(Mark One)
/X/ QUARTERLY REPORT PURSUANT TO
SECTION 13 or 15(d) OF THE
SECURITIES
EXCHANGE
ACT OF
1934
For
the quarterly period ended July 3, 2004
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 No.) |
251 O'CONNOR RIDGE BLVD., SUITE 300, IRVING, TEXAS
75038
(Address of principal executive offices)
(972)
717-0300
(Registrant's telephone number)
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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes / / No /X/
There were 63,897,346 shares of common stock, $0.01 par value, outstanding at August 10, 2004.
Page 1
DARLING INTERNATIONAL INC. AND SUBSIDIARIES
FORM 10-Q FOR THE THREE MONTHS ENDED JULY 3, 2004
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
| Item 1. FINANCIAL STATEMENTS | |||
| Consolidated Balance Sheets July 3, 2004 (unaudited) and January 3, 2004 |
3 | ||
| Consolidated Statements of Operations (unaudited) Three and Six Months Ended July 3, 2004 and June 28, 2003 |
4 | ||
| Consolidated Statements of Cash Flows (unaudited) Six Months Ended July 3, 2004 and June 28, 2003 |
5 | ||
| Notes to Consolidated Financial Statements (unaudited) |
6 | ||
| Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
15 | ||
| Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
30 | ||
| Item 4. CONTROLS AND PROCEDURES |
30 | ||
PART II: OTHER INFORMATION
| Item 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
31 | ||
| Item 6.
EXHIBITS AND REPORTS ON FORM 8-K |
31 | ||
| Signatures | 33 | ||
Page 2
DARLING INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
July 3, 2004 and January 3, 2004
(in thousands, except shares and per share data)
July 3, January 3,
2004 2004
------------ ------------
ASSETS (unaudited)
- -------
Current assets:
Cash and cash equivalents ................................... $ 36,509 $ 25,383
Accounts receivable ......................................... 24,885 29,353
Inventories ................................................. 7,494 7,837
Prepaid expenses ............................................ 5,101 4,509
Deferred income taxes ....................................... 3,371 3,937
Assets held for sale ........................................ 706 1,160
Other ....................................................... 31 16
--------- ---------
Total current assets .................................... 78,097 72,195
Property, plant and equipment, less accumulated depreciation
of $162,231 at July 3, 2004 and $161,051 at January 3, 2004 ... 71,828 73,274
Collection routes and contracts, less accumulated amortization of
$27,257 at July 3, 2004 and $28,118 at January 3, 2004 ........ 17,485 19,458
Goodwill, less accumulated amortization of $1,077 at July 3, 2004
and January 3, 2004 ........................................... 4,429 4,429
Deferred loan costs .............................................. 3,842 2,986
Other assets ..................................................... 3,876 2,307
--------- ---------
$ 179,557 $ 174,649
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current portion of long-term debt ........................... $ 5,036 $ 7,489
Accounts payable, principally trade ......................... 7,173 9,059
Accrued expenses ............................................ 28,444 24,132
Accrued interest ............................................ 241 326
--------- ---------
Total current liabilities ............................... 40,894 41,006
Long-term debt, net .............................................. 53,796 48,188
Other non-current liabilities .................................... 17,361 16,083
Deferred income taxes ............................................ 3,819 4,878
Redeemable preferred stock, $0.01 par value, 1,000,000 shares
authorized, 100,000 shares outstanding ........................ - 9,212
--------- ---------
Total liabilities ....................................... 115,870 119,367
--------- ---------
Stockholders' equity:
Common stock, $0.01 par value; 100,000,000 shares authorized;
63,885,346 and 63,654,240 shares issued and outstanding at
July 3, 2004 and at January 3, 2004, respectively ........ 639 637
Additional paid-in capital .................................. 77,290 77,179
Treasury stock, at cost; 21,000 shares at July 3, 2004 and
January 3, 2004 ........................................ (172) (172)
Accumulated other comprehensive loss ........................ (5,285) (5,176)
Accumulated deficit ......................................... (8,785) (17,186)
--------- ---------
Total stockholders' equity .............................. 63,687 55,282
--------- ---------
Commitments and contingencies
$ 179,557 $ 174,649
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
DARLING INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three months and six months ended July 3, 2004 and June 28, 2003
(in thousands, except per share data)
(unaudited)
Three Months Ended Six Months Ended
--------------------------- ------------------------
July 3, June 28, July 3, June 28,
2004 2003 2004 2003
---------- ---------- --------- ----------
Net sales ....................................... $ 91,509 $ 78,536 $ 169,233 $ 147,187
--------- --------- --------- ---------
Costs and expenses:
Cost of sales and operating expenses ....... 67,309 60,033 125,528 111,083
Selling, general and administrative expenses 9,175 8,879 18,193 17,399
Depreciation and amortization .............. 3,971 3,623 7,746 7,280
--------- --------- --------- ---------
Total costs and expenses ................ 80,455 72,535 151,467 135,762
--------- --------- --------- ---------
Operating income ........................ 11,054 6,001 17,766 11,425
--------- --------- --------- ---------
Other income (expense):
Interest expense ........................... (1,800) (419) (3,560) (911)
Other, net ................................. (1,734) (453) (339) 130
--------- --------- --------- ---------
Total other income (expense) ........... (3,534) (872) (3,899) (781)
--------- --------- --------- ---------
Income before income taxes ...................... 7,520 5,129 13,867 10,644
Income taxes .................................... (3,054) (1,949) (5,466) (4,045)
--------- --------- --------- ---------
Net income ...................................... 4,466 3,180 8,401 6,599
Preferred dividends and accretion .......... - (342) - (697)
--------- --------- --------- ---------
Net income applicable to common shareholders $ 4,466 $ 2,838 $ 8,401 $ 5,902
========= ========= ========= =========
Basic income per share: ......................... $ 0.07 $ 0.05 $ 0.13 $ 0.10
========= ========= ========= =========
Diluted income per share: ....................... $ 0.07 $ 0.05 $ 0.13 $ 0.09
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
DARLING INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended July 3, 2004 and June 28, 2003
(in thousands)
(unaudited)
Six Months Ended
--------------------------
July 3, June 28,
2004 2003
--------- ----------
Cash flows from operating activities:
Net income ....................................................... $ 8,401 $ 6,599
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation and amortization ................................. 7,746 7,280
Gain on disposal of property, plant, equipment and other assets (341) (11)
Gain on early extinguishment of debt .......................... (1,306) (555)
Loss on early redemption of preferred stock ................... 1,678 -
Deferred taxes ................................................ (493) -
Changes in operating assets and liabilities:
Accounts receivable .......................................... 4,468 945
Inventories and prepaid expenses ............................. (249) (4,054)
Accounts payable and accrued expenses ........................ 2,534 1,905
Accrued interest ............................................. (85) 48
Other ........................................................ 793 (248)
--------- ---------
Net cash provided by operating activities ................ 23,146 11,909
--------- ---------
Cash flows from investing activities:
Capital expenditures ............................................. (4,377) (4,876)
Business acquisitions ............................................ - (1,131)
Gross proceeds from disposal of property, plant and equipment
and other assets .............................................. 447 28
--------- ---------
Net cash used by investing activities ................... (3,930) (5,979)
--------- ---------
Cash flows from financing activities:
Proceeds from debt ............................................... 92,302 102,662
Payments on debt ................................................. (87,080) (108,692)
Deferred loan costs .............................................. (2,078) -
Redemption of preferred stock .................................... (10,000) -
Payment of preferred dividends ................................... (1,240) -
Contract payments ................................................ (107) (180)
Issuance of common stock ......................................... 113 4
--------- ---------
Net cash used by financing activities ................... (8,090) (6,206)
--------- ---------
Net increase (decrease) in cash and cash equivalents .................. 11,126 (276)
Cash and cash equivalents at beginning of period ...................... 25,383 15,537
--------- ---------
Cash and cash equivalents at end of period ............................ $ 36,509 $ 15,261
========= =========
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest ..................................................... $ 3,011 $ 1,950
========= =========
Income taxes, net of refunds ................................. $ 3,427 $ 2,772
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
Page 5
DARLING INTERNATIONAL INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
July 3, 2004
(unaudited)
| (1) | General |
| The accompanying consolidated financial statements for the three month and six month periods ended July 3, 2004 and June 28, 2003 have been prepared in accordance with generally accepted accounting principles in the United States of America by Darling International Inc. (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) which 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 January 3, 2004. |
| (2) | Summary of Significant Accounting Policies |
| (a) | Basis of Presentation |
| The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. |
| (b) | Fiscal Periods |
| 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 July 3, 2004, and include the 13 and 26 weeks ended July 3, 2004, and the 13 and 26 weeks ended June 28, 2003. |
| (c) | Earnings per Share |
| Basic income per common share is computed by dividing net earnings attributable to outstanding common stock by the weighted average number of common shares outstanding during the period. Diluted income per common share is computed by dividing net earnings attributable to outstanding common stock by the weighted average number of common shares outstanding during the period increased by dilutive common equivalent shares (stock options) determined using the treasury stock method, based on the average market price exceeding the exercise price of the stock options. |
Page 6
| Pro forma treasury shares represent the shares which potentially may be reacquired by the Company as treasury shares from the proceeds of option shares for which the contractual exercise price is less than the market price (“in the money”), based upon a reacquisition price equal to the average market price of the Company’s common shares during the period presented. |
Net Income Per Common Share (in thousands, except per share data)
-----------------------------------------------------------------------
Three Months Ended
-----------------------------------------------------------------------
July 3, June 28,
2004 2003
--------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
---------- --------- ------------ --------- --------- ----------
Net income $4,466 63,851 $0.07 $3,180 62,289 $0.05
Less: Preferred dividends and accretion - - (342) -
------- ------ ------ ------- ------ -----
Basic:
Income available to common shareholders 4,466 63,851 0.07 2,838 62,289 0.05
Effect of dilutive securities:
Add: Option shares in the money 1,046 2,087
Less: Pro forma treasury shares (398) (1,057)
------ -------
Diluted:
Income available to common shareholders $4,466 64,499 $0.07 $2,838 63,319 $0.05
------- ------- ------- ------- ------- -----
-----------------------------------------------------------------------
Six Months Ended
-----------------------------------------------------------------------
July 3, June 28,
2004 2003
--------------------------------- ----------------------------------
Income Shares Per Share Income Shares Per Share
---------- --------- ------------ --------- --------- ----------
Net income $8,401 63,786 $0.13 $6,599 62,285 $0.11
Less: Preferred dividends and accretion - - (697) (0.1)
------- ------ ------ ------- ------ -----
Basic:
Income available to common shareholders 8,401 63,786 0.13 5,902 62,285 0.10
Effect of dilutive securities:
Add: Option shares in the money 1,038 2,087
Less: Pro forma treasury shares (452) (1,069)
------ -------
Diluted:
Income available to common shareholders $8,401 64,372 $0.13 $5,902 63,303 $0.09
------- ------- ------- ------- ------- -----
| For the six months ended July 3, 2004 and June 28, 2003, respectively, 81,000 and 1,062,430 outstanding stock options were excluded from diluted income per common share as the effect was antidilutive. |
Page 7
| (d) | Accounting for Stock-Based Compensation |
| The Company accounts for its stock option plan in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. |
| The following table illustrates the effect on net income and income per share if the fair value-based method had been applied to all outstanding and invested awards in each period. |
| Three Months Ended |
|||||||||
| July 3, 2004 |
June 28, 2003 |
||||||||
| amount |
per share |
amount |
per share |
||||||
| |
Reported net income applicable to common shareholders |
$4,466 |
|
$0.07 |
|
$2,838 |
|
$ 0.05 |
|
| Deduct total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax | (88) |
- |
(95) |
(0.01) |
|||||
| Pro forma | $4,378 |
|
$0.07 |
|
$2,743 |
|
$0.04 |
||
| Six Months Ended |
|||||||||
| July 3, 2004 |
June 28, 2003 |
||||||||
| amount |
per share |
amount |
per share |
||||||
| |
Reported net income applicable to common shareholders |
$8,401 |
|
$0.13 |
|
$5,902 |
|
$ 0.10 |
|
| Deduct total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax | (173) |
- |
(189) |
(0.01) |
|||||
| Pro forma | $8,228 |
|
$0.13 |
|
$5,713 |
|
$0.09 |
||
| (3) | Contingencies |
| LITIGATION |
| The Company is a party to several lawsuits, claims and loss contingencies incidental to its business, including assertions by certain regulatory agencies related to air, wastewater, and storm water discharges from the Company’s processing facilities. |
| Self Insured Risks |
| The Company purchases its workers compensation, auto and general liability insurance on a retrospective basis. The Company estimates and accrues its expected ultimate costs related to claims 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 July 3, 2004 and January 3, 2004, the reserves for insurance, environmental and litigation contingencies reflected on the balance sheet in accrued expenses and other non-current liabilities were approximately $14.4 million and $14.0 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 any additional liability relative to such lawsuits and claims which may not be covered by insurance would not likely have a material adverse effect on the Company’s financial position, although it could potentially have a material impact on the results of operations in any one year. |
Page 8
| (4) | Business Segments |
| The Company operates on a worldwide basis within two industry segments: Rendering and Restaurant Services. The measure of segment profit 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. During the first quarter of Fiscal 2004, the Company increased the allocation of plant selling, general and administrative expense to the Restaurant Services segment, which resulted in additional expense of $0.5 million and $1.3 million of expense allocated to this segment during the second quarter and first six months of Fiscal 2004, respectively. |
| 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. |
| Rendering Rendering consists of the collection and processing of animal by-products from butcher shops, grocery stores and independent meat and poultry processors, converting these by-products into similar products such as useable oils and proteins utilized by the agricultural and oleochemical industries. Restaurant Services Restaurant Services consists of the collection of used cooking oils from food service establishments and recycling them into similar products such as high-energy animal feed ingredients and industrial oils. Restaurant Services also provides grease trap servicing and equipment sales. |
| Business Segment Net Sales (in thousands): |
| Three Months Ended |
Six Months Ended |
|||||||
| July 3, 2004 |
June 28, 2003 |
July 3, 2004 |
June 28, 2003 |
|||||
| Rendering: | ||||||||
| Trade | $58,858 | $51,328 | $108,218 | $ 97,481 | ||||
| Intersegment | 8,035 |
5,966 |
13,525 |
12,875 |
||||
| 66,893 |
57,294 |
121,743 |
110,356 |
|||||
| Restaurant Services: | ||||||||
| Trade | 32,651 | 27,208 | 61,015 | 49,706 | ||||
| Intersegment | 3,176 |
4,138 |
5,937 |
7,141 |
||||
| 35,827 |
31,346 |
66,952 |
56,847 |
|||||
| Eliminations | (11,211) |
(10,104) |
(19,462) |
(20,016) |
||||
| Total | $91,509 |
$78,536 |
$169,233 |
$147,187 |
||||
Page 9
| Business Segment Profit (in thousands): |
| Three Months Ended |
Six Months Ended |
|||||||
| July 3, 2004 |
June 28, 2003 |
July 3, 2004 |
June 28, 2003 |
|||||
| Rendering | $11,010 | $5,925 | $17,129 | $10,736 | ||||
| Restaurant Services | 6,408 | 5,785 | 12,706 | 11,818 | ||||
| Corporate Activities | (11,152) | (8,111) | (17,874) | (15,044) | ||||
| Interest Expense | (1,800) |
(419) |
(3,560) |
(911) |
||||
| Net Income | $4,466 |
$3,180 |
$8,401 |
$6,599 |
||||
| 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 Combined Rendering/Restaurant Services. Depreciation of Combined Rendering/Restaurant Services assets is allocated based upon an estimate of the percentage of corresponding activity attributed to each segment. |
| Business Segment Assets (in thousands): |
| July 3, 2004 |
January 3, 2004 |
||||
| Rendering | $ 48,492 | $ 52,931 | |||
| Restaurant Services | 16,172 | 13,853 | |||
| Combined Rendering/Restaurant Services | 61,268 | 67,291 | |||
| Corporate | 53,625 |
40,574 |
|||
| Total | $179,557 |
$174,649 |
| (5) | Income Taxes |
|
The Company has provided income taxes for the three-month and six-month periods ended July 3, 2004,
based on its estimate of the effective tax rate for the entire 2004 fiscal year. In determining whether its deferred tax assets are more likely to be recoverable, than not recoverable, the Company assessed its ability to carryback net operating losses, scheduled reversals of future taxable and deductible amounts, tax planning strategies, and the extent of 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 not provide sufficient historical evidence at this time of sustained future profitability sufficient to result in taxable income against which the net operating losses can be carried forward and utilized. |
Page 10
| (6) | Financing |
| (a) | Refinancing - Senior Credit Agreement |
| The Company entered into a new Senior Credit Agreement with new lenders on April 2, 2004, and entered into a new lender acknowledgement on May 28, 2004, that increased the committed amount as permitted by the Senior Credit Agreement. The refinancing replaces the prior Amended and Restated Credit Agreement executed on May 13, 2002. The new Senior Credit Agreement provides for $75 million in financing facilities, has a term of five years, maturing on April 2, 2009, and bears interest at a rate which may be based upon either prime or LIBOR, or a combination of both rates plus a margin which may be adjusted quarterly based upon the Company’s leverage ratios. The new Senior Credit Agreement provides for a $25.0 million Term Loan Facility, with scheduled amortization of $1.25 million each quarter during the five-year agreement. Additionally, the new Senior Credit Agreement provides for a $50 million Revolver Facility which includes a $25.0 million Letter of Credit sub-facility. At July 3, 2004, the interest rate for $0.25 million of the term loan was based upon a prime rate of 4.25% per annum, plus a margin of 1.5% per annum for a total of 5.75% per annum. The interest rate at July 3, 2004 for the remaining $23.5 million term loan was based upon a three-month LIBOR rate of 1.49% per annum plus a margin of 2.75% per annum for a total of 4.24% per annum. |
| The refinancing provides increased availability and liquidity, an extended term, lower interest rates, and more flexible capital investment limitations than the prior Amended and Restated Credit Agreement. Restrictive covenants in the Company’s new Senior Credit Agreement permit the Company, within limitations defined in the new Senior Credit Agreement, to incur additional indebtedness; issue additional capital or preferred stock; pay dividends; redeem common shares as treasury stock; create liens; merge, consolidate, or acquire other businesses; sell and dispose of assets; and make investments; and requires the maintenance of certain minimum financial ratios. |
| On April 2, 2004, proceeds of the new Term Loan Facility were used to pay off the outstanding balance of the prior Amended and Restated Credit Agreement of approximately $18.0 million. Additional proceeds were used for other general corporate and working capital purposes. The terms of the new Senior Credit Agreement required the Company to redeem the Company’s preferred stock during the second quarter of 2004. As such, the remaining proceeds and cash on hand were used to redeem the Company’s preferred stock at face value of $10.0 million plus accumulated preferred dividends of approximately $1.2 million, for a total aggregate consideration of $11.2 million. The preferred stock had a carrying value of approximately $9.5 million at April 3, 2004. Consequently, redemption of the preferred stock and accumulated dividends during the second quarter of 2004 resulted in a loss on extinguishment of approximately $1.7 million, which is included in other expense. |
| On May 13, 2002, the Company consummated a recapitalization and executed the prior Amended and Restated Credit Agreement with its lenders. The prior Amended and Restated Credit Agreement reflects the effect of applying the provisions of Statement of Financial Accounting Standards No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings (“SFAS No. 15”). SFAS No. 15 requires that the previously existing amount of debt owed by the Company to the lenders be reduced by the fair value of the equity interest granted and that no gain from restructuring the Company’s bank debt be recognized. As a result, the carrying amount of the debt of $20.6 million exceeded its contractual amount of $18.3 million by $2.3 million at January 3, 2004. The outstanding balance of the prior Amended and Restated Credit Agreement at April 2, 2004 of approximately $20.1 million was reduced to zero through a payment of approximately $18.0 million in cash proceeds from the new Senior Credit Agreement. The remaining balance related to the SFAS 15 effect of approximately $2.1 million was recorded as a gain on early retirement of debt, included in other income in the operating statement, net of related deferred loan costs of approximately $0.8 million, also extinguished upon payment of the related debt, which results in a net gain on early retirement of debt of approximately $1.3 million recorded in the first quarter of Fiscal 2004. |
Page 11
| (b) | Senior Subordinated Notes |
| On December 31, 2003, the Company issued Senior Subordinated Notes in the amount of $35,000,000 and applied the net proceeds of such issuance to reduce the outstanding term loan portion of its prior Amended and Restated Credit Agreement executed on May 13, 2002. The Senior Subordinated Notes have a term of six years, maturing on December 31, 2009. Interest accrues on the outstanding principal balance of the Notes at an annual rate of 12% that is payable quarterly in arrears. Restrictive covenants in the Notes permit the Company, within limitations defined in the Notes, to incur additional indebtedness and to pay cash dividends. |
| The Company’s new Senior Credit Agreement, Senior Subordinated Notes, and prior Amended and Restated Credit Agreement consisted of the following elements at July 3, 2004 and January 3, 2004, respectively (in thousands): |
July 3, January 3,
2004 2004
----------- -------------
Senior Credit Agreement:
Term Loan $ 23,750 -
========= =========
Revolving Credit Facility:
Maximum availability $ 50,000 -
Borrowings outstanding - -
Letters of credit issued 13,083 -
--------- ---------
Availability $ 36,917 -
========= =========
Senior Subordinated Notes Payable: $ 35,000 $ 35,000
========= =========
Prior Amended and Restated Credit Agreement:
Term Loan:
Contractual amount - $18,266
SFAS 15 effect - 2,303
--------- ---------
Carrying amount - $20,569
========= =========
Revolving Credit Facility:
Maximum availability - $17,337
Borrowings outstanding - -
Letters of credit issued - 10,450
--------- ---------
Availability - $ 6,887
========= =========
| Substantially all of the Company’s assets are either pledged or mortgaged as collateral for borrowings under the new Senior Credit Agreement. The new Senior Credit Agreement contains certain terms and covenants which permit the incurrence of additional indebtedness, the payment of cash dividends, the retention of certain proceeds from sales of assets, and capital expenditures, within limitations defined by the new Senior Credit Agreement, and require the maintenance of certain minimum financial ratios. |
| (7) | Derivative Instrumenets |
| The Company makes limited use of derivative instruments to manage cash flow risks related to natural gas expense. The Company does not use derivative instruments for trading purposes. |
Page 12
| Through July 3, 2004, the Company had forward purchase agreements in place for purchases of approximately $0.9 million of natural gas. These agreements have no net settlement provisions and the Company intends to take physical delivery, which it has done under similar forward purchase agreements, during Fiscal 2003 and the first six months of Fiscal 2004. Accordingly, the agreements are not subject to the requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), because they qualify as normal purchases as defined in the standard. |
| At July 3, 2004, the Company was party to natural gas swap agreements representing 90,000 mmbtu’s of natural gas per month for the months of July, August, September and October 2004, with a NYMEX purchase price of approximately $6.48/mmbtu. At July 3, 2004, the fair value of the Company’s positions in these swap agreements was a liability of $0.1 million. The Company has designated the natural gas swap agreements as cash flow hedges and such agreements qualify for hedge accounting under SFAS 133. |
| (8) | Comprehensive Income |
| The Company follows the provisions of Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income (“SFAS 130”). SFAS 130 establishes standards for reporting and presentation of comprehensive income or loss and its components. Total comprehensive income for the six months ended July 3, 2004, and June 28, 2003, were $8.3 million and $6.6 million, respectively. |
| (9) | Revenue Recognition |
| 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) | Assets Held for Sale |
| Assets held for sale consist of the following (in thousands): |
| July 3, 2004 |
|
January 3, 2004 |
|||
| Petaluma, CA | $ 497 | $ 497 | |||
| Tyler, TX | 183 | 183 | |||
| London, Ontario Canada | 26 | - | |||
| Billings, MT | - | 421 | |||
| Oklahoma City, OK | - |
59 |
|||
| $706 |
$1,160 |
| Assets held for sale are carried at the lower of cost, less accumulated depreciation, or fair value. The assets are expected to be sold within the next 12 months. These assets were previously utilized in rendering operations. The Billings, MT location was reclassified to operating property, plant and equipment and prepaid costs of sale during the second quarter of Fiscal 2004 because the sale of the asset is not expected to occur within the next twelve months. The Company has signed a letter of intent to sell its transfer station at London, Ontario, Canada. An agreement to consummate the sale is being negotiated with the potential buyer. From time to time, the Company receives offers from prospective buyers of Company assets. Until the offers meet criteria established by the Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long Lived Assets (“SFAS No. 144”), the assets remain classified as property, plant and equipment. The Company’s Oklahoma City, OK site was sold during the first quarter of Fiscal 2004. |
Page 13
| (11) | 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
pension plans for all salaried and hourly employees (excluding those covered by
union-sponsored plans) who meet service and age requirements. Benefits are based
principally on length of service and earnings patterns during the five years preceding
retirement. Net pension cost for the six months ended July 3, 2004 and June 28, 2003 includes the following components (in thousands): |
| July 3, 2004 |
June 28, 2003 |
||||
| Service cost | $ 876 | $ 716 | |||
| Interest cost | 1,992 | 1,912 | |||
| Expected return on plan assets | (2,019) | (1,852) | |||
| Amortization of prior service cost | 70 | 64 | |||
| Amortization of net (gain) loss | 434 |
331 |
|||
| Net pension cost | $1,353 |
$1,171 |
| 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. The Company contributed $0.5 million to its pension plan in the second quarter of Fiscal 2004 in order to meet minimum funding requirements, which reduced current accrued expenses on the Company’s balance sheet at July 3, 2004. The Company plans to make a voluntary contribution of $0.8 million during the third quarter of Fiscal 2004. |
Page 14
| 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 January 3, 2004, 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
Darling International Inc. is a recycler of food and animal by-products and provides grease trap services to food service establishments. The Company collects and recycles animal by-products and used cooking oil from food service establishments. The Company processes such raw materials at 24 facilities located throughout the United States, into finished products such as protein (primarily meat and bone meal, “MBM”), tallow (primarily bleachable fancy tallow, “BFT”), and yellow grease (“YG”). The Company sells these products nationally and internationally, primarily to producers of oleo-chemicals, soaps, pet foods, and livestock feed, for use as ingredients in their products or for further processing. The Company’s operations are currently organized into two segments: rendering and restaurant services. 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 January 3, 2004.
Major challenges faced by the Company during the second quarter of Fiscal 2004 included the impact of the occurrence of a single case of bovine spongiform encephalopathy (“BSE”) or “mad cow disease” in the United States at the end of Fiscal 2003 and a single case of BSE in Canada in late spring of Fiscal 2003. The impact of BSE is still not completely identified or known, but recent events are summarized in the sections which follow. Management of the Company expects continued uncertainties relative to BSE and potential new government regulations and expects its impact to remain fluid during the remainder of Fiscal 2004 and thereafter. During the second quarter of Fiscal 2004, high average finished product commodity prices were partially offset by the negative impact of high raw material prices and high diesel fuel costs. Management also expects high energy prices to continue throughout Fiscal 2004. The effects of these challenges during the second quarter and year-to-date Fiscal 2004 are summarized in the sections which follow.
While operating income increased by $5.1 million in the second quarter of Fiscal 2004 compared to the second quarter of Fiscal 2003, these challenges indicate there can be no assurance that operating results achieved by the Company in the second quarter of Fiscal 2004 are indicative of future operating performance of the Company.
Page 15
Summary of Critical Issues Faced by the Company During the Second Quarter of 2004
Summary of Critical Issues and Known Trends Faced by the Company in 2004 and Thereafter
Page 16
These challenges indicate there can be no assurance that operating results of the Company achieved in the second quarter of Fiscal 2004 are indicative of future operating performance of the Company.
Page 17
Results of Operations
Three Months Ended July 3, 2004 Compared to Three Months Ended June 28, 2003
Summary of Key Factors Impacting Second Quarter 2004 Results:
Principal factors which contributed to a $5.1 million (85.0%) increase in operating income, which are discussed in greater detail in the following section, were:
These increases were partially offset by:
Summary of Key Indicators of 2004 Performance:
Principal indicators which management routinely monitors and compares to previous periods as an indicator of problems or improvements in operating results include:
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 from the Jacobsen prices because the Company’s finished products are delivered to multiple locations. Average Jacobsen prices (at the specified delivery point) for the second quarter of Fiscal 2004 compared to average Jacobsen prices for the second quarter of Fiscal 2003 follow:
| |
Avg. Price 2nd Quarter 2004 |
Avg. Price 2nd Quarter 2003 |
Increase |
% Increase |
|||||||||||||
| MBM (Illinois) | $229.62 /ton | $169.20 /ton | $60.42 /ton | 35.7% | |||||||||||||
| BFT (Chicago) | $ 19.05 /cwt | $ 16.79 /cwt | $ 2.26 /cwt | 13.5% | |||||||||||||
| YG (Illinois) | $ 16.21 /cwt | $ 12.86 /cwt | $ 3.35 /cwt | 26.0% | |||||||||||||
Page 18
The increases in average price of the finished products the Company sells had a favorable impact on revenue which was partially offset by a negative impact to the Company’s raw material cost, due to formula pricing arrangements which compute raw material cost, based upon the price of finished product.
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 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 an indication of achievement of the Company’s business plan.
Net Sales. The Company collects and processes animal by-products (fat, bones and offal), and used restaurant cooking oil to produce finished products of MBM, BFT, and YG. Sales are significantly affected by finished goods prices, quality of raw material, and volume of raw material. Net sales include the sales of produced finished goods, collection fees, grease trap services, and finished goods purchased for resale, which constitute approximately 14.9% of total sales.
During the second quarter of Fiscal 2004, net sales increased by $13.0 million (16.6%) to $91.5 million as compared to $78.5 million during the second quarter of Fiscal 2003. The increase in net sales was primarily due to the following (in millions of dollars):
| - Higher finished goods pricess | $ 9.2 | ||
| - Higher sales of finished product purchased for resale | 4.1 | ||
| - Improved recovery of collection expenses | 0.5 | ||
| - Other sales increases | 0.1 |
These increases were partially offset by:
| - Lower hide sales | (0.5) | ||
| - Lower raw material volume | (0.4) | ||
| $13.0 |
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 and process the raw material. 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.
During the second quarter of Fiscal 2004, cost of sales and operating expenses increased $7.3 million (12.2%) to $67.3 million as compared to $60.0 million during the second quarter of Fiscal 2003. The increase in cost of sales and operating expenses was primarily due to the following (in millions of dollars):
| - Higher purchases of finished product for resale | $ 4.1 | ||
| - Higher raw material prices | 3.5 | ||
| - Higher payroll and related benefits | 0.3 | ||
| - Higher gas, diesel fuel and oil expense | 0.3 |
These increases were partially offset by:
| - Lower hauling expenses | (0.4) | ||
| - Lower energy expenses | (0.3) | ||
| - Other expense decreases | (0.2) | ||
| $ 7.3 |
Page 19
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $9.2 million during the second quarter of Fiscal 2004, a $0.3 million increase (3.4%) from $8.9 million during the second quarter of Fiscal 2003, primarily due to the following (in millions of dollars):
| - Higher payroll and related benefits expense | $ 0.5 |
This increase was partially offset by:
| - Other expense decreases | (0.2) | ||
| $(0.3) |
Depreciation and Amortization. Depreciation and amortization charges increased $0.4 million (11.1%) to $4.0 million during the second quarter of Fiscal 2004 as compared to $3.6 million during the first quarter of Fiscal 2003, primarily due to impairment recorded on various property and equipment of $0.3 million.
Interest Expense. Interest expense was $1.8 million during the second quarter of Fiscal 2004 compared to $0.4 million during the second quarter of Fiscal 2003, an increase of $1.4 million, primarily due to reduced amortization of SFAS 15 effect related to the prior Amended and Restated Credit Agreement of May 2002; interest expense on the Company’s Senior Subordinated Notes with an outstanding balance of $35.0 million which bears interest at a fixed rate of 12.0% per annum; and inclusion of preferred stock dividends and accretion in interest expense as a result of the adoption of SFAS 150 in the third quarter of Fiscal 2003. The increase in interest expense was primarily due to the following (in millions of dollars):
| - Reduced amortization of SFAS 15 effect increased interest expense | $ 0.7 | ||
| - Interest expense on the contractual amount of debt increased | 0.6 | ||
| - Preferred stock dividends and accretion increased interest expense | 0.1 | ||
| $1.4 |
Other Income/Expense. Other expense was $1.7 million in the second quarter of Fiscal 2004, a $1.2 million increase from other expense of $0.5 million in the second quarter of Fiscal 2003. The increase in other expense in the first quarter of Fiscal 2004 is primarily due to the following (in millions of dollars):
| - Loss on early redempton of preferred stock | $ 1.7 |
This increase was partially offset by:
| - Increase in gain on extinguishment of bank debt | (0.3) | ||
| - Increase in gain on disposal of assets | (0.1) | ||
| - Decreases in other expense | (0.1) | ||
| $1.2 |
The Company’s new Senior Credit Agreement required early redemption of the Company’s preferred stock outstanding at its face value of $10.0 million and accumulated dividends of approximately $1.2 million, or total aggregate consideration of $11.2 million. The Company’s preferred stock had a carrying value of approximately $9.5 million at April 3, 2004. Subsequent to April 3, 2004, the Company issued an irrevocable notice of redemption to holders of the Company’s preferred stock. The Company incurred a loss of approximately $1.7 million which is included in other expense in the second quarter of Fiscal 2004 on the early redemption of the preferred stock. The Company expects that early redemption of the preferred stock will generate incremental savings on interest expense.
Page 20
Income Taxes. The Company recorded income tax expense of $3.1 million for the second quarter of Fiscal 2004, compared to income tax expense of $1.9 million recorded in the second quarter of Fiscal 2003, an increase of $1.2 million (63.2%), primarily due to the increased pre-tax earnings of the Company in Fiscal 2004 and the loss on early redemption of preferred stock of $1.7 million which is non-deductible for tax purposes, but is treated as a return of equity to preferred shareholders, creating an incremental tax effect of approximately $0.6 million. The estimated combined effective annual tax rate for state and Federal income taxes for Fiscal 2004 is approximately 40.0% and for Fiscal 2003 is approximately 38%.
Six Months Ended July 3, 2004 Compared to Six Months Ended June 28, 2003
Summary of Key Factors Impacting the First Six Months of Fiscal 2004 Results:
Principal factors which contributed to a $6.3 million (55.3%) increase in operating income, which are discussed in greater detail in the following section, were:
These increases were partially offset by:
Summary of Key Indicators of 2004 Performance:
Principal indicators which management routinely monitors and compares to previous periods as an indicator of problems or improvements in operating results include:
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 from the Jacobsen prices because the Company’s finished products are delivered to multiple locations. Average Jacobsen prices (at the specified delivery point) for the first six months of Fiscal 2004 compared to average Jacobsen prices for the first six months of Fiscal 2003 follow:
Page 21
| |
Avg. Price Six Months 2004 |
Avg. Price Six Months 2003 |
Increase |
% Increase |
|||||||||||||
| MBM (Illinois) | $207.15 /ton | $170.42 /ton | $36.73 /ton | 21.6% | |||||||||||||
| BFT (Chicago) | $ 19.16 /cwt | $ 16.61 /cwt | $ 2.55 /cwt | 15.4% | |||||||||||||
| YG (Illinois) | $ 15.74 /cwt | $ 13.11 /cwt | $ 2.63 /cwt | 20.1% | |||||||||||||
The increases in average price of the finished products the Company sells had a favorable impact on revenue which was partially offset by a negative impact to the Company’s raw material cost, due to formula pricing arrangements which compute raw material cost, based upon the price of finished product.
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 an indication of achievement of the Company’s business plan.
Net Sales. The Company collects and processes animal by-products (fat, bones and offal), and used restaurant cooking oil to produce finished products of MBM, BFT and YG. Sales are significantly affected by finished goods prices, quality of raw material, and volume of raw material. Net sales include the sales of produced finished goods, collection fees, grease trap services, and finished goods purchased for resale, which constitute approximately 12.1% of total sales.
During the first six months of Fiscal 2004, net sales increased by $22.0 million (14.9%) to $169.2 million as compared to $147.2 million during the first six months of Fiscal 2003. The increase in net sales was primarily due to the following (in millions of dollars):
| - Higher finished goods pricess | $16.9 | ||
| - Higher sales of finished product purchased for resale | 3.5 | ||
| - Improved recovery of collection expenses | 2.0 | ||
| - Higher raw material volume | 1.0 |
These increases were partially offset by:
| - Lower hide sales | (0.8) | ||
| - Other sales decreases | (0.6) | ||
| $22.0 |
Page 22
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 and process the raw material. 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.
During the first six months of Fiscal 2004, cost of sales and operating expenses increased $14.4 million (13.0%) to $125.5 million as compared to $111.1 million during the first six months of Fiscal 2003. Included in operating expenses during the first six months of Fiscal 2004 are incremental labor and freight costs of transferring finished product from cities with lower MBM prices to cities with higher MBM prices. The increase in cost of sales and operating expenses was primarily due to the following (in millions of dollars):
| - Higher raw material prices | $ 9.0 | ||
| - Higher purchases of finished product for resale | 3.5 | ||
| - Higher payroll and related benefits | 1.7 | ||
| - Higher gas, diesel fuel and oil expense | 0.6 | ||
| - Other expense increases | 0.3 |
These increases were partially offset by:
| - Lower contract hauling expenses | (0.4) | ||
| - Lower trap waste and sewer expense | (0.3) | ||
| $14.4 |
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $18.2 million during the first six months of Fiscal 2004, a $0.8 million increase (4.6%) from $17.4 million during the first six months of Fiscal 2003, primarily due to the following (in millions of dollars):
| - Higher payroll and related benefits expense | $ 1.0 |
This increase was partially offset by:
| - Lower legal, audit and professional fees | (0.2) | ||
| $ 0.8 |
Depreciation and Amortization. Depreciation and amortization charges increased $0.4 million (5.5%) to $7.7 million during the first six months of Fiscal 2004 as compared to $7.3 million during the first six months of Fiscal 2003, primarily due to impairment recorded on various property and equipment of $0.3 million.
Interest Expense. Interest expense was $3.6 million during the first six months of Fiscal 2004 compared to $0.9 million during the first six months of Fiscal 2003, an increase of $2.7 million, primarily due to reduced amortization of SFAS 15 effect related to the prior Amended and Restated Credit Agreement of May 2002, interest expense on the Company’s Senior Subordinated Notes with an outstanding balance of $35.0 million which bears interest at a fixed rate of 12.0% per annum, and inclusion of preferred stock dividends and accretion in interest expense as a result of the adoption of SFAS 150 in the third quarter of Fiscal 2003. The increase in interest expense was primarily due to the following (in millions of dollars):
| - Reduced amortization of SFAS 15 effect increased interest expense | $ 1.2 | ||
| - Interest expense on the contractual amount of debt increased | 1.0 | ||
| - Preferred stock dividends and accretion increased interest expense | 0.4 | ||
| - Other increases, primarily fees for letters of credit | 0.1 | ||
| $ 2.7 |
Page 23
Other Income/Expense. Other expense was $0.3 million in the first six months of Fiscal 2004, an $0.4 million increase in expense from other income of $0.1 million in first six months of Fiscal 2003. The increase in other expense in the first six months of Fiscal 2004 is primarily due to the following (in millions of dollars):
| - Loss on early redemption of preferred stock | $ 1.7 |
This increase was partially offset by:
| - Increase in gain on extinguishment of bank debt | (0.7) | ||
| - Increase in gain on disposal of assets | (0.3) | ||
| - Other income increase | (0.3) | ||
| $0.4 |
The Company’s new Senior Credit Agreement required early redemption of the Company’s preferred stock outstanding at its face value of $10.0 million and accumulated dividends of approximately $1.2 million, or total aggregate consideration of $11.2 million. The Company’s preferred stock had a carrying value of approximately $9.5 million at April 3, 2004. Subsequent to April 3, 2004, the Company issued an irrevocable notice of redemption to holders of the Company’s preferred stock. The Company incurred a loss of approximately $1.7 million which is included in other expense in the second quarter of Fiscal 2004 on the early redemption of the preferred stock. The Company expects that early redemption of the preferred stock will generate incremental savings on interest expense.
Gain on extinguishment of debt in the first six months of Fiscal 2004 was $1.3 million, which resulted from retirement of debt with a carrying value of $20.1 million extinguished by a cash payment of $18.0 million, reduced by related deferred loan costs of $0.8 million, also extinguished upon payment of the debt. Also included in other income in the first six months of Fiscal 2004 is gain on the sale of property and equipment of approximately $0.3 million, which includes the sale of the Company’s land in Oklahoma City, OK. Included in other income in the first six months of Fiscal 2003 was a gain on extinguishment of debt of $0.6 million, which resulted from retirement of debt with a carrying value of $4.9 million with a cash payment of $4.1 million due to SFAS 15 accounting, reduced by related deferred loan costs of $0.2 million.
Income Taxes. The Company recorded income tax expense of $5.5 million for the first six months of Fiscal 2004, compared to income tax expense of $4.0 million recorded in the first six months of Fiscal 2003, an increase of $1.5 million (37.5%), primarily due to the increased pre-tax earnings of the Company in Fiscal 2004 and the loss on early redemption of preferred stock of $1.7 million which is non-deductible for tax purposes, but is treated as a return of equity to preferred shareholders, creating an incremental tax effect of approximately $0.6 million. The estimated combined effective annual tax rate for state and Federal income taxes for Fiscal 2004 is approximately 40.0% and for Fiscal 2003 is approximately 38.0%.
FINANCING, LIQUIDITY, AND CAPITAL RESOURCES
On April 2, 2004, the Company entered a new Senior Credit Agreement with new lenders, and entered into a new lender acknowledgement on May 28, 2004, that increased the committed amount as permitted by the Senior Credit Agreement. This refinancing replaces the prior Amended and Restated Credit Agreement executed on May 13, 2002, which is summarized below. The principal components of the refinancing consist of the following.
Page 24
On December 31, 2003, the Company issued Senior Subordinated Notes in the amount of $35.0 million and applied the net proceeds to the reduction of the outstanding term loan of its then outstanding prior Amended and Restated Credit Agreement executed on May 13, 2002. The Senior Subordinated Notes have a term of six years, maturing on December 31, 2009. Interest accrues on the outstanding principal balance of the Notes at an annual rate of 12%, payable quarterly in arrears. Restrictive covenants in the Notes permit the Company, within limitations defined in the Notes, to incur additional indebtedness and to pay cash dividends.
The Company’s new Senior Credit Agreement and Senior Subordinated Notes consist of the following elements at July 3, 2004 (in thousands):
| Senior Credit Agreement: | |
||
| Term Loan: | $ 23,750 |
||
| Revolving Credit Facility: | |||
| Maximum availability | $ 50,000 | ||
| Borrowings outstanding | - | ||
| Letters of credit issued | 13,083 |
||
| Availability | $ 36,917 |
||
| Senior Subordinated Notes Payable: | $35,000 |
|
Page 25
Substantially all of the Company’s assets are either pledged or mortgaged as collateral for borrowings under the new Senior Credit Agreement. The new Senior Credit Agreement contains certain terms and covenants, which permit the incurrence of additional indebtedness, the payment of cash dividends, the retention of certain proceeds from sales of assets, and capital expenditures, within limitations defined by the new Senior Credit Agreement, and require the maintenance of certain minimum financial ratios, including: minimum fixed charge coverage ratio; maximum leverage ratio, and minimum tangible net worth ratio, each as defined in the new Senior Credit Agreement. The Company is currently in compliance with all of the covenants contained in the new Senior Credit Agreement.
The classification of long-term debt in the accompanying July 3, 2004 consolidated balance sheet is based on the contractual repayment terms of the debt issued under the Senior Subordinated Debt and the new Senior Credit Agreement pursuant to the refinancing.
On July 3, 2004, the Company had working capital of $37.2 million and its working capital ratio was 1.91 to 1 compared to working capital of $31.2 million and a working capital ratio of 1.76 to 1 on January 3, 2004. At July 3, 2004, the Company had unrestricted cash of $36.0 million and funds available under the revolving credit facility of $36.9 million, compared to unrestricted cash of $24.8 million and funds available under the revolving credit facility of $6.9 million at January 3, 2004.
Net cash provided by operating activities was $23.1 million and $11.9 million for the six months ended July 3, 2004 and June 28, 2003, respectively, an increase of $11.2 million, primarily due to an increase in inventory and prepaid expense in Fiscal 2003 and a reduction in accounts receivable in Fiscal 2004. Cash used by investing activities was $3.9 million for the first six months of Fiscal 2004, compared to $6.0 million for the first six months of Fiscal 2003, a decrease of $2.1 million, primarily due to lower capital investment in Fiscal 2004. Net cash used by financing activities was $8.1 for the six months ended July 3, 2004, compared to cash used of $6.2 million for the six months ended June 28, 2003, an increase of cash used of $1.9 million, principally due to redemption of the Company’s preferred stock and payment of cumulative dividends in Fiscal 2004, net of proceeds of the Company’s new Senior Credit Agreement.
The Company made capital expenditures of $4.4 million during the first six months of Fiscal 2004, compared to capital expenditures of $4.9 million and acquisitions of rendering and grease businesses for a net investment of approximately $1.1 million in Fiscal 2003, for a net decrease of $0.5 million primarily due to timing of planned capital investment between the two years. Capital expenditures related to compliance with environmental regulations were $0.2 million and $0.7 million for the six months ended July 3, 2004 and June 28, 2003, respectively.
Based upon the underlying terms of the new Senior Credit Agreement, the Company was required to pay approximately $11.2 million during the second quarter of Fiscal 2004 for redemption of the Company’s preferred stock at face value of $10.0 million and accumulated preferred dividends of approximately $1.2 million. The Company’s preferred stock had a carrying value of approximately $9.5 million at April 3, 2004. Consequently, the Company incurred a loss on early redemption of the preferred stock and accumulated dividends of approximately $1.7 million, which is included in other expense.
Based upon the underlying terms of the new Senior Credit Agreement, the Company expects approximately $5.0 million in current debt, which is included in current liabilities on the Company’s balance sheet at April 3, 2004, will be due during the next twelve months, consisting of scheduled installment payments of $1.25 million due each quarter.
Page 26
Based upon the annual actuarial estimate, current accruals, and claims paid during the first six months of Fiscal 2004, the Company has accrued approximately $5.8 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 July 3, 2004. 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 or the administrator of the Company’s self insurance reserve. 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 paid approximately $0.5 million in order to meet minimum pension funding requirements during the second quarter of Fiscal 2004, which reduced current accrued compensation and benefit expenses at July 3, 2004. The Company plans to make a voluntary contribution of $0.8 million during the third quarter of Fiscal 2004. 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.
The Company’s management believes that cash flows from operating activities at the current level in Fiscal 2004, unrestricted cash, and funds available under the new Senior Credit Agreement should be sufficient to meet the Company’s working capital needs and capital expenditures for at least the next 12 months. The impact on cash flows from operations in Fiscal 2004 of the occurrence of BSE in the United States, resulting regulations by government agencies, the impact on export markets, and the impact on market prices for the Company’s finished products is not known at this time. These factors, coupled with high prices for natural gas and diesel fuel, among others, could negatively impact the Company’s results of operations in 2004 and thereafter. The Company cannot provide assurance that the cash flows from operating activities generated in the first or second quarters of Fiscal 2004 are indicative of the future cash flows from operating activities which will be generated by the Company’s operations.
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 sales, potential inventory buildup, or higher operating costs.
The principal products that the Company sells are commodities, the prices of which are quoted on established commodity markets and are subject to volatile changes. Although the current market prices of these commodities are favorable, a decline in these prices has the potential to adversely impact the Company’s liquidity. A disruption in international sales, a decline in commodities prices, or a rise in energy prices resulting from the recent war with Iraq and the subsequent political instability and uncertainty, has the potential to adversely impact the Company’s liquidity. There can be no assurance that 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 those events, will not cause the Company to fail to meet management’s expectations, or otherwise result in liquidity concerns.
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CONTRACTUAL OBLIGATIONS AND OTHER COMMERCIAL COMMITMENTS
The following table summarizes the Company’s expected material contractual payment obligations, including both on- and off-balance sheet arrangements at July 3, 2004 (in thousands):
Less Than 1 - 3 3 - 5 More than
Total 1 Year Years Years 5 Years
----------- ----------- ---------- ----------- -----------
Contractual obligations:
Long-term debt obligations $58,832 $ 5,036 $10,046 $ 8,750 $35,000
Operating lease obligations 22,577 5,035 5,411 2,548 9,583
Purchase commitments 4,500 4,500 - - -
Other long-term liabilities 269 79 190 - -
----------- ----------- ---------- ----------- ----------
Total $86,178 $14,650 $15,647 $11,298 $44,583
=========== =========== ========== =========== ==========
The Company's off-balance sheet contractual obligations and commercial commitments as of July 3, 2004 relate to operating lease obligations, letters of credit, forward purchase agreements, and employment agreements. The Company has excluded these items from the balance sheet in accordance with accounting principles generally accepted in the United States.
The following table summarizes the Company's other commercial commitments, including both on- and off-balance sheet arrangements at July 3, 2004.
| Other commercial commitments: | |||
| Standby letters of credit | $13,083 |
||
| Total other commercial commitments: | $13,083 |
OFF BALANCE SHEET OBLIGATIONS
Based upon the underlying purchase agreements, the Company has commitments to purchase $4.5 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 July 3, 2004. These purchase agreements are entered 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 2004, in accordance with accounting principles generally accepted in the United States.
Based upon the underlying lease agreements, the Company expects to pay approximately $5.0 million in operating lease obligations during the next twelve months which are not included in liabilities on the Company’s balance sheet at July 3, 2004. 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 United States.
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 Annual Report on Form 10-K for the year ended January 3, 2004.
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Certain of the policies require management to make significant and subjective estimates or assumptions which may deviate from actual results. In particular, management makes estimates regarding the fair value of the Company’s reporting units in assessing potential impairment of goodwill, estimates regarding future undiscounted cash flows from the future use of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, estimates regarding the net realizable value of long-lived assets held for sale, estimates regarding pension expense, estimates of bad debts and estimates regarding self insured risks including insurance, environmental and litigation contingencies.
In assessing impairment of goodwill, the Company uses estimates and assumptions in determining the estimated fair value of reporting units. In assessing the impairment of long-lived assets where there has been a change in circumstances indicating the carrying value of a long-lived asset may not be recoverable, the Company has estimated future undiscounted net cash flows from use of the asset based on actual historical results and expectations about future economic circumstances including future business volume, finished product prices and operating costs. The estimates of fair value of reporting units and of future net cash flows from use of the asset could change if actual prices and costs differ due to industry conditions or other factors affecting the level of business volume or the Company’s performance. In assessing impairment of long-lived assets held for sale, the Company has estimated the net realizable value of such assets based on information from various external sources regarding possible selling prices for such assets. The estimate of reserve for bad debts is based upon the Company’s bad debt experience, market conditions, aging of trade accounts receivable, and interest rates, among other factors. Pension expense is based upon actuarial estimates. These estimates could change based on changes in market conditions, interest rates, and other factors. In estimating liabilities for self insured risks, the Company considers information from outside consultants and experts, and past historical experience, in projecting future costs expected to be incurred. These estimates could change if future events are different than assumed by management, actual costs to settle the liabilities differ from those estimated and the circumstances associated with the self insured risks change.
NEW ACCOUNTING PRONOUNCEMENTS
No new accounting pronouncements were issued during the second quarter of Fiscal 2004.
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 7A of Part I of the Company’s annual report on Form 10-K for the year ended January 3, 2004, 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; and BSE and its impact on finished product prices, export markets, energy prices and government regulation are still evolving and are beyond the Company’s control. Among other things, future profitability may be affected by the Company’s ability to grow its business which faces competition from companies which may have substantially greater resources than the Company.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
Market risks affecting the Company are exposures to changes in interest rates on debt and the price of natural gas used in the Company's plants. The Company has used interest rate and natural gas swaps to manage these related risks. The Company is not currently party to any interest rate swap agreements. The Company uses natural gas forward purchase agreements with its suppliers to manage the price risk of natural gas used in its facilities.
As of July 3, 2004, the Company had forward purchase agreements in place for purchases of approximately $0.9 million of natural gas for the month of July 2004.
At July 3, 2004, the Company was party to natural gas swap agreements representing 90,000 mmbtu's of natural gas per month for the months of July, August, September and October 2004, with a NYMEX purchase price of approximately $6.48/mmbtu. At July 3, 2004, the fair value of the Company's positions in these swap agreements was a liability of $0.1 million. The Company has designated the natural gas swap agreements as cash flow hedges and such agreements quality for hedge accounting under SFAS 133.
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 Rule 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 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 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 Company management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Based on that 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 have been no significant changes in the Company’s internal controls or in other factors that could significantly affect the internal controls subsequent to the date of their evaluation in connection with the preparation of this quarterly report on Form 10-Q.
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DARLING INTERNATIONAL INC. AND SUBSIDIARIES
FORM 10-Q FOR THE THREE MONTHS ENDED JULY 3, 2004
PART II: Other Information
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The matters voted upon at the annual meeting of stockholders held on May 18, 2004 were as follows:
The election of six directors to serve until the next annual meeting of stockholders or until their successors have been elected and qualified. The number of votes cast for and against the election of each nominee, as well as the number of abstentions and broker non-votes with respect to the election of each nominee, were as follows:
| Randall C. Stuewe | ||||
| For | 59,579,362 | Against/Withheld | 1,566,343 |
|
| O. Thomas Albrecht | ||||
| For | 59,317,168 | Against/Withheld | 1,828,537 |
|
| Kevin S. Flannery | ||||
| For | 59,599,885 | Against/Withheld | 1,545,820 |
|
| Fredric J. Klink | ||||
| For | 56,432,083 | Against/Withheld | 4,713,622 |
|
| Charles Macaluso | ||||
| For | 59,312,898 | Against/Withheld | 1,832,807 |
|
| Richard A. Peterson | ||||
| For | 59,317,468 | Against/Withheld | 1,828,237 |
|
| Item 6. | EXHIBITS AND REPORTS ON FORM 8-K. |
| (a) | Exhibits | |
| 10.1 | Credit Agreement, dated as of April 2, 2004, among Darling International Inc., the Other Credit Parties signatory thereto, the Lenders signatory thereto from time to time, General Electric Capital Corporation and Comerica Bank. (1) | |
| 10.2 | Security Agreement, dated as of April 2, 2004, among Darling International Inc., and each of the Credit Parties signatory to the Credit Agreement, and General Electric Capital Corporation. (1) | |
| 10.3 | Trademark Security Agreement, dated as of April 2, 2004, among Darling International Inc., and each of the Credit Parties signatory to the Credit Agreement, and General Electric Capital Corporation. (1) |
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| 10.4 | Patent Security Agreement, dated as of April 2, 2004, among Darling International Inc., and each of the Credit Parties signatory to the Credit Agreement, and General Electric Capital Corporation. (1) | |
| 10.5 | Copyright Security Agreement, dated as of April 2, 2004, among Darling International Inc., and each of the Credit Parties signatory to the Credit Agreement, and General Electric Capital Corporation. (1) | |
| 10.6 | Pledge Agreement, dated as of April 2, 2004, among Darling International Inc. and General Electric Capital Corporation. (1) | |
| 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. | |
| 32.1 | 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. | |
| 32.2 | Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of John O. Muse, the Chief Financial Officer of the Company. |
(1) Incorporated by reference to the Current Report on Form 8-K filed by the Company on April 7, 2004.
| (b) | Reports on Form 8-K
Current report on Form 8-K filed on April 7, 2004. Current report on Form 8-K (Items 7 and 12) filed on May 19, 2004. |
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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. | ||
| Registrant | ||
| Date: August 16, 2004 | By: /s/ Randall C. Stuewe Randall C. Stuewe Chairman and Chief Executive Officer | |
| Date: August 16, 2004 |
By: /s/ John O. Muse John O. Muse Executive Vice President Administration and Finance (Principal Financial Officer) |
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