XFRA:43D Darling Ingredients Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC  20549
 
FORM 10-Q
 
 (Mark One)      
/X/  QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2012
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   001-13323

DARLING INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
 
 Delaware
 
 36-2495346
 (State or other jurisdiction     
 
(I.R.S. Employer
of incorporation or organization)   
 
Identification Number)
 
 
 
 251 O'Connor Ridge Blvd., Suite 300
 
 
 Irving, Texas
 
 75038
(Address of principal executive offices)  
 
(Zip Code)
 
Registrant's telephone number, including area code:  (972) 717-0300
 
    Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.       Yes    X         No ____
 
    Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).        Yes    X        No ___

 Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer     
X
 
Accelerated filer    
 
 
Non-accelerated filer 
 
 
Smaller reporting company       
 
 
 
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes            No  X  
 
There were 117,610,419 shares of common stock, $0.01 par value, outstanding at May 3, 2012.

1



DARLING INTERNATIONAL INC. AND SUBSIDIARIES
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2012
 
 
TABLE OF CONTENTS   

 
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 37
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2






DARLING INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
March 31, 2012 and December 31, 2011
(in thousands, except shares)

 
March 31,
2012
 
December 31,
2011
ASSETS
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
27,584

 
$
38,936

Restricted cash
381

 
365

Accounts receivable, net
83,373

 
95,807

Inventories
58,481

 
50,830

Income taxes refundable
6,015

 
17,042

Other current assets
9,840

 
9,235

Deferred income taxes
8,050

 
7,465

Total current assets
193,724

 
219,680

Property, plant and equipment, less accumulated depreciation of
   $288,851 at March 31, 2012 and $278,400 at December 31, 2011
408,547

 
400,222

Intangible assets, less accumulated amortization of
   $89,347 at March 31, 2012 and $82,364 at December 31, 2011
355,931

 
362,914

Goodwill
381,369

 
381,369

Investment in unconsolidated subsidiary
32,848

 
21,733

Other assets
29,787

 
31,112

 
$
1,402,206

 
$
1,417,030

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
10

 
$
10

Accounts payable, principally trade
44,078

 
60,402

Accrued expenses
59,553

 
66,845

Total current liabilities
103,641

 
127,257

Long-term debt, net of current portion
250,018

 
280,020

Other non-current liabilities
57,610

 
58,245

Deferred income taxes
34,971

 
31,133

Total liabilities
446,240

 
496,655

Commitments and contingencies


 


Stockholders’ equity:
 

 
 

     Common stock, $0.01 par value; 150,000,000 shares authorized;
        118,275,617 and 117,591,822 shares issued at March 31, 2012
        and at December 31, 2011, respectively
1,183

 
1,176

Additional paid-in capital
595,786

 
587,685

     Treasury stock, at cost;  665,198 and 543,384 shares at
       March 31, 2012 and at December 31, 2011, respectively
(7,567
)
 
(5,588
)
Accumulated other comprehensive loss
(30,013
)
 
(30,904
)
Retained earnings
396,577

 
368,006

Total stockholders’ equity
955,966

 
920,375

 
$
1,402,206

 
$
1,417,030


 The accompanying notes are an integral part of these consolidated financial statements.

3



DARLING INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
Three months ended March 31, 2012 and April 2, 2011
(in thousands, except per share data)
(unaudited)


 
 
Three Months Ended
 
March 31,
2012
 
April 2,
2011
Net sales
$
387,108

 
$
439,898

Costs and expenses:
 

 
 

Cost of sales and operating expenses
276,469

 
301,351

Selling, general and administrative expenses
37,369

 
30,693

Depreciation and amortization
20,760

 
19,681

Total costs and expenses
334,598

 
351,725

Operating income
52,510

 
88,173

 
 
 
 
Other expense:
 

 
 

Interest expense
(6,925
)
 
(14,228
)
Other, net
(608
)
 
(606
)
Total other expense
(7,533
)
 
(14,834
)
 
 
 
 
Equity in net loss of unconsolidated subsidiary
(236
)
 

Income before income taxes
44,741

 
73,339

Income taxes
16,170

 
26,777

Net income
$
28,571

 
$
46,562

 
 
 
 
Basic income per share
$
0.24

 
$
0.43

Diluted income per share
$
0.24

 
$
0.43



 



The accompanying notes are an integral part of these consolidated financial statements.

4



DARLING INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three months ended March 31, 2012 and April 2, 2011
(in thousands)
(unaudited)


 
Three Months Ended
 
March 31, 2012
 
April 2, 2011
Net income
$
28,571

 
$
46,562

Other comprehensive income (loss):
 
 
 
Pension adjustments, net of tax
742

 
431

Natural gas swap derivative adjustments, net of tax
7

 
(39
)
Interest rate swap derivative adjustment, net of tax
142

 
195

Total other comprehensive income
891

 
587

Total comprehensive income
$
29,462

 
$
47,149







The accompanying notes are an integral part of these consolidated financial statements.


5



DARLING INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
Three months ended March 31, 2012 and April 2, 2011
(in thousands)
(unaudited)

 
March 31,
2012
 
April 2,
2011
Cash flows from operating activities:
 
 
 
Net income
$
28,571

 
$
46,562

Adjustments to reconcile net income to net cash provided by
         operating activities:
 
 
 
Depreciation and amortization
20,760

 
19,681

Loss/(gain) on disposal of property, plant, equipment and other assets
360

 
(40
)
Deferred taxes
3,253

 
3,422

Increase in long-term pension liability
135

 
265

Stock-based compensation expense
3,071

 
1,214

Write-off deferred loan costs
725

 
4,184

Deferred loan cost amortization
764

 
900

Equity in net loss of unconsolidated subsidiary
236

 

Changes in operating assets and liabilities:
 
 
 
Restricted cash
(16
)
 
(11
)
Accounts receivable
12,434

 
(12,370
)
Income taxes refundable/payable
11,027

 
21,802

Inventories and prepaid expenses
(8,337
)
 
(5,019
)
Accounts payable and accrued expenses
(23,438
)
 
(1,765
)
Other
4,026

 
1,875

Net cash provided by operating activities
53,571

 
80,700

Cash flows from investing activities:
 
 
 
Capital expenditures
(24,690
)
 
(12,757
)
       Investment in unconsolidated subsidiary
(11,351
)
 
(1,601
)
Gross proceeds from disposal of property, plant and equipment
        and other assets
2,228

 
273

Net cash used by investing activities
(33,813
)
 
(14,085
)
Cash flows from financing activities:
 
 
 
Payments on long-term debt
(30,002
)
 
(240,002
)
Borrowings from revolving credit facility

 
90,000

Payments on revolving credit facility

 
(190,000
)
Deferred loan costs

 
(267
)
Issuance of common stock
64

 
292,843

Minimum withholding taxes paid on stock awards
(2,157
)
 
(1,154
)
Excess tax benefits from stock-based compensation
985

 
809

Net cash used by financing activities
(31,110
)
 
(47,771
)
Net increase/(decrease) in cash and cash equivalents
(11,352
)
 
18,844

Cash and cash equivalents at beginning of period
38,936

 
19,202

Cash and cash equivalents at end of period
$
27,584

 
$
38,046

Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the period for:
 
 
 
Interest
$
155

 
$
3,579

Income taxes, net of refunds
$
295

 
$
1,205


The accompanying notes are an integral part of these consolidated financial statements.

6



DARLING INTERNATIONAL INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
March 31, 2012
(unaudited)

(1)
General

Darling International Inc., a Delaware corporation (“Darling”, and together with its subsidiaries, 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. The Company operates over 120 processing and transfer facilities located throughout the United States to process raw materials into finished products such as protein (primarily meat and bone meal (“MBM”) and poultry meal (“PM”)), hides, fats (primarily bleachable fancy tallow (“BFT”), poultry grease (“PG”) and yellow grease (“YG”)) and bakery by-products (“BBP”) as well as a range of branded and value-added products. The Company sells these products nationally and internationally, primarily to producers of animal feed, pet food, fertilizer, bio-fuels and other consumer and industrial ingredients including oleo-chemicals, soaps and leather goods for use as ingredients in their products or for further processing. The accompanying consolidated financial statements for the three month periods ended March 31, 2012 and April 2, 2011, have been prepared in accordance with generally accepted accounting principles in the United States by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”).  The information furnished herein reflects all adjustments (consisting only of normal recurring accruals) that are, in the opinion of management, necessary to present a fair statement of the financial position and operating results of the Company as of and for the respective periods. However, these operating results are not necessarily indicative of the results expected for a full fiscal year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations.  However, management of the Company believes, to the best of their knowledge, that the disclosures herein are adequate to make the information presented not misleading.  The Company has determined that there were no subsequent events that would require disclosure or adjustments to the accompanying consolidated financial statements through the date the financial statements were issued.  The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company’s Form 10-K for the fiscal year ended December 31, 2011

(2)
Summary of Significant Accounting Policies

(a)
Basis of Presentation

The consolidated financial statements include the accounts of Darling and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

(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 March 31, 2012, and include the 13 weeks ended March 31, 2012, and the 13 weeks ended April 2, 2011.

(c)
Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

(d)
Earnings Per Share

Basic income per common share is computed by dividing net income by the weighted average number of common shares including non-vested and restricted shares outstanding during the period.  Diluted income per common share is computed by dividing net income by the weighted average number of common shares including non-vested and restricted shares outstanding during the period increased by dilutive common equivalent shares determined using the treasury stock method. As a result of the use of weighted average number of shares the full effect of the issuance of 24,193,548 shares as discussed in Note 8 are not in the earnings per share calculation set forth below for fiscal 2011.

7




 
Net Income per Common Share (in thousands, except per share data)
 
Three Months Ended
 
 
 
March 31, 2012
 
 
 
 
 
April 2, 2011
 
 
 
Income
 
Shares
 
Per Share
 
Income
 
Shares
 
Per Share
Basic:
 
 
 
 
 
 
 
 
 
 
 
Net Income
$
28,571

 
117,302

 
$
0.24

 
$
46,562

 
108,573

 
$
0.43

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Effect of dilutive securities:
 

 
 

 
 

 
 

 
 

 
 

Add: Option shares in the money and dilutive effect of non-vested stock
 

 
875

 
 

 
 

 
999

 
 

Less: Pro forma treasury shares
 

 
(347
)
 
 

 
 

 
(407
)
 
 

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Net income
$
28,571

 
117,830

 
$
0.24

 
$
46,562

 
109,165

 
$
0.43


For the three months ended March 31, 2012 and April 2, 2011, respectively, 211,890 and 77,834 outstanding stock options were excluded from diluted income per common share as the effect was antidilutive. For the three months ended March 31, 2012 and April 2, 2011, respectively, 123,260 and 378,787 shares of non-vested stock were excluded from diluted income per common share as the effect was antidilutive.

(3)
Investment in Unconsolidated Subsidiary

The Company announced on January 21, 2011 that a wholly-owned subsidiary of Darling entered into a limited liability company agreement with a wholly-owned subsidiary of Valero Energy Corporation (“Valero”) to form Diamond Green Diesel Holdings LLC (the “Joint Venture”). The Joint Venture is owned 50% / 50% with Valero and was formed to design, engineer, construct and operate a renewable diesel plant (the “Facility”), which will be capable of producing approximately 9,300 barrels per day of renewable diesel fuel and certain other co-products, to be located adjacent to Valero's refinery in Norco, Louisiana. The Joint Venture is in the process of constructing the Facility under an engineering, procurement and construction contract that is intended to fix the Company's maximum economic exposure for the cost of the Facility.

On May 31, 2011, the Joint Venture and Diamond Green Diesel LLC, a wholly-owned subsidiary of the Joint Venture (“Opco”), entered into (i) a facility agreement (the “Facility Agreement”) with Diamond Alternative Energy, LLC, a wholly-owned subsidiary of Valero (the “Lender”), and (ii) a loan agreement (the “Loan Agreement”) with the Lender, which will provide the Joint Venture with a 14 year multiple advance term loan facility of approximately $221,300,000 (the “JV Loan”) to support the design, engineering and construction of the Facility, which is now under construction. The Facility Agreement and the Loan Agreement prohibit the Lender from assigning all or any portion of the Facility Agreement or the Loan Agreement to unaffiliated third parties. Opco has also pledged substantially all of its assets to the Lender, and the Joint Venture has pledged all of Opco's equity interests to the Lender, until the JV Loan has been paid in full and the JV Loan has terminated in accordance with its terms.

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 $93.2 million of the estimated aggregate costs of approximately $407.7 million for the completion of the Facility. The Company is also required to pay for 50% of any cost overruns incurred in connection with the construction of the Facility, including relating to any project scope changes and working capital funding. As of March 31, 2012 under the equity method of accounting, the Company has an investment in the Joint Venture of approximately $32.8 million on the consolidated balance sheet and has recorded approximately $0.2 million in losses in the unconsolidated subsidiary for the three months ended March 31, 2012 and no earnings or losses for the three months ended April 2, 2011.

(4)
Contingencies 

The Company is a party to several lawsuits, claims and loss contingencies arising in the ordinary course of its business, including assertions by certain regulatory and governmental agencies related to permitting requirements and air, wastewater and storm water discharges from the Company’s processing facilities.


8



The Company’s workers compensation, auto and general liability policies contain significant deductibles or self-insured retentions.  The Company estimates and accrues its expected ultimate claim costs related to accidents occurring during each fiscal year and carries this accrual as a reserve until these claims are paid by the Company.

As a result of the matters discussed above, the Company has established loss reserves for insurance, environmental and litigation matters.  At March 31, 2012 and December 31, 2011, the reserves for insurance, environmental and litigation contingencies reflected on the balance sheet in accrued expenses and other non-current liabilities were approximately $38.8 million and $38.0 million, respectively.  The Company has insurance recovery receivables of approximately $9.6 million as of March 31, 2012 and December 31, 2011, respectively, related to these liabilities. The Company's management believes these reserves for contingencies are reasonable and sufficient based upon present governmental regulations and information currently available to management; however, there can be no assurance that final costs related to these matters will not exceed current estimates. The Company believes that the likelihood is remote that any additional liability from these lawsuits and claims that may not be covered by insurance would have a material effect on the financial statements.

Lower Passaic River Area. The Company has been named as a third party defendant in a lawsuit pending in the Superior Court of New Jersey, Essex County, styled New Jersey Department of Environmental Protection, The Commissioner of the New Jersey Department of Environmental Protection Agency and the Administrator of the New Jersey Spill Compensation Fund, as Plaintiffs, vs. Occidental Chemical Corporation, Tierra Solutions, Inc., Maxus Energy Corporation, Repsol YPF, S.A., YPF, S.A., YPF Holdings, Inc., and CLH Holdings, as Defendants (Docket No. L-009868-05) (the “Tierra/Maxus Litigation”). In the Tierra/Maxus Litigation, which was filed on December 13, 2005, the plaintiffs seek to recover from the defendants past and future cleanup and removal costs, as well as unspecified economic damages, punitive damages, penalties and a variety of other forms of relief, purportedly arising from the alleged discharges into the Passaic River of a particular type of dioxin and other unspecified hazardous substances. The damages being sought by the plaintiffs from the defendants are likely to be substantial. On February 4, 2009, two of the defendants, Tierra Solutions, Inc. (“Tierra”) and Maxus Energy Corporation (“Maxus”), filed a third party complaint against over 300 entities, including the Company, seeking to recover all or a proportionate share of cleanup and removal costs, damages or other loss or harm, if any, for which Tierra or Maxus may be held liable in the Tierra/Maxus Litigation. Tierra and Maxus allege that Standard Tallow Company, an entity that the Company acquired in 1996, contributed to the discharge of the hazardous substances that are the subject of this case while operating a former plant site located in Newark, New Jersey. The Company is investigating these allegations, has entered into a joint defense agreement with many of the other third-party defendants and intends to defend itself vigorously. The court has issued a trial plan that contemplates a liability trial for third-party defendants (including the Company) in April 2013, with additional proceedings if necessary to allocate costs between third-party defendants in January 2014. Additionally, in December 2009, the Company, along with numerous other entities, received notice from the United States Environmental Protection Agency (EPA) that the Company (as successor-in-interest to Standard Tallow Company) is considered a potentially responsible party with respect to alleged contamination in the lower Passaic River area which is part of the Diamond Alkali Superfund Site located in Newark, New Jersey. In the letter, EPA requested that the Company join a group of other parties in funding a remedial investigation and feasibility study at the site. As of the date of this report, the Company has not agreed to participate in the funding group. The Company's ultimate liability for investigatory costs, remedial costs and/or natural resource damages in connection with the lower Passaic River area cannot be determined at this time; however, as of the date of this report, there is nothing that leads the Company to believe that these matters will have a material effect on the Company's financial position or results of operation.

Fresno Facility Permit Issue. The Company has been named as a defendant and a real party in interest in a lawsuit filed on April 9, 2012 in the Superior Court of the State of California, Fresno County, styled Concerned Citizens of West Fresno vs. The City of Fresno and Darling International Inc. In the complaint, the plaintiff alleges that the City of Fresno has failed to enforce its own zoning ordinances and engaged in a number of discriminatory practices against the citizens of West Fresno. In addition, the complaint alleges that the Company's Fresno facility is operating without a proper use permit. Rendering operations have been conducted on the site since 1955, and the Company believes that it possesses all of the required federal, state and local permits to continue to operate the facility in the manner currently conducted and intends to defend itself vigorously in this matter. While management cannot predict the ultimate outcome of this matter, management does not believe the outcome will have a material effect on the Company's financial condition or results of operations.



9



(5)
Business Segments

The Company sells its products domestically and internationally and operates within two industry segments: Rendering and Bakery. The measure of segment profit (loss) includes all revenues, operating expenses (excluding certain amortization of intangibles), and selling, general and administrative expenses incurred at all operating locations and excludes general corporate expenses. Included in corporate activities are general corporate expenses and the amortization of intangibles. Assets of corporate activities include cash, unallocated prepaid expenses, deferred taxes, prepaid pension, and miscellaneous other assets.

Rendering
Rendering operations process poultry, animal by-products and used cooking oil into fats (primarily BFT, PG and YG), protein (primarily MBM and PM (feed grade and pet food)) and hides. Fat was approximately $194.0 million and $236.2 million of net sales for the three months ended March 31, 2012 and April 2, 2011, respectively. Protein was approximately $103.5 million and $110.1 million of net sales for the three months ended March 31, 2012 and April 2, 2011, respectively. Rendering operations also provides grease trap servicing. Included in the Rendering Segment is the National Service Center (“NSC”). The NSC schedules services such as fat and bone and used cooking oil collection and trap cleaning for contracted customers using the Company's resources or third party providers.

Bakery
Bakery products are collected from large commercial bakeries that produce a variety of products, including cookies, crackers, cereal, bread, dough, potato chips, pretzels, sweet goods and biscuits, among others. The Company processes the raw materials into BBP, including Cookie Meal®, an animal feed ingredient primarily used in poultry rations.

Business Segment Net Sales (in thousands):

 
 
Three Months Ended
 
March 31,
2012
April 2,
2011
Rendering
$
322,312

$
371,570

Bakery
64,796

68,328

Total
$
387,108

$
439,898


Business Segment Profit/(Loss) (in thousands):

 
 
Three Months Ended
 
March 31, 2012
April 2, 2011
Rendering
$
64,578

$
88,956

Bakery
11,052

14,968

Corporate Activities
(40,134
)
(43,134
)
Interest expense
(6,925
)
(14,228
)
Net Income
$
28,571

$
46,562


 Business Segment Assets (in thousands):

 
 
March 31,
2012
December 31,
2011
Rendering
$
1,087,947

$
1,092,988

Bakery
167,297

165,885

Corporate Activities
146,962

158,157

Total
$
1,402,206

$
1,417,030

 
(6)
Income Taxes
 
The Company has provided income taxes for the three-month periods ended March 31, 2012 and April 2, 2011, based on its estimate of the effective tax rate for the entire 2012 and 2011 fiscal years.

10



 
The Company accounts for income taxes using the asset and liability method.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

The Company periodically assesses whether it is more likely than not that it will generate sufficient taxable income to realize its deferred income tax assets.  In making this determination, the Company considers all available positive and negative evidence and makes certain assumptions.  The Company considers, among other things, its deferred tax liabilities, the overall business environment, its historical earnings and losses, current industry trends and its outlook for future years.  Although the Company is unable to carryback any of its net operating losses, based upon recent favorable operating results and future projections, the Company believes it is more likely than not that certain net operating losses can be carried forward and utilized and other deferred tax assets will be realized.

The Company’s major taxing jurisdiction is the U.S. (federal and state).  The Company is no longer subject to federal examinations on years prior to fiscal 2008.  The number of years open for state tax audits varies, depending on the tax jurisdiction, but are generally from three to five years. Currently, several state examinations are in progress.  The Company does not anticipate that any state or federal audits will have a significant impact on the Company’s results of operations or financial position.  In addition, the Company does not reasonably expect any significant changes to the estimated amount of liability associated with the Company’s unrecognized tax positions in the next twelve months.

(7)
Debt

Credit Facilities

Senior Secured Credit Facilities. On December 17, 2010, the Company entered into a credit agreement (the “Credit Agreement”) consisting of a five-year senior secured revolving loan facility and a six-year senior secured term loan facility. On March 25, 2011, the Company amended its Credit Agreement to increase the aggregate available principal amount under the revolving loan facility from $325.0 million to $415.0 million (approximately $75.0 million of which will be available for a letter of credit sub-facility and $15.0 million of which will be available for a swingline sub-facility) and to add additional stepdowns to the pricing grid providing lower spread margins to the applicable base or Libor rate under the Credit Agreement based on defined leverage ratio levels. As of March 31, 2012, the Company had availability of $389.3 million under the revolving loan facility, taking into account no outstanding borrowings and letters of credit issued of $25.7 million. As of March 31, 2012, the Company had repaid all of the original $300.0 million term loan issued under the Credit Agreement, including $30.0 million repaid in the quarter ended March 31, 2012. The amounts that have been repaid on the term loan may not be reborrowed. As a result of the term loan payments, the Company incurred a write-off of a portion of the senior term loan facilities deferred loan costs of approximately $0.7 million and $4.2 million in the three month periods ending March 31, 2012 and April 2, 2011, respectively,which is included in interest expense. The revolving credit facility has a five-year term ending December 17, 2015. The Company used the original proceeds of the term loan facility and a portion of the revolving loan facility to pay a portion of the consideration of its prior year acquisitions, to pay related fees and expenses and to provide for working capital needs and general corporate purposes.

The Credit Agreement allows for borrowings at per annum rates based on the following loan types. With respect to any revolving facility loan, i) an alternate base rate means a rate per annum equal to the greatest of (a) the prime rate (b) the federal funds effective rate (as defined in the Credit Agreement) plus ½ to 1% and (c) the adjusted London Inter-Bank Offer Rate (“LIBOR”) for a month interest period plus 1%, plus in each case, a margin determined by reference to a pricing grid under the Credit Agreement and adjusted according to the Company's adjusted leverage ratio, and, ii) Eurodollar rate loans bear interest at a rate per annum based on the then applicable LIBOR multiplied by the statutory reserve rate plus a margin determined by reference to a pricing grid and adjusted according to the Company's adjusted leverage ratio. With respect to an alternate base rate loan that is a term loan, at no time will the alternate base rate be less than 2.50% per annum, plus the term loan alternate base rate margin of 2.50%. With respect to a LIBOR loan that is a term loan, at no time will the LIBOR rate applicable to the term loans (before giving effect to any adjustment for reserve requirements) be less than 1.50% per annum, plus the term loan LIBOR margin of 3.50%.

The Credit Agreement contains various customary representations and warranties by the Company, which include customary use of materiality, material adverse effect and knowledge qualifiers. The Credit Agreement also contains (a)

11



certain affirmative covenants that impose certain reporting and/or performance obligations on the Company, (b) certain negative covenants that generally prohibit, subject to various exceptions, the Company from taking certain actions, including, without limitation, incurring indebtedness, making investments, incurring liens, paying dividends, and engaging in mergers and consolidations, sale leasebacks and sales of assets, (c) financial covenants such as maximum total leverage ratio and a minimum fixed charge coverage ratio and (d) customary events of default (including a change of control). Obligations under the Credit Agreement may be declared due and payable upon the occurrence of such customary events of default.

Senior Notes. On December 17, 2010, Darling issued $250.0 million aggregate principal amount of its 8.5% Senior Notes due 2018 (the “Restricted Notes”) under an indenture with U.S. Bank National Association, as trustee. Darling used the net proceeds from the sale of the Restricted Notes to finance in part the cash portion of the purchase price paid in connection with Darling's acquisition of Griffin Industries, Inc. The Company will pay 8.5% annual cash interest on the Restricted Notes on June 15 and December 15 of each year, commencing June 15, 2011. Other than for extraordinary events such as change of control and defined assets sales, the Company is not required to make any mandatory redemption or sinking fund payments on the Restricted Notes.

The original holders of the Restricted Notes were given the benefit of registration rights pursuant to a registration rights agreement (the “Notes Registration Rights Agreement”) with the representative of the initial purchasers. In accordance with the terms of the Notes Registration Rights Agreement, on June 15, 2011, the Company filed a registration statement on Form S-4 to offer to exchange all outstanding Restricted Notes for $250.0 million 8.5% Senior Notes due 2018 (the “Exchange Notes” and collectively with the Restricted Notes, the “Notes”). The exchange offer was made effective June 27, 2011 and expired July 27, 2011 with the Company offering to exchange all outstanding Restricted Notes that were validly tendered and not withdrawn prior to the expiration or termination of the exchange offer for an equal principal amount of the applicable Exchange Notes. All of the Notes have been exchanged. The terms of the Exchange Notes are substantially identical in all material respects to those of the applicable outstanding Restricted Notes, except that transfer restrictions, registration rights and additional interest provisions relating to the Restricted Notes do not apply to the Exchange Notes. The Exchange Notes have been issued under the same indenture as the Restricted Notes. The Company did not receive any proceeds from the exchange offer. The Exchange Notes may be sold in the over-the-counter market, in negotiated transactions or through a combination of such methods. The Company does not plan to list the Notes on a national market.

The Company may at any time and from time to time purchase Notes in the open market or otherwise. The Notes are redeemable, in whole or in part, at any time on or after December 15, 2014 at the redemption prices specified in the indenture. Prior to December 15, 2014, the Company may redeem some or all of the Notes at a redemption price of 100% of the principal amount of the Notes redeemed, plus accrued and unpaid interest to the redemption date and an applicable premium as specified in the indenture.

The indenture contains covenants limiting Darling's ability and the ability of its restricted subsidiaries to, among other things; incur additional indebtedness or issue preferred stock; pay dividends on or make other distributions or repurchase of Darling's capital stock or make other restricted payments; create restrictions on the payment of dividends or other amounts from Darling's restricted subsidiaries to Darling or Darling's other restricted subsidiaries; make loans or investments; enter into certain transactions with affiliates; create liens; designate Darling's subsidiaries as unrestricted subsidiaries; and sell certain assets or merge with or into other companies or otherwise dispose of all or substantially all of Darling's assets.

The indenture also provides for customary events of default, including, without limitation, payment defaults, covenant defaults, cross acceleration defaults to certain other indebtedness in excess of specified amounts, certain events of bankruptcy and insolvency and judgment defaults in excess of specified amounts. If any such event of default occurs and is continuing under the indenture, the Trustee or the holders of at least 25% in principal amount of the total outstanding Notes may declare the principal, premium, if any, interest and any other monetary obligations on all the then outstanding Notes issued under the indenture to be due and payable immediately.

The Credit Agreement and the Notes consisted of the following elements at March 31, 2012 and December 31, 2011, respectively (in thousands):


12



 
 
March 31,
2012
December 31,
2011
Senior Notes:
 
 
8.5% Senior Notes due 2018
$
250,000

$
250,000

Senior Secured Credit Facilities:
 
 
Term Loan
$

$
30,000

Revolving Credit Facility:
 

 

Maximum availability
$
415,000

$
415,000

Borrowings outstanding


Letters of credit issued
25,652

23,440

Availability
$
389,348

$
391,560


The obligations under the Credit Agreement are guaranteed by Darling National LLC, a Delaware limited liability company (“Darling National”), Griffin Industries LLC, a Kentucky limited liability company (“Griffin”), and its subsidiary, Craig Protein Division, Inc (“Craig Protein”) and are secured by substantially all of the property of the Company, including a pledge of 100% of the stock of all material domestic subsidiaries and 65% of the capital stock of certain foreign subsidiaries. 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.

As of March 31, 2012, the Company believes it is in compliance with all of the financial covenants, as well as all of the other covenants contained in the Credit Agreement and the Notes Indenture. 

(8)
Stockholders' Equity

On January 27, 2011, the Company entered into an underwritten public offering for 24,193,548 shares of its common stock, at a price to the public of $12.70 per share, pursuant to an effective shelf registration statement. The offering closed on February 2, 2011. In addition, certain former stockholders of Griffin Industries, Inc. (pursuant to such stockholders' contractual registration rights) granted the underwriters a 30-day option, which the underwriters subsequently exercised in full, to purchase from them up to an additional 3,629,032 shares of Darling common stock to cover over-allotments. The Company used the net proceeds of approximately $292.7 million from the offering to repay all of its then outstanding revolver balance and a portion of its term loan facility under the Company's Credit Agreement. Darling did not receive any proceeds from the sale of shares by the former stockholders of Griffin Industries, Inc.

(9)
Derivatives

The Company’s operations are exposed to market risks relating to commodity prices that affect the Company’s cost of raw materials, finished product prices and energy costs and the risk of changes in interest rates.

The Company makes limited use of derivative instruments to manage cash flow risks related to interest expense, natural gas usage, diesel fuel usage and inventory. The Company does not use derivative instruments for trading purposes. Interest rate swaps are entered into with the intent of managing overall borrowing costs by reducing the potential impact of increases in interest rates on floating-rate long-term debt. Natural gas swaps and options are entered into with the intent of managing the overall cost of natural gas usage by reducing the potential impact of seasonal weather demands on natural gas that increases natural gas prices. Heating oil swaps and options are entered into with the intent of managing the overall cost of diesel fuel usage by reducing the potential impact of seasonal weather demands on diesel fuel that increases diesel fuel prices. Inventory swaps and options are entered into with the intent of managing seasonally high concentrations of MBM, PM, BFT, PG, YG and BBP inventories by reducing the potential impact of decreasing prices. At March 31, 2012, the Company had natural gas swaps outstanding that qualified and were designated for hedge accounting as well as heating oil swaps and options that did not qualify and were not designated for hedge accounting.

13




Entities are required to report all derivative instruments in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, on the reason for holding the instrument. If certain conditions are met, entities may elect to designate a derivative instrument as a hedge of exposures to changes in fair value, cash flows or foreign currencies. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income (outside of earnings) and is subsequently reclassified into earnings when the forecasted transaction affects earnings. Any amounts excluded from the assessment of hedge effectiveness as well as the ineffective portion of the gain or loss are reported in earnings immediately. If the derivative instrument is not designated as a hedge, the gain or loss is recognized in earnings in the period of change.

Cash Flow Hedges

On May 19, 2006, the Company entered into two interest rate swap agreements that were considered cash flow hedges according to FASB authoritative guidance. In December 2010, as a result of the Merger and entry into a new Credit Agreement the term loan that specifically related to these interest swap transactions was repaid. As such, the Company discontinued the interest rate swaps and paid approximately $2.0 million representing the fair value of these two interest swap transactions at the discontinuance date with the effective portion recorded in accumulated other comprehensive loss to be reclassified to income over the remaining original term of the interest swaps which ends April 7, 2012.

In fiscal 2011, the Company entered into natural gas swap contracts that are considered cash flow hedges. Under the terms of the natural gas swap contracts the Company fixed the expected purchase cost of a portion of its plants expected natural gas usage into the third quarter of fiscal 2012. As of March 31, 2012, some of the contracts have expired and settled according to the contracts while the remaining contract positions and activity are disclosed below.

In the first three months of fiscal 2012, the Company entered into natural gas swap contracts that are considered cash flow hedges. Under the terms of the natural gas swap contracts the Company fixed the expected purchase cost of a portion of its plants expected natural gas usage into the third quarter of fiscal 2012. As of March 31, 2012, the contract positions and activity are disclosed below.

The Company estimates the amount that will be reclassified from accumulated other comprehensive loss at March 31, 2012 into earnings over the next 12 months will be approximately $0.7 million. As of March 31, 2012, approximately $0.2 million of losses have been reclassified into earnings as a result of the discontinuance of cash flow hedges.

The following table presents the fair value of the Company’s derivative instruments under FASB authoritative guidance as of March 31, 2012 and December 31, 2011 (in thousands):

Derivatives not
Designated as
Hedges
Balance Sheet
Asset Derivatives Fair Value
Location
March 31, 2012
December 31, 2011
Heating oil swaps and options
Other current assets
$
49

$
6

 
 
 
 
Total asset derivatives not designated as hedges
$
49

$
6

 
 
 
 
Total asset derivatives
 
$
49

$
6



14



Derivatives Designated
Balance Sheet
Liability Derivatives Fair Value
as Hedges
Location
March 31, 2012
December 31, 2011
Natural gas swaps
Accrued expenses
$
653

$
669

 
 
 
 
Total liability derivatives designated as hedges
$
653

$
669

 
 
 
 
Derivatives not
Designated as
Hedges
 
 

 

Natural gas swaps
Accrued expenses
$

$
143

Heating oil swaps
Accrued expenses
4

24

 
 
 
 
Total liability derivatives not designated as hedges
$
4

$
167

 
 
 
 
Total liability derivatives
$
657

$
836


The effect of the Company’s derivative instruments on the consolidated financial statements as of and for the three months ended March 31, 2012 and April 2, 2011 is as follows (in thousands):

 
 
 
Derivatives
Designated as
Cash Flow Hedges
 
Gain or (Loss)
Recognized in OCI
on Derivatives
(Effective Portion) (a)
Gain or (Loss)
Reclassified From
Accumulated OCI
into Income
(Effective Portion) (b)
Gain or (Loss)
Recognized in Income
on Derivatives
(Ineffective Portion and
Amount Excluded from
Effectiveness Testing) (c)
 
2012
2011
2012
2011
2012
2011
Interest rate swaps
$

$

$
(232
)
$
(319
)
$

$

Natural gas swaps
(700
)
(213
)
(713
)
(150
)
3

8

 
 
 
 
 
 
 
Total
$
(700
)
$
(213
)
$
(945
)
$
(469
)
$
3

$
8


(a)
Amount recognized in accumulated OCI (effective portion) is reported as accumulated other comprehensive income/(loss) of approximately $0.7 million and approximately $0.2 million recorded net of taxes of approximately $0.3 million and approximately $0.1 million as of March 31, 2012 and April 2, 2011, respectively.
(b)
Gains and (losses) reclassified from accumulated OCI into income (effective portion) for interest rate swaps and natural gas swaps is included in interest expense and cost of sales, respectively, in the Company’s consolidated statements of operations.
(c)
Gains and (losses) recognized in income on derivatives (ineffective portion) for interest rate swaps and natural gas swaps is included in other, net in the Company’s consolidated statements of operations.

At March 31, 2012, the Company had forward purchase agreements in place for purchases of approximately $5.6 million of natural gas and diesel fuel.  These forward purchase agreements have no net settlement provisions and the Company intends to take physical delivery of the underlying product.  Accordingly, the forward purchase agreements are not subject to the requirements of fair value accounting because they qualify as normal purchases as defined in the FASB authoritative guidance.

(10)    Revenue Recognition

The Company recognizes revenue on sales when products are shipped and the customer takes ownership and assumes risk of loss.  Certain customers may be required to prepay prior to shipment in order to maintain payment protection related to certain foreign and domestic sales.  These amounts are recorded as unearned revenue and recognized when the products have shipped and the customer takes ownership and assumes risk of loss.  The Company has formula arrangements with certain suppliers whereby the charge or credit for raw materials is tied to published finished product commodity prices after deducting a fixed processing fee incorporated into the formula and is recorded as a cost of sale by line of business.  The Company recognizes revenue related to grease trap servicing in the month the trap service occurs.

15



(11)  
Comprehensive Income

The Company follows Financial Accounting Standards Board ("FASB") authoritative guidance for reporting and presentation of comprehensive income or loss and its components.  Other comprehensive income (loss) is derived from adjustments that reflect pension adjustments, natural gas derivative adjustments and interest rate swap derivative adjustments. The components of other comprehensive income (loss) and the related tax impacts are as follows (in thousands):

 
Before-Tax
 
Tax (Expense)
 
Net-of-Tax
 
Amount
 
or Benefit
 
Amount
 
March 31,
2012
April 2,
2011
 
March 31,
2012
April 2,
2011
 
March 31,
2012
April 2,
2011
Defined benefit pension plans
 
 
 
 
 
 
 
 
Amortization of prior service cost
$
22

$
22

 
$
(8
)
$
(8
)
 
$
14

$
14

Amortization of actuarial loss
1,189

681

 
(461
)
(264
)
 
728

417

Total defined benefit pension plans
1,211

703

 
(469
)
(272
)
 
742

431

 
 
 
 
 
 
 
 
 
Natural gas swap derivatives
 
 
 
 
 
 




Loss reclassified to net income
713

150

 
(276
)
(58
)
 
437

92

Loss activity recognized in other comprehensive loss
(700
)
(213
)
 
270

82

 
(430
)
(131
)
Total natural gas swap derivatives
13

(63
)
 
(6
)
24

 
7

(39
)
 
 
 
 
 
 
 
 
 
Interest rate swap derivatives
 
 
 
 
 
 
 
 
Loss reclassified to net income
232

319

 
(90
)
(124
)
 
142

195

 
 
 
 
 
 
 
 
 
Other Comprehensive income (loss)
$
1,456

$
959

 
$
(565
)
$
(372
)
 
$
891

$
587


(12)    Employee Benefit Plans

The Company has retirement and pension plans covering substantially all of its employees.  Most retirement benefits are provided by the Company under separate final-pay noncontributory and contributory defined benefit and defined contribution plans for all salaried and hourly employees (excluding those covered by union-sponsored plans) who meet service and age requirements. Defined benefits are based principally on length of service and earnings patterns during the five years preceding retirement. 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 January 1, 2012, to include the closing of Darling's salaried and hourly defined benefit plans to new participants as well as the freezing of service and wage accruals thereunder effective December 31, 2011 (a curtailment of these plans for financial reporting purposes) and the enhancing of benefits under the Company's defined contribution plans.

Net pension cost for the three months ended March 31, 2012 and April 2, 2011 includes the following components (in thousands):

 
Three Months Ended
 
March 31,
2012
April 2,
2011
Service cost
$
81

$
295

Interest cost
1,363

1,513

Expected return on plan assets
(1,677
)
(1,722
)
Amortization of prior service cost
22

22

Amortization of net loss
1,189

681

Net pension cost
$
978

$
789

  

16



The Company's funding policy for employee benefit pension plans is to contribute annually not less than the minimum amount required nor more than the maximum amount that can be deducted for federal income tax purposes.  Contributions are intended to provide not only for benefits attributed to service to date, but also for those expected to be earned in the future. Based on actuarial estimates at March 31, 2012, the Company expects to contribute approximately $2.4 million to its pension plans to meet funding requirements during the next twelve months. Additionally, the Company has made tax deductible discretionary and required contributions to its pension plans for the three months ended March 31, 2012 and April 2, 2011 of approximately $0.4 million and $0.2 million, respectively.  

The Company participates in various multi-employer pension plans which provide defined benefits to certain employees covered by labor contracts.  These plans are not administered by the Company and contributions are determined in accordance with provisions of negotiated labor contracts to meet their pension benefit obligations to their participants.   The Company's contributions to each individual multi-employer plan represent less than 5% of the total contributions to each such plan. Based on the most currently available information, the Company has determined that, if a withdrawal were to occur, withdrawal liabilities on two of the plans in which the Company currently participates could be material to the Company, with one of these material plans certified as critical or red zone. With respect to the other multi-employer pension plans in which the Company participates and which are not individually significant, five plans have certified as critical or red zone and one plan has certified as endangered or yellow zone as defined by the Pension Protection Act of 2006.

In June 2009, the Company received a notice of a mass withdrawal termination and a notice of initial withdrawal liability from a multi-employer plan in which it participated. The Company had anticipated this event and as a result had accrued approximately $3.2 million as of January 3, 2009 based on the most recent information that was probable and estimable for this plan. The plan had given a notice of redetermination liability in December 2009. In fiscal 2010, the Company received further third party information confirming the future payout related to this multi-employer plan. As a result, the Company reduced its liability to approximately $1.2 million. In fiscal 2010, another underfunded multi-employer plan in which the Company participates gave notification of partial withdrawal liability. As of March 31, 2012, the Company has an accrued liability of approximately $1.0 million representing the present value of scheduled withdrawal liability payments under this multi-employer plan. While the Company has no ability to calculate a possible current liability for under-funded multi-employer plans that could terminate or could require additional funding under the Pension Protection Act of 2006, the amounts could be material.

(13)    Fair Value Measurements

FASB authoritative guidance defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  The following table presents the Company’s financial instruments that are measured at fair value on a recurring and nonrecurring basis as of March 31, 2012 and are categorized using the fair value hierarchy under FASB authoritative guidance.  The fair value hierarchy has three levels based on the reliability of the inputs used to determine the fair value.
 
 
 
Fair Value Measurements at March 31, 2012 Using
 
 
Quoted Prices in
Active Markets for
Identical Assets
Significant Other
Observable
Inputs
Significant
Unobservable
Inputs
(In thousands of dollars)
Total
(Level 1)
(Level 2)
(Level 3)
Assets:
 
 
 
 
Derivative instruments
$
49

$

$
49

$

Total Assets
$
49

$

$
49

$

 
 
 
 
 
Liabilities:
 
 
 
 
Derivative instruments
$
657

$

$
657

$

Senior Notes
278,750


278,750


Total Liabilities
$
279,407

$

$
279,407

$


Derivative assets consist of the Company’s heating oil swap and option contracts, which represents the difference between observable market rates of commonly quoted intervals for similar assets and liabilities in active markets and the fixed swap rate considering the instruments term, notional amount and credit risk.  See Note 9 Derivatives for breakdown by instrument type.


17



Derivative liabilities consist of the Company’s natural gas swap and heating oil swap contracts, which represents the difference between observable market rates of commonly quoted intervals for similar assets and liabilities in active markets and the fixed swap rate considering the instruments term, notional amount and credit risk.  See Note 9 Derivatives for breakdown by instrument type.

The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximates fair value due to the short maturity of these instruments and as such have been excluded from the table above. The carrying amount for the Company's other debt is not deemed to be significantly different than the fair value and all other instruments have been recorded at fair value. 

The fair value of the senior notes is based on market quotation from a third-party bank.

(14)     New Accounting Pronouncements

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income. The ASU amends ASC Topic 220, Comprehensive Income.  The new standard eliminates the option to report other comprehensive income and its components in the statement of changes in equity and instead requires entities to present net income and other comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. Reclassification adjustments between net income and other comprehensive income must be shown on the face of the statement(s), with no resulting change in net earnings. In December 2011, the FASB issued ASU No. 2011-12, Deferral of Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. This ASU amends ASC Topic 220, Comprehensive Income. The new standard deferred the requirement to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income while the FASB further deliberates this aspect of the proposal. This update is effective for the Company on January 1, 2012 and must be applied retrospectively. The Company adopted this standard as of March 31, 2012. The adoption did not have a material impact on the Company's consolidated financial statements.

In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment. The ASU amends ASC Topic 350, Intangibles - Goodwill and Other. The new standard is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary. Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. This standard is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permissible. The Company adopted this standard in the first quarter of 2012 and the adoption did not have a material impact on the Company's consolidated financial statements.



18




(15)     Guarantor Financial Information

The Company's Notes (see Note 7) are guaranteed on an unsecured basis by the Company's 100% directly and indirectly owned subsidiaries Darling National, Griffin and its subsidiary Craig Protein (collectively, the "Guarantors"). The Guarantors fully and unconditionally guaranteed the Notes on a joint and several basis. The following financial statements present condensed consolidating financial data for (i) Darling, the issuer of the Notes, (ii) the combined Guarantors, (iii) the combined other subsidiaries of the Company that did not guarantee the Notes (the "Non-guarantors"), and (iv) eliminations necessary to arrive at the Company's consolidated financial statements, which include condensed consolidated balance sheets as of March 31, 2012 and December 31, 2011, and the condensed consolidating statements of operations, the condensed consolidating statements of comprehensive income and the condensed consolidating statements of cash flows for the three months ended March 31, 2012 and April 2, 2011.





Condensed Consolidating Balance Sheet
As of March 31, 2012
(in thousands)

 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
ASSETS
 
 
 
 
 
Total current assets
$
101,566

$
366,530

$
2,183

$
(276,555
)
$
193,724

Investment in subsidiaries
1,327,883



(1,327,883
)

Property, plant and equipment, net
121,893

286,654



408,547

Intangible assets, net
14,080

341,564

287


355,931

Goodwill
21,860

359,243

266


381,369

Investment in unconsolidated subsidiary


32,848


32,848

Other assets
26,168

3,619



29,787

 
$
1,613,450

$
1,357,610

$
35,584

$
(1,604,438
)
$
1,402,206

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 

 
 
 

Total current liabilities
$
327,136

$
52,039

$
1,021

$
(276,555
)
$
103,641

Long-term debt, net of current portion
250,000

18



250,018

Other noncurrent liabilities
45,377

12,052

181


57,610

Deferred income taxes
34,971




34,971

Total liabilities
657,484

64,109

1,202

(276,555
)
446,240

Stockholders’ equity:
 

 

 
 
 

Common stock, additional paid-in capital and treasury stock
589,402

1,022,544

39,358

(1,061,902
)
589,402

Retained earnings and accumulated other comprehensive loss
366,564

270,957

(4,976
)
(265,981
)
366,564

Total stockholders’ equity
955,966

1,293,501

34,382

(1,327,883
)
955,966

 
$
1,613,450

$
1,357,610

$
35,584

$
(1,604,438
)
$
1,402,206




19



Condensed Consolidating Balance Sheet
As of December 31, 2011
(in thousands)

 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
ASSETS
 
 
 
 
 
Total current assets
$
124,675

$
347,989

$
3,980

$
(256,964
)
$
219,680

Investment in subsidiaries
1,286,175



(1,286,175
)

Property, plant and equipment, net
119,898

280,324



400,222

Intangible assets, net
14,747

347,874

293


362,914

Goodwill
21,860

359,243

266


381,369

Investment in unconsolidated subsidiary


21,733


21,733

Other assets
27,725

3,387



31,112

 
$
1,595,080

$
1,338,817

$
26,272

$
(1,543,139
)
$
1,417,030

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 

 
 
 

Total current liabilities
$
317,561

$
63,718

$
2,942

$
(256,964
)
$
127,257

Long-term debt, net of current portion
280,000

20



280,020

Other noncurrent liabilities
46,011

12,052

182


58,245

Deferred income taxes
31,133




31,133

Total liabilities
674,705

75,790

3,124

(256,964
)
496,655

Stockholders’ equity:
 

 

 
 
 

Common stock, additional paid-in capital and treasury stock
583,273

1,022,544

27,982

(1,050,526
)
583,273

Retained earnings and accumulated other comprehensive loss
337,102

240,483

(4,834
)
(235,649
)
337,102

Total stockholders’ equity
920,375

1,263,027

23,148

(1,286,175
)
920,375

 
$
1,595,080

$
1,338,817

$
26,272

$
(1,543,139
)
$
1,417,030




Condensed Consolidating Statements of Operations
For the three months ended March 31, 2012
(in thousands)

 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Net sales
$
152,988

$
273,509

$
2,554

$
(41,943
)
$
387,108

Cost and expenses:
 
 
 
 
 
Cost of sales and operating expenses
121,097

194,813

2,502

(41,943
)
276,469

Selling, general and administrative expenses
20,785

16,545

39


37,369

Depreciation and amortization
6,296

14,458

6


20,760

Total costs and expenses
148,178

225,816

2,547

(41,943
)
334,598

Operating income
4,810

47,693

7


52,510

 
 

 

 
 
 

Interest expense
(6,925
)



(6,925
)
Other, net
(642
)
27

7


(608
)
Equity in net loss of unconsolidated subsidiary


(236
)

(236
)
Earnings in investments in subsidiaries
30,332



(30,332
)

Income/(loss) before taxes
27,575

47,720

(222
)
(30,332
)
44,741

Income taxes (Benefit)
(996
)
17,246

(80
)

16,170

Net income (loss)
$
28,571

$
30,474

$
(142
)
$
(30,332
)
$
28,571


 
 
 
 
 
 

20



Condensed Consolidating Statements of Operations
For the three months ended April 2, 2011
(in thousands)
 
 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Net sales
$
174,655

$
307,114

$
6,549

$
(48,420
)
$
439,898

Cost and expenses:
 
 
 
 
 
Cost of sales and operating expenses
131,988

211,525

6,257

(48,419
)
301,351

Selling, general and administrative expenses
15,187

15,466

40


30,693

Depreciation and amortization
6,184

13,497



19,681

Total costs and expenses
153,359

240,488

6,297

(48,419
)
351,725

Operating income
21,296

66,626

252

(1
)
88,173

 
 

 

 
 
 

Interest expense
(14,227
)
(1
)


(14,228
)
Other, net
(524
)
(76
)
(7
)
1

(606
)
Earnings in investments in subsidiaries
42,407



(42,407
)

Income/(loss) before taxes
48,952

66,549

245

(42,407
)
73,339

Income taxes
2,390

24,297

90


26,777

Net income (loss)
$
46,562

$
42,252

$
155

$
(42,407
)
$
46,562

 
 
 
 
 
 

Condensed Consolidating Statements of Comprehensive Income (Loss)
For the three months ended March 31, 2012
(in thousands)
 
 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Net income
$
28,571

$
30,474

$
(142
)
$
(30,332
)
$
28,571

Other comprehensive income (loss):
 
 
 
 
 
Pension adjustments, net of tax
742




742

Natural gas swap derivative adjustments, net of tax
7




7

Interest rate swap derivative adjustment, net of tax
142




142

Total other comprehensive income (loss)
891




891

Total comprehensive income (loss)
$
29,462

$
30,474

$
(142
)
$
(30,332
)
$
29,462


Condensed Consolidating Statements of Comprehensive Income (Loss)
For the three months ended April 2, 2011
(in thousands)
 
 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Net income
$
46,562

$
42,252

$
155

$
(42,407
)
$
46,562

Other comprehensive income (loss):
 
 
 
 
 
Pension adjustments, net of tax
431




431

Natural gas swap derivative adjustments, net of tax
(39
)



(39
)
Interest rate swap derivative adjustment, net of tax
195




195

Total other comprehensive income (loss)
587




587

Total comprehensive income (loss)
$
47,149

$
42,252

$
155

$
(42,407
)
$
47,149



21





Condensed Consolidating Statements of Cash Flows
For the three months ended March 31, 2012
(in thousands)

 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Cash flows from operating activities:
 
 
 
 
 
Net income
$
28,571

$
30,474

$
(142
)
$
(30,332
)
$
28,571

Earnings in investments in subsidiaries
(30,332
)


30,332


Other operating cash flows
31,598

(16,795
)
10,197


25,000

Net cash provided by operating activities
29,837

13,679

10,055


53,571

 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
Capital expenditures
(8,123
)
(16,567
)


(24,690
)
Investment in unconsolidated subsidiary


(11,351
)

(11,351
)
Gross proceeds from sale of property, plant and equipment and other assets
1,111

1,117



2,228

Net cash used in investing activities
(7,012
)
(15,450
)
(11,351
)

(33,813
)
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Payments on long-term debt
(30,000
)
(2
)


(30,002
)
Issuances of common stock
64




64

Minimum withholding taxes paid on stock awards
(2,157
)



(2,157
)
Excess tax benefits from stock-based compensation
985




985

Net cash used in financing activities
(31,108
)
(2
)


(31,110
)
 
 
 
 
 
 
Net decrease in cash and cash equivalents
(8,283
)
(1,773
)
(1,296
)

(11,352
)
Cash and cash equivalents at beginning of year
35,207

1,773

1,956


38,936

Cash and cash equivalents at end of year
$
26,924

$

$
660

$

$
27,584



22



Condensed Consolidating Statements of Cash Flows
For the three months ended April 2, 2011
(in thousands)

 
Issuer
Guarantors
Non-guarantors
Eliminations
Consolidated
Cash flows from operating activities:
 
 
 
 
 
Net income
$
46,562

$
42,252

$
155

$
(42,407
)
$
46,562

Earnings in investments in subsidiaries
(42,407
)


42,407


Other operating cash flows
65,061

(32,202
)
1,279


34,138

Net cash provided by operating activities
69,216

10,050

1,434


80,700

 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
Capital expenditures
(5,047
)
(7,710
)


(12,757
)
Investment in unconsolidated subsidiary


(1,601
)

(1,601
)
Gross proceeds from sale of property, plant and equipment and other assets
198

75



273

Net cash used in investing activities
(4,849
)
(7,635
)
(1,601
)

(14,085
)
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
Payments on long-term debt
(240,000
)
(2
)


(240,002
)
Borrowings from revolving credit facility
90,000




90,000

Payments on revolving credit facility
(190,000
)



(190,000
)
Deferred loan costs
(267
)



(267
)
Issuances of common stock
292,843




292,843

Minimum withholding taxes paid on stock awards
(1,154
)



(1,154
)
Excess tax benefits from stock-based compensation
809




809

Net cash used in financing activities
(47,769
)
(2
)


(47,771
)
 
 
 
 
 
 
Net increase/(decrease) in cash and cash equivalents
16,598

2,413

(167
)

18,844

Cash and cash equivalents at beginning of year
13,108

5,480

614


19,202

Cash and cash equivalents at end of year
$
29,706

$
7,893

$
447

$

$
38,046



23



Item 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including those set forth below under the heading “Forward Looking Statements” and elsewhere in this report, and under the heading “Risk Factors” in the Company's Annual Report on Form 10-K for the year ended December 31, 2011, and in the Company's other public filings with the SEC.

The following discussion should be read in conjunction with the historical consolidated financial statements and notes thereto.

Overview

The Company is a leading provider of rendering, 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. The Company operates over 120 processing and transfer facilities located throughout the United States to process raw materials into finished products such as protein (primarily meat and bone meal (“MBM”) and poultry meal (“PM”)), hides, fats (primarily bleachable fancy tallow (“BFT”), poultry grease (“PG”) and yellow grease (“YG”)), and bakery by-product (“BBP”) as well as a range of branded and value-added products. The Company sells these products nationally and internationally, primarily to producers of animal feed, pet food, fertilizer, bio-fuels and other consumer and industrial ingredients, including oleo-chemicals, soaps and leather goods for use as ingredients in their products or for further processing. All of the Company's finished products are commodities and are priced relative to competing commodities, primarily corn, soybean oil and soybean meal. Finished product prices will track as to nutritional and industry value to the ultimate customer's use of the product. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company's Form 10-K for the fiscal year ended December 31, 2011.

The Company's operating performance for the first quarter of fiscal 2012 moderated relative to the first quarter of fiscal 2011. Year over year, lower finished product selling prices for proteins and fats were the primary driver as export volumes all but came to a standstill. As compared to the fourth quarter of fiscal 2011, finished product prices continued to decline through most of the first quarter of fiscal 2012 before rapidly escalating in March 2012. As a result, the Company built significant inventories during the quarter. Rendering raw material volumes as compared to the fourth quarter of fiscal 2011 remained steady; however, mild winter weather had a mixed impact on the Company as it provided historically low rendering volume from mortalities but positively influenced operating costs in the factory. Energy costs for natural gas continued to decline and positively influenced earnings.

The bakery business segment made a solid contribution during the first quarter of fiscal 2012 but business segment net sales and profit were lower as compared to the first quarter of fiscal 2011. First quarter volumes were lower as commercial bakeries took abnormally longer winter shutdowns while selling prices for the Company's finished products remained flat.

Operating income decreased by $35.7 million in the first quarter of fiscal 2012 compared to the first quarter of fiscal 2011. The challenges faced by the Company indicate there can be no assurance that operating results achieved by the Company in the first quarter of fiscal 2012 are indicative of future operating performance of the Company.

Summary of Critical Issues Faced by the Company during the First Quarter of 2012

Lower finished product prices for MBM, BFT, PG, YG and BPP as compared to the first quarter of fiscal 2011 is a sign of decreased demand due to a slowdown in the domestic and international markets. These lower prices were partially offset by an overall increase in average PM (both feed grade and pet food grade) prices. Overall, finished product prices were unfavorable to the Company's sales revenue, but this unfavorable result was partially offset by the positive impact on raw material cost, due to the Company's formula pricing arrangements with raw material suppliers, which index raw material cost to the prices of finished product derived from the raw material. The financial impact of finished goods prices on sales revenue and raw material cost is summarized below in Results of Operations. Comparative sales price information from the Jacobsen index, an established trading exchange publisher used by management to monitor performance, is provided below in Summary of Key Indicators.

24



Lower raw material volumes were collected from suppliers during the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011. Management believes the decline in raw material volume is due to weaker slaughter and processor rates resulting from a slowdown of the economy that contributed to a decline in raw material volumes collected by the Company during the quarter. The financial impact of lower raw material volumes is summarized below in Results of Operations.
Energy prices for natural gas decreased and diesel fuel decreased slightly during the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011. 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 2012 and Thereafter

Critical Issues and Challenges:

The Company collected lower raw material volumes due to the slowdown of the economy resulting in weaker slaughter and processor rates in the first quarter of fiscal 2012. If this reduction continues or accelerates, there could be a negative impact on the Company's ability to obtain raw materials for the Company's operation.
Finished product prices for MBM, BFT, PG, YG and BBP commodities have decreased during the first quarter of fiscal 2012 as compared to the same period of fiscal 2011.  No assurance can be given that this decrease in commodity prices for various proteins, fats and bakery products will not continue in the future, as commodity prices are volatile by their nature.  A further decrease in commodity prices could have a significant impact on the Company’s earnings for the remainder of 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.  Lower natural gas and diesel fuel prices were incurred during the first quarter of fiscal 2012 as compared to the same period of fiscal 2011. These 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 Policies

Pursuant to the requirements established by the Energy Independence and Security Act of 2007, on February 3, 2010 the EPA finalized regulations for the National Renewable Fuel Standard Program (“RFS2”).  The regulation mandates the domestic use of biomass-based diesel (biodiesel or renewable diesel) of 1.0 billion gallons in 2012.  Beyond 2012 the regulation requires a minimum of 1.0 billion gallons of biomass-based diesel for each year through 2022, which amount is subject to increase by the EPA Administrator.  On June 20, 2011, the EPA issued a proposed rule which would require 1.28 billion gallons for the calendar year 2013. Biomass-based diesel also qualifies to fulfill the non-specified portion of the advanced bio-fuel requirement.  In order to qualify as a “renewable fuel” each type of fuel from each type of feedstock is required to lower greenhouse gas emissions (“GHG”) by levels specified in the regulation.  The EPA has determined that bio-fuels (either biodiesel or renewable diesel) produced from waste oils, fats and greases result in an 86% reduction in GHG emissions, exceeding the 50% requirement established by the regulation.  Prices for the Company’s finished products may be impacted by worldwide government policies relating to renewable fuels and GHG.  Programs like 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.  Accordingly, changes to, a failure to enforce or discontinuing of any of these programs 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.

25



Other Food Safety and Regulatory Issues

Effective August 1997, the FDA promulgated a rule prohibiting the use of mammalian proteins, with some exceptions, in feeds for cattle, sheep and other ruminant animals (referred to herein as the “BSE Feed Rule”) to prevent further spread of BSE, commonly referred to as “mad cow disease.” Detection of the first case of BSE in the United States in December 2003 resulted in additional U.S. government regulations, finished product export restrictions by foreign governments, market price fluctuations for the Company's finished products and reduced demand for beef and beef products by consumers. Even though the export markets for U.S. beef rebounded to record volumes in fiscal 2011 that exceeded pre-BSE levels, most export markets remain closed to MBM derived from U.S. beef. On April 24, 2012, the United States Department of Agriculture (“USDA”) confirmed the occurrence of a new, single case of BSE in a dairy cow in central California.  Even though the USDA confirmed that material derived from the cow did not enter the food or feed supply and that this appears to be a single, isolated incident of "atypical" BSE which is not spread through feed and does not affect humans, Indonesia closed its markets to MBM derived from U.S. beef, and those markets remain closed as of the filing date of this Report.  The Company does not expect this trade disruption to have material impact on the Company's business, financial condition or results of operations. Continued concern about BSE in the United States may result in additional regulatory and market related challenges that may affect the Company's operations or increase the Company's operating costs.
With respect to BSE in the United States, on October 26, 2009, the FDA began enforcing new regulations intended to further reduce the risk of spreading BSE (“Enhanced BSE Rule”). These new regulations included amending the BSE Feed Rule to prohibit the use of tallow having more than 0.15% insoluble impurities in feed for cattle or other ruminant animals. In addition, the FDA implemented rules that prohibit the use of brain and spinal cord material from cattle aged 30 months and older or the carcasses of such cattle, if the brain and spinal cord are not removed, in the feed or food for all animals (“Prohibited Cattle Materials”). Tallow derived from Prohibited Cattle Materials that also contains more than 0.15% insoluble impurities cannot be fed to any animal. The Company has followed the Enhanced BSE Rule since it was first published in 2008 and has made capital expenditures and implemented new processes and procedures to be compliant with the Enhanced BSE Rule at all of the Company's operations. Based on the foregoing, while the Company acknowledges that unanticipated issues may arise as the FDA continues to implement the Enhanced BSE Rule and conducts compliance inspections, the Company does not currently anticipate that the Enhanced BSE Rule will have a significant impact on the Company operations or financial performance. Notwithstanding the foregoing, the Company can provide no assurance that unanticipated costs and/or reductions in raw material volumes related to the Company's compliance with the Enhanced BSE Rule will not negatively impact the Company's operations and financial performance.
With respect to human food, pet food and animal feed safety, the Food and Drug Administration Amendments Act of 2007 (the “FDAAA”) was signed into law on September 27, 2007 as a result of Congressional concern for pet and livestock food safety, following the discovery in March 2007 of pet and livestock food that contained adulterated imported ingredients. The FDAAA directs the Secretary of Health and Human Services and the FDA to promulgate significant new requirements for the pet food and animal feed industries. As a prerequisite to new requirements specified by the FDAAA, the FDA was directed to establish a Reportable Food Registry, which was implemented on September 8, 2009. On June 11, 2009, the FDA issued “Guidance for Industry: Questions and Answers Regarding the Reportable Food Registry as Established by the Food and Drug Administration Amendments Act of 2007: Draft Guidance.” Stakeholder comments and questions about the Reportable Food Registry that were submitted to the docket or during public meetings were incorporated into a second draft guidance (“RFR Draft Guidance”), which was published on September 8, 2009. In the RFR Draft Guidance, the FDA defined a reportable food, which the manufacturer or distributor would be required to report in the Reportable Food Registry, to include materials used as ingredients in animal feeds and pet foods, if there is reasonable probability that the use of such materials will cause serious adverse health consequences or death to humans or animals. The FDA issued a second version of its RFR Draft Guidance in May 2010 without finalizing it. On July 27, 2010, the FDA released “Compliance Policy guide Sec. 690.800, Salmonella in Animal Feed, Draft Guidance” (“Draft CPG”), which describes differing criteria to determine whether pet food and farmed animal feeds that are contaminated with salmonella will be considered to be adulterated under section 402(a)(1) of the Food Drug and Cosmetic Act. According to the Draft CPG, any finished pet food contaminated with any species of salmonella will be considered adulterated because such feeds have direct human contact. Finished animal feeds intended for pigs, poultry and other farmed animals, however, will be considered to be adulterated only if the feed is contaminated with a species of salmonella that is considered to be pathogenic for the animal species that the feed is intended for. The impact of the FDAAA and implementation of the Reportable Food Registry on the Company, if any, will not be clear until the FDA 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

26



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 demand for the Company's finished products.
In addition, on January 4, 2011, President Barack Obama signed the Food Safety Modernization Act (“FSMA”) into law. As enacted, the FSMA gave the FDA new authorities, which became effective immediately. Included among these is mandatory recall authority for adulterated foods that are likely to cause serious adverse health consequences or death to humans or animals, if the responsible party fails to cease distribution and recall such adulterated foods voluntarily. The FSMA further instructed the FDA to amend existing regulations that define its administrative detention authority so that the criteria needed for detaining human or animal food are lowered. Prior to the FSMA becoming law, FDA had authority to order that an article of food be detained only if there was credible evidence or information indicating that the article of food presented a threat of serious adverse health consequences or death to humans or animals. On May 5, 2011, FDA issued an interim final rule amending its administrative detention authority and lowering both the level of proof and the degree of risk required for detaining an article of food. This interim final rule, which became effective on July 3, 2011, gives the FDA authority to detain an article of food if there is reason to believe the food is adulterated or misbranded. In addition to amending existing regulations, the FSMA requires the FDA to develop new regulations that, among other provisions, place additional registration requirements on food and feed producing firms; require registered facilities to perform hazard analysis and to implement preventive plans to control those hazards identified to be reasonably likely to occur; increase the length of time that records are required to be retained; and regulate the sanitary transportation of food. Such new food safety provisions will require new FDA rule making. The Company has followed the FSMA throughout its legislative history and implemented hazard prevention controls and other procedures that the Company believes will be needed to comply with the FSMA. Such rule-making could, among other things, require the Company to amend certain of the Company's other operational policies and procedures. While unforeseen issues and requirements may arise as the FDA promulgates the new regulations provided for by the FSMA, the Company does not anticipate that the costs of compliance with the FSMA will materially impact the Company's business or operations.
The emergence of diseases such as 2009 H1N1 flu (initially know as “Swine Flu”) and H5N1 avian influenza (“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 in the 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.

Results of Operations

Three Months Ended March 31, 2012 Compared to Three Months Ended April 2, 2011

Summary of Key Factors Impacting First Quarter 2012 Results:
 
Principal factors that contributed to a $35.7 million decrease in operating income, which are discussed in greater detail in the following section, were:

Decrease in raw material volumes,
Decrease in finished product prices,
Increases in payroll and related benefits costs, and
A prior year purchase accounting contingency gain not in the current year.

These decreases were partially offset by:

Decreases in energy costs, primarily natural gas and diesel fuel.


27



Summary of Key Indicators of 2012 Performance:
 
Principal indicators which management routinely monitors and compares to previous periods as an indicator of problems or improvements in operating results include:

Finished product commodity prices,
Raw material volume,
Production volume and related yield of finished product,
Energy prices for natural gas quoted on the NYMEX index and diesel fuel,
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 Jacobsen index, an established trading exchange price publisher. The Jacobsen index reports industry sales from the prior day's activity by product. The Jacobsen index includes reported prices for MBM, PM (both feed grade and pet food), BFT, PG and YG, which are end products of the Company's Rendering Segment. During the first quarter of fiscal 2012, the Jacobsen index stopped reporting BBP, which is the end product of the Company's Bakery Segment. As a result, the Company is reporting prices for corn, which is a substitute commodity for BBP. The Company regularly monitors Jacobsen index reports on MBM, PM, BFT, PG, YG and corn because they provide a daily indication of the Company's revenue performance against business plan benchmarks. Although the Jacobsen index provides one useful metric of performance, the Company's finished products are commodities that compete with other commodities such as corn, soybean oil, palm oil complex, soybean meal and heating oil on nutritional and functional values and therefore actual pricing for the Company's finished products, as well as competing products, can be quite volatile. In addition, the Jacobsen index does not provide forward or future period pricing. The Jacobsen prices quoted below are for delivery of the finished product at a specified location. Although the Company's prices generally move in concert with reported Jacobsen prices, the Company's actual sales prices for its finished products may vary significantly from the Jacobsen index because of delivery timing differences and because the Company's finished products are delivered to multiple locations in different geographic regions which utilize different price indexes. In addition, certain of the Company's premium branded finished products may also sell at prices that may be higher than the closest product on the related Jacobsen index. During the first quarter of fiscal 2012, the Company's actual sales prices by product trended with the disclosed Jacobsen prices. Average Jacobsen prices (at the specified delivery point) for the first quarter of fiscal 2012, compared to average Jacobsen prices for the first quarter of fiscal 2011 follow:

 
Avg. Price
1st Quarter
2012
Avg. Price
1st Quarter
2011
 
Increase/(Decrease)
%
Increase/(Decrease)
Rendering Segment:
 
 
 
 
MBM (Illinois)
$ 315.56/ton
$ 335.81/ton
$ (20.25)/ton
(6.0
)%
Feed Grade PM (Carolina)
$ 386.51/ton
$ 360.24/ton
$ 26.27/ton
7.3
 %
Pet Food PM (Southeast)
$ 658.93/ton
$ 563.93/ton
$ 95.00/ton
16.8
 %
BFT (Chicago)
$ 46.06/cwt
$   48.14/cwt
$     (2.08)/cwt
(4.3
)%
PG (Southeast)
$ 44.03/cwt
$   44.89/cwt
$     (0.86)/cwt
(1.9
)%
YG (Illinois)
$ 38.83/cwt
$   42.40/cwt
$   (3.57)/cwt
(8.4
)%
Bakery Segment:
 
 
 
 
Corn (Illinois)
$ 6.62/bushel
$ 6.64/bushel
$ (0.02)/bushel
(0.3
)%

 The overall decrease in average MBM, BFT, PG, YG and BPP prices of the finished products the Company sells had an unfavorable impact on revenue that was partially offset by an overall increase in average PM (both feed grade and pet food) prices and the positive 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

28



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 NYMEX exchange for future months of delivery of natural gas and delivery of diesel fuel.  The prices are important to the Company because natural gas and diesel fuel are major components of factory operating and collection costs and natural gas and diesel fuel prices are an indicator of achievement of the Company’s business plan.

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 principally to 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 the first quarter of fiscal 2012, net sales were $387.1 million as compared to $439.9 million during the first quarter of fiscal 2011. The Rendering operations process poultry, animal by-products and used cooking oil into fats (primarily BFT, PG and YG), protein (primarily MBM and PM (feed grade and pet food)) and hides. Fat was approximately $194.0 million and $236.2 million of net sales for the three months ended March 31, 2012 and April 2, 2011, respectively, and protein was approximately $103.5 million and $110.1 million of net sales for the three months ended March 31, 2012 and April 2, 2011, respectively. The decrease in net sales was primarily due to the following (in millions of dollars):

 
Rendering
Bakery
Corporate
Total
Decrease in finished product prices
$
(31.4
)
$
(0.3
)
$

$
(31.7
)
Decrease in raw material volume
(18.4
)
(3.5
)

(21.9
)
Increase in other sales
0.5

0.3


0.8

 
$
(49.3
)
$
(3.5
)
$

$
(52.8
)

Further detail regarding the $49.3 million decrease in sales in the Rendering Segment and the $3.5 million decrease in sales in the Bakery Segment in the first quarter of fiscal 2012 is as follows:


29



Rendering

Finished Product Prices:  Lower prices in the overall commodity market for corn, soybean oil and soybean meal, which are competing proteins and fats to MBM, BFT and PG, negatively impacted the Company's finished product prices. In addition a decrease in global demand for use of YG in bio-fuels negatively impacted the Company's finished product prices. The $31.4 million decrease in Rendering sales resulting from decreases in finished product prices is due to a market-wide decrease in MBM, BFT, PG and YG prices, but was slightly offset by an increase in PM(both feed grade and pet food) prices. The market decreases were due to changes in supply/demand in both the domestic and export markets for commodity fats and meals, including MBM, BFT, PG and YG.

Raw Material Volume:  Rendering volumes have decreased Rendering sales by approximately $18.4 million, which is a result of weaker slaughter and processor rates due to a slowdown of the economy in the first quarter of fiscal 2012 as compared to the first quarter of fiscal 2011.
  
Other Sales:  The $0.5 million increase in other Rendering Segment sales was primarily due to an increase in yields and the purchase of finished product for resale that more than offset lower collection and processing fees and product sales.

Bakery

Raw Material Volume: The Bakery volumes have decreased Bakery sales by approximately $3.5 million, which is due to production cutbacks by the Company's commercial bakery suppliers.

Finished Product Prices: The slightly lower prices in the commodity market for corn negatively impacted the Company's BBP finished product prices by approximately $0.3 million.

Other Sales: The $0.3 million increase in other Bakery Segment sales is due to a slight increase in yields.

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 the first quarter of fiscal 2012, cost of sales and operating expenses was $276.5 million as compared to $301.4 million during the first quarter of fiscal 2011.  Decreases in Rendering Segment cost of sales and operating expenses of $25.1 million and the decrease in Bakery Segment cost of sales and operating expenses of $0.4 million accounted for substantially all of the $24.9 million decrease in cost of sales and operating expenses.  The decrease in cost of sales and operating expenses was primarily due to the following (in millions of dollars):

 
Rendering
Bakery
Corporate
Total
Increase/(decrease) in raw material costs
$
(20.4
)
$
1.8

$

$
(18.6
)
Decrease in raw material volume
(6.1
)
(1.7
)

(7.8
)
Decrease in energy costs, primarily natural gas and diesel fuel
(2.4
)
(0.2
)
(0.2
)
(2.8
)
Increase/(decrease) in other costs of sales
3.8

(0.3
)
0.8

4.3

 
$
(25.1
)
$
(0.4
)
$
0.6

$
(24.9
)

Further detail regarding the $25.1 million decrease in cost of sales and operating expenses in the Rendering Segment and the $0.4 million decrease in the Bakery Segment in the first quarter of fiscal 2012 is as follows:


30



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, PM (both feed grade and pet food), BFT, PG and YG.  Since finished product prices overall were lower in the first quarter of fiscal 2012 as compared to the same period in fiscal 2011, the raw material costs decreased $20.4 million.

Raw Material Volume:  Production cutbacks from packers and processors resulted in lower raw material available to be processed and formula pricing resulted in lower cost of sales of approximately $6.1 million.

Energy Costs: Both natural gas and diesel fuel are major components of collection and factory operating costs. During the first quarter of fiscal 2012 energy costs, primarily natural gas, were lower as compared to the first quarter of fiscal 2011 and are reflected in the $2.4 million decrease in cost of sales.

Other Expense:  The $3.8 million increase in other expense includes increases in purchases of finished product for resale and increases in repairs and maintenance.

Bakery

Raw Material Costs: The increase in raw material cost of sales of approximately $1.8 million is due mainly from an increase in finished product blending costs in the first quarter of fiscal 2012 as compared to the same period in fiscal 2011.

Raw Material Volume: Production cutbacks from the Company's bread and cake suppliers resulted in lower raw material available to be processed and formula pricing resulted in lower cost of sales of approximately $1.7 million.

Energy Costs: Natural gas is a component of factory operating costs. During the first quarter of fiscal 2012 natural gas costs were lower and are reflected in the $0.2 million decrease in the first quarter of fiscal 2012 as compared to the same period in fiscal 2011.

Other Expense:  The $0.3 million decrease in other expense includes decreases in repairs and maintenance and general reductions as a result of less raw material processed.
 
Selling, General and Administrative Expenses.  Selling, general and administrative expenses were $37.4 million during the first quarter of fiscal 2012, a $6.7 million increase (21.8%) from $30.7 million during the first quarter of fiscal 2011.  Selling, general and administrative expenses increased primarily due to payroll and related expense increases and an increase in expense from a fiscal 2011 purchase accounting contingency gain that did not occur in the first quarter of fiscal 2012. The increase was primarily due to the following (in millions of dollars):
 
 
Rendering
Bakery
Corporate
Total
Increase in payroll and incentive-related benefits
$
0.7

$
0.1

$
2.5

$
3.3

Increase from prior year purchase accounting contingency
2.1