long-lived assets for impairment
when
events or changes in circumstances indicate that the carrying amount
of an
asset, or related asset group, may not be recoverable from estimated
future
undiscounted cash flows. Recoverability of assets to be held and used
is
measured by a comparison of the carrying amount of an asset or asset
group to
estimated undiscounted future cash flows expected to be generated by
the asset
or asset group. If the carrying amount of the asset exceeds its estimated
future
cash flows, an impairment charge is recognized by the amount by which
the
carrying amount of the asset exceeds the fair value of the asset.
The
net
book value of property, plant and equipment was approximately $130.0
million and
$132.1 million at March 31, 2007 and December 30, 2006, respectively.
The net
book value of intangible assets was approximately $32.4 million and $33.7
million at March 31, 2007 and December 30, 2006, respectively.
Goodwill
Valuation
The
Company reviews the carrying value of goodwill on a regular basis, including
at
the end of each fiscal year, for indications of impairment at each reporting
unit that has recorded goodwill as an asset. Impairment is indicated
whenever
the carrying value of a reporting unit exceeds the estimated fair value
of a
reporting unit. For purposes of evaluating impairment of goodwill, the
Company
estimates fair value of each reporting unit based upon future discounted
net
cash flows from the reporting units. In calculating these estimates,
actual
historical operating results and anticipated future economic factors,
such as
future business volume, future finished product prices, and future operating
costs and expenses are evaluated and estimated as a component of the
calculation
of future discounted cash flows for each reporting unit with recorded
goodwill.
The estimates of fair value of the reporting units and of future discounted
net
cash flows from operation could change if actual volumes, prices, costs
or
expenses vary from these estimates. A future reduction of earnings in
the
reporting units with recorded goodwill could result in an impairment
charge
because the estimate of fair value would be negatively impacted by a
reduction
of earnings at those reporting units. Goodwill was approximately $71.9
million
at March 31, 2007 and December 30, 2006.
Self
Insurance, Environmental and Legal Reserves
The
Company’s workers compensation, auto and general liability policies contain
significant deductibles or self insured retentions. The Company estimates
and
accrues for its expected ultimate claim costs related to accidents occurring
during each fiscal year and carries this accrual as a reserve until these
claims
are paid by the Company. In developing estimates for self insured losses,
the
Company utilizes its staff, a third party actuary and outside counsel
as sources
of information and judgment as to the expected undiscounted future costs
of the
claims. The Company accrues reserves related to environmental and litigation
matters based on estimated undiscounted future costs. With respect to
the
Company’s self insurance, environmental and litigation reserves, estimates of
reserve liability could change if future events are different than those
included in the estimates of the actuary, consultants and management
of the
Company. The reserve for self insurance, environmental and litigation
contingencies included in accrued expenses and other non-current liabilities
was
approximately $22.5 million and $21.5 million at March 31, 2007 and December
30,
2006, respectively.
Pension
Liability
The
Company provides retirement benefits to employees under separate final-pay
noncontributory pension plans for salaried and hourly employees (excluding
those
employees covered by a union-sponsored plan) who meet service and age
requirements. Benefits are based principally on length of service and
earnings
patterns during the five years preceding retirement. Pension expense
and pension
liability recorded by the Company is based upon an annual actuarial estimate
provided by a third party administrator. Factors included in estimates
of
current year pension expense and pension liability at the balance sheet
date
include estimated future service period of employees, estimated future
pay of
employees, estimated future retirement ages of employees, and the projected
time
period of pension benefit payments. Two of the most significant assumptions
used
to calculate future pension obligations are the discount rate applied
to pension
liability and the expected rate of return on pension plan assets. These
assumptions and estimates are subject to the risk of change over time,
and each
factor has inherent uncertainties which neither the actuary nor the Company
is
able to control or to predict with certainty.
The
discount rate applied to the Company’s pension liability is the interest rate
used to calculate the present value of the pension benefit obligation.
The
discount rate is based on the yield of long-term corporate fixed income
securities at the measurement date of October 1 in the year of calculation.
The
Company considered the Citigroup Pension Discount Liability Index (5.83%
as of
October 1, 2006) as well as the Lehman A/AA/AAA Indices which combined
to
average 5.78% as of October 1, 2006. With estimated liability payment
streams
under the plans being 30 to 40 years out and no bonds available with
maturity
dates that far into the future, but with the yield curve historically
flat, the
Company believes it is appropriate to reference from the Citigroup and
Lehman
bond rates. The weighted average discount rate was 5.75% in fiscal 2006.
The net
periodic benefit cost for fiscal 2007 would increase by approximately
$0.8
million if the discount rate was 0.5% lower at 5.25%. The net periodic
benefit
cost for fiscal 2007 would decrease by approximately $0.7 million if
the
discount rate was 0.5% higher at 6.25%.
The
expected rate of return on the Company’s pension plan assets is the interest
rate used to calculate future returns on investment of the plan assets.
The
expected return on plan assets is a long-term assumption whose accuracy
can only
be assessed over a long period of time. The weighted average expected
return on
pension plan assets was 8.38% for fiscal 2006.
The
Company has recorded a pension liability of approximately $19.1 million
and
$18.7 million at March 31, 2007 and December 30, 2006, respectively.
The
Company’s net pension cost was approximately $0.7 million and $0.9 million for
the three months ended March 31, 2007 and April 1, 2006,
respectively.
Income
Taxes
In
calculating net income, the Company includes estimates in the calculation
of tax
expense, the resulting tax liability and in future utilization of deferred
tax
assets that arise from temporary timing differences between financial
statement
presentation and tax recognition of revenue and expense. The Company’s deferred
tax assets include a net operating loss carry-forward which is limited
to
approximately $0.7 million per year in future utilization due to the
change in
majority control resulting from the May 2002 recapitalization of the
Company.
Valuation allowances for deferred tax assets are recorded when it is
more likely
than not that deferred tax assets will expire before they are utilized
and the
tax benefit is realized. Based upon the Company’s evaluation of these matters, a
significant portion of the Company’s net operating loss carry-forwards will
expire unused. The valuation allowance established to provide a reserve
against
these deferred tax assets was approximately $9.4 million at March 31,
2007 and
December 30, 2006.
Stock
Option Expense
Effective
January 1, 2006, the Company adopted the provisions of SFAS 123(R) and
related
interpretations, using the modified prospective method. The calculation
of
expense of stock options issued utilizes the Black-Scholes mathematical
model
which estimates the fair value of the option award to the holder and
the
compensation expense to the Company, based upon estimates of volatility,
risk-free rates of return at the date of issue and projected vesting
of the
option grants. The Company recorded compensation expense related to stock
options expense of $0.2 million and $0.1 million for the three months
ended
March 31, 2007 and April 1, 2006, respectively.
NEW
ACCOUNTING PRONOUNCEMENTS
In
September 2006, the FASB issued SFAS 157,
which
defines fair value, establishes a framework for measuring fair value
and expands
disclosures about fair value measurements. The provisions of SFAS 157
are
effective as of the beginning of fiscal year 2008. The Company is currently
evaluating the impact of adopting SFAS 157 on the consolidated financial
statements.
In
February 2007, the FASB issued SFAS 159,
which
allows entities to choose to measure financial instruments and certain
other
items at fair value. This statement is effective for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the impact
of
adopting SFAS 159 on the consolidated financial statements.
FORWARD
LOOKING STATEMENTS
This
Quarterly Report on Form 10-Q includes “forward-looking” statements that involve
risks and uncertainties. The words “believe,” “anticipate,” “expect,”
“estimate,” “intend” and similar expressions identify forward-looking
statements. All statements other than statements of historical facts
included in
the Quarterly Report on Form 10-Q, including, without limitation, the
statements
under the section entitled “Business,” “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” and “Legal Proceedings” and
located elsewhere herein regarding industry prospects and the Company’s
financial position are forward-looking statements. Actual results could
differ
materially from those discussed in the forward-looking statements as
a result of
certain factors. Although the Company believes that the expectations
reflected
in such forward-looking statements are reasonable, it can give no assurance
that
such expectations will prove to be correct.
In
addition to those factors discussed in this report and under the heading
“Risk
Factors” in Item 1A of Part I of the Company’s annual report on Form 10-K for
the year ended December 30, 2006, and in the Company’s other public filings with
the SEC, important factors that could cause actual results to differ
materially
from the Company’s expectations include:
the Company’s continued ability to obtain sources of supply for its rendering
operations; general economic conditions in the American, European and
Asian markets; prices in the competing commodity markets, which are
volatile and are beyond the Company’s control; BSE and its impact on finished
product prices, export markets, energy prices and government regulations,
which
are still evolving and are beyond the Company’s control; the occurrence of
Bird Flu in the U.S.; possible product recall resulting from developments
relating to the discovery of unauthorized adulterations to food additives;
and
increased contributions to the Company’s multi-employer defined benefit pension
plans as required by the PPA. Among other things, future
profitability may be affected by the Company’s ability to grow its business,
which faces competition from companies that may have substantially greater
resources than the Company. The Company cautions readers that all
forward-looking statements speak only as of the date made, and the Company
undertakes no obligation to update any forward-looking statements, whether
as a
result of changes in circumstances, new events or otherwise.
ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISKS
Market
risks affecting the Company are exposures to changes in prices of the
finished
products the Company sells, interest rates on debt, availability of raw
material
supply and the price of natural gas used in the Company’s plants. Raw materials
available to the Company are impacted by seasonal factors, including
holidays,
when raw material volume declines; warm weather, which can adversely
affect the
quality of raw material processed and finished products produced; and
cold
weather, which can impact the collection of raw material. Predominantly
all of
the Company’s finished products are commodities that are generally sold at
prices prevailing at the time of sale.
The
Company makes limited use of derivative instruments to manage cash flow
risks
related to interest and natural gas expense. The Company uses interest
rate
swaps with the intent of managing overall borrowing costs by reducing
the
potential impact of increases in interest rates on floating-rate long-term
debt.
The interest rate swaps are subject to the requirements of SFAS
133.
The
Company’s natural gas instruments are not subject to the requirements of
SFAS
133,
because
the natural gas instruments qualify as normal purchases as defined in
SFAS 133.
The
Company does not use derivative instruments for trading purposes.
On
May
19, 2006, the Company entered into two interest rate swap agreements
that are
considered cash flow hedges according to SFAS 133. Under the terms of
these swap
agreements, beginning June 30, 2006, the cash flows from the Company’s $50.0
million floating-rate term loan facility under the Credit Agreement have
been
exchanged for fixed rate contracts that bear interest, payable quarterly.
The
first swap agreement for $25.0 million matures April 7, 2012 and bears
interest
at 5.42%, which does not include the borrowing spread per the Credit
Agreement,
with amortizing payments that mirror the term loan facility. The second
swap
agreement for $25.0 million matures April 7, 2012 and bears interest
at 5.415%,
which does not include the borrowing spread per the Credit Agreement,
with
amortizing payments that mirror the term loan facility. The Company’s receive
rate on each swap agreement is based on three-month LIBOR. At March 31,
2007,
the fair value of these interest swap agreements was $0.8 million and
is
included in non-current liabilities on the balance sheet, with an offset
recorded to accumulated other comprehensive income.
As
of
March 31, 2007, the Company had forward purchase agreements in place
for
purchases of approximately $2.0 million of natural gas for the month
of April
2007. As of March 31, 2007, the Company had forward purchase agreements
in place
for purchases of approximately $1.4 million of finished product for the
month of
April 2007.
ITEM
4. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures.
As
required by Exchange Act Rule 13a-15(b), the Company's management, including
the
Chief Executive Officer and Chief Financial Officer, conducted an evaluation,
as
of the end of the period covered by this report, of the effectiveness
of the
design and operation of the Company's disclosure controls and procedures.
As
defined in Exchange Act Rules 13a-15(e) and 15d-15(e) under the Exchange
Act,
disclosure controls and procedures are controls and other procedures
of the
Company that are designed to ensure that information required to be disclosed
by
the Company in the reports it files or submits under the Exchange Act
is
recorded, processed, summarized and reported within the time periods
specified
in the SEC's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports it files or submits
under
the Exchange Act is accumulated and communicated to the Company's management,
including the Chief Executive Officer and Chief Financial Officer, as
appropriate to allow timely decisions regarding required disclosure.
Because of
its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with
the
policies or procedures may deteriorate.
Based
on
management’s evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that the Company's disclosure controls and procedures were
effective
as of the end of the period covered by this report.
Changes
in Internal Control over Financial Reporting.
As
required by Exchange Act Rule 13a-15(d), the Company’s management, including the
Chief Executive Officer and Chief Financial Officer, also conducted an
evaluation of the Company’s internal control over financial reporting to
determine whether any change occurred during the quarter covered by this
report
that has materially affected, or is reasonably likely to materially affect,
the
Company’s internal control over financial reporting. Based on that evaluation,
there has been no change in the Company’s internal control over financial
reporting during the quarter covered by this report that has materially
affected, or is reasonably likely to materially affect, the Company’s internal
control over financial reporting.
On
May
15, 2006, the Company completed the acquisition of substantially all
of the
assets of NBP. The Company is currently in the process of integrating
these
acquired assets pursuant to the Sarbanes Act. Under the Sarbanes Act,
the
Company is not required to include NBP assets in its assessment of its
internal
control over financial reporting for SEC reports until the period ended
December
29, 2007. The impact of the acquisition of these acquired assets has
not
materially affected and is not likely to materially affect the Company's
internal control over financial reporting. However, as a result of the
Company's
integration activities, and possible further changes to the Company’s operations
and systems, controls will be periodically changed. The Company believes,
however, it will be able to maintain sufficient controls over the substantive
results of its financial reporting throughout this integration process.
DARLING
INTERNATIONAL INC. AND SUBSIDIARIES
FORM
10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2007
PART
II: Other Information
Item
6. EXHIBITS.
The
following exhibits are filed herewith:
31.1
|
Certification pursuant to Rule 13a-14(a)
or Rule
15d-14(a) of the Securities Exchange Act of 1934, of Randall
C. Stuewe,
the Chief Executive Officer of the Company.
|
31.2
|
Certification pursuant to Rule 13a-14(a)
or Rule
15d-14(a) of the Securities Exchange Act of 1934, of John O.
Muse, the
Chief Financial Officer of the Company.
|
32
|
Certification
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of
the Sarbanes-Oxley Act of 2002, of Randall C. Stuewe, the Chief
Executive
Officer of the Company, and of John O. Muse, the Chief Financial
Officer
of the Company.
|
SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant
has
duly caused this report to be signed on its behalf by the undersigned
thereunto
duly authorized.
DARLING INTERNATIONAL INC.
Date: May 10, 2007 By:
/s/
Randall C. Stuewe
Randall C. Stuewe
Chairman and
Chief Executive Officer
Date: May 10, 2007 By:
/s/
John O. Muse
John
O.
Muse
Executive
Vice President
Administration
and Finance
(Principal
Financial Officer)
33