Document


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 July 2, 2016
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 INGREDIENTS 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 164,591,781 shares of common stock, $0.01 par value, outstanding at August 4, 2016.

1



DARLING INGREDIENTS INC. AND SUBSIDIARIES
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JULY 2, 2016
 
 
TABLE OF CONTENTS   

 
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  60
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2






DARLING INGREDIENTS INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
July 2, 2016 and January 2, 2016
(in thousands, except share data)

 
July 2,
2016
 
January 2,
2016
ASSETS
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
157,815

 
$
156,884

Restricted cash
312

 
331

Accounts receivable, net
399,877

 
371,392

Inventories
364,362

 
344,583

Prepaid expenses
43,131

 
36,175

Income taxes refundable
12,839

 
11,963

Other current assets
25,822

 
10,460

Total current assets
1,004,158

 
931,788

Property, plant and equipment, less accumulated depreciation of
   $756,440 at July 2, 2016 and $652,875 at January 2, 2016
1,528,387

 
1,508,167

Intangible assets, less accumulated amortization of
   $267,226 at July 2, 2016 and $252,719 at January 2, 2016
769,427

 
782,349

Goodwill
1,258,480

 
1,233,102

Investment in unconsolidated subsidiaries
243,801

 
247,238

Other assets
38,592

 
41,623

Deferred income taxes
17,049

 
16,352

 
$
4,859,894

 
$
4,760,619

LIABILITIES AND STOCKHOLDERS’ EQUITY
 

 
 

Current liabilities:
 

 
 

Current portion of long-term debt
$
30,842

 
$
45,166

Accounts payable, principally trade
177,303

 
149,998

Income taxes payable
9,118

 
6,679

Accrued expenses
249,435

 
239,825

Total current liabilities
466,698

 
441,668

Long-term debt, net of current portion
1,874,492

 
1,885,851

Other non-current liabilities
93,692

 
97,809

Deferred income taxes
366,936

 
360,681

Total liabilities
2,801,818

 
2,786,009

Commitments and contingencies


 


Stockholders’ equity:
 

 
 

     Common stock, $0.01 par value; 250,000,000 shares authorized;
        167,617,151 and 167,070,983 shares issued at July 2, 2016
        and at January 2, 2016, respectively
1,676

 
1,671

Additional paid-in capital
1,494,075

 
1,488,783

     Treasury stock, at cost;  3,026,816 and 2,335,607 shares at
       July 2, 2016 and at January 2, 2016, respectively
(40,878
)
 
(34,316
)
Accumulated other comprehensive loss
(282,226
)
 
(335,918
)
Retained earnings
783,567

 
750,489

Total Darling's stockholders’ equity
1,956,214

 
1,870,709

Noncontrolling interests
101,862

 
103,901

 Total stockholders' equity
$
2,058,076

 
$
1,974,610

 
$
4,859,894

 
$
4,760,619


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

3



DARLING INGREDIENTS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
Three and six months ended July 2, 2016 and July 4, 2015
(in thousands, except per share data)
(unaudited)


 
 
Three Months Ended
 
Six Months Ended
 
July 2,
2016
 
July 4,
2015
 
July 2,
2016
 
July 4,
2015
Net sales
$
877,341

 
$
859,315

 
$
1,656,982

 
$
1,734,009

Costs and expenses:
 

 
 

 
 
 
 
Cost of sales and operating expenses
677,115

 
668,276

 
1,276,008

 
1,352,797

Selling, general and administrative expenses
76,158

 
84,294

 
157,627

 
170,925

Acquisition and integration costs
70

 
1,208

 
401

 
6,527

Depreciation and amortization
69,531

 
66,245

 
141,787

 
132,643

Total costs and expenses
822,874

 
820,023

 
1,575,823

 
1,662,892

Operating income
54,467

 
39,292

 
81,159

 
71,117

 
 
 
 
 
 
 
 
Other expense:
 

 
 

 
 
 
 
Interest expense
(23,980
)
 
(34,285
)
 
(47,881
)
 
(57,394
)
Foreign currency gain/(loss)
8

 
1,622

 
(2,595
)
 
(838
)
Other expense, net
(2,373
)
 
(1,199
)
 
(3,678
)
 
(1,708
)
Total other expense
(26,345
)
 
(33,862
)
 
(54,154
)
 
(59,940
)
 
 
 
 
 
 
 
 
Equity in net income of unconsolidated subsidiaries
13,852

 
4,172

 
19,495

 
2,364

Income before income taxes
41,974

 
9,602

 
46,500

 
13,541

 
 
 
 
 
 
 
 
Income tax expense
7,983

 
4,665

 
9,846

 
6,780

 
 
 
 
 
 
 
 
Net income
33,991

 
4,937

 
36,654

 
6,761

 
 
 
 
 
 
 
 
Net income attributable to noncontrolling interests
(1,992
)
 
(1,857
)
 
(3,576
)
 
(3,572
)
 
 
 
 
 
 
 
 
Net income attributable to Darling
$
31,999

 
$
3,080

 
$
33,078

 
$
3,189

 
 
 
 
 
 
 
 
Basic income per share
$
0.19

 
$
0.02

 
$
0.20

 
$
0.02

Diluted income per share
$
0.19

 
$
0.02

 
$
0.20

 
$
0.02



 



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

4



DARLING INGREDIENTS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME/(LOSS)
Three and six months ended July 2, 2016 and July 4, 2015
(in thousands)
(unaudited)


 
Three Months Ended
 
Six Months Ended
 
July 2, 2016
 
July 4, 2015
 
July 2, 2016
 
July 4, 2015
Net income
$
33,991

 
$
4,937

 
$
36,654

 
$
6,761

Other comprehensive income/(loss), net of tax:
 
 
 
 
 
 
 
Foreign currency translation
(8,008
)
 
7,443

 
49,523

 
(85,872
)
Pension adjustments
651

 
778

 
1,377

 
1,547

Corn option derivative adjustments
1,227

 
(1,325
)
 
521

 
(1,287
)
Total other comprehensive income/(loss), net of tax
(6,130
)
 
6,896

 
51,421

 
(85,612
)
Total comprehensive income/(loss)
$
27,861

 
$
11,833

 
$
88,075

 
$
(78,851
)
Comprehensive income attributable to noncontrolling interests
1,725

 
848

 
1,305

 
7,890

Comprehensive income/(loss) attributable to Darling
$
26,136

 
$
10,985

 
$
86,770

 
$
(86,741
)






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


5



DARLING INGREDIENTS INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
Six months ended July 2, 2016 and July 4, 2015
(in thousands)
(unaudited)
 
July 2,
2016
 
July 4,
2015
Cash flows from operating activities:
 
 
 
Net Income
$
36,654

 
$
6,761

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
141,787

 
132,643

Loss on disposal of property, plant, equipment and other assets
827

 
233

Gain on insurance proceeds from insurance settlements
(356
)
 
(341
)
Deferred taxes
(1,812
)
 
(3,225
)
Increase/(decrease) in long-term pension liability
(1,596
)
 
350

Stock-based compensation expense
5,067

 
4,642

Write-off deferred loan costs
57

 
10,633

Deferred loan cost amortization
5,600

 
4,868

Equity in net income of unconsolidated subsidiaries
(19,495
)
 
(2,364
)
Distributions of earnings from unconsolidated subsidiaries
25,994

 
26,155

Changes in operating assets and liabilities, net of effects from acquisitions:
 
 
 
Accounts receivable
(20,081
)
 
22,582

Income taxes refundable/payable
1,559

 
(1,368
)
Inventories and prepaid expenses
(19,501
)
 
(21,451
)
Accounts payable and accrued expenses
30,989

 
(1,505
)
Other
(17,460
)
 
8,937

Net cash provided by operating activities
168,233

 
187,550

Cash flows from investing activities:
 
 
 
Capital expenditures
(109,406
)
 
(98,722
)
       Acquisitions, net of cash acquired
(8,511
)
 

Gross proceeds from disposal of property, plant and equipment and other assets
2,404

 
1,484

Proceeds from insurance settlement
1,537

 
341

Payments related to routes and other intangibles

 
(2,242
)
Net cash used by investing activities
(113,976
)
 
(99,139
)
Cash flows from financing activities:
 
 
 
Proceeds from long-term debt
17,277

 
579,974

Payments on long-term debt
(59,255
)
 
(583,736
)
Borrowings from revolving credit facility
41,000

 
41,244

Payments on revolving credit facility
(47,207
)
 
(83,506
)
Net cash overdraft financing

 
(880
)
Deferred loan costs

 
(11,629
)
Issuance of common stock
143

 
171

Repurchase of treasury stock
(5,000
)
 

Minimum withholding taxes paid on stock awards
(1,812
)
 
(4,775
)
Excess tax benefits from stock-based compensation
(413
)
 
(12
)
Distributions to noncontrolling interests

 
(1,866
)
Net cash used by financing activities
(55,267
)
 
(65,015
)
Effect of exchange rate changes on cash
1,941

 
(6,160
)
Net increase in cash and cash equivalents
931

 
17,236

Cash and cash equivalents at beginning of period
156,884

 
108,784

Cash and cash equivalents at end of period
$
157,815

 
$
126,020

Supplemental disclosure of cash flow information:
 
 
 
Accrued capital expenditures
$
(3,684
)
 
$
274

Cash paid during the period for:
 
 
 
Interest, net of capitalized interest
$
41,813

 
$
37,524

Income taxes, net of refunds
$
11,799

 
$
11,436

Non-cash financing activities
 
 
 
Debt issued for assets
$
10

 
$
2,521

Contribution of assets to unconsolidated subsidiary
$
2,674

 
$


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

6



DARLING INGREDIENTS INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements
July 2, 2016
(unaudited)

(1)
General

The accompanying consolidated financial statements for the three and six month periods ended July 2, 2016 and July 4, 2015, have been prepared by Darling Ingredients Inc., a Delaware corporation (“Darling”, and together with its subsidiaries, the “Company”) in accordance with generally accepted accounting principles in the United States (“GAAP”) 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 GAAP have been omitted pursuant to such rules and regulations.  However, management of the Company believes, to the best of their knowledge, that the disclosures herein are adequate to make the information presented not misleading.  The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements contained in the Company’s Form 10-K for the fiscal year ended January 2, 2016

(2)
Summary of Significant Accounting Policies

(a)
Basis of Presentation

The consolidated financial statements include the accounts of Darling and its consolidated subsidiaries. Noncontrolling interests represents the outstanding ownership interest in the Company's consolidated subsidiaries that are not owned by the Company. In the accompanying Consolidated Statements of Operations, the noncontrolling interest in net income (loss) of the consolidated subsidiaries is shown as an allocation of the Company's net income and is presented separately as “Net income/(loss) attributable to noncontrolling interests”. In the Company's Consolidated Balance Sheets, noncontrolling interests represents the ownership interests in the Company consolidated subsidiaries' net assets held by parties other than the Company. These ownership interests are presented separately as “Noncontrolling interests” within “Stockholders' Equity.” All significant intercompany balances and transactions have been eliminated in consolidation.

(b)
Fiscal Periods

The Company has a 52/53 week fiscal year ending on the Saturday nearest December 31.  Fiscal periods for the consolidated financial statements included herein are as of July 2, 2016, and include the 13 and 26 weeks ended July 2, 2016, and the 13 and 26 weeks ended July 4, 2015.

(c)
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 recognizes service revenue in the fiscal month the service occurs.

(d)
Foreign Currency Translation and Remeasurement

Foreign currency translation is included as a component of accumulated other comprehensive income and reflects the adjustments resulting from translating the foreign currency denominated financial statements of foreign subsidiaries into U.S. dollars. The functional currency of the Company's foreign subsidiaries is the currency of the primary economic environment in which the entity operates, which is generally the local currency of the country. Accordingly, assets and liabilities of the foreign subsidiaries are translated to U.S. dollars at fiscal period end exchange rates, including intercompany foreign currency transactions that are of long-term investment nature. Income and expense items are translated at average exchange rates occurring during the period. Changes

7



in exchange rates that affect cash flows and the related receivables or payables are recognized as transaction gains and losses in determining net income. The Company incurred net foreign currency translation gains of approximately $51.8 million for the six months ended July 2, 2016 and net foreign currency translation losses of approximately $90.2 million for the six months ended July 4, 2015.

(e)
Reclassifications

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

(f)
Earnings Per Share

Basic income per common share is computed by dividing net income attributable to Darling 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 attributable to Darling by the weighted average number of common shares outstanding during the period increased by dilutive common equivalent shares determined using the treasury stock method.
 
Net Income per Common Share (in thousands, except per share data)
 
Three Months Ended
 
 
 
July 2, 2016
 
 
 
 
 
July 4, 2015
 
 
 
Income
 
Shares
 
Per Share
 
Income
 
Shares
 
Per Share
Basic:
 
 
 
 
 
 
 
 
 
 
 
Net Income attributable to Darling
$
31,999

 
164,634

 
$
0.19

 
$
3,080

 
165,228

 
$
0.02

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Effect of dilutive securities:
 

 
 

 
 

 
 

 
 

 
 

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

 
1,793

 
 

 
 

 
188

 
 

Less: Pro forma treasury shares
 

 
(953
)
 
 

 
 

 
(118
)
 
 

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Net income attributable to Darling
$
31,999

 
165,474

 
$
0.19

 
$
3,080

 
165,298

 
$
0.02

 
Net Income per Common Share (in thousands, except per share data)
 
Six Months Ended
 
 
 
July 2, 2016
 
 
 
 
 
July 4, 2015
 
 
 
Income
 
Shares
 
Per Share
 
Income
 
Shares
 
Per Share
Basic:
 
 
 
 
 
 
 
 
 
 
 
Net Income attributable to Darling
$
33,078

 
164,534

 
$
0.20

 
$
3,189

 
165,077

 
$
0.02

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Effect of dilutive securities:
 

 
 

 
 

 
 

 
 

 
 

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

 
975

 
 

 
 

 
303

 
 

Less: Pro forma treasury shares
 

 
(496
)
 
 

 
 

 
(136
)
 
 

Diluted:
 

 
 

 
 

 
 

 
 

 
 

Net income/(loss) attributable to Darling
$
33,078

 
165,013

 
$
0.20

 
$
3,189

 
165,244

 
$
0.02


For the three months ended July 2, 2016 and July 4, 2015, respectively, 1,231,664 and 825,711 outstanding stock options were excluded from diluted income per common share as the effect was antidilutive. For the three months ended July 2, 2016 and July 4, 2015, respectively, 899,422 and 582,559 shares of non-vested stock and stock equivalents were excluded from diluted income per common share as the effect was antidilutive.

For the six months ended July 2, 2016 and July 4, 2015, respectively, 1,080,410 and 674,834 outstanding stock options were excluded from diluted income per common share as the effect was antidilutive. For the six months ended July 2, 2016 and July 4, 2015, respectively, 824,068 and 578,899 shares of non-vested stock and stock equivalents were excluded from diluted income per common share as the effect was antidilutive.



8



(3)
Inventories

A summary of inventories follows (in thousands):

        
 
July 2, 2016
 
January 2, 2016
Finished product
$
182,292

 
$
164,428

Work in process
91,626

 
84,474

Raw material
40,034

 
48,401

Supplies and other
50,410

 
47,280

 
$
364,362

 
$
344,583


(4)
Intangible Assets

The gross carrying amount of intangible assets not subject to amortization and intangible assets subject to amortization is as follows (in thousands):
        
 
 
July 2, 2016
 
January 2, 2016
Indefinite Lived Intangible Assets
 
 
 
Trade names
$
53,002

 
$
52,466

 
53,002

 
52,466

Finite Lived Intangible Assets:
 

 
 

Routes
387,321

 
390,888

Permits
502,203

 
494,754

Non-compete agreements
3,745

 
6,996

Trade names
76,331

 
75,825

Royalty, consulting, land use rights and leasehold
14,051

 
14,139

 
983,651

 
982,602

Accumulated Amortization:
 
 
 
Routes
(93,074
)
 
(99,819
)
Permits
(153,877
)
 
(134,752
)
Non-compete agreements
(1,547
)
 
(4,628
)
Trade names
(16,757
)
 
(11,959
)
Royalty, consulting, land use rights and leasehold
(1,971
)
 
(1,561
)
 
(267,226
)
 
(252,719
)
Total Intangible assets, less accumulated amortization
$
769,427

 
$
782,349


Gross intangible routes, permits, trade names, non-compete agreements and other intangibles partially decreased in fiscal 2016 as a result of approximately $27.7 million of asset retirements. Amortization expense for the three and six months ended July 2, 2016 and July 4, 2015, was approximately $19.7 million, $21.1 million and $38.8 million, $42.2 million, respectively.

(5)
Goodwill

Changes in the carrying amount of goodwill (in thousands):
 
Feed Ingredients
Food Ingredients
Fuel Ingredients
Total
Balance at January 2, 2016
 
 
 
 
Goodwill
$
812,797

$
323,385

$
112,834

$
1,249,016

Accumulated impairment losses
(15,914
)


(15,914
)
 
796,883

323,385

112,834

1,233,102

Goodwill acquired during year
827


2

829

Foreign currency translation
16,255

4,387

3,907

24,549

Balance at July 2, 2016
 

 

 
 

Goodwill
829,879

327,772

116,743

1,274,394

Accumulated impairment losses
(15,914
)


(15,914
)
 
$
813,965

$
327,772

$
116,743

$
1,258,480


9




(6)
Investment in Unconsolidated Subsidiaries

On January 21, 2011 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 “DGD Joint Venture”). The DGD Joint Venture is owned 50% / 50% with Valero and was formed to design, engineer, construct and operate a renewable diesel plant (the “DGD Facility”), which is capable of processing approximately 12,000 barrels per day of input feedstock to produce renewable diesel fuel and certain other co-products, and is located adjacent to Valero's refinery in Norco, Louisiana. The DGD Joint Venture reached mechanical completion and began the production of renewable diesel in late June 2013.

On May 31, 2011, the DGD Joint Venture and Diamond Green Diesel LLC, a wholly-owned subsidiary of the DGD 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 provided the DGD Joint Venture with a 14 year multiple advance term loan facility of approximately $221.3 million (the “JV Loan”) to support the design, engineering and construction of the DGD Facility, which is now in production. 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 DGD 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.

In addition to the DGD Joint Venture, the Company has investments in other unconsolidated subsidiaries that are insignificant to the Company. Selected financial information for the Company's DGD Joint Venture is as follows (in thousands):

(in thousands)
 
June 30, 2016
December 31, 2015
Assets:
 
 
 
Total current assets
 
$
175,782

$
261,444

Property, plant and equipment, net
 
355,809

356,230

Other assets
 
17,070

3,034

Total assets
 
$
548,661

$
620,708

Liabilities and members' equity:
 
 
 
Total current portion of long term debt
 
$
17,023

$
62,023

Total other current liabilities
 
22,785

19,935

Total long term debt
 
68,564

86,819

Total other long term liabilities
 
400

380

Total members' equity
 
439,889

451,551

Total liabilities and member's equity
 
$
548,661

$
620,708



 
 
Three Months Ended
 
Six Months Ended
(in thousands)
 
June 30, 2016
June 30, 2015
 
June 30, 2016
June 30, 2015
Revenues:
 
 
 
 
 
 
Operating revenues
 
$
132,226

$
156,160

 
$
203,994

$
272,888

Expenses:
 
 
 
 
 
 
Total costs and expenses less depreciation, amortization and accretion expense
 
95,565

140,343

 
148,074

252,378

Depreciation, amortization and accretion expense
 
7,547

4,956

 
12,925

9,965

Total costs and expenses
 
103,112

145,299

 
160,999

262,343

Operating income
 
29,114

10,861

 
42,995

10,545

Other income
 
70

32

 
85

52

Interest and debt expense, net
 
(1,928
)
(3,352
)
 
(4,742
)
(7,508
)
Net income
 
$
27,256

$
7,541

 
$
38,338

$
3,089



10



As of July 2, 2016 under the equity method of accounting, the Company has an investment in the DGD Joint Venture of approximately $219.9 million on the consolidated balance sheet and has recorded an equity net gain of approximately $19.2 million and $1.5 million for the six months ended July 2, 2016 and July 4, 2015, respectively. In the second quarter of fiscal 2016, the DGD Joint Venture received $156.4 million of the 2015 calendar year blenders tax credits from the Internal Revenue Service, made a debt payment of approximately $54.7 million and made dividend distributions to each partner in the amount $25.0 million. Additionally, with Congress' extension of the biodiesel blenders tax credit in December 2015 through December 31, 2016, the DGD Joint Venture fiscal 2016 results include blenders tax credits, while no blenders tax credits are included in the same period in the prior year.

(7)
Debt

Debt consists of the following (in thousands): 
        
 
July 2, 2016
 
January 2, 2016
Amended Credit Agreement:
 
 
 
Revolving Credit Facility ($3.9 million and $9.4 million denominated in CAD at July 2, 2016 and January 2, 2016, respectively)
$
3,869

 
$
9,358

Term Loan A ($100.1 million and $97.1 million denominated in CAD at July 2, 2016 and January 2, 2016, respectively)
248,371

 
277,181

Less unamortized deferred loan costs
(1,230
)
 
(1,552
)
Carrying value Term Loan A
247,141

 
275,629

 
 
 
 
Term Loan B
586,500

 
589,500

Less unamortized deferred loan costs
(7,040
)
 
(7,774
)
Carrying value Term Loan B
579,460

 
581,726

 
 
 
 
5.375% Senior Notes due 2022 with effective interest of 5.72%
500,000

 
500,000

Less unamortized deferred loan costs
(8,318
)
 
(8,952
)
Carrying value 5.375% Senior Notes due 2022
491,682

 
491,048

 
 
 
 
4.75% Senior Notes due 2022 - Denominated in euro with effective interest of 5.10%
572,654

 
560,912

Less unamortized deferred loan costs - Denominated in euro
(10,189
)
 
(10,705
)
Carrying value 4.75% Senior Notes due 2022
562,465

 
550,207

 
 
 
 
Other Notes and Obligations
20,717

 
23,049

 
1,905,334

 
1,931,017

Less Current Maturities
30,842

 
45,166

 
$
1,874,492

 
$
1,885,851


In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2015-03, Simplifying the Presentation of Debt Issuance Costs. The ASU amends ASC (Subtopic 835-30), Interest - Imputation of Interest. The new standard requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the carrying value of the debt liability, which is similar to the presentation of debt discounts or premiums. The costs will continue to be amortized to interest expense using the effective interest method. On January 3, 2016, the Company adopted this standard as a change in accounting principal on a retrospective basis. As of July 2, 2016 and January 2, 2016, the Company has presented debt issuance costs related to the Company's term loans and senior notes, previously reported in other assets, as direct deductions from the carrying amount of the debt liability. In addition, the Company has presented the debt issuance costs related to the Company's amended credit agreement as a deferred asset within other assets as permitted by ASU No. 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, which was issued in August 2015. Upon adoption of ASU No. 2015-03, other assets of approximately $29.0 million were reclassified as deduction from the carrying value of the recognized debt liability at January 2, 2016.

As of July 2, 2016, the Company had outstanding debt under a term loan facility and revolving credit facility denominated in Canadian dollars of CAD$129.4 million and CAD$5.0 million, respectively. See below for discussion relating to the Company's debt agreements. In addition, as of July 2, 2016, the Company had capital lease obligations denominated in

11



Canadian dollars included in debt. The current and long-term capital lease obligation was approximately CAD$1.9 million and CAD$1.8 million, respectively.

As of July 2, 2016, the Company had outstanding debt under the Company's 4.75% Senior Notes due 2022 denominated in euros of €515.0 million. See below for discussion relating to the Company's debt agreements. In addition, at July 2, 2016, the Company had capital lease obligations denominated in euros included in debt. The current and long-term capital lease obligation was approximately €0.4 million and €0.5 million, respectively.

Senior Secured Credit Facilities. On January 6, 2014, Darling, Darling International Canada Inc. (“Darling Canada”) and Darling International NL Holdings B.V. (“Darling NL”) entered into a Second Amended and Restated Credit Agreement (as subsequently amended, the “Amended Credit Agreement”), restating its then existing Amended and Restated Credit Agreement dated September 27, 2013 (the “Former Credit Agreement”), with the lenders from time to time party thereto, JPMorgan Chase Bank, N.A., as Administrative Agent, and the other agents from time to time party thereto.

The Company's Amended Credit Agreement provides for senior secured credit facilities in the aggregate principal amount of $2.65 billion comprised of (i) the Company's $350.0 million term loan A facility, (ii) the Company's $1.3 billion term loan B facility and (iii) the Company's $1.0 billion five-year revolving loan facility (approximately $250.0 million of which is available for a letter of credit sub-facility and $50.0 million of which is available for a swingline sub-facility) (collectively, the “Senior Secured Credit Facilities”). The Amended Credit Agreement also permits Darling and the other borrowers thereunder to incur ancillary facilities provided by any revolving lender party to the Senior Secured Credit Facilities (with certain restrictions). Up to $350.0 million of the revolving loan facility is available to be borrowed by Darling in U.S. dollars, Canadian dollars, euros and other currencies to be agreed and available to each applicable lender, to be borrowed by Darling Canada in Canadian dollars and to be borrowed by Darling NL, Darling Ingredients International Holding B.V. (“Darling BV”) and CTH Germany GmbH (“CTH”) in U.S. dollars, euros and other currencies to be agreed and available to each applicable lender. The revolving loan facility and term loan A facility will mature on September 27, 2018, and the term loan B facility will mature on January 7, 2021.

The interest rate applicable to any borrowings under the term loan A facility and the revolving loan facility will equal either LIBOR/euro interbank offered rate/CDOR plus 2.75% per annum or base rate/Canadian prime rate plus 1.75% per annum, subject to certain step-downs based on the Company's total leverage ratio. The interest rate applicable to any borrowings under the term loan B facility will equal (a) for U.S. dollar term loans, either the base rate plus 1.50% or LIBOR plus 2.50%, and (b) for euro term loans, the euro interbank offered rate plus 2.75%, in each case subject to a step-down based on Darling’s total leverage ratio. For term loan B loans, the LIBOR rate shall not be less than 0.75%.

As of July 2, 2016, the Company had $146.3 million outstanding under the term loan A facility at LIBOR plus a margin of 2.75% per annum for a total of 3.25% per annum and $2.0 million outstanding under the term loan A facility at base rate plus a margin of 1.75% per annum for a total of 5.25% per annum. The Company had $586.5 million outstanding under the term loan B facility at LIBOR plus a margin of 2.50% per annum for a total of 3.25% per annum. The Company had CAD$129.4 million outstanding under the term loan A facility at CDOR plus a margin of 2.75% per annum for a total of 3.7114% per annum and CAD$5.0 million outstanding under the revolver at CDOR plus a margin of 2.75% per annum for a total of 3.7115% per annum. As of July 2, 2016, the Company had revolver availability of $969.9 million under the Amended Credit Agreement taking into account amounts borrowed and letters of credit issued of $26.3 million. The Company also has foreign bank guarantees that are not part of the Company's Amended Credit Agreement in the amount of approximately $9.7 million at July 2, 2016.

The Amended Credit Agreement contains various customary representations and warranties by the Company, which include customary use of materiality, material adverse effect and knowledge qualifiers. The Amended Credit Agreement also contains (a) certain affirmative covenants that impose certain reporting and/or performance obligations on Darling and its subsidiaries, (b) certain negative covenants that generally prohibit, subject to various exceptions, Darling and its restricted subsidiaries from taking certain actions, including, without limitation, incurring indebtedness, making investments, incurring liens, paying dividends and engaging in mergers and consolidations, sale and leasebacks and asset dispositions, (c) financial covenants, which include a maximum total leverage ratio, a maximum secured leverage ratio and a minimum interest coverage ratio and (d) customary events of default (including a change of control) for financings of this type. Obligations under the Senior Secured Credit Facilities may be declared due and payable upon the occurrence and during the continuance of customary events of default.

5.375 % Senior Notes due 2022. On January 2, 2014, Darling Escrow Corporation, a wholly-owned subsidiary of Darling, issued $500.0 million aggregate principal amount of its 5.375% Notes due 2022 (the “5.375% Notes”) pursuant to a 5.375% Notes Indenture, dated as of January 2, 2014 (the “Original 5.375% Indenture”), among Darling Escrow

12



Corporation, the subsidiary guarantors party thereto from time to time, and U.S. Bank National Association, as trustee (the “5.375% Trustee”). On January 8, 2014, Darling Escrow Corporation merged with and into Darling and entered into a supplemental indenture with Darling, the subsidiary guarantors party thereto and the 5.375% Trustee (the “Supplemental 5.375% Indenture,” and together with the Original 5.375% Indenture, the “5.375% Indenture”), pursuant to which Darling assumed all obligations under the 5.375% Notes and the 5.375% Indenture. Darling and the 5.375% Guarantors completed a registered exchange offer for the 5.375% Notes under the Securities Act during the third quarter of 2014. Darling used a portion of the proceeds from the offering of the 5.375% Notes to pay certain fees and expenses (including bank fees and expenses) related to the offering and the financing of its acquisition of its Darling Ingredients International business from VION Holding, N.V. ( the “VION Acquisition”) and for purposes of satisfying, discharging and redeeming its 8.5% Notes due 2018. Darling used the remaining proceeds of the 5.375% Notes to pay certain other fees and expenses related to the completion of the VION Acquisition and its related financings, to repay a portion of the borrowings under its revolving credit facility used to fund a portion of the consideration for the VION Acquisition and for general corporate purposes.

The 5.375% Notes will mature on January 15, 2022. Darling will pay interest on the 5.375% Notes on January 15 and July 15 of each year, commencing on July 15, 2014. Interest on the 5.375% Notes will accrue at a rate of 5.375% per annum and be payable in cash. The 5.375% Notes are guaranteed on a unsecured senior basis by all of Darling's restricted subsidiaries (other than any foreign subsidiary or any receivables entity) that guarantee the Senior Secured Credit Facilities (the “5.375% Guarantors”). The 5.375% Notes and the guarantees thereof are senior unsecured obligations of Darling and the 5.375% Guarantors and rank equally in right of payment to all of Darling's and the 5.375% Guarantors' existing and future senior unsecured indebtedness. The 5.375% 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 distributions or repurchases 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.

Other than for extraordinary events such as change of control and defined assets sales, Darling is not required to make mandatory redemption or sinking fund payments on the 5.375% Notes. The 5.375% Notes are redeemable, in whole or in part, at any time on or after January 15, 2017 at the redemption prices specified in the 5.375% Indenture. Darling may redeem some or all of the 5.375% Notes at any time prior to January 15, 2017, at a redemption price equal to 100% of the principal amount of the 5.375% Notes redeemed, plus accrued and unpaid interest to the redemption date and an Applicable Premium as specified in the 5.375% Indenture.

4.75 % Senior Notes due 2022. On June 3, 2015, Darling Global Finance B.V. (the “4.75% Issuer”), a wholly-owned subsidiary of Darling, issued €515.0 million aggregate principal amount of the 4.75% Senior Notes due 2022 (the “4.75% Notes”) pursuant to a Senior Notes Indenture, dated as of June 3, 2015 (the “4.75% Indenture”), among the 4.75% Issuer, Darling (as guarantor), the subsidiary guarantors party thereto from time to time, Citibank, N.A., London Branch, as trustee (the “4.75% Trustee”) and principal paying agent, and Citigroup Global Markets Deutschland AG, as principal registrar. Darling used the gross proceeds from the sale of the 4.75% Notes to refinance a portion of the term loan B outstanding under Darling's Senior Secured Credit Facilities and to pay certain fees and expenses related to the offering of the 4.75% Notes and the refinancing of the term loan B. Darling intends to use any remaining proceeds for general corporate purposes.
 
The 4.75% Notes will mature on May 30, 2022. The 4.75% Issuer will pay interest on the 4.75% Notes on May 30 and November 30 of each year, commencing on November 30, 2015. Interest on the 4.75% Notes will accrue from June 3, 2015 at a rate of 4.75% per annum and be payable in cash. The 4.75% Notes are guaranteed on a senior unsecured basis by Darling and all of Darling's restricted subsidiaries (other than any foreign subsidiary, the 4.75% Issuer or any receivables entity) that guarantee the Senior Secured Credit Facilities (collectively “4.75% Guarantors”). The 4.75% Notes and the guarantees thereof are senior unsecured obligations of the 4.75% Issuer and the 4.75% Guarantors and rank equally in right of payment to all of the 4.75% Issuer's and the 4.75% Guarantors' existing and future senior unsecured indebtedness. The 4.75% Indenture contains covenants limiting Darling's ability and the ability of its restricted subsidiaries (including the 4.75% Issuer) to, among other things: incur additional indebtedness or issue preferred stock; pay dividends on or make other distributions or repurchases of Darling's capital stock or make other restricted payments; create restrictions on the payment of dividends or certain 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 of substantially all of Darling's assets.

13




Other than for extraordinary events such as change of control and defined assets sales, the 4.75% Issuer is not required to make mandatory redemption or sinking fund payments on the 4.75% Notes. The 4.75% Notes are redeemable, in whole or in part, at any time on or after May 30, 2018 at the redemption prices specified in the 4.75% Indenture. The 4.75% Issuer may redeem some or all of the 4.75% Notes at any time prior to May 30, 2018, at a redemption price equal to 100% of the principal amount of the 4.75% Notes redeemed, plus accrued and unpaid interest to the redemption date and an Applicable Premium as specified in the 4.75% Indenture and all additional amounts (if any) then due or which will become due on the redemption date as a result of the redemption or otherwise (subject to the rights of holders on the relevant record dates to receive interest due on the relevant interest payment date and additional amounts (if any) in respect thereof).

As of July 2, 2016, the Company believes it is in compliance with all of the financial covenants under the Amended Credit Agreement, as well as all of the other covenants contained in the Amended Credit Agreement, the 5.375% Indenture and the 4.75% Indenture. 

(8)
Income Taxes
 
The Company has provided income taxes for the three and six month periods ended July 2, 2016 and July 4, 2015, based on its estimate of the effective tax rate for the entire 2016 and 2015 fiscal years. The Company’s estimated annual effective tax rate is based on forecasts of income by jurisdiction, permanent differences between book and tax income, including Subpart F income and biofuel tax incentives, the relative proportion of income and losses by jurisdiction, and statutory income tax rates. Discrete events such as the assessment of the ultimate outcome of tax audits, audit settlements, recognizing previously unrecognized tax benefits due to the lapsing of statutes of limitation, recognizing or derecognizing deferred tax assets due to projections of income or loss and changes in tax laws are recognized in the period in which they occur.
 
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 expects to indefinitely reinvest the earnings of its foreign subsidiaries outside of the United States and has generally not provided deferred income taxes on the accumulated earnings of its foreign subsidiaries.

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.  Certain VION Companies acquired as part of the VION Acquisition have deferred tax assets for tax loss carryforwards, and the Company has recorded valuation allowances in respect to those losses to the extent it has been determined that it is not more likely than not that the deferred tax assets will be realized.

Unrecognized tax benefits represent the difference between tax positions taken or expected to be taken in a tax return and the benefits recognized for financial statement purposes. As of July 2, 2016, the Company had $3.6 million of gross unrecognized tax benefits and $1.8 million of related accrued interest and penalties. An indemnity receivable of $4.7 million has been recorded for the uncertain tax positions related to the VION Acquisition. It is reasonably possible within the next twelve months that the Company’s gross unrecognized tax benefits may decrease by up to $2.3 million, excluding interest and penalties, primarily due to potential settlements and expiration of certain statutes of limitations.

The Company’s major taxing jurisdictions include the United States (federal and state), Canada, the Netherlands, Belgium, Brazil, Germany, France and China. The Company is subject to regular examination by various tax authorities and although the final outcome of these examinations is not yet determinable, the Company does not anticipate that any of the examinations will have a significant impact on the Company's results of operations or financial position. The statute of limitations for the Company’s major tax jurisdictions is open for varying periods, but is generally closed through the 2009 tax year.

(9)  
Other Comprehensive Income

The Company follows 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

14



gas derivative adjustments, corn option adjustments and interest rate swap derivative adjustments. The components of other comprehensive income (loss) and the related tax impacts for the three and six months months ended July 2, 2016 and July 4, 2015 are as follows (in thousands):

 
Three Months Ended
 
Before-Tax
Tax (Expense)
Net-of-Tax
 
Amount
or Benefit
Amount
 
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
Defined benefit pension plans
 
 
 
 
 
 
Amortization of prior service cost/(benefit)
$
7

$
(20
)
$
(2
)
$
10

$
5

$
(10
)
Amortization of actuarial loss
1,166

1,284

(445
)
(496
)
721

788

Amortization of settlement
(123
)

48


(75
)

Total defined benefit pension plans
1,050

1,264

(399
)
(486
)
651

778

Corn option derivatives
 
 
 
 
 
 
Loss/(gain) reclassified to net income
(869
)
(347
)
337

134

(532
)
(213
)
Gain/(loss) activity recognized in other comprehensive income (loss)
2,875

(1,819
)
(1,116
)
707

1,759

(1,112
)
Total corn option derivatives
2,006

(2,166
)
(779
)
841

1,227

(1,325
)
 
 
 
 
 
 
 
Foreign currency translation
(8,008
)
7,443



(8,008
)
7,443

 
 
 
 
 
 
 
Other comprehensive income (loss)
$
(4,952
)
$
6,541

$
(1,178
)
$
355

$
(6,130
)
$
6,896


 
Six Months Ended
 
Before-Tax
Tax (Expense)
Net-of-Tax
 
Amount
or Benefit
Amount
 
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
Defined benefit pension plans
 
 
 
 
 
 
Amortization of prior service cost/(benefit)
$
14

$
(40
)
$
(5
)
$
20

$
9

$
(20
)
Amortization of actuarial loss
2,334

2,569

(891
)
(1,002
)
1,443

1,567

Amortization of settlement
(123
)

48


(75
)

Total defined benefit pension plans
2,225

2,529

(848
)
(982
)
1,377

1,547

Corn option derivatives
 
 
 
 
 
 
Loss/(gain) reclassified to net income
(2,343
)
(581
)
909

225

(1,434
)
(356
)
Gain/(loss) activity recognized in other comprehensive income (loss)
3,195

(1,523
)
(1,240
)
592

1,955

(931
)
Total corn option derivatives
852

(2,104
)
(331
)
817

521

(1,287
)
 
 
 
 
 
 
 
Foreign currency translation
49,523

(85,872
)


49,523

(85,872
)
 
 
 
 
 
 
 
Other Comprehensive income (loss)
$
52,600

$
(85,447
)
$
(1,179
)
$
(165
)
$
51,421

$
(85,612
)

The following table presents the amounts reclassified out of each component of other comprehensive income (loss), net of tax for the three and six months months ended July 2, 2016 and July 4, 2015 as follows (in thousands):


15



 
Three Months Ended
Six Months Ended
 
 
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
Statement of Operations Classification
Derivative instruments
 
 
 
 
 
Corn option derivatives
$
869

$
347

$
2,343

$
581

Cost of sales and operating expenses
 
869

347

2,343

581

Total before tax
 
(337
)
(134
)
(909
)
(225
)
Income taxes
 
532

213

1,434

356

Net of tax
Defined benefit pension plans
 
 
 
 
 
Amortization of prior service (cost)/benefit
$
(7
)
$
20

$
(14
)
$
40

(a)
Amortization of actuarial loss
(1,166
)
(1,284
)
(2,334
)
(2,569
)
(a)
Amortization of settlement
123


123


(a)
 
(1,050
)
(1,264
)
(2,225
)
(2,529
)
Total before tax
 
399

486

848

982

Income taxes
 
(651
)
(778
)
(1,377
)
(1,547
)
Net of tax
Total reclassifications
$
(119
)
$
(565
)
$
57

$
(1,191
)
Net of tax

(a)
These items are included in the computation of net periodic pension cost. See Note 11 Employee Benefit Plans for additional information.

The following table presents changes in each component of accumulated comprehensive income (loss) as of July 2, 2016 as follows (in thousands):

 
 
Six Months Ended July 2, 2016
 
 
Foreign Currency
Derivative
Defined Benefit
 
 
 
Translation
Instruments
Pension Plans
Total
Accumulated Other Comprehensive Income (loss) January 2, 2016, attributable to Darling, net of tax
 
$
(305,213
)
$
1,843

$
(32,548
)
$
(335,918
)
Other comprehensive gain before reclassifications
 
49,523

1,955


51,478

Amounts reclassified from accumulated other comprehensive income/(loss)
 

(1,434
)
1,377

(57
)
Net current-period other comprehensive income
 
49,523

521

1,377

51,421

Noncontrolling interest
 
(2,271
)


(2,271
)
Accumulated Other Comprehensive Income (loss) July 2, 2016, attributable to Darling, net of tax
 
(253,419
)
$
2,364

$
(31,171
)
$
(282,226
)

(10)    Stockholders' Equity

In August 2015, the Company's Board of Directors approved a share repurchase program of up to an aggregate of $100.0 million of the Company's Common Stock depending on market conditions. The repurchases may be made from time to time on the open market at prevailing market prices or in negotiated transactions off the market. Repurchases may occur over the 24 month period ending in August 2017, unless extended or shortened by the Board of Directors. During the first six months of fiscal 2016, the Company repurchased approximately $5.0 million of its Common Stock in the open market. As of July 2, 2016, the Company has approximately $89.1 million remaining under the share repurchase program approved in August 2015.

Fiscal 2015 Long-Term Incentive Opportunity Awards (2015 LTIP). The Company met the requisite performance measure under the 2015 LTIP. Accordingly, in accordance with the terms of the 2015 LTIP, the Company granted 452,878 stock options, 454,916 shares of nonvested stock and 147,390 restricted stock units in the first quarter of fiscal 2016.

Fiscal 2016 Long-Term Incentive Opportunity Awards (2016 LTIP). On February 25, 2016, the Compensation Committee (the “Committee”) of the Company's Board of Directors adopted the 2016 LTIP pursuant to which they awarded certain of the Company's key employees, including the Company's named executive officers', 1,092,942 stock options and 663,419 performance share units (the “PSUs”) under the Company's 2012 Omnibus Incentive Plan. The stock options vest 33.33% on the first, second and third anniversaries of the grant date. The PSUs are tied to two- and three-year forward looking performance periods and will be earned based on the Company's average return on capital employed (ROCE) relative the

16



average ROCE of the Company's performance peer group companies, with the earned award to be determined in the first quarter of fiscal 2018 or fiscal 2019, respectively, after the final results for the relevant performance period are determined. The PSUs were granted at a target of 100%, but each PSU will reduce or increase depending on the Company's ROCE relative to that of the performance peer group companies and is also subject to the application of a total shareholder return (TSR) cap/collar modifier depending on the Company's TSR during the performance period relative to that of the performance peer group companies. In addition, certain of the PSUs have a two-year holding requirement after vesting before the PSUs are settled in shares of the Company's Common Stock.

(11)    Employee Benefit Plans

The Company has retirement and pension plans covering a substantial number of its domestic and foreign 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. Although various defined benefit formulas exist for employees, generally these are based on length of service and earnings patterns during employment. Effective January 1, 2012, the Company's Board of Directors authorized the Company to proceed with the restructuring of its domestic retirement benefit program 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 domestic defined contribution plans. The Company-sponsored domestic hourly union plan has not been curtailed; however, several locations of the Company-sponsored domestic hourly union plan have been curtailed as a result of collective bargaining renewals for those sites.

In March 2016 a small pension plan acquired in the VION Acquisition was amended to terminate the plan effective in May 2016 (a curtailment of the plan for financial reporting purposes at April 2, 2016).

Net pension cost for the three and six months months ended July 2, 2016 and July 4, 2015 includes the following components (in thousands):

 
Pension Benefits
 
Pension Benefits
 
Three Months Ended

Six Months Ended
 
July 2,
2016
July 4,
2015

July 2,
2016
July 4,
2015
Service cost
$
685

$
1,667

 
$
1,322

$
3,345

Interest cost
1,770

2,638

 
3,515

5,285

Expected return on plan assets
(1,890
)
(3,051
)
 
(3,775
)
(6,116
)
Amortization of prior service cost
7

(20
)
 
14

(40
)
Amortization of net loss
1,166

1,284

 
2,334

2,569

Curtailment gain


 
(1,223
)

Settlement gain
(123
)

 
(123
)

Net pension cost
$
1,615

$
2,518

 
$
2,064

$
5,043


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 and foreign 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 July 2, 2016, the Company expects to contribute approximately $3.7 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 six months ended July 2, 2016 and July 4, 2015 of approximately $2.1 million and $2.5 million, respectively.  

The Company participates in various multiemployer 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 multiemployer 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 multiemployer pension plans in which the Company participates and which are not individually significant, six plans have certified as critical or red zone, one plan has certified as endangered or yellow zone as defined by the Pension Protection Act of 2006.

17




The Company has received notices of withdrawal liability from two U.S. multiemployer plans in which it participated. As of July 2, 2016, the Company has an aggregate accrued liability of approximately $1.9 million representing the present value of scheduled withdrawal liability payments under these multiemployer plans. While the Company has no ability to calculate a possible current liability for under-funded multiemployer plans that could terminate or could require additional funding under the Pension Protection Act of 2006, the amounts could be material.

(12)
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 and foreign currency exchange rates.

The Company makes limited use of derivative instruments to manage cash flow risks related to natural gas usage, diesel fuel usage, inventory, forecasted sales and foreign currency exchange rates. The Company does not use derivative instruments for trading purposes.  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.  Corn options and future contracts are entered into with the intent of managing U.S. forecasted sales of bakery by-products (“BBP”) by reducing the impact of changing prices.  Foreign currency forward contracts are entered into to mitigate the foreign exchange rate risk for transactions designated in a currency other than the local functional currency. At July 2, 2016, the Company had corn option contracts outstanding that qualified and were designated for hedge accounting as well as heating oil swap contracts, corn option and forward contracts and foreign currency forward contracts that did not qualify and were not designated for hedge accounting.

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

In fiscal 2015 and the first six months of fiscal 2016, the Company entered into corn option contracts on the Chicago Board of Trade that are considered cash flow hedges. Under the terms of the corn option contracts, the Company hedged a portion of its U.S. forecasted sales of BBP through the fourth quarter of fiscal 2017. As of July 2, 2016, some of the contracts have settled while the remaining contract positions and activity are disclosed below. From time to time, the Company may enter into corn option contracts in the future.

As of July 2, 2016, the Company had the following outstanding forward contract amounts that were entered into to hedge the future payments of intercompany note transactions, foreign currency transactions in currencies other than the functional currency and forecasted transactions in currencies other than the functional currency. All of these transactions are currently not designated for hedge accounting (in thousands):


18



Functional Currency
 
Contract Currency
Type
Amount
 
Type
Amount
Brazilian real
33,438

 
Euro
7,650

Brazilian real
81,823

 
U.S. dollar
20,975

Euro
231,536

 
U.S. dollar
264,696

Euro
10,761

 
Polish zloty
47,000

Euro
2,351

 
Japanese yen
291,389

Euro
34,263

 
Chinese renminbi
254,639

Euro
10,286

 
Australian dollar
15,900

Polish zloty
19,974

 
Euro
4,522

Japanese yen
21,775

 
U.S. dollar
184


The Company estimates the amount that will be reclassified from accumulated other comprehensive gain at July 2, 2016 into earnings over the next 12 months will be approximately $3.9 million. As of July 2, 2016, no amounts 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 July 2, 2016 and January 2, 2016 (in thousands):

Derivatives Designated
Balance Sheet
Asset Derivatives Fair Value
as Hedges
Location
July 2, 2016
January 2, 2016
Corn options
Other current assets
$
4,554

$
3,215

 
 
 
 
Total asset derivatives designated as hedges
$
4,554

$
3,215

 
 
 
 
Derivatives Not
Designated as
Hedges
 
 

 

Foreign currency contracts
Other current assets
$
11,888

$
644

Corn options and futures
Other current assets
1,244

599

 
 
 
 
Total asset derivatives not designated as hedges
$
13,132

$
1,243

 
 
 
 
Total asset derivatives
 
$
17,686

$
4,458


 
Balance Sheet
Liability Derivatives Fair Value
 
Location
July 2, 2016
January 2, 2016
 
 
 
 
Derivatives Not
Designated as
Hedges
 
 

 

Foreign currency contracts
Accrued expenses
$
975

$
4,435

Heating oil swaps and options
Accrued expenses
49


Corn options and futures
Accrued expenses
454

2

 
 
 
 
Total liability derivatives not designated as hedges
$
1,478

$
4,437

 
 
 
 
Total liability derivatives
$
1,478

$
4,437



19



The effect of the Company’s derivative instruments on the consolidated financial statements as of and for the three months ended July 2, 2016 and July 4, 2015 is as follows (in thousands):

 
 
 
Derivatives
Designated as
Cash Flow Hedges
 
Gain or (Loss)
Recognized in Other Comprehensive Income (“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)
 
2016
2015
2016
2015
2016
2015
Corn options
$
2,875

$
(1,819
)
$
869

$
347

$
162

$
(672
)
 
 
 
 
 
 
 
Total
$
2,875

$
(1,819
)
$
869

$
347

$
162

$
(672
)

(a)
Amount recognized in accumulated OCI (effective portion) is reported as accumulated other comprehensive income/(loss) of approximately $2.9 million and $(1.8) million recorded net of taxes of approximately $(1.1) million and $0.7 million as of July 2, 2016 and July 4, 2015, respectively.
(b)
Gains and (losses) reclassified from accumulated OCI into income (effective portion) for corn options are included in cost of sales, respectively, in the Company’s consolidated statements of operations.
(c)
Gains and (losses) recognized in income on derivatives (ineffective portion) for corn options are included in other income/ (expense), net in the Company’s consolidated statements of operations.

The effect of the Company’s derivative instruments on the consolidated financial statements as of and for the six months ended July 2, 2016 and July 4, 2015 is as follows (in thousands):

 
 
 
Derivatives
Designated as
Cash Flow Hedges
 
Gain or (Loss)
Recognized in Other Comprehensive Income (“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)
 
2016
2015
2016
2015
2016
2015
Corn options
$
3,195

$
(1,523
)
$
2,343

$
581

$
214

$
(727
)
 
 
 
 
 
 
 
Total
$
3,195

$
(1,523
)
$
2,343

$
581

$
214

$
(727
)

(a)
Amount recognized in accumulated OCI (effective portion) is reported as accumulated other comprehensive income/(loss) of approximately $3.2 million and $(1.5) million recorded net of taxes of approximately $(1.2) million and $0.6 million as of July 2, 2016 and July 4, 2015, respectively.
(b)
Gains and (losses) reclassified from accumulated OCI into income (effective portion) for corn options are included in cost of sales, respectively, in the Company’s consolidated statements of operations.
(c)
Gains and (losses) recognized in income on derivatives (ineffective portion) for corn options are included in other income/ (expense), net in the Company’s consolidated statements of operations.

The table below summarizes the effect of derivatives not designated as hedges on the Company's consolidated statements of operations for the three and six months months ended July 2, 2016 and July 4, 2015 (in thousands):


20



 
 
 
 
Loss or (Gain) Recognized in Income on Derivatives Not Designated as Hedges
 
 
 
 
Three Months Ended
Six Months Ended
Derivatives not designated as hedging instruments
 
Location
 
July 2, 2016
July 4, 2015
July 2, 2016
July 4, 2015
 
 
 
 
 
 
 
 
Foreign Exchange
 
Foreign currency loss/(gain)
 
$
(7,204
)
$
1,637

$
4,083

$
(21,407
)
Foreign Exchange
 
Selling, general and administrative expense
 
(3,868
)
(348
)
(6,779
)
2,991

Corn options and futures
 
Net sales
 
344

81

345

70

Corn options and futures
 
Cost of sales and operating expenses
 
(81
)
633

(613
)
378

Heating Oil swaps and options
 
Net sales
 
226


153


Heating Oil swaps and options
 
Cost of sales and operating expenses
 

35


130

Soybean Meal
 
Net sales
 
7


7


Total
 
 
 
$
(10,576
)
$
2,038

$
(2,804
)
$
(17,838
)

At July 2, 2016, the Company had forward purchase agreements in place for purchases of approximately $9.9 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 and the Company has elected to account for these as normal purchases as defined in the FASB authoritative guidance.

(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 July 2, 2016 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 July 2, 2016 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
$
17,686

$

$
17,686

$

Total Assets
$
17,686

$

$
17,686

$

 
 
 
 
 
Liabilities:
 
 
 
 
Derivative instruments
$
1,478

$

$
1,478

$

5.375% Senior notes
515,000


515,000


4.75% Senior notes
578,381


578,381


Term loan A
248,992


248,992


Term loan B
588,318


588,318


Revolver debt
3,811


3,811


Total Liabilities
$
1,935,980

$

$
1,935,980

$



21



 
 
Fair Value Measurements at January 2, 2016 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
$
4,458

$

$
4,458

$

Total Assets
$
4,458

$

$
4,458

$

 
 
 
 
 
Liabilities:
 
 
 
 
Derivative instruments
$
4,437

$

$
4,437

$

5.375% Senior notes
495,000


495,000


4.75% Senior notes
541,280


541,280


Term loan A
277,874


277,874


Term loan B
577,710


577,710


Revolver debt
9,218


9,218


Total Liabilities
$
1,905,519

$

$
1,905,519

$


Derivative assets consist of the Company’s heating oil swap and option contracts, corn option and future contracts and foreign currency 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 12 (Derivatives) for breakdown by instrument type.

Derivative liabilities consist of the Company’s heating oil swap and option contracts, corn option and future contracts and foreign currency 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 12 (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, term loan A, term loan B and revolver debt is based on market quotation from third-party banks.

(14)
Contingencies 

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

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

As a result of the matters discussed above, the Company has established loss reserves for insurance, environmental, litigation and tax matters. At July 2, 2016 and January 2, 2016, the reserves for insurance, environmental, litigation and tax contingencies reflected on the balance sheet in accrued expenses and other non-current liabilities were approximately $55.8 million and $54.6 million, respectively.  The Company has insurance recovery receivables of approximately $12.2 million as of July 2, 2016 and January 2, 2016, 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 Company's financial position, results of operations or cash flows.


22



Lower Passaic River Area. 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 (a “PRP”) 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. The Company’s designation as a PRP is based upon the operation of a former plant site located in Newark, New Jersey by Standard Tallow Company, an entity that the Company acquired in 1996. 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. In March 2016, the Company received another letter from EPA notifying the Company that it had issued a Record of Decision selecting a remedy for the lower 8.3 miles of the lower Passaic River area at an estimated cost of $1.38 billion. The EPA letter makes no demand on the Company and lays out a framework for remedial design/remedial action implementation in which the EPA will first seek funding from major PRPs. The letter indicates that the EPA has sent the letter to over 100 parties, which include large chemical and refining companies, manufacturing companies, foundries, plastic companies, pharmaceutical companies and food and consumer product companies. The Company's ultimate liability, if any, 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, the Company has found no evidence that the former Standard Tallow Company plant site contributed any of the primary contaminants of concern to the Passaic River and, therefore, there is nothing that leads the Company to believe that this matter will have a material effect on the Company's financial position, results of operations or cash flows.

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. Darling International Inc. The complaint, as subsequently amended, alleges that the Company's Fresno facility is operating without a proper use permit and seeks, among other things, injunctive relief. The complaint had at one time also alleged that the Company's Fresno facility constitutes a continuing private and public nuisance, but the plaintiff has since amended the complaint to drop these allegations. The City of Fresno was also named as a defendant in the original complaint but has since had a judgment entered in its favor and is no longer a defendant in the lawsuit; however, in December 2013 the City of Fresno filed a motion to intervene as a plaintiff in this matter. The Superior Court heard the motion on February 4, 2014, and entered an order on February 18, 2014 denying the motion. 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 that its operations do not constitute a private or public nuisance. Accordingly, the Company intends to defend itself vigorously in this matter. Discovery has begun and this matter was scheduled for trial in July 2014; however, the parties have agreed to stay the litigation while they participate in a mediation process. 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, results of operations or cash flows.

(15)
Business Segments

The Company sells its products domestically and internationally and operates within three industry segments: Feed Ingredients, Food Ingredients and Fuel Ingredients. 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 certain intangibles. Assets of corporate activities include cash, unallocated prepaid expenses, deferred tax assets, prepaid pension, and miscellaneous other assets.

Feed Ingredients
Feed Ingredients consists principally of (i) the Company's U.S. ingredients business, including the Company's used cooking oil, trap grease and food residuals collection businesses, the Rothsay ingredients business, and the ingredients and specialty products businesses conducted by Darling Ingredients International under the Sonac name (proteins, fats, and plasma products) and (ii) the Company's bakery residuals business. Feed Ingredients operations process animal by-products and used cooking oil into fats, protein and hides.

Food Ingredients
Food Ingredients consists principally of (i) the gelatin and collagen hydrolysates business conducted by Darling Ingredients International under the Rousselot name, (ii) the natural casings and meat-by-products business conducted by Darling

23



Ingredients International under the CTH name and (iii) certain specialty products businesses conducted by Darling Ingredients International under the Sonac name.

Fuel Ingredients
The Company's Fuel Ingredients segment consists of (i) the Company's biofuel business conducted under the Dar Pro® and Rothsay names (ii) the bioenergy business conducted by Darling Ingredients International under the Ecoson and Rendac names and (iii) the Company's investment in the DGD Joint Venture.

Business Segments (in thousands):

 
Feed Ingredients
Food Ingredients
Fuel Ingredients
Corporate
Total
Three Months Ended July 2, 2016
 
 
 
 
 
Net Sales
$
542,955

$
272,120

$
62,266

$

$
877,341

Cost of sales and operating expenses
416,145

214,279

46,691


677,115

Gross Margin
126,810

57,841

15,575


200,226

 
 
 
 
 
 
Selling, general and administrative expense
43,319

20,455

1,804

10,580

76,158

Acquisition and integration costs



70

70

Depreciation and amortization
42,119

17,736

7,184

2,492

69,531

Segment operating income/(loss)
41,372

19,650

6,587

(13,142
)
54,467

 
 
 
 
 
 
Equity in net income of unconsolidated subsidiaries
224


13,628


13,852

Segment income/(loss)
41,596

19,650

20,215

(13,142
)
68,319

 
 
 
 
 
 
Total other expense
 
 
 
 
(26,345
)
Income before income taxes
 
 
 
 
$
41,974



 
Feed Ingredients
Food Ingredients
Fuel Ingredients
Corporate
Total
Three Months Ended July 4, 2015
 
 
 
 
 
Net Sales
$
529,429

$
283,354

$
46,532

$

$
859,315

Cost of sales and operating expenses
404,899

223,190

40,190

(3
)
668,276

Gross Margin
124,530

60,164

6,342

3

191,039