DARLING INTERNATIONAL INC – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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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 in Item 1A of this report under the heading "Risk Factors."
The following discussion should be read in conjunction with the historical consolidated financial statements and notes thereto included in Item 8. During fiscal 2010, the Company was organized into two operating business segments, Rendering and Restaurant Services. Effective
Overview
The Company is a leading provider of rendering, cooking oil and bakery waste recycling and recovery solutions to the nation's food industry. The Company collects and recycles animal by-products, bakery waste and used cooking oil from poultry and meat processors, commercial bakeries, grocery stores, butcher shops, and food service establishments and provides grease trap cleaning services to many of the same establishments. On
Fiscal 2011 was a record setting year for the Company. Earnings performance was attributable to strong finished product markets driven by an improving global economy and continued implementation of global bio-fuel mandates. Additionally, a full year of integration efforts reflecting the late 2010 acquisition of Griffin supported the Company's performance. During fiscal 2011, the Company watched values for the global feed grains and oilseeds complex escalate throughout the first half of the year, only to be tempered in the back half of the year by economic conditions in
The bakery business segment made a solid contribution during fiscal 2011. Input volumes grew throughout the year as general economic conditions improved and commercial bakeries operated longer hours. Cookie Meal® prices improved and tracked with the rising price of corn, which ultimately drove bakery segment earnings.
Operating income of
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Summary of Critical Issues Faced by the Company during Fiscal 2011
• The acquisition of Griffin has contributed a significant amount to the Company's operations during fiscal 2011. The financial impact of the acquisition of Griffin is summarized below in Results of Operations. • Significantly higher finished product prices for fats and proteins in fiscal 2011 as compared to fiscal 2010 are a sign of increased global demand for BFT and YG for use in bio-fuels, tightening global grain supplies and increased Asian demand for protein. 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 theJacobsen index, an established trading exchange publisher used by management to monitor performance, is provided below in Summary of Key Indicators. • Energy prices for natural gas declined during fiscal 2011 as compared to fiscal 2010, but were more than offset by an increase in diesel prices during fiscal 2011 as compared to fiscal 2010. The financial impact of energy costs is summarized below in Results of Operations.
Summary of Critical Issues and Known Trends Faced by the Company in Fiscal 2012 and Thereafter
Critical Issues and Challenges
• The acquisition of Griffin is the largest and most significant acquisition Darling has undertaken. Although significant progress has been made in the integration of the two businesses, the Company's management will continue to be required to devote a significant amount of time and attention to the process of integrating the operations of Darling's business and the business of Griffin, which may decrease the time it will have to develop new services or strategies. • Finished product prices for MBM, PM (both feed grade and pet food), BFT, PG, YG and BBP commodities have increased during fiscal 2011 as compared to the same period of fiscal 2010. No assurance can be given that this increase in commodity prices for various proteins, fats and bakery products will continue in the future, as commodity prices are volatile by their nature. A future decrease in commodity prices could have a significant impact on the Company's earnings for fiscal 2012 and into future periods • The Company consumes significant volumes of natural gas to operate boilers in its plants, which generate steam to heat raw material. 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. Diesel fuel prices represent a significant component of cost of collection expenses included in cost of sales. Energy prices for natural gas declined during fiscal 2011 as compared to fiscal 2010, but were more than offset by an increase in diesel prices during fiscal 2011 as compared to fiscal 2010. Both natural gas and diesel fuel prices can be volatile and there can be no assurance that these prices will not increase in the near future, thereby representing an ongoing challenge to the Company's operating results for future periods. A material increase in energy prices for natural gas and/or diesel fuel over a sustained period of time could materially adversely affect the Company's business, financial condition and results of operations.
Worldwide Government Energy Policies
• As previously noted, prices for the Company's finished products may be impacted by worldwide government policies relating to renewable fuels and greenhouse gas emissions, and programs such as RFS2 and tax credits for bio-fuels both in the U.S. and abroad may positively impact the demand for the Company's finished products. See the risk factor entitled "The Company's business may be affected by energy policies of U.S. and foreign governments," on page 14, for more information regarding RFS2 and how changes to these worldwide government policies could have a negative impact on the Company's business and results of operations. • The Company's exports are subject to the imposition of tariffs, quotas, trade barriers and other trade protection measures imposed by foreign countries regarding the import of the Company's MBM, BFT and YG. General economic and political conditions as well as the closing of borders by foreign countries to the import of the Company's products due to animal disease or other perceived health or safety issues impact the Company. As a result trade policies of both U.S and foreign countries could have a negative impact on the Company's business and results of operations. Page 33
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Other Food Safety and Regulatory Issues
• Effective
the use of mammalian proteins, with some exceptions, in feeds for cattle, sheep and other ruminant animals. The intent of this rule is to prevent the spread of BSE, commonly referred to as "mad cow disease." As previously noted, theFDA has amended the BSE Feed Rule, which theFDA began enforcing onOctober 26, 2009 . Management has followed this amendment throughout its history in order to assess and minimize the impact of its implementation on the Company.
Even though the export markets for U.S. beef have rebounded and 2011 export volumes may exceed pre-BSE levels, most export markets remain closed to MBM derived from U.S. beef. Continued concern about BSE in
• With respect to human food, pet food and animal feed safety, the FDAAA was signed into law onSeptember 27, 2007 as a result of Congressional concern for pet and livestock food safety, following the discovery inMarch 2007 of pet and livestock food that contained adulterated imported ingredients. As previously noted, the FDAAA establishes the Reportable Food Registry. The impact of the FDAAA and implementation of the Reportable Food Registry on the Company, if any, will not be clear until theFDA finalizes its RFR Draft Guidance and the Draft CPG, neither of which were finalized as of the date of this report. The Company believes that it has adequate procedures in place to assure that its finished products are safe to use in animal feed and pet food and the Company does not currently anticipate that the FDAAA will have a significant impact on the Company's operations or financial performance. Any pathogen, such as salmonella, that is correctly or incorrectly associated with the Company's finished products could have a negative impact on the demands for the Company's finished products.
In addition, on
See the risk factor entitled "The Company's business may be affected by the impact of BSE and other food safety issues," beginning on page 15, for more information about BSE, including the Enhanced BSE Rule, and other food safety issues and their potential effects on the Company, including the potential effects of additional government regulations, finished product export restrictions by foreign governments, market price fluctuations for finished goods, reduced demand for beef and beef products by consumers and increases in operating costs resulting from BSE-related concerns.
• The emergence of diseases such as Swine Flu and Bird Flu that are in or associated with animals and have the potential to also threaten humans has created concern that such diseases could spread and cause a global pandemic. Even though such a pandemic has not occurred, governments may be pressured to address these concerns and prohibit imports of animals, meat and animal by-products from countries or regions where the disease is detected. The occurrence of Swine Flu, Bird Flu or any other disease inthe United States that is correctly or incorrectly linked to animals and has a negative impact on meat or poultry consumption or animal production could have a material negative impact on the volume of raw materials available to the Company or the demand for the Company's finished products
These challenges indicate there can be no assurance that fiscal 2011 operating results are indicative of future operating performance of the Company.
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Results of Operations
Fifty-two Week Fiscal Year Ended
Summary of Key Factors Impacting Fiscal 2011 Results:
Principal factors that contributed to a
• Inclusion of a full 52 weeks of contribution from the acquisition of Griffin, and
• Improvements in finished product prices, offset by quality downgrades.
These factors which contributed to increases in operating income were partially offset by:
• Increase in raw material costs,
• Decreases in yield,
• Increases in payroll and incentive-related benefits, and
• Increases in energy costs primarily diesel fuel.
Summary of Key Indicators of Fiscal 2011 Performance: Principal indicators that management routinely monitors and compares to previous periods as an indicator of problems or improvements in operating results include:
• Finished product commodity prices,
• Raw material volume,
• Production volume and related yield of finished product,
• Energy prices for natural gas quoted on the
• Collection fees and collection operating expense, and
• Factory operating expenses.
These indicators and their importance are discussed below in greater detail. Finished Product Commodity Prices. Prices for finished product commodities that the Company produces are reported each business day on the
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Avg. Price Avg. Price % Fiscal 2011 Fiscal 2010 Increase Increase Rendering Segment: MBM (Illinois )$354.84 /ton$297.35 /ton$ 57.49 /ton 19.3% Feed Grade PM (Carolina)$400.21 /ton$366.89 /ton$ 33.32 /ton 9.1% Pet Food PM (Southeast)$637.30 /ton$606.55 /ton$ 30.75 /ton 5.1% BFT (Chicago )$ 49.58 /cwt$ 33.43 /cwt$ 16.15 /cwt 48.3% PG (Southeast)$ 45.94 /cwt$ 29.01 /cwt$ 16.93 /cwt 58.4% YG (Illinois )$ 43.19 /cwt$ 26.89 /cwt$ 16.30 /cwt 60.6% Bakery Segment: BBP (Chicago )$236.89 /ton$143.57 /ton$ 93.32 /ton 65.0%
The overall increase in average prices of the finished products the Company sells had a favorable impact on revenue that was partially offset by the 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.
During the fourth quarter of Fiscal 2011, the Company experienced a significant decline in all of its average commodity prices as compared to the third quarter of Fiscal 2011 due to reduced export of feed stock, and a decrease in protein prices, due to soft protein meal demand domestically as a result of cut-backs by poultry producers. The following table shows the average Raw Material Volume. Raw material volume represents the quantity (pounds) of raw material collected from Rendering Segment suppliers, such as butcher shops, grocery stores and independent beef, pork and poultry processors and food service establishments, or in the case of the Bakery Segment, commercial bakeries. Raw material volumes from the Company's Rendering Segment suppliers provide an indication of the future production of MBM, PM (feed grade and pet food), BFT, PG and YG finished products while raw material volumes from the Company's Bakery Segment suppliers provide an indication of the future production of BBP finished products. Production Volume and Related Yield of Finished Product. 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. In addition, physical inventory turn-over is impacted by both the availability of credit to the Company's customers and suppliers and reduced market demand which can lower finished product inventory values. 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 quantities of finished products produced varies depending on the mix of raw materials used in production. For example, raw material from cattle yields more fat and protein than raw material from pork or poultry. Accordingly, the mix of finished products produced by the Company can vary from quarter to quarter depending on the type of raw material being received by the Company. The Company cannot increase the production of protein or fat based on demand since the type of raw material available will dictate the yield of each finished product. -------------------------------------------------------------------------------- Energy Prices for Natural Gas Quoted on the NYMEX Index and Diesel Fuel. Natural gas and heating oil commodity prices are quoted each day on the Collection Fees and Collection Operating Expense. The Company charges collection fees which are included in net sales. 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 importance of monitoring collection fees and collection expense is that they provide an indication of achievement of the Company's business plan. Furthermore, management monitors collection fees and collection expense so that the Company can consider implementing measures to mitigate against unforeseen increases in these expenses. Factory Operating Expenses. The Company incurs factory operating expenses which are included in cost of sales. Each month the Company monitors factory operating expense. The importance of monitoring factory operating expense is that it provides an indication of achievement of the Company's business plan. Furthermore, when unforeseen expense increases occur, the Company can consider implementing measures to mitigate such increases. Net Sales. The Company collects and processes animal by-products (fat, bones and offal), including hides, commercial bakery waste and used restaurant cooking oil to principally produce finished products of MBM, PM (feed grade and pet food), BFT, PG, YG, BBP and hides as well as a range of branded and value-added products. 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 Fiscal 2011, net sales were Increase in net sales due to acquisition Further detail regarding the Rendering Net Sales from Acquisition of Griffin: The Company's net sales have increased by Finished Product Prices: Higher prices in the overall commodity market for corn, soybean oil and soybean meal, which are competing proteins and fats to MBM and BFT, positively impacted the Company's finished product prices. In addition an increase in global demand for use of YG in bio-fuels positively impacted the Company's finished product prices. The -------------------------------------------------------------------------------- Other Sales: The Yield: The raw material processed in Fiscal 2011 compared to the same period of Fiscal 2010 yielded less finished product for sale and decreased sales by Bakery Net Sales from Acquisition of Griffin: The Bakery Segment was acquired in the Griffin Transaction and net sales have increased by Cost of Sales and Operating Expenses. Cost of sales and operating expenses include the 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. Significant changes in finished goods market conditions impact finished product inventory values, 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 Fiscal 2011, cost of sales and operating expenses were Increase in cost of sales and operating expense due to acquisition of Griffin Increase in energy costs primarily Further detail regarding the Rendering Cost of Sales and Operating Expenses from Acquisition of Griffin: The Company's cost of sales and operating expenses increased by Raw Material Costs: A portion of the Company's volume of raw material is acquired on a formula basis. Under a formula arrangement, the cost of raw material is tied to the finished product market for MBM, BFT and YG. Since finished product prices were higher in Fiscal 2011 as compared to the same period in Fiscal 2010, the raw material costs increased Other Expense: The -------------------------------------------------------------------------------- Energy Costs: Both natural gas and diesel fuel are major components of collection and factory operating costs to the Rendering Segment. During Fiscal 2011, energy costs were higher and are reflected in the Bakery Cost of Sales and Operating Expenses from Acquisition of Griffin: The Company's cost of sales and operating expenses related to the Bakery Segment acquired in the Griffin Transaction increased Selling, General and Administrative Expenses. Selling, general and administrative expenses were Depreciation and Amortization. Depreciation and amortization charges increased Acquisition Costs. Acquisition costs were Interest Expense. Interest expense was Other Income/Expense. Other expense was Equity in Net Loss in Investment of Unconsolidated Subsidiary. Represents the Company's portion of the expenses of the Joint Venture with Valero in Fiscal 2011. The Joint Venture losses are primarily from the write-off of capitalized loan costs relating to loan discussions with the Income Taxes. The Company recorded income tax expense of -------------------------------------------------------------------------------- Results of Operations Fifty-two Week Fiscal Year Ended Summary of Key Factors Impacting Fiscal 2010 Results: Principal factors that contributed to a • Changes in finished product prices and quality downgrades, • Higher raw material volumes, and • Two weeks of contribution from the acquisition of Griffin. These factors which contributed to increases in operating income were partially offset by: • Acquisition costs and expense from current year acquisitions, • Higher payroll and incentive-related benefits, and • Higher energy costs, primarily related to diesel fuel. Summary of Key Indicators of Fiscal 2010 Performance: Principal indicators that management routinely monitors and compares to previous periods as an indicator of problems or improvements in operating results include: • Finished product commodity prices, • Raw material volume, • Production volume and related yield of finished product, • Energy prices for natural gas quoted on the • Collection fees and collection operating expense, and • Factory operating expenses. These indicators and their importance are discussed below in greater detail. Finished Product Commodity Prices. Prices for finished product commodities that the Company produces are reported each business day on the -------------------------------------------------------------------------------- The overall increase in average BFT and YG prices of the finished products the Company sells had a favorable impact on revenue that was partially offset by lower MBM prices and 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. Raw Material Volume. Raw material volume represents the quantity (pounds) of raw material collected from Rendering Segment suppliers, such as butcher shops, grocery stores and independent beef, pork and poultry processors and food service establishments, or in the case of the Bakery Segment, commercial bakeries. Raw material volumes from the Company's Rendering Segment suppliers provide an indication of the future production of MBM, PM (feed grade and pet food), BFT, PG and YG finished products while raw material volumes from the Company's Bakery Segment suppliers provide an indication of the future production of BBP finished products. Production Volume and Related Yield of Finished Product. 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. In addition, physical inventory turn-over is impacted by both the availability of credit to the Company's customers and suppliers and reduced market demand which can lower finished product inventory values. 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 quantities of finished products produced varies depending on the mix of raw materials used in production. For example, raw material from cattle yields more fat and protein than raw material from pork or poultry. Accordingly, the mix of finished products produced by the Company can vary from quarter to quarter depending on the type of raw material being received by the Company. The Company cannot increase the production of protein or fat based on demand since the type of raw material available will dictate the yield of each finished product. Energy Prices for Natural Gas Quoted on the NYMEX Index and Diesel Fuel. Natural gas and heating oil commodity prices are quoted each day on the Collection Fees and Collection Operating Expense. The Company charges collection fees which are included in net sales. 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 importance of monitoring collection fees and collection expense is that they provide an indication of achievement of the Company's business plan. Furthermore, management monitors collection fees and collection expense so that the Company can consider implementing measures to mitigate against unforeseen increases in these expenses. Factory Operating Expenses. The Company incurs factory operating expenses which are included in cost of sales. Each month the Company monitors factory operating expense. The importance of monitoring factory operating expense is that it provides an indication of achievement of the Company's business plan. Furthermore, when unforeseen expense increases occur, the Company can consider implementing measures to mitigate such increases. Net Sales. The Company collects and processes animal by-products (fat, bones and offal), including hides, commercial bakery waste and used restaurant cooking oil to principally produce finished products of MBM, PM (feed grade and pet food), BFT, PG, YG, BBP and hides as well as a range of branded and value-added products. 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 Fiscal 2010, net sales were Increase in finished product prices Further detail regarding the Rendering Finished Product Prices: Higher prices in the overall commodity market for corn and soybean oil, which are competing fats to BFT, as well as an increase in global demand for use of YG in bio-fuels, positively impacted the Company's finished product prices while MBM prices were lower as soybean meal prices were lower. Net Sales from Acquisition of Griffin: The Company's Fiscal 2010 net sales increased by Raw Material Volume: The positive effect of the integration of Fiscal 2010 and prior year acquisition activity other than Griffin as well as improving conditions in the food service industry in Fiscal 2010 resulted in higher raw material volumes available to process. The higher raw material volumes from Rendering Segment suppliers, which are processed into fats and protein finished products, increased sales by Yield: The raw material processed in Fiscal 2010 compared to the same period of Fiscal 2009 yielded more finished product for sale and increased sales by Purchases of Finished Product for Resale: The Other Sales: The -------------------------------------------------------------------------------- Bakery Net Sales from Acquisition of Griffin: The Bakery segment was acquired with Griffin and contributed Cost of Sales and Operating Expenses. Cost of sales and operating expenses include the 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. Significant changes in finished goods market conditions impact finished product inventory values, 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 Fiscal 2010, cost of sales and operating expenses were Increase in cost of sales and operating Increase in energy costs primarily Further detail regarding the Rendering Raw Material Costs: A portion of the Company's volume of raw material is acquired on a formula basis. Under a formula arrangement, the cost of raw material is tied to the finished product market for MBM, BFT and YG. The Company's formula pricing was impacted by extreme summer temperatures in Fiscal 2010 as compared to Fiscal 2009 due primarily to raw material being priced based on higher quality rendered tallow and grease than the Company's actual sales, which increased the overall impact of higher raw material costs from overall higher BFT and YG prices in Fiscal 2010 resulting in an increase of Cost of Sales and Operating Expenses from Acquisition of Griffin: The Company's cost of sales and operating expenses increased by Other Expense: The Raw Material Volume: The integration of Fiscal 2010 and prior year acquisition activity and signs of an improved U.S. economy in Fiscal 2010 resulted in higher raw material volume available to process. The higher raw material volume from Rendering Segment suppliers increased cost of sales by Energy Costs: Both natural gas and diesel fuel are major components of collection and factory operating costs to the Rendering Segment. During Fiscal 2010, energy costs were higher and are reflected in the -------------------------------------------------------------------------------- Purchases of Finished Product for Resale: The Company purchased less finished product for resale from third party suppliers in Fiscal 2010 compared to the same period in Fiscal 2009 by Bakery Cost of Sales and Operating Expenses from Acquisition of Griffin: The Company's cost of sales and operating expenses related to the Bakery segment acquired with Griffin were Selling, General and Administrative Expenses. Selling, general and administrative expenses were Depreciation and Amortization. Depreciation and amortization charges increased Acquisition Costs. Acquisition costs were Interest Expense. Interest expense was Other Income/Expense. Other expense was Income Taxes. The Company recorded income tax expense of FINANCING, LIQUIDITY, AND CAPITAL RESOURCES Senior Secured Credit Facilities. On -------------------------------------------------------------------------------- Senior Notes. On As of The Credit Agreement and Notes consisted of the following elements at Notes: 8.5% Senior Notes due 2018 The classification of long-term debt in the Company's On -------------------------------------------------------------------------------- Net cash provided by operating activities was Capital expenditures of Based upon the annual actuarial estimate, current accruals, and claims paid during Fiscal 2011, the Company has accrued approximately Based upon current actuarial estimates, the Company expects to make payments of approximately The Pension Protection Act of 2006 ("PPA") was signed into law in -------------------------------------------------------------------------------- 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 The Company announced on On Pursuant to sponsor support agreements executed in connection with the Facility Agreement and the Loan Agreement, each of the Company and Valero are committed to contributing approximately In connection with the acquisition of Griffin, the Merger Agreement contained provisions pursuant to which Darling and the former Griffin shareholders (the "Griffin Shareholders") agreed that Darling could elect certain tax treatment under Section 338(h)(10) of the U.S. Internal Revenue Code ("Section 338(h)(10)"). Generally, Section 338(h)(10) permits parties to agree to treat a stock sale as if it had instead been a sale of the assets of the underlying business. The Company and the Griffin Shareholders have made an election as permitted under Section 338(h)(10) to increase the tax basis of Griffin's tangible and intangible assets to the deemed purchase price of the assets at the time of the Merger. As a result of the Section 338(h)(10) election, on The Company's management believes that cash flows from operating activities consistent with the level generated in Fiscal 2011, 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, scheduled debt and interest payments, income tax obligations, continued funding of the Joint Venture and other contemplated needs through the next twelve months. Numerous factors could have adverse consequences to the Company that cannot be estimated at this time, such as: reductions in raw material -------------------------------------------------------------------------------- volumes available to the Company due to weak margins in the meat production industry as a result of higher feed costs or other factors, reduced volume from food service establishments, reduced demand for animal feed, or otherwise; a reduction in finished product prices; changes to worldwide government policies relating to renewable fuels and greenhouse gas emissions that adversely affect programs like RFS2 and tax credits for bio-fuels both in the U.S. and abroad; possible product recall resulting from developments relating to the discovery of unauthorized adulterations to food or food additives; the occurrence of Bird Flu in the U.S.; any additional occurrence of BSE in the U.S. or elsewhere; unanticipated costs and/or reductions in raw material volumes related to the Company's compliance with the Enhanced BSE Rule, unforeseen new U.S. and foreign regulations affecting the rendering industry (including new or modified animal feed, 2009 H1N1 flu, Bird Flu or BSE regulations); increased contributions to the Company's multi-employer and employer-sponsored defined benefit pension plans as required by the PPA or resulting from a mass withdrawal event; bad debt write-offs; loss of or failure to obtain necessary permits and registrations; unexpected cost overruns related to the Joint Venture; continued or escalated conflict in the 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 raw materials availability, reduced finished product prices, reduced sales, potential inventory buildup, increased bad debt reserves, potential impairment charges 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 decline in raw material availability, a decline in commodities prices, increases in energy prices 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, continued or escalated conflict in the 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 Contractual obligations(a): Long-term debt obligations (b) -------------------------------------------------------------------------------- (c) See Note 9 to the consolidated financial statements. The Company's off-balance sheet contractual obligations and commercial commitments as of The following table summarizes the Company's other commercial commitments, including both on- and off-balance sheet arrangements at Total other commercial commitments: OFF BALANCE SHEET OBLIGATIONS Based upon the underlying purchase agreements, the Company has commitments to purchase Based on the sponsor support agreements executed in connection with the Facility Agreement and the Loan Agreement relating to the Joint Venture with Valero, the Company has committed to contribute an aggregate of approximately Based upon underlying lease agreements, the Company is obligated to pay approximately 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. -------------------------------------------------------------------------------- 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 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: 1) the backlog of unfilled sales orders at the balance sheet date; or 2) unsold inventory, calculated using regional finished product prices quoted in the 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 The Company's intangible assets, including permits, routes, non-compete agreements, trade names and royalty, consulting and leasehold 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 5 to 20 years; non-compete agreements are amortized over a useful life of 3 to 7 years; trade names with a finite life are amortized over a useful life of 15 years; royalty, consulting and leasehold agreements are amortized over the term of the agreement; and permits are amortized over a useful life of 11 to 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 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. In Fiscal 2011, Fiscal 2010 and Fiscal 2009, no triggering event occurred requiring that the Company perform testing of all of its long-lived assets for impairment. The net book value of property, plant and equipment was approximately -------------------------------------------------------------------------------- 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 a reporting unit, based upon future discounted net cash flows. 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 these reporting units and of future discounted net cash flows from operation of these reporting units could change if actual volumes, prices, costs or expenses vary from these estimates. Based on the Company's annual impairment testing at the end of the fourth quarter of Fiscal 2011, Fiscal 2010 and Fiscal 2009, the fair values of the Company's reporting units containing goodwill exceeded the related carrying value. However, the fair value of one of the Company's reporting units was approximately 14% greater than its carrying value, which was substantially less than the percentage by which the fair values of the Company's other seven reporting units with goodwill exceeded their carrying values. It is possible, depending upon a number of factors that are not determinable at this time or within the control of the Company, that the fair value of this reporting unit could decrease in the future and result in an impairment to goodwill. The amount of goodwill allocated to this reporting unit was approximately 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. At 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. During the third quarter of fiscal 2011, as part of the initiative to combine the Darling and Griffin retirement benefit programs, the Company's Board of Directors authorized the Company to proceed with the restructuring of its retirement benefit program effective 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 weighted average discount rate was 4.50% and 5.55% at -------------------------------------------------------------------------------- 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 7.85% for Fiscal 2011 and Fiscal 2010, respectively. During Fiscal 2011, the Company's actual return on pension plan assets was a loss of The Company has recorded a pension liability of approximately Income Taxes In calculating net income, the Company includes estimates in the calculation of income tax expense, the resulting tax liability and in future realization of deferred tax assets that arise from temporary 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 Stock Option Expense 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 for the year ended NEW ACCOUNTING PRONOUNCEMENTS In In -------------------------------------------------------------------------------- In In FORWARD LOOKING STATEMENTS This Annual Report on Form 10-K includes "forward-looking" statements that involve risks and uncertainties. The words "believe," "anticipate," "expect," "estimate," "intend," "could," "may," "will," "should," "planned," "potential," and similar expressions identify forward-looking statements. All statements other than statements of historical facts included in the Annual Report on Form 10-K, including, without limitation, the statements under the sections entitled "Business," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Legal Proceedings" and located elsewhere herein regarding industry prospects, expectations for construction of the Facility 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, including many that are beyond the control of the Company. Although the Company believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to be correct. In addition to those factors discussed under the heading "Risk Factors" in Item 1A of this report and elsewhere in this report, and in the Company's other public filings with the Avg. Price Avg. Price % 4th Quarter 2011 3rd Quarter 2011 Decrease Decrease Rendering Segment: MBM (Illinois) $309.69/ton $353.79/ton $ (44.10/ton) (12.5)% Feed Grade PM (Carolina) $364.42/ton $436.86/ton $ (72.44/ton) (16.6)% Pet Food PM (Southeast) $610.57/ton $658.59/ton $ (48.02/ton) (7.3)% BFT (Chicago) $ 46.40/cwt $ 51.06/cwt $ (4.66/cwt) (9.1)% PG (Southeast) $ 41.98/cwt $ 48.18/cwt $ (6.20/cwt) (12.9)% YG (Illinois) $ 38.69/cwt $ 45.03/cwt $ (6.34/cwt) (14.1)% Bakery Segment: BBP (Chicago) $239.86/ton $250.34/ton $ (10.48/ton) (4.2)%
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Rendering Bakery Corporate Total
of Griffin $ 582.4 $ 285.8 $ - $ 868.2 Increase in finished product prices 210.7 - - 210.7 Increase in other sales 0.6 - - 0.6 Decrease in yield (7.2 ) - - (7.2 ) $ 786.5 $ 285.8 $ - $ 1,072.3
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Rendering Bakery Corporate Total
139.6 - - 139.6 Increase in other 11.3 - - 11.3
diesel fuel 3.8 - - 3.8 $ 529.6 $ 206.6 $ (0.2 ) $ 736.0
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Rendering Bakery Corporate Total Increases in selling, general and administrative expense from 52 weeks of contribution related to Griffin $ 27.5 $ 9.9 $ 21.9 $ 59.3 Increase/(decrease) in other (0.7 ) 0.7 7.6 7.6 Payroll and related benefits expense (1.6 ) - 6.6 5.0 Decrease in purchase accounting contingency (3.1 ) (0.7 ) - (3.8 ) $ 22.1 $ 9.9 $ 36.1 $ 68.1
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• Increased costs due to current and prior year acquisition activity other than Griffin,
Page 40
% Avg. Price Avg. Price Increase/ Increase/ Fiscal 2010 Fiscal 2009 (Decrease) (Decrease) Rendering Segment: MBM (Illinois) $297.35/ton $338.09/ton $ (40.74)/ton (12.1)% Feed Grade PM (Carolina) $366.89/ton $390.04/ton $ (23.15)/ton (5.9)% Pet Food PM (Southeast) $606.55/ton $626.39/ton $ (19.84)/ton (3.2)% BFT (Chicago) $ 33.43/cwt $ 25.21 /cwt $ 8.22/cwt 32.6% PG (Southeast) $ 29.01/cwt $ 23.44 /cwt $ 5.57/cwt 23.8% YG (Illinois) $ 26.89/cwt $ 20.73 /cwt $ 6.16/cwt 29.7% Bakery Segment: BBP (Chicago) $143.57/ton $135.70/ton $ 7.87/ton 5.8%
Page 41
Rendering Bakery Corporate Total
of Griffin 17.5 10.2 - 27.7 Increase in raw material volume 24.4 - - 24.4 Increase in yield 2.7 - - 2.7 Purchases of finished product for resale 1.0 - - 1.0 Decrease in other sales (2.0 ) - - (2.0 ) $ 116.9 $ 10.2 $ - $ 127.1
Page 42
Rendering Bakery Corporate Total Increase in raw material costs $ 51.3 $ - $ - $ 51.3
expense due to acquisition of Griffin 11.8 8.0 - 19.8 Increase in other 13.1 - - 13.1 Increase in raw material volume 5.3 - - 5.3
diesel fuel 3.1 - 0.1 3.2 Purchases of finished product for resale (1.2 ) - - (1.2 ) $ 83.4 $ 8.0 $ 0.1 $ 91.5
Page 43
Rendering Bakery Corporate Total Payroll and related benefits expense $ 1.3 $ - $ 2.7 $ 4.0 Increases in selling, general and administrative expense from two weeks of contribution related to Griffin 1.0 0.4 0.9 2.3 Increase/(decrease) in other 0.9 - (0.3 ) 0.6 $ 3.2 $ 0.4 $ 3.3 $ 6.9
Page 44
• As of
• The Notes are guaranteed on an unsecured basis by Darling's existing restricted subsidiaries, including Darling National, Griffin and all of its subsidiaries, other than Darling's foreign subsidiaries, its captive insurance subsidiary and any inactive subsidiary with nominal assets. The Notes rank equally in right of payment to any existing and future senior debt of Darling. The Notes will be effectively junior to existing and future secured debt of Darling and the guarantors, including debt under the Credit Agreement, to the extent of the value of assets securing such debt. The Notes will be structurally subordinated to all of the existing and future liabilities (including trade payables) of each of the subsidiaries of Darling that do not guarantee the Notes. The guarantees by the guarantors (the "Guarantees") rank equally in right of payment to any existing and future senior indebtedness of the guarantors. The Guarantees will be effectively junior to existing and future secured debt of the guarantors including debt under the Credit Agreement, to the extent the value of the assets securing such debt. The Guarantees will be structurally subordinated to all of the existing and future liabilities (including trade payables) of each of the subsidiaries of each Guarantor that do not guarantee the Notes.
Credit Agreement: Term Loan
Page 45
Page 46
Page 47
Less than 1 - 3 3 - 5 More than Total 1 Year Years Years 5 Years
68,494 15,152 21,529 11,505 20,308 Estimated interest payable (d) 158,697 23,450 47,280 45,467 42,500 Joint Venture capital contributions (e) 69,895 69,895 - - - Purchase commitments (f) 22,417 22,417 - - - Pension funding obligation (g) 2,321 2,321 - - - Other obligations 30 10 20 - - Total $ 601,854 $ 133,245 $ 69,516 $ 86,285 $ 312,808 Page 48
(a) The above table does not reflect uncertain tax positions of approximately
(d) Interest payable was calculated using the current rate for term, revolver, senior notes and current rates on other liabilities that existed as of
Other commercial commitments: Standby letters of credit
Page 49
Page 50
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Wordcount:
16371
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