Darling Ingredients Inc.

Good morning and welcome to the Darling Ingredients, Inc. conference call to discuss the company's second quarter 2020 results. After the speaker's prepared remarks, there will be a question and answer period and instructions to ask a question will be given at that time. Today's call is being recorded. I would now like to turn the call over to Mr. Jim Stark. Please go ahead.

Thank you and welcome to the Darling Ingredients earnings call. Participants on the call this morning are Randall C. Stewie, our chairman and chief executive officer, Brad Phillips, our chief financial officer, and John Bullock, our chief strategy officer. There is a slide presentation available, and you can find that presentation on the investor page under the events and presentations link on our corporate website. During this call, we will be making forward-looking statements, which are predictions, projections, or other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results could materially differ because of factors discussed in yesterday's press release, in the comments made during this conference call, and in the risk factors section of our Form 10-K, 10-Q, and other reported filings with the Securities and Exchange Commission. We do not undertake any duty to update any forward-looking statement. Now, I would like to turn the call over to Randy.

Thanks, Jim. Good morning, everybody. Thanks for joining us. When we were hosting our first quarter earnings call in May, we were in the middle of some of the most uncertain times I have witnessed in my career. And I have to say that our global management team pulled together and orchestrated a solid operational and financial performance for the second quarter. The quarter's results would not have been achieved without all our essential workers globally doing their part as well. While COVID-19 continues to be a significant threat, our team has adopted operating procedures and tactics that allow us to service our suppliers, ship our customers, and keep our employees safe. For the second quarter of 2020, combined adjusted EBITDA of $195.2 million was admirable given the volatility in our health, nutrient, fuel, and service markets. Driving this performance were strong results in our feed segment. The $85.2 million in EBITDA was the best quarter we have had in the last three years and was done on flat raw material volumes to a year ago and volumes 4% lower than Q1 of this year. For most of the quarter, we had higher fat and protein prices, which were mostly the results of disruptions in slaughterhouses. Fat and protein prices have pulled off their highs now from the second quarter. The food segment, despite COVID-19 causing disruptions to both consumer purchasing and production capabilities, turned in a good performance, similar to a year ago period when you removed the gain on the sale of assets in 2019. As you saw our announcement in mid-July, we have commissioned the collagen peptide production facility at Ghent, Belgium, and commissioned the expansion project at Angoulême, France. We have seen a pickup in collagen peptide or peptin sales and anticipate a better second half 2020 for this product group. The fuel segment performance was a little better than a year ago, but weaker on a sequential basis, We made the decision to idle our biodiesel plants for the majority of the second quarter in the U.S. and Canada because of the poor margin environment. Our EcoSun and Rendac businesses were stronger in the second quarter to offset the biodiesel plants not running. We have since restarted our biodiesel production as it is marginally profitable to produce biodiesel. DGD achieved $1.91 EBITDA per gallon margin, or $69.1 million, which is Darling's share of DGD EBITDA in the second quarter. The energy market had a significant price decline, affecting the selling price of renewable diesel. Coming into the quarter, we have seen prices improve to where the EBITDA stock margin is averaging between 235 to 240 per gallon. As noted in our release yesterday, the DGD aboard approved and distributed another $80 million in cash distribution to each of the JV partners in accordance with the distribution policy of DGD. For 2020, Darling has received $205 million in distributions from DGD, and I would also like to add that counting the first dollar we received from DGD, Darling has been the recipient of approximately $413 million of cash distributions. For the first half of a pandemic year, Darling has generated $408.5 million of combined adjusted EBITDA for the company, and we believe that we can contribute to produce solid results for the balance of 2020. Also, as we noted yesterday in the release, Darling Ingredients Board has approved the replenishing the company's previously announced share repurchase program back to $200 million of availability and have extended the term of the program. Now, with that, I'd like to hand the call over to Brad to take us through a few financial highlights, and I will follow up with some additional outlook for the rest of the year. Brad?

Okay. Thanks, Randy. As a reminder, before we go through our results... Darling did not adjust our results for the Blender's tax credit recorded in the second quarter of 2020 compared to the second quarter of 2019, with the BTC being recorded in the fourth quarter of 2019 caused by the reinstatement of the tax credit at that time. Now for a few of the highlights. Net income for the second quarter of 2020 totaled $65.4 million, or $0.39 per diluted share, compared to a net income of $26.3 million or $0.16 per diluted share for the 2019 second quarter. For the first six months of 2020, net income was $150.9 million or $0.90 per diluted share compared to $44.3 million or $0.26 per diluted share for the same period of 2019. Our gross margin improved to 25.5% for the second quarter of 2020 compared to 22.1% for the same period in 2019 as net sales increased 21.3 million and cost of sales and operating expenses decreased 12.4 million. Operating income improved 45.3 million in the second quarter of 2020 as compared to the prior year period when you exclude the 13.1 million gain on the sale of China land in Q2 2019. The improvement in operating income was not only a result of the gross margin improvement, but also a $25.4 million increase in Darling's equity and net income from Diamond Green Diesel. These increases more than offset a $9.2 million increase in SG&A and a $3.8 million increase in depreciation and amortization. SG&A increased from the prior period primarily due to higher compensation-related costs, COVID-19-related costs, and certain insurance increases. However, SG&A declined $6 million from the first quarter of 2020 as expected. Depreciation and amortization declined $1.4 million as compared to the first quarter of 2020. Interest expense declined $2.9 million for the second quarter of 2020 as compared to the prior year period, primarily due to debt reduction as well as lower rates. The company reported income tax expense of $19.9 million for the three months into June 27, 2020. The effective tax rate is 23.1%, which differs from the federal statutory rate of 21%, due primarily to the biofuel tax incentives, the relative mix of earnings among jurisdictions with different tax rates and certain taxable income inclusion items in the U.S. based on foreign earnings. For the six months into June 27, 2020, the company recorded income tax expense of $38.2 million and an effective tax rate of 20%. The company also has paid $18 million of income taxes year to date. For 2020, we project an effective tax rate of 20% and cash taxes of approximately $20 million for the remainder of the year. For the first half of 2020, Darling's share of Diamond Green Diesel's earnings was $161.3 million as compared to $62.4 million for the first half of 2019. There was no BTC in place to recognize earnings. until the fourth quarter of the year. Capital expenditures of $123.2 million were made during the first half of 2020. Our CapEx spend was approximately $44.7 million lower than the first half of 2019. We continue to take a disciplined approach on CapEx as a result of the uncertainty surrounding COVID-19, but we continue to prioritize compliance and safety needs of the business in our reduced CapEx spend. Our liquidity remains very strong with approximately $940 million available under our revolving credit facility as of June 27, 2020. And as Randy mentioned, we received an $80 million distribution from DGD in early July per the distribution policy at DGD. We utilized the $125 million distribution received in April from DGD to pay down bank debt. which improved our bank covenant leverage ratio at Q2 to 2.39 to 1. As mentioned on our prior earnings call, we anticipate this ratio to remain well below 3 to 1 the remainder of 2020. With that, I'll turn it back over to you, Randy.

Thanks, Brad. We are past the halfway point of a very erratic year. Our feed segment performed well by processing significant tonnage of depopulated animals during the second quarter. Again, hats off to our operations personnel for managing through this unusual event all the while the COVID pandemic was exploding all around us. We believe the commissioning of two collagen peptide production facilities in Europe gives us a solid base of capacity to meet the growing consumer trends in the hydrolyzed collagen products market. We anticipate the facility in Brazil to be commissioned in October of this year, barring any further interruption to construction related to COVID-19. Energy markets seem to have stabilized and are showing some improvement in the back half of 2020. The volatility which took place in the second quarter was something not experienced in over a decade. Ultra-low sulfur diesel prices remained 37% lower than they were a year ago and 20% lower than during the first quarter. With the resilient spot margin combined with the first half performance of DGD, we are holding to our guidance of EBITDA per gallon in the range of 230 to 240 for DGD for the full year of 2020. We anticipate selling approximately 280 million to 285 million gallons of renewable diesel for the year, with a plant turnaround coming in the month of October. Our share of the 2020 DGD earnings should be approximately 335 million, based on the ranges I just laid out for you. With the strength we have seen in our feed segment and an improving food segment in the back half of the year, we believe we can produce core EBITDA of approximately 450 to 465 during 2020. Combining our core estimated EBITDA with our share of DBG gives us approximately 785 to 800 million of EBITDA on a combined pro forma basis for 2020. That is a significant earnings milestone for Darling, better than 2019 when you remove the retroactive blenders tax credit, and particularly in a year there has been so much upheaval. We continue to monitor all things that can affect our business, whether it's flooding in China, currency fluctuations in Brazil, or the effects of a worldwide pandemic. Our focus is to have a steady hand on the controls of this global platform and focus on the long-term growth opportunities in front of us. I will remind everyone that we are now 16 months away from commissioning 400 million gallons of additional renewable diesel capacity at DGD in Norco, Louisiana. As others have delayed or extended or even abandoned their projects in renewable diesel, Darling and our joint venture partner have kept the wheels turning on this new and exciting project. As I mentioned earlier, Darling has received $413 million of cash distributions from the JV, which is more than three times the initial cash outlay we made in the original project. To think that in 2022... Diamond Green Diesel can produce 675 million gallons of renewable diesel, and a conservative $2.25 EBITDA per gallon is a significant contribution in growth to Darling's earnings. And don't forget, DGD will be producing approximately 60 million gallons of renewable naphtha, and that will contribute 15 cents a gallon margin to the 675 million gallons already produced. Now, the rendering of animals doesn't grab headlines around the world or even get people excited to own Darling, but is the key ingredient that makes Diamond Green Diesel the leader in renewable diesel market today. Our ability to be the largest collector and processor of animal fats and oils to provide feedstock to DGD is of high value and is why our vertical integration will enhance DGD's ability to be the best low-cost producer of the greenest fuel on the planet. With that, let's go ahead and open it up to Q&A.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw from the question queue, please press star then two. Our first question is from Heather Jones of Heather Jones Research, LLC. Please go ahead.

Good morning. Congratulations on a great quarter. Thanks, Heather. Thank you. So real quickly, just wondering, thank you for the color regarding the second half outlook. I was wondering if you could give us a sense of, I mean, it was an incredibly strong quarter for feed. So just trying to get a sense of how much of that was due to the help from depopulating the whole hogs. And I know you probably won't give an exact number, but just trying to get a sense of How much that helped?

No, you know, I think number one, we want to point out that we have always said that within the business model, as you look at it over the last five years, that there was pretty much, there was significant implied optionality built in that feed segment. And that optionality exists everywhere in the U.S., Canada, and the Europe rendering model. So while depopulating the hogs, we took in about 40 million pounds of hogs during the quarter. That wasn't all of it. It was Canada turned in a very nice performance. Europe had 12 months in a row now of a very strong performance. You know, what you saw was a combination of alignment issues there. Number one, you saw slaughterhouses that weren't predominantly, that Darling doesn't service, the big names out there. that were having COVID-19 issues in the sense of being able to staff. And we talked about those adjustments in several other calls that they would have to make. Well, they reduced the supply of really protein to the market and to a degree the fats also during the month of really May. So we had a little bit of an uptick in the protein markets in the month of May all around the world. And then you also had the major disruption in the ethanol, the shut-ins or curtailments of those ethanol plants that took a whole bunch of DGGs off the market during the quarter there. You know, that's the positive. You had disruptions of trade around the world again between China and Indonesia. But nonetheless, you saw really the markets were driven in the second quarter by a run-up in protein while fat prices were actually down We've now seen, as we go forward, protein prices have stabilized, although a little lower than they were in Q2. But fat prices seem to have improved around the world as the world digests how much palm oil there is going to be available, and China seems to continue to replenish their stockpiles. So, I mean, while I don't know that the – I guess I'm not totally answering your question. Hogs played a little bit part of it. But maybe we shouldn't have put it out there as the major driver. It was all those items around the world. What we're seeing right now in the raw material markets around the world is we're very strong in Canada. We continue to be strong in the U.S. right now. As the slaughterhouses are all running, especially the beef guys are running really hard. The time of the year that we get a lot of breakdown tonnage, they just can't seem to keep their plants in condition to handle it all. And so we're full in the U.S. In Europe, margins remain good and spreads remain good in that business, although the tonnage is off a little bit now for us. China has stepped back in and is taking out pigskin and some of the lower-grade cuts that were going into the, quote, rendering process in Q2. So, you know, overall, we're probably steady when you net it all out, but... I would say our breakdown tonnage in the US is pretty much offsetting most of the hog impact in Q2.

So when I'm thinking about Q3 for the core feed business, and now that meat and bone meal prices have come back down, volumes have normalized, but given the tighter fat market, should we see growth in the core food business in Q3, year on year?

Year over year, I think the way I would answer that is I think we put out guidance of 450 to 465 for the year, which would tell you that we think that the Q3, the feed segment, could be a little softer than Q2 because of the lower protein prices. And remember, Q3 globally for us is always the challenge with hot summer temperatures. You've got 10 days in Europe now of record heat going on, and the U.S. is not much different. You know, that's always a little bit of a challenge. What we're trying to telegraph is that we hope that the food segment, that the consumer demand starts to continue to pick up as it has. And that's in our food segment, really with our Russolo business. I think interesting also then in the feed segment is where our used cooking oil collection business is. While we said that hit a low about April 15th, We still have a couple locations that you can imagine with no eat-in dining in the northeast that are off 25%, but for the most part, we're now off around the country between 10% and 15% year over year. So that's moved back nicely, which should help us a little more within the feed segment in Q3.

Okay. Thank you for the answer.

The next question is from Craig Irwin of Roth Capital Partners. Please go ahead.

Good morning, and congratulations on a really solid quarter again. Randy, I wanted to ask about the commodity environment. So many of my clients think we're heading into an inflationary environment, watching all the central banks globally printing money as fast as they can. You've had to deal with the weight on your EBITDA in the core platform for from a deflationary commodity environment over the last several years. Can you maybe remind us what you did to keep the EBITDA essentially flat now, and now it's inflecting up in that business a little bit, and how this translates forward to leverage if we do see a positive cycle the way it looks like we're facing one now?

Thanks, Craig. You know, I think it's an academic discussion to a degree. I think, number one, the prices of our finished products that do compete in the nutrient markets are still well under the 10-year average. So, as we said, we still believe there's implied optionality as those improve. You know, we have a fundamental belief in this room that commodities, if you want to call them that, all seem to retrace to their their 10-year averages over time. So that's number one. Number two, we've seen weak currencies from the euro side, the Brazilian real as we look at it. The euro is, I think when I looked this morning, was 119. That's up from 110 or 111 in the first quarter. So that translates back to better gap earnings in the US. You know, overall demand, I mean, and then you look at the weaker dollar, that should incent additional buying of our products and make them more competitive around the world. I mean, clearly, COVID-19 has disrupted trade. Clearly, the tension in China has made it a challenging environment to get permits to bring different products in. But nonetheless, we're starting to see pretty nice demand around the world. I mean, The pet food side, at the end of the day, we've seen it remain strong. It's finally backing off just a little bit. Hopefully, that's not a trend, but nonetheless, the typical seasonality in the pet food business in Q2 has now carried stronger into Q3. Overall, I think at the end of the day, we're seeing a nice resurgence of our business here. I mean, If the criticisms that we have taken over the past of capital deployed, we were expanding at a time when we had the capability to expand to capture the growth in tonnage that now drives our system and our supply chain to diamond green diesel. That's starting to pay off. Number two, we made a conscious effort to look at ourselves in the mirror and say we haven't done as good a job as we should have. on recapturing the shareholders' monies we deployed. And there's been an initiative all around the world to widen out margins, to shut down different processes that don't make sense. And really, while I hate the word optimize, that's what I would use here to try to enhance the margins. And the US team and the North American team and the European team have done a really nice job in that area. looking at what products we're making, what we should be charging for them, and getting rewarded for being an essential supplier of services. So to sum it up, Craig, you know, we've got getting back to the 10-year averages, FX that's attractive to earnings, FX that's attractive to exports, and then margin enhancement that we've consciously done to pay for the new capacity that we brought online. Great.

Thank you for that. So on a totally different subject, right, Diamond Green Diesel, COVID-19 was an issue for everybody in the energy markets, some more than others, right? So the construction of Diamond II, has there been any impact on the capex there or the potential capex in the second half of the year? And, you know, you did reiterate the 220 to 240. But is there anything you can maybe say about potential dividends in the back end of the year, given that the cash flows on that business are really fantastic right now?

Yeah. First off, our hats go off to the construction teams down at St. Charles. We have been fortunate to have construction be uninterrupted for us. We are on time, on budget, on plan. Everything is, at this point in time, knock on wood. The hurricanes keep taking right turns. But we still have two hurricane seasons to go through. So at the end of the day, the construction team has done just a fabulous job down there. We're also blessed that the rest of the petroleum industry has been curtailed under CapEx, which makes a lot of great labor at great values available to us. to keep the project moving. We were down last week. I think Jim put out on our pictures out there the latest, greatest, maybe within the last two weeks of the pictures. Steel is coming up out of the ground. The tanks are up. Equipment's being set. Reactors should be in here later this fall or later this summer, early fall. And we're right on time. So everything looks good. We gave a margin environment of 230 to 240 for the balance of the year. It feels that way unless we get another COVID interruption within the petroleum industry. But as you go back and look at gasoline demand now, it's running 10%, 11% off from a year ago. So things are more normal than they've been. But nonetheless, right now, margins feel doable, possibly some upside to them. And if we get a little bit of upside, that's number one. We could have a second dividend out of this, although it would probably be small. As you know, the second year of construction, you know, it takes 32 months here, magically, versus what other people think they can do in a year. But at the end of the day, the big spending will come heavily starting here in fourth quarter and about the first three quarters of next year. So I think a dividend is probably – it's hopeful, but I don't know that I would predict it out there. However, if in, you know, COVID-4 and – In Washington, D.C., there's some fund legislations out there that might send a few additional dollars our way, and if that comes our way, then I think a dividend could be likely. Excellent. Congratulations again.

Thanks for taking my questions.

The next question is from Adam Samuelson of Goldman Sachs. Please go ahead.

Yes, thanks. Good morning, everyone. Morning, everyone. Hi. So I guess just my first question is thinking about kind of the preliminary views on phase three in Port Arthur. And just I know that's still undergoing engineering review. But if we think about kind of the base plan from a capital intensity perspective and kind of the investment case margins that you're looking to underwrite, any way of framing just Differences that would be present relative to what you have in Louisiana and specifically trying to get a handle on how feedstock sourcing might be different into Texas, product markets, if it's just California anymore, how you're framing and evaluating the supply-demand of renewable diesel around the world. Maybe we'll start there.

So, Adam, this is John Bullock. We continue forward with our analysis on Diamond Green Diesel III, heading towards the completion of the Phase III engineering and the decision on whether or not to ultimately move forward with the plant early next year. I will tell you, everything looks very favorable at this point in time. It's just a fabulous location for a renewable diesel plant. You know, as we site these plants, and the siting of renewable diesel plants we've talked about in the past is massively complicated. You have to have your supply chain right, you have to have your capabilities right, you have to have the flexibility to be able to both get the raw material in effectively and get it out to the marketplace and have flexibility to go to the various LCFS markets that are currently in place and that are developing around the world. Port Arthur has all of those capabilities. It's just an ideal second location. We have water capability through our IMTT deal at St. Charles, so we can bring in both river barges and fat internationally if we want to bring that fat in. We have ability on the outbound side to go by water, by rail, and by pipeline out of both facilities. So excellent, excellent flexibility. And as we think about the marketplace going forward, we have a massively experienced team As Randy mentioned, we were down at our construction meeting on Diamond Green Diesel 2 a couple of weeks ago. And as you look around the room, the team that's building Diamond Green Diesel 2, the team that's going to build Diamond Green Diesel 3, built Diamond Green Diesel 1, expanded it, put all the logistics capabilities in, and are now in the process of designing and engineering Diamond Green Diesel 3. It's a massively experienced team. These are massively complicated facilities. If you're just going to start a facility and say, I'm not going to have any pre-treatment, I'm not going to have the right logistics capability around it, you know, you're entering the contest with one hand tied behind your back. And so that's going to be difficult to compete. We say it all the time. We're building Diamond Green Diesel III to be the low-cost, most flexible, lowest CI, most suite of finished products that meet the renewable markets going forward. And if we have that in position with the growing markets that are happening in the United States and around the world, Canada and other places, we feel we're going to be excellently positioned to be able to compete in that marketplace going forward. We're building diamond for the long haul, not for a quick buck if we can get it in place in time to pick up a buck tax credit. We're really trying to do something that's more for the long haul.

That's very helpful. And then just one clarification question as we start thinking about project economics. You talked about $2.25 a gallon in 2022 with the Blender's credit on the $6.75 of renewable diesel. Do we also think on the $60 million of renewable naphtha that separately is $1.25 a gallon for $60 on top? Or how do we think about the renewable naphtha economics on top of the existing renewable diesel economics?

I think for the time being, it probably includes the naphtha in that $2.25 number. I mean, obviously... you know, when we get out to 2022, we're talking about a projection here. But at this point in time, you know, the NAFTA helps improve the baseline profitability of the facility. Maybe it'll be additive on top of that. But if you were thinking about it right now, 225 is probably a pretty good all-in number.

Okay. That's very helpful. I appreciate the color. Thank you.

The next question is from Donald McLee of Barenburg. Please go ahead.

Good morning, guys. Just to kick things off, I'm curious to know how comfortable you are with the overall level of capacity additions in the U.S. market that are expected over the next couple of years and any potential for oversupply. And then within that backdrop of increasing competition, do you think that could highlight some differentiation within the space between Darling and its fears?

Donald, this is Randy. First off, thank you for initiating coverage on us. We sincerely appreciate it. You've done a really nice job for us. We spend a lot of time thinking about the world and where the demand is going to be and the points, and then we spend no time or little time thinking about competition because, as John highlighted earlier, it's really a real estate game, location, location, location. Do you have hydrogen? Are you on the pipeline? Are you on the water? Can you bring in barge? Can you bring in a ship? Can you bring in off two railroads? So, number one, as John said, we're not focused on other people. We're focused on what products we can make around the world to meet the growing needs of both, you know, road fuel, marine fuel, Arctic grade fuel, jet fuels. that we see happening over the world. And ultimately, that's what's going to drive future expansion for us. The supply chain that we built here with the rendering business, with the oil collection, the waste collection businesses, gives just a significant advantage for anybody going forward. Now, all said, we believe that nonetheless, if we're correct on these margins, which, as John said, they're predictions, but we also believe seem to have been able to predict them now for about the last seven, eight, nine years. So I think we've got a pretty good feel with our team of how to price products, where the demand is, et cetera. It'll encourage people to take a shot at it. Clearly, there's been a lot of announcements out there. I mean, everybody, you know, Jim had me read through, you know, three or four petroleum companies, and they all seem to have wonderful renewables products. visions, but there's not one of them that has either got a permit, broken ground, or made a customer sale yet, or bought a pound of feedstock. As I said earlier, permitting is one to one and a half years, and construction, to do it right, is somewhere between 30 and 36 months. That's proven out by us, by Neste, and by Total in Europe. Nonetheless, I suspect somebody will take a shot at it, given these margins. You're seeing some of these refineries that are in the wrong place, if you will, logistically for crude oil, now magically think they're in the right place to buy vegetable oil, high CI vegetable oil to be in the business. Good luck. We welcome the competition. As John says, we're in it for the long haul.

Okay, thanks. That's really helpful. And then just one more on the feed and food side of the business. Could you talk a bit about where you think livestock inventory levels ended at the, ended up, winded up at the end of the quarter relative to historical levels following that round of depopulation in Q2? And is there any concern about a potential headwind from reduced near-term demand amid all that depopulation?

Yeah, I mean, good question. You know, I would point everybody just simply, if you look at the frozen inventories out there, they've really been knocked down. Somebody's buying everything that we can process out there. Remember, you've got slaughterhouses that aren't back to full two-shift, five-day, six-day-a-week capacity, and they're still dealing with some labor issues, et cetera. But nonetheless, the beef business is really – Very strong out there right now. I think it was shared with me that there's enough cattle on feed or in the feedlots to process every Saturday for another year or six days a year. The pork side, what's interesting in the pork side, and I'll comment both here in North America, is the demand remains very robust for the finished product. While cut-out margins are down, at the end of the day, producer margins, etc., At the end of the day, the demand is really strong. And while we depopulated animals that really should have gone to the food chain, and it was tragic that they had to be rendered, if you will. But remember, we make some great products out of it that ultimately end up in the circular economy again. But at the end of the day, we weren't depopulating the sow herd. So at the end of the day, they were just making room for the next letter of... next litter to come into the system. So the hog system seems to remain very, very strong right now. The chicken side, you know, at the end of the day, you still have, you know, if you read U.S. Foods food service, you know, call script, you can go look at it. They're down, they're still saying their distribution system's down 40 to 46 percent from a year ago, if I remember the numbers right. So it's not back. So you're really packed, you know, you're From a chicken side, you're doing a retail pack and you're still not getting the food service, although wing prices have now come back up to where they were nearly a year ago. But that remains fairly strong. In Europe, like I said, we've seen a little bit of Chinese diversion of the product, of the cheap cuts. And then if you move all the way around the world to China, what's interesting is we're now, we didn't even have a discussion on African swine fever in our script or a call, it's still out there. And at the end of the day, what you've now seen is what I believe, and obviously no data out of China can be relied on here. But at the end of the day, what you've seen is it appears that the sow herd got hit by ASF in China because their Chinese numbers of animals has not improved from where they were six months ago, a year ago, even though some of the media says it's up. It may be But it's not obvious to us. And how do we know that? Well, as we operate three gelatin plants there, pig skin is not available. Animal hides that we make a high gelatin product aren't available. Our five blood processing plants there are still running limited hours. There's just really not any. The commercial slaughterhouses don't have any availability to pigs. There may be a few more in the backyard, but they aren't in the commercial system yet. Overall, I know I gave you a little too much color there, but at the end of the day, meat supplies around the world and in South America, everything seems very robust still, and I don't see any changing of that as we go forward here. We're in the middle of barbecue season in North America and in Europe, and we'll keep moving forward here. The numbers to produce an animal are very attractive right now also.

Okay, thanks. That's really insightful. I'll stop there and I appreciate you taking my questions.

The next question is from Tom Palmer of JP Morgan. Please go ahead.

Good morning and thanks for the question. You talked earlier about some tweaks to how you think about capital deployment. I know this year's CapEx is lighter given the uncertainty. But going forward, how might we think about your CapEx plans? Were you suggesting CapEx might be lower than in past years? Or is it more that you're changing the types of projects that you're investing in or maybe how you're thinking about the project that you would invest in?

I think it's all the above, Tom. This is Randy. I mean, number one, we came into a very uncertain, erratic year. You know, clearly we were responding to our board and looking at, you know, doomsday scenarios. And then we were, you know, at the end of the day, these are very capital-intensive businesses to be in, both from a truck fleet where we have to haul our own material in most cases to the plants where it's just very corrosive. So, you know, essentially we came into the first half of the year and said, we want to watch and make sure that our business model works in this environment. And so I think for the first half of the year, $120 million, $125 million, I see about the same thing, maybe just a little bit more in the back half of the year. We're finishing out the two pepton plants that are commissioning. The Epitasio Brazil is in those numbers. But no, we're taking a cautious approach still to the balance of the year. Also trying to make sure that our operations and management team understand that we're kind of moving the bar on them a little bit to make sure that we get a return on the capital. And that's part of the margin enhancement program. You know, going forward, I really look for a number, you know, closer to the 275, and that's all in going forward would be my target as we go forward. You know, we've always said that it really takes about 175, 185 to maintain the business. And really, when you've got 215 or 18 plants now around the world, when you do the divisor on that, it's not a lot of capital per plant. And then the trucking fleet, if we try to maintain a seven, eight year age on that trucking fleet, takes 50 million. The rest is then competition for good projects that will meet the 15 to 20% internal hurdle rate for us. So that's how I'd look at it going forward.

Thanks for that. I also wanted to follow up on the new collagen plant opening. Could you just remind us how much your production capacity of collagen increases what you're assuming in terms of volume growth as we think about the second half of the year, including the ramp, and then just what you're seeing on the demand side to support that supply growth. Thank you.

Thanks, Tom. I'll take a stab, and if John wants to jump in and help me here, if I – you know, number one, what we're adding is a process to an existing process. around the world. We have the pepton plants, the two pepton plants in Amparo, Brazil today, that are running near capacity. We've just commissioned Ghent, Belgium, and are commissioning an expanding angle in France. That's a fish pepton plant, predominantly geared towards the Asian countries. And then we're bringing on another plant in Epitasio, Brazil. So what we're trying to do is capture a trend or a move within the global collagen market. If you say gelatin is collagen and peptin, as we call it, is hydrolyzed collagen, or a fancy word is saying it's spray dried. So you can either send the gelatin down or the collagen down a belt dryer and you have gelatin, or you can divert it to an enzymatic process and spray dry it. So it's a balancing of production capacity for us. It's obviously being driven by the margin structure in it. It's also optimizing. our product mix around the world where maybe we were making too much of a lower-grade collagen that can now be spray-dried and moved into a different market. Remember that the absolutes within the business for us are that this is a water-soluble product that goes into health and nutrition and beauty, and that's what's key about it for us. And it really is we embark on a multi-year strategy in our Rusillo business that this is the next processing step for us. Collagen, in a sense, is we talk about collagen peptides, and that's where the brand Peptin came out of. And you will see additional health and beauty nutrition uses as we isolate the different peptides and find the markets for them. I think we've also made an announcement during the quarter of our X-Pure product, which is a low endotoxin product. It's very, very exciting. For us, you know what and clearly we're putting these products out here competitively. We're not going to tell you the margins on them We're going to show you the results here over the the next coming quarters But really for us the system is going to run the same amount of tonnage in it It's just going to be which markets it goes to and that's going to be allowed us to move our product mix around relative to the market and if you think through the second quarter here and You know, we made less pepton because that's a little step closer to the consumer. The consumer, that's a big box retailer. The customers had to move that to an online system. It took them most of the quarter to get there. It's now there. But conversely, we saw significant growth in demand of basic gelatin to go into the gel cap business. And that was really, really a positive thing as customers. as everybody staying at home is looking for that magic pill to take now to keep them safe. And so we'll see that happen, and I suspect we'll probably move a little bit of that capacity back to the U.S. and Europe, away from China over time. But nonetheless, it's an optimization of product mix for us.

Okay, thanks for all that detail, Randy.

The next question is from Ben Callow of Baird. Please go ahead.

Hey, good morning. Congrats on the quarter. So just to clarify the last question, it's the same, you're basically, it's the same process for gelatin and your collagen, is that what I heard? You're adding a different processing line?

Yeah, it's an additional processing line to existing plants. That's why we could build four plants for whatever it was, $125, $160 million.

Okay, the only reason I ask about that is because there's a worry if it gets more commoditized or the fad goes away that we have sunk capital there. So we get that question. I'm just wondering what your thoughts are on that front.

Yeah, so this is John. So it was very interesting as the pepton opportunity came up because it was a rapidly rising trend. In the nutraceutical markets, nutraceutical markets have a tendency to have products that become very hot and they become very cold. We wanted to make sure that we took advantage of the opportunity without spending a tremendous amount of capital, and that's what we did by modifying essentially the back end of some of our existing units. So while we spent a fair bit of money on this, if we would have tried to develop entirely new facilities to do this, we would have spent four times the amount of money that we did spend. So we went into this on relatively a low capital approach. We are extremely excited because we believe that peptins and hydrolyzed collagens are now mainstreaming into the marketplace. And I think the proof positive on that is when we saw Nestle invest in vital proteins. They are now going to be able to take the hydrolyzed collagen and move that out on many more platforms into many more marketplaces And quite frankly, if you've got the stamp of a great consumer product, have a company like Nestle say, we want to be in that business. And so we are extremely excited. We think we've seen a validation of hydrolyzed collagen. There's going to be a lot more utilization and a lot more categories out there, and that's going to really help drive the growth in that category of those products. So we went at relatively modest capital for the capability that we got, and we really think now we've received the stamp of validation for the product category.

Okay, just two more. Randy, you talked about the core being 450 and 475. I think the last call you kind of walked down to 425, and I'm just wondering what the changes are there, the big drivers.

I was just really being conservative. I mean, on the back half of the year, I mean, and there's still some risk there. I mean, it is a resurgence and some of the economy is shutting down, but it You know, it really, at the end of the day, it feels like meat demand, food demand, fuel demand is just very solid for us. So it's really an improvement of back half of the year, I think, food pricing for us for the Ruslo system, also with palm oil improving, and then really our tonnage remaining strong. And it's really all those things combined.

And then lastly, and this kind of follows other people's questions on Diamond Green, as you move forward on Port Arthur, if you do, or even with your current expansion, the logistics around getting feedstock, I guess, get more complicated. How do we think about, you know, do you leverage nicely? How do we think about your thoughts around you controlling more of feedstock, whether North America or elsewhere? Is that a priority for you or do you already have, you know, kind of what you need in the core business for both of those expansions? Thanks.

Yeah, this is John. I mean, we are the, I think we publicly say, you know, 10% of all slaughtered animal byproducts around the world go through a darling facility. So we have a significant ability to source and supply fats to Diamond Green Diesel. We will always continue to look at new opportunities to add additional capacity, as Randy talked about. But one of the things we also do, is we show, I think, great restraint on when we invest. We've been buying companies, but when the multiples got too high to buy companies, we didn't chase. We look to put new capacity on place, and we look at what it will make on a 10-year average price, commodity price. And if commodity prices are a little lower, we know we might not make quite as much in the short term, but we're building that supply base for Diamond Green Diesel. So we're going to continue to be aggressive out there to build our vertically integrated platform But we will show financial restraint and just not throw money to buy stuff at high multiples that we don't think we can make a good return on processing that material. But absolutely, we'll take advantage of more growth opportunities if they become available in the market. But today, we have a tremendous supply base already for diamond green diesel.

Okay, thanks, Gilbert.

The next question is from Ken Zaslow of the Bank of Montreal. Please go ahead.

Hey, good morning, everyone. Good morning, Ken. Good morning. Just one quick one. When you think about your leverage, where do you want to get it to? And then once you get it to a certain level, what do you plan to do with the capital? Is it more of a dividend strategy? Is it more of a share of a purchase? How do you think about it? Because it's starting to get to a point where you're generating significant cash, and what are you going to end up doing with that? Are there any thoughts on that longer term?

Yeah, Ken, this is Randy, and I'll let Brad chime in if I don't say it right. I mean, two words, investment grade is where we're headed. We've had some challenges at the rating agencies recognizing DGD as part of the whole system, that we've had some challenges there of being big enough to be investment grade, but I think we're getting there with them. Clearly, we set out all the conferences we did over the last two years We kept telling you a number of 2.5. Brad said 2.39 now is where we're at. You know, clearly as DGD2 or number 3 comes on or DGD2 comes online, we still have to fund a little bit of DGD3. Whether that, you know, we're clearly still open and in discussions with our partner on outside finance there. And clearly the market is readily available to us to do that if we so choose. at which time then there's significant amounts of cash that will start to pour into Darling. As you know, then there's three tranches of our debt structure that are out there, the Term B and then a couple bonds, a Euro bond and a U.S. bond that still aren't callable today, but eventually they will be. But, you know, obviously the first use would be to pay off the Term B. And then after that, you know, I think you're going to see us look seriously, and this is a board decision, so, you know, I have to defer to my bosses, then you would look at a dividend and a repurchase program. Obviously, we put the repurchase reauthorization out there just from an opportunistic standpoint as we go forward. But clearly, we're in a different position here in about 16 months, as Jim Stark said in the script, to be a net cash generator program. delever and then to put a meaningful dividend under it and then hopefully with that comes a recognition of long-term value and a shareholder that they couldn't hold the day that can hold once there's a dividend great greatly appreciate it thank you the next question is from carla casella of jp morgan please go ahead hi um my question relates to that collagen and the other new businesses i'm just wondering

What's the magnitude of those today and how big do you see those getting over the near term?

Hey, Carla, can you repeat the question? You were really loud there.

Sorry, I'll stop yelling. I'm just wondering how big those collagen and the other ancillary businesses are today and how big they could become.

Yeah, this is John. I don't know that we release specific information about Peptin or what our gelatin sales are. What we see is we see the gelatin segment now showing some fairly good growth because, quite frankly, a lot of nutraceuticals and a lot of medical pills are being taken by people as the COVID crisis is upon us. So we've seen that segment show some real resilience here. And then we think the hydrolyzed collagen market, the peptin market, is a market that is really just beginning its process to growth as it mainstreams into the large international marketing companies. We'll see how far that goes, and we'll see what type of growth that entails for us. But we believe that, in essence, what amounts to tailwinds, As we get through the COVID crisis, and as Randy talked about, there's no doubt about it, Peptin is a little closer to the consumer, and it got hit a little harder up front with the COVID crisis. But as we work through the COVID crisis, and we will get out of this at some point in time relatively soon, when we do, we think we're going to see really, really good growth in that Peptin collagen business.

Okay, great. Thanks.

And the last question is from Bill Baldwin of Baldwin Anthony Securities. Please go ahead.

Thank you very much. Good morning, folks.

Morning, Bill.

Morning, Bill. Wanted to just get a feel on the used cooking oil collections. Are there any regions of the country that are more important to you than others here in the U.S. on that business, Randy? Okay.

Yeah, Bill, I mean, it's clearly the, you know, we have a strong presence in the northeast and a very high concentration of population in that New York tri-state area. That's the part that's down, you know, 25% right now just because dining's not open. But clearly in the southeast, you know, the home of fried food is clearly an important part for us. And it... it has for the most part reopened and the high producers are your drive-thrus, your fast food QSRs versus your sit-down dining. As we said, we saw that business come back to, I don't know, 10%, 11% off now versus last year. I suspect it'll hold there as we go forward. The thing about it is we always talked about there's limited seasonality in there, but when the ballpark's open... You know, it seemed that, you know, the cooking oil demand picked up or used cooking oil supply picked up. And, you know, clearly those virtual fans out there aren't really eating any French fries or corn dogs now. And so I suspect we'll probably hold at the off 10% to 15% for the year before it reopens.

And I guess that business is probably pretty heavily weighted towards the national chains, you know, the McDonald's, the Burger King, people like that.

Clearly, it's weighted towards the heavy deep fryers, which are the chicken guys, if you will.

Right. Okay. And then on the food ingredient segment, can you give just a rough breakdown on revenues between the Russolo brand, your Edible Fats, and your sausage caching businesses? We have not ever –

We've never really broke it down, Bill. What we've said is Russolo is a significant portion of that, and we try to leave it there. You know, as John was answering the competitive market for Carla, you know, the gelatin market is roughly 400,000, 425,000 tons globally, so it's a micro market, and we prefer to keep that pretty close to the best there.

Okay, fair enough. Thank you much, and good job.

This concludes our question and answer session. I would like to turn the conference back over to Randy Stewie for closing remarks.

Thank you. We appreciate everyone's time today. Look forward to talking to you soon. And if anything happens during the update of the next quarter in November, we'll be the first to let everybody know. Thanks again.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.