Darling Ingredients Inc.

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

Thanks, Matt. 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, chief financial officer, and John Bullock, our chief strategy officer, and a few other senior executives of Darling Ingredients. 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 and 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 statements. Now, I would like to turn the call over to Randy.

Thanks, Jim. Good morning, everyone, and thanks for joining us on the day after the election. First off, let me thank our 10,000 plus darling employees around the world. COVID-19 remains a constant in our daily work and home lives. Our team has been able to rapidly adapt to a very dynamic situation, and I sincerely appreciate their ongoing efforts to deliver the products and services we provide to our customers around the world for the third quarter of 2020 our combined adjusted eva doll was 218.5 million as our global ingredients platform continues to be resilient our health nutrient and bioenergy businesses continue to prosper and make the necessary adjustments to keep our momentum for a record 2020 and set the stage for even a better 2021. Our fuel segment and our food segment showed improvement year over year and growth sequentially to the second quarter of 2020. Overall, we continued to see an improving and positive trend on our gross margin percentages across our business lines. As I talked with you back in May, we continue to work diligently on cost control measures and widening our gross margins, thus improving our returns. Our USA team has done an exceptional job. As expected, our feed segment for the third quarter declined from the strong performance we had in the second quarter as protein prices in the third quarter moved lower sequentially compared to Q2, and prices for Q3 2020 were also lower when you compare them to 2019. With the positive upward movement in the grain and oilseed complex, we're experiencing a better pricing environment for our protein products and for our fats and oil products in the fourth quarter, And this should provide a positive catalyst heading into 2021. In the food segment, there was a nice recovery of hydrolyzed collagen sales for the quarter. We're in the process of commissioning our third new collagen peptide production facility in Presidente Epitácio, Brazil, as we speak, which broadens our ability to supply this on-trend food ingredient to our customers worldwide. The food segment, led by Ruslo, the number one collagen provider in the world, is poised to provide meaningful earnings growth in 2021. The fuel segment performance was significantly better than a year ago, both in our international green energy businesses and at Diamond Green Diesel. Diamond Green Diesel achieved a 241 per gallon EBITDA margin on record sales of 80 million gallons for the quarter. We recorded 96.4 million of EBITDA, which is Darling's share of the joint venture. The energy market did show some improvements from a demand standpoint during the quarter, although oil and diesel prices remained significantly lower than the same time a year ago. Diesel is currently trading 80 cents a gallon under Q4 of 2019. On the positive side, the green premium we are able to capture for the renewable diesel has offset the majority of this downward price in the current environment. As we noted in our press release yesterday, the turnaround at Diamond Green Diesel was completed on time and the plant is running at full capacity. And we expect that Diamond Green will sell between 55 and 60 million gallons of renewable diesel in the fourth quarter and should average between 230 and 240 a gallon for those gallons sold. On a year-to-date basis, Darling has generated $627 million of combined adjusted EBITDA for the company. putting us on pace to finish what most everyone considers to be a challenging year with record results. We currently believe that we can finish 2020 with combined adjusted EBITDA between 800 and 810 million. We certainly believe this gives us a solid platform as we move into 2021 for what we believe will be a transformative year as the 400 million gallon expansion, or what's known as DGD2, comes online in late 2021. If you've not had a chance to look at our refreshed corporate website or read our 2020 ESG report, I encourage you to do so. Our ESG team did an excellent job in publishing our 2020 fact sheet, which gives us an exciting story to build on as we move forward. It outlines our goals and initiatives and how Darling will play a significant role in the decarbonization of our planet. For Darling, We take great pride in our green leadership position in the world, and we plan to do our part in conserving water, energy, and reducing greenhouse gas emissions directly and indirectly by our DGD business producing more low-carbon renewable fuels for the world to consume. So that completes my comments, and I'd like to turn it over to Brad to give us a few financial highlights. Brad?

Okay, Randy, thanks. Okay, everyone, I'll touch base on a few of the highlights. for this quarter and year to date. Net income for the third quarter of 2020 totaled $101.1 million or $0.61 per diluted share compared to a net income of $25.7 million or $0.15 per diluted share for the 2019 third quarter. For the first nine months of 2020, net income was $252.1 million or $1.51 per diluted share compared to $70 million or $0.42 per diluted share for the same period of 2019. As Randy mentioned earlier, our gross margin continues to show improvement as reported 24.9% for the third quarter of 2020 compared to 22.5% for the same period in 2019 as net sales increased 8.5 million and cost of sales and operating expenses decreased 14.6 million. Operating income improved 67.7 million in the third quarter 2020 as compared to the prior year reaching $127.5 million for the third quarter and totaled $356.6 million year-to-date 2020, compared to $182.5 million for the 2019 period. In addition to the improved gross margin, the improvement in operating income benefited from a $59.1 million increase in Darling's equity and net income from Diamond Green Diesel. SG&A expense was higher by $6.4 million in the quarter, partially attributable to the higher cost related to COVID-19, certain insurance increases as we recently renewed our coverages across the business, and higher benefits, more than offsetting lower travel costs. Interest expense was $18.8 million for the third quarter of 2020 compared to $19.4 million for the prior year period. We currently project quarterly interest expense to be approximately $15 million per quarter over the next several quarters. The company reported income tax expense of $4.8 million for the three months ended September 26, 2020. The effective tax rate is 4.5%, 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 discrete items, including the recognition of a previously unrecognized tax benefit, and the favorable impact of certain U.S. Treasury regulations issued during the quarter. For the nine months ended September 26, 2020, the company recorded income tax expense of $43.1 million with an effective tax rate of 14.5%. Excluding discrete items, the year-to-date effective tax rate is 18.2%. The company also paid $24.9 million of income taxes as of the end of the third quarter. For the remainder of the year, we project the effective tax rate to be about 20%, with cash taxes for the year totaling approximately $35 million. For the three and nine months of 2020, Darling's share of Diamond Green Diesel's earnings was 91.1 million and 252.4 million as compared to 32 million and 94.4 million for the same period of 2019. A reminder that there was no BTC in place or recognized during 2019 until the fourth quarter. Capital expenditures of 184.9 million were made for the nine months of 2020 as we continue to take a disciplined approach during the pandemic prioritizing compliance and safety needs of the business and our reduced CapEx spend. Now, turning to the balance sheet. In the third quarter, we were successful in amending and extending our $1 billion revolving credit facility with favorable terms. The amendment extends the maturity date of the revolving credit facility under the credit agreement from December 16, 2021 to September 18, 2025. In addition, we paid down our term loan balance by $145 million to a new balance of $350 million outstanding at the end of the quarter. With our improved financial results and the pay down of the Term Loan B, our bank covenant leverage ratio for Q3 was 1.93 to 1. We continue to make progress toward achieving an investment grade rating. Our liquidity remains very strong with approximately $934 million available under our revolving credit facility at the end of Q3. providing strategic flexibility while at the same time maintaining a very solid capital structure. I'll turn it back to you, Randy.

Hey, thanks, Brad. As I mentioned earlier, our share of the 2020 DGD earnings should be approximately $330 million based on the ranges I laid out for you. With the strong performance of Q3 and prices for our products improving as we work through the fourth quarter, we believe we can produce EBITDA of approximately $470 to $480 in 2020 in our global ingredients business. That is back in line with the guidance we were anticipating back in February of this year, pre-COVID. As you saw in the press release we issued last week, the gated development process of DGD-3 to be located in Port Arthur, Texas, remains on track for both joint venture partners, boards of directors, to be in a position to approve moving forward with the project in early 2021. The permitting process for these types of facilities is no easy task. And I once again thank our teams, especially Valero's engineering and construction team, for knocking this huge hurdle out of the way. Once approved, construction should begin immediately, putting DG D3 in a position to be operational in early 2024. We understand that there is concern with oversupply of renewable diesel and potentially a shortage of low-carbon feedstocks in the future. Our simple answer is we plan to take advantage of the first mover position we have to be the largest low-cost producer of renewable diesel in North America. While others are trying to figure out how to build or convert existing 80-year-old refineries to renewable diesel, we continue to focus on building new facilities with the lowest operating cost structure, the latest technologies, incorporating the trade secrets we've learned over the last seven years of operating our plants. Darling's vertically integrated supply chain will continue to provide DGD with superior low-cost feedstock, which enhances that first mover advantage for DGD. And finally, as you may have read in our earnings release yesterday, we were successful in acquiring a three-plant Belgian poultry rendering processor and a food waste recycling business. This was especially challenging for diligence given COVID-19 protocols, but our Euro team did a nice job, and we expect, even while small, this acquisition to strengthen our already successful Belgian system and immediately be accretive. With that, let's go ahead, Matt, 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're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Adam Samuelson with Goldman Sachs. Please go ahead.

Yes, thank you. Good morning, everyone. Morning, Adam. Hi. So I guess first question, maybe just thinking about Diamond Green Phase 3 a little bit as we get closer to the final investment decision. Do you have any more color on potential financing and likelihood or possibility of structured finance to get that done so cash flow from the JV could start blowing up to the parent fund? sooner than 2024?

Yeah, Adam, this is Brad. There is that possibility. We are talking to the partner, our partner, regarding that. So, yeah, that's something that could become a possibility.

Okay. And then just more broadly on Phase 3, any more color you can have on the low-carbon feedstock sourcing there, just kind of how you think about the Gulf position as a base for imports and just where You think you can get the feedstock that others building in the market can't?

Yeah, Adam, this is John Bullock. I think we've discussed this a lot with everybody out there. The feedstock supply is one of really two critical analysis we run from a commercial standpoint. We always feel that we were in a unique and advantaged position because, quite frankly, we have an enormous supply of low-carbon feedstocks that we control within our system. and are able to bring to Diamond Green Diesel as Diamond Green Diesel needs that feedstock. Overall, our assessment is, while it's something that everybody needs to watch that wants to get in the renewable diesel business, we feel comfortable that if we move forward with Diamond Green Diesel 3, we are going to have the supply of low-carbon feedstocks we need to supply that facility. But I must emphasize, one of the reasons we look at it probably differently than everybody else in the world is, Because we are the only company that has a large source of low-carbon feedstocks in our control, and we have a renewable diesel facility that we're partnered with Valero on.

Okay, great. I appreciate the call. I'll pass it on. Thank you. Our next question comes from Donald McLee with Barenburg Capital Markets. Please go ahead.

Good morning, guys. Can you hear me?

Morning. Sure.

So just to touch on the acquisition of those rendering plants a bit, could you talk about how that fits in your overall strategy and maybe what type of capabilities it unlocks with the recently commissioned collagen peptide production plants there?

Yeah, this is Randy. You know, it's a rather small by tonnage acquisition. You know, as we've described over the years and been around the business a long time, Still, Western Europe is still a little bit of the Wild West with still a lot of small family 1Zs, 2Z rendering plants. And this was just a series of brothers that had three small little rendering plants that will be consolidated into our much larger Belgian system today. So it's a nice fit. You know, as these family succession businesses come and they're priced right, then they're We'll fold them in. It meets our strategy of both controlling fat and protein and, you know, to a degree, rendering production within different geographies around the world. And so this was just a nice, natural bolt-on for us. I would tell you, you know, I don't get that excited about moving the needle, but it was nice. It's accretive, and we'd like to have, you know, 10 more of these if we can find them. It gives us more fat. more protein and once again gives us more control in the Belgian poultry rendering market. And poultry rendering puts out a series of products that are premium products to the high-end pet food ingredient business. So not only do you get the fat that can go into different food applications and also into fuel applications, you get the proteins.

Okay, that's helpful. And then just looking at the fuel segment, there was some pretty significant top-line growth and margin expansion there. which it sounds like from your comments was driven by the performance of the international fuel segment. But I was wondering if you could maybe provide more color on what some of the specific underlying dynamics were that supported that strength.

Yeah, this is Randy again. Within the fuel segment, obviously, we roll up diamond groove into the operating income side there. But above that is really predominantly our mortality processing business in Europe, and then our digesting business, where we take food waste, pig manure, and produce green energy and put it into the grid. Both of those businesses had very strong earnings in the quarter. What we call the RENDAC business, which is our seven-plant mortality disposal or destruction business, It was a very hot summer, if you remember, in Europe this summer, and we just had a lot of extra tonnage in there that flowed through with good pricing and demand for what are considered to be Cat 1 fats to go back into biofuels, into renewable diesel in Europe. So that was the primary driver of those businesses along with the strong DGD performance.

Okay, thanks. And then the last one for me. So there's clearly a big push into renewable diesel with all the growth going on at the JV. And I was just curious, what do you think about the longer term fit of the biodiesel business, just given the emphasis on renewable diesel?

Let me clarify the question. You're asking what's the long term fit of biodiesel in the industry versus renewable diesel?

Within the company.

Oh, within the company. You know, clearly we've been on a strategy to expand the renewable diesel business. You know, clearly from a logistics, earnings, transportability, and product demand standpoint, it's a superior product. You know, we only operate the small facility up in Montreal today and then a very, very tiny facility in Butler, Kentucky today. Clearly those businesses in the corridor were very, very challenged, again, as biodiesel margins were sometimes below break even and not even really contributing to fix. So ultimately, we're going to have to make a decision there on Montreal. And as John Bullock said, given the location of Diamond Green Diesel 2 and Diamond Green Diesel 3, we now have a home for the fat out of Montreal, out of Ontario. to move south, and we're looking at those economics all the time, whether it makes more sense to arbitrage the fat into the USA versus leaving it up north. So good question, Donald. Clearly, renewable diesel is a more fungible, superior-earning investment than a biodiesel plant in Montreal today.

All right, thanks, guys. That's all my questions. I appreciate it.

Our next question comes from Manav Gupta with Credit Suisse. Please go ahead.

Manav Gupta Thank you for taking my question. In your opening remarks, you had mentioned that there are a number of refiners that are trying to figure out how to retrofit and fix the 80-year-old refineries to produce renewable diesel. Can you help elaborate on it? And there's a little bit of skepticism there as to if all of these projects actually do come online. So can you help us understand what some of the problems these refineries might run into as they try and enter into renewable diesel, which they have never done before?

Yeah, I'll take a little stab here, and then I'll let John Bullock kind of clean up the mess that I start. You know, number one, we spend no time worrying about other people entering the business because of our vertically integrated supply chain and the location of economics of DGD 1, 2, and soon to be number 3, and that's both outbound and inbound. Keep in mind the low carbon fuel standard is simply not a California program. Every one of those retrofitted or to be retrofitted or to be engineered or to be studied or to be permitted facilities that they're talking about are old, out of place locations with high cost that they're trying to, you know, convert over. It has nothing to do, in my opinion, with the longevity of putting an asset in the right place with the right economics. That's number one. Number two, when you look at what it takes to be effective in this business, look at the carbon intensity scores of the feedstocks that each one of these places, quote, says they're going to run. You know, we've not seen anybody put in pretreatment necessary, as we call it, the secret sauce to make this business work. So when you start to look at businesses and you say, well, we're going to run soybean oil, that's great. However, you've got to look at the price differential of refined bleached soy today, and it's probably anywhere from $0.08 to $0.10 a pound premium to waste fats and greases today. That doesn't mean that waste fats and greases won't come up in the future. Our core business will benefit and ultimately we'll have some gain there too. But the other side is then when you look at the net effect of the carbon intensity score of using a soybean oil between the cost of the raw material and the CI differential, you're talking anywhere from a buck to a buck and a half a gallon difference to diamond green diesel running today. And so you look at that and you say, well, how does this work as the business goes forward? Number one, today the economics look good because the blender's tax credit's there. It may be there in the future. It's been there for a lot of years since 2007, so it's hard to handicap. But if it's not there, a soybean oil based out of position retrofitted doesn't look all so good on paper as you go forward. And so, you know, that's how we're kind of looking at. We spend no time worried about who's doing what. All we know is we're under construction. We'll be up before the end of 2021 here on number two. Number three is progressing nicely with the permit, which was a big hurdle. And hopefully we'll come online within a couple years of pushing dirt here. John, do you want to add?

Yeah, I think it's important to realize we evaluated California as a location for a renewable diesel facility and chose Port Arthur over trying to do anything in California. We did that for a number of reasons. One, the cost of doing anything in California is a 1.5 to 2 times what you're doing in Texas. And quite frankly, California has a law called CEQA, which is the process you have to go through to permit a facility or a revised facility in California. It is a difficult process with a lot of public comment. And inevitably, the CEQA process in California takes folks longer than you think it's going to take to be able to get it done. We felt speed to market was important, and the reason we felt speed to market was important was not only because of the increasing CI or carbon requirements in California, but we see rapidly developing markets in New York, Canada, potentially Washington State, potentially Oregon. Under red, too, in Europe, we see rapidly developing markets there. So we know that there are folks out there that are either thinking about are trying to or might put additional renewable diesel capacity in. We like where we're located. We like the technology that we're using. And it is really important for everybody to understand that while a part of a renewable diesel facility looks like a traditional petroleum facility, that is a bit of a mirage. It only looks like a diesel facility. It's a quite different technology. And from our perspective, anybody that builds one of these things that doesn't hook a pretreatment system up and all the supply logistics around it that requires is not developing a competitive facility going forward. So we know there's going to be competition out there. Quite frankly, there needs to be additional capacity with the demand for credits that's going to be coming on from these new markets that are developing. We're really comfortable with where we're positioned, our partner, our technology, our vertically integrated feed supply. We're building Diamond Green Diesel to compete not only now, but for 5, 10, 15 years into the future.

Thank you so much. That was a very comprehensive answer. I have a quick follow-up. Can you give us some idea quarter-to-date of what you're seeing with protein prices, fats prices, and other ingredients which kind of make up your segment income? So any update on quarter-to-date pricing of fats and proteins?

Yeah, and I think what we'll – this is Randy again. On fats and proteins around the world, If you think back, we came in to January, February, and COVID hit. You saw a lot of shuttering of slaughterhouse capacity in both North America and Europe as it reacted to COVID protocols. That's a different way of saying that some of these large slaughterhouses were curtailed in their production. And thus, we saw protein and fat prices, because of the reduction in supply, run up very rapidly towards the end of Q2 or mid-Q2 and then fall off as we saw the slaughterhouses restart. In Q3, we kind of hit the bottom. We've now seen the grain and oilseed complex, meaning the price of corn, soybean, palm oil, all start to feel like they've hit a bottom here and are starting to move back up to where we thought they would be. And so we're carrying pretty good momentum. We're carrying really good momentum into Q4, both here, Canada, and Europe today as we go forward. I mean, ultimately, I think, you know, the Chinese demand out there for grains and oil seeds continues to be unbelievably large. I don't see that tailing off anytime soon. And that goes to the hog herd replenishment. I mean, our trans... You know, our ability, our transparency to animal production in China is pretty, pretty optic. And what I mean by that is we're a big buyer of pig skin, animal bones, hives, and also blood in China. And we have just not seen animal numbers come back yet in China. However, we know that they're now, that animals are under production and being grown. So we're probably a year to 18 months out. That bodes well for continued demand of soybeans and corn into China as we go forward here. John, do you want to add anything to that?

Yeah, I think nobody should underestimate the tremendous power of the Chinese economy, one, turning around and looking like it's performing very strong, and two, the fact that they are reconstituting their pig herd. But not only are they reconstituting their pig herd, but they are also doing more of it in concentrated large growing. that will use more of the meals and the corns as opposed to the garbage and waste that was being fed by the small private family farm. This is a fundamental shift, and that dynamic has a tremendous impact on the world, and clearly China needs to come to the United States to buy those products, and they are in massive quantities. It's going to take a year or two to reconstitute that pig herd in China, so we would anticipate the demand is going to remain high. extremely good for all of those products, as well as meat out of the United States in the term of pork and poultry, which is very good for the volumes we handle in the U.S.

Thank you for taking my questions.

Our next question comes from Ben Bienview with Stevens. Please go ahead.

Hey, thanks. Good morning, everybody.

Morning, Ben.

I want to ask a follow-up to Adam's question about DGD3. You know, you announced the air permit for Port Arthur. You said that was a big milestone. Can you help us think about what other critical milestones are in front of us on the critical path to, you know, getting this facility approved? And I'm more focused on the external, you know, critical path than the internal deliberations that you might have. What should we be monitoring going forward? Thanks.

Yeah, this is John Bullock. I'm not sure you can distinguish between the two. We are on track with our cost estimate, the detailed phase three engineering. We are on track with the analysis. We always update our analysis from a commercial perspective. Both companies do. We will be in a position to make a final decision on Diamond Green Diesel 3 in January, February of 2021, just as we said. I will tell you everything is going well. on track just exactly as we had hoped it would. The analysis continues to show that we should be moving in a positive direction at that facility. Then we see the marketplace as being very good, and we're going to be very well positioned at Port Arthur. We love the location. We love the logistics flexibility we're going to have down there. It is just a fabulous location as a second overall logistics site for our Diamond Green Diesel system.

Okay, great. The second question is, as relates to debt pay down on term line B, the refinancing of the revolver. You guys already are at a pretty modest leverage level. You've got more cash coming given the increase in production and presumably the inflow of cash from the JV forthcoming down the road. What are your priorities on cash deployment given that it's poised to ramp pretty meaningfully here over the next few years?

Yeah, this is Randy, and Brad will help me out here. I mean, you know, our priorities haven't changed. I mean, we're on an investment-grade glide slope here. You know, clearly the timing, weather, outflows as relative to DGD2 here as we, you know, approach 2021, you know, and then the margin structure as we come into next year. I mean, we're thinking we're going to get a fourth-quarter startup God willing, and then weather willing into next year. Could put up some extra gallons next year, higher than the 285 this year. And we see the margin structure, again, somewhere between two and a quarter and 250. We don't see much changing there coming into next year. So, you know, relative to cash out of DGD next year will depend on the timing of the construction and the aggressiveness that goes there, along with, as Brad, you know, kind of telegraphed clearly the momentum for outside finance on DGD 2 and 3 has more momentum than it's had in the past. And we remain very optimistic that the leadership team at Valero understands the importance of that cash availability to Darling. Interesting as the oil crack spread cycle, cash becomes important to them too. for, for, you know, for the first time in seven years, I think we're absolutely aligned that cash is King. So hopefully that will, will lend itself to a positive outcome. So with that comes Brad, Brad paid down 140 on the, uh, the term loan B we've got three 50 of prepayable debt left out there today, nine 60 or something left on a revolver. If we ever found something that was wonderful. And then at the end of the day, you know, we, we've kind of, um, we've, We've tightened our purse strings. I mean, we listened to our shareholders, our investors on deploying cash the last several years. We were building out our supply chain and expanding with our customers on rendering. We're getting the margins back in that business now where we thought we would. They dipped down. People always have to remember, this business is still, from the commodity exposure side, we're still way below the 10-year averages on fats and proteins. in this business. And obviously, if you came back and modeled it at those levels, you would see some pretty tremendous, you know, growth in the base ingredient business. So, you know, with that comes, you know, I think we'll continue with the 350. I think next spring or summer, the Euro bond comes callable at one and seven eighths. You know, if we can get the rating agencies to give us the respect that Brad and I believe we deserve, then we might go back out and put some longer-term capital underneath this and a very attractive interest rate as we go forward. But we've got a lot of things that have to happen here in the next six months for that to become a reality. Otherwise, it's just keep paying down the Term B and manage it from there. Brad, anything you want to add? That's good, Randy.

Okay. That's great color. Thanks, and best of luck, guys.

Our next question comes from Craig Irwin with Roth Capital Partners. Please go ahead.

Good morning, and thanks for taking my questions. So, Randy, you had $30 million in EBITDA upside in the third quarter, and it sounds like you're pretty much keeping the guide that you've been talking about for a while, 8 to 8.10 for the full year. Is there anything in the fourth quarter, maybe extended turnaround for Diamond Green longer than the the couple weeks we've seen previously, or on the margin side or on the operational side that maybe has you a little bit more conservative about the fourth quarter? Or should we interpret this as maybe you could be a little bit conservative as you guide to that 8 to 8.10?

Yeah, you know, first off, Craig, I think, number one, we try to be conservative in the view here. Fourth quarter had – It has three major things in there. It has two holidays between Thanksgiving and Christmas. Not sure how the slaughterhouses in here in Europe will run during what's been a very challenging year for their employees. So we're going to have to see how tonnage really holds in there. We're optimistic about the feed segment improving in Q4 versus Q3. Q3 was it came off of the euthanization of the 40 loads of hogs a day in Q2. and a nice price run-up that we got on the backside of, if you will, in Q3. That's come back. Prices have improved in here, Canada, and Europe. So the feed segment feels more positive for Q4. The food segment absolutely feels, you know, the orders feel very good in that business now. You know, it's still challenging around the world. I mean, our China operations are doing quite well, but finding raw material in China continues to be challenging. In South America, we're still dealing with lots of COVID-related absences, but we're doing quite well. And in Europe, now we're getting the benefit with Germany being shut off from shipping pork material into China. It's allowed pigskin to get cheaper in Europe. So now we're going to have some improved margins there. So the food segment feels very good. And then the fuel segment, you know, we did take down 18 to 20 days here, came up nice and strong. You know, I think we'll be around that, you know, 60 million gallon level, maybe a little more for Q4. We'll just see how we run through it. John, anything you want to add on the fuel segment there?

No, Diamond Green Diesel's turnaround was excellent. The guys did a great job. You know, we had a hurricane come close to us during the middle of our turnaround, and yet they still managed to bring that turnaround a day or two in earlier than we thought it was going to be, and the facility is operating perfectly post the turnaround.

Great, great. So feed had margins up 150 basis points year over year. We all understand the gyrations from COVID in the second and third quarters this year, but it seems like your initiatives in there, things like, you know, making Peptan, converting to collagen versus gelatin, having a little bit of a nice margin bump in that segment. Can you maybe describe how this is likely to follow through? Do we have the potential for another 150 basis points over the next year? Any other color on the margin growth in this segment would be helpful.

Yeah, and, Craig, I think we'll talk the feed segment. We came into the year and challenged our global operating team. We said, look, we've deployed a billion dollars of capital into these plants over the last five years. We need to be paid for it. It's becoming increasingly expensive to run these businesses because of environmental, wastewater, steel costs, et cetera. And so what used to be in a historically old business, if you will, a fair margin doesn't work anymore. And so as we started to look at our North American and our European business, we looked at where we could, if you will, push the envelope from a standpoint of processing margins. Where do we have a key leverageable location? We challenged each of the teams to figure out how to take out, you know, 2%, 3%, 5% of their operating costs out of this, you know, And, and, and so, you know, at the end of the day, you either figure out how to get a better return or you're not getting capital. It was a little bit of a, you know, chicken and egg here. And then, then ultimately we started charging in different businesses more for our services. And some of it was COVID related. It really, when COVID hit and you became an essential service and you had to pay a little more per hour, or you had to, you had 25% absenteeism in some locations around North America. you really got to see your cost structure in action very rapidly and transparently. And so we were able to react to that. And so, yeah, I think where we're at in the feed segment as we look forward in the margin structure, clearly there's commodity risk there that goes up and down 100 points or so. But at the end of the day, I think we've still got more room and more work to do in there as we come into 2021 and the teams will be challenged. In the food segment, clearly, The demand destruction we saw of our near-consumer product in our Peptin line was very obvious to us. We went in the April, May, part of June period basically without any orders with new plants coming online. Those are now commissioned online approvals, and we're going to carry some pretty nice momentum into next year. And, you know, you can start to look back on the food segment and you look at the EBITDA of basically now around 39 to 40 million per quarter. As we've telegraphed in the past, as those pepton investments come online, we think the food segment over the next year and a half will trend on up towards the 200, maybe north of 200 level. So you'd be 50 million a quarter there as we look forward. And then the fuel segment is really just as it is. It's probably a tariff-related business and very, very transparent other than Diamond Green. And, you know, as we said for 2021, if we can get number two online here with good weather, you know, instead of 285, maybe we make 300 million gallons next year, maybe make a little more. We see the margin structure similar between two and a quarter and 250 for the year. So, you know, as you start to put this together, you can start to see while we're talking and, you know, an 800, 810 total here, maybe it ends up being a little higher than that. with a strong Q4, but we got that same momentum in the next year that should show us even better earnings next year, provided we've got the markets forecasted right here. Great. Well, congrats on the impressive result.

Thanks. Our next question comes from Ken Zaslow with Bank of Montreal. Please go ahead.

Hey, good morning, guys. Morning. My first question is, How much demand for LCFS is available to soak up any new supply that comes on? How do we frame that?

Yeah, Ken, this is John Bullock. I think, you know, obviously California is extremely important. And I have to remind everybody, California is heading to a 20% carbon reduction by 2030 on a steady path all the way up. And I think today we're at less than 8% in that total. So we got a long ways to go in California. That's a huge market. In addition to that, though, Washington State has been very close to putting in an LCFS. That's, again, possible this year. New York is going to put in an LCFS, we believe. That's an enormous market up there and could lead to an even bigger market if the entire Northeast decides to put in an LCFS program. The Clean Fuel Standard in Canada is in place and is in process of the rules being promulgated, and we believe that's going to be online in 2022, 2023. That's, again, an enormous market that it goes for. And under REDD2, we see strong increases in renewable diesel demand in all of the Nordic countries and potentially as well in Germany, potentially France, potentially Spain, potentially Italy. So I think it's a mistake for everybody to just look at all the production capacity coming online and look at that versus today's demand. What makes us most excited about this business is the fact that carbon reduction is a thing. And it's a thing going forward. And quite frankly, that means there's going to be a lot more demand for a person that can supply renewable credits to that marketplace. And so we look at that supply and demand balance all the time. It's the other critical thing we look at before we make a final investment decision. We're very comfortable with the way that this market is developing.

So how much would you frame that as? Would you say you could absorb... Two billion, one billion, how much renewable diesel can be absorbed in the next couple of years? How do I think about it or how do we all think about it? I agree with you. I just kind of figure out mathematically what you're thinking of the demand.

Yeah. The LCFS market is different than a traditional biodiesel or biofuel mandate market like RFS2. You're looking to reduce carbon emissions in these various marketplaces, and they allow the various products to compete to reduce those emissions. So the analysis on how you determine what the LCFS demand is complicated. You have to go and dig into the weeds and look at how the LCFS credits are generated under each of the programs and how many deficits are going to be generated underneath the programs. Quite frankly, it's something that we've looked at for a long period of time. But it's not something that I necessarily want to start to throw gallon estimates out there on. We believe that there's plenty of demand for everything we're building, plus a lot of the stuff that other people might be building out there, too. And I think we've said that consistently, Ken, for a long period of time. And as short a period of time as two or three years ago, we had tons of people that said, oh, there's just not going to be enough demand for this product. There's plenty of demand for this product today. We've got great demand into 2021, 2022, and forward. We see the market. We're selling obligation is what we're doing and compliance. We see the market as being very, very good for our product as we look forward.

And my second question that I have is when you think about the base of your business, so you have a rendering business and you have obviously the 50%, of the Diamond Green Diesel. At this point, higher input prices are good for you, right? You want higher fat prices, higher, you know, all the rendering products. Is there a point in time where that doesn't move that way, that you'd prefer to have lower input prices? And at what capacity levels does that work out to be? And then I'll leave it there and very much appreciate it.

Yeah, it's a fascinating question. academic question. I mean, clearly the downturn in fat prices in Q2 translated to better earnings in diamond green diesel. So that's the model we've been trying to talk to people about. As competition picks up for waste fats and greases or low CI inputs, you're going to have two markets ultimately that happen. One, you're going to have the people that can run it, They have pretreatment and the people that can't run it. And as Diamond Green Diesel 2 comes online and Diamond Green Diesel 3, we will use up to 65% of the North American supply of waste, fats, and greases. So ultimately, we will be the biggest and best home between Port Arthur and Norco, Louisiana for those products as we go forward. Who then becomes... challenged in that operating environment. Ultimately, it would be the biodiesel industry that that feedstock would initially then be diverted from because they can't compete with the margin structure. The same thing goes, Ken, and you wrote a very nice summary as you were looking at the crushing industry. Make no mistake, a renewable diesel plant cannot compete with Kraft salad dressings for vegetable oil. And the world's going to find out that argument again in a very hard fashion. So ultimately, you know, the pretreatment side, the first mover, the advantage that we have I think is pretty special. It will translate into better margins in our non-formulaic business, in our core business. It also helps us then provide superior values to our slaughterhouses and make meat more competitive to feed the world. So there's a little bit of an esoteric side to it. You know, as we often tell people, our job is to make our raw material suppliers more and more competitive so they can sell more product and we can pick up whatever's left over. John, anything you want to add?

I think it is always interesting because how the margin and diamond works over a period of time is fairly complicated. There's the price of diesel fuel, there's the price of fat, there's what's happening with the green premiums. But all I would point out, Ken, is that since the LCFS markets have really developed about three or three and a half years ago, we've seen the diesel fuel market anywhere from $2.20 a gallon to $0.86 a gallon. We've seen the Jacobs anywhere from $0.18 a gallon to $0.18 a pound to $0.29 a pound. And guess what? Diamond Green Diesel has made $2.25 when you allocate the tax credit to the appropriate year, $2.25 to $2.50 every single year. So the market adjusts. This is a competitively advantaged product if you have the right facility with the right capability and you can get to the various LCFS markets. And we have adjusted over time. We anticipate that's going to continue going forward.

Great. Thank you very much.

Our next question comes from Matthew Blair with Tudor Pickering Holt. Please go ahead.

Hey, good morning, Randy, Brad, and John.

Good morning.

I'd like to circle back to the pricing front. Earlier there was talk that fats and protein prices were up a little bit in October. We noticed soybean prices have also moved up about 6% so far this quarter. How does that compare to any trends you're seeing on the Yuko pricing front?

Yuko has remained very strong the whole time. you know, clearly it's the preferred feedstock. And there just really isn't, you know, on a macro basis, all that much yuko that's out there. I mean, you started to see, you know, fats and proteins move back up here as we started to rationalize what the size of the U.S. corn crop was after the straight-line winds, derecho, or whatever you call that thing in Iowa. And then ultimately, as we started to see... the global demand for bean oil moved back up. So, you know, ultimately, you know, as we look around the world, it looks pretty solid going into next year. I mean, it looks even better than where we're at today. I mean, when we look at it, we stop the macro world. We look at where we see animal fat prices, soybean meal prices, and then where we see pet food demand for our specialty ingredients, and all three of them look really, really positive going into 21. John, anything you want to add?

Absolutely. The demand picture for all of the products that Darling is producing is, quite frankly, the best I can remember in maybe three to five years.

Sounds good. And then I guess on the feed side, you've highlighted previously that you collect about 40% of North America used cooking oil. Can you talk about efforts to protect and potentially even grow that collection business if you start to face more competition from, I guess, new renewable diesel plants looking for low CI feedstocks?

Well, number one, the market share that you represented is pretty close to what we would say that we collect in the U.S. with a specialty truck fleet and 130,000 customers. You know, I don't think Mr. New Renewable Diesel Plant is going to go buy trucks and collect used cooking oil. That's number one. We have a value proposition that's very, very difficult for anybody to overcome. If you look at the UCO market, and I think this is a relatively important optic, we've seen it come back from the April COVID lows to about 85% to 90% of normal. I would still tell you we're off 25%, 30% in the Northeast as New York, New Jersey refused to open. But overall, the rest of the country, especially the Southeast, which is kind of the king of fried foods, has really come back strong. So that looks good. The second thing is hidden within Darling is, you know, a changed approach to how we do business with customers. And, you know, we have built a customer engagement program. platform now that really takes us to a new level. No longer are we knocking on the door of a restaurant saying, can we buy or remove your waste cooking oil? John, you want to comment a little on what you've done there?

Yeah, this is something we've been working on for about four years now. We've totally revised our marketing and our go-to-market strategy associated with used cooking oil. And right now, quite frankly, we're in an operation that looks like something that Microsoft or one of the tech companies would be running. As we've changed, as we know, the restauranteurs that we go out and talk to, quite frankly, are millennials and Generation Z, and they wanted to be communicated in a different way. We are doing that, and actually that platform has been built, has been in place now for a couple of years. We're really proud of it because it's a total redo of how we were approaching our customers out there. It has strengthened our market position, and quite frankly, In a sustainable world, in an ESG world, we have the number one message to anybody that has used cooking oil. Your product is going to be made, turned into what amounts to a highly sustainable, carbon-reducing, vertically integrated chain that Darling controls. That is a statement that, quite frankly, most of the other people out there picking up used cooking oil cannot claim.

Sounds good. Thanks.

Our next question comes from Ben Callow with Baird. Please go ahead.

Hey, thanks for fitting me in, guys. Could you remind us about just the percentage of fats that would go into the Port Arthur facility if you go forward with that in the U.S.? And then do you plan on, you know, importing them? And that's my first question. My second is... is palm oil and using that as a feedstock. And I think NestE does that, but how do you think of that? And then the third question is, does it make sense for the JV to be a JV or how far down the road have you gotten looking at different strategies for it being a standalone or something else?

I'll ask you the first two, and then I think I might be able to sort of start the third answer, and I'll let Randy finish up. Yeah, we anticipate that as the world gets more renewable diesel capacity, you're going to start to see some fat move around the world a little bit more, whereas today it's mostly we've just been using North American-based feedstocks. We announced about, oh, I don't know, seven or eight months ago that we had entered into a throughput arrangement with IMTT in New Orleans. One of the really critical aspects of that is that gives us an excellent facility not only to receive fat off of the river, off of barges, but also to receive fat as it becomes available in the world to bring in to, and we can directly pipe it over to Diamond Green Diesel, which is absolutely wonderful. So we've got full-scale capability. Obviously, as folks get bigger in renewable diesel capacity, a larger and larger portion of the waste fats in North America are going to go to the renewable diesel capacity. But they're only going to go to those folks that have pretreatment capacity because if you try to run wastebats on one of these facilities, one of these renewable diesel plants without pretreatment facility, you are not going to like the result that you're going to get in a very short period of time. And we've got the full pretreatment capability both at Diamond Green Diesel 1 and 2 in Norco in Louisiana, but also at Port Arthur we're going to have the full pretreatment capability. So we're going to be buying a larger and larger percentage of wastebats. IMTT gives us full flexibility to bring fat in from anywhere in the world, which we love that logistics flexibility. We think it's critical moving forward to compete in this business. You had asked, Tom, your second question was?

Ben, palm oil. Palm oil, yeah.

We're not going to use palm oil.

Then your third question. Then Ben, the third.

Ben, I'm sorry.

Why not palm oil, I guess? Why not?

Because our primary market is North America, and palm oil doesn't qualify in the North American markets.

Got it. Doesn't have a pathway, Ben. And your third question is, I'm going to speak for my partner, Joe Gorder at Edvalero. We're very happy with our relationship today and how it's structured and have no intent, never say never, but at this time we're going to get number three built out, and then we'll see where we're at from there.

That was good. Thanks, guys.

Our last question will come from Tom Palmer with J.P. Morgan. Please go ahead.

Good morning. Thanks for the question. It's been only half a day, but since your press release, it feels much longer. I just wanted to ask on the feedstock side – And I know you've gotten a lot of questions about this, but I just wanted to maybe revisit the mix. A couple years ago at the Investor Day, you estimated that Superdiamond would run, I think it was 15% to 20% used cooking oil, 50% animal fat, and then the remainder mostly comprising corn oil. Could you give us an idea of what the feedstock mix would be today if that proposed mix is kind of still how you're thinking about Superdiamond? and then how we might think about that mix evolving if you do go ahead with Port Arthur. Thanks.

Yeah, this is John. As we move forward with larger-sized diamonds, what you will see is there's only so much used cooking oil out there, although it's expanding, not only in the United States but around the world. You'll see a greater mix of animal fat as opposed to used cooking oil, although we see a lot more corn oil too. But generally, you'll see our usage of animal fat as a percentage increase a little bit, We're fully capable of handling all those mixes at our pretreatment systems in both Norco and what we're building in Port Arthur, Texas. So whatever that mix is, that's one of the beauties of the system that we built and are in the process of building in Port Arthur, is however that mix of product works out there, we're okay because we're going to adjust and be able to buy what the cheapest price feedstock is.

Okay, and just to clarify, does soybean oil become a factor as you think about Port Arthur, or do you think that kind of those other three are going to continue to be the driver?

This is John again. We would think the waste fats would continue to be the driver. You know, it's possible, and from time to time, indeed, at Diamond Green Diesel, we have processed soybean oil. I'm not going to say that's out of the question going forward. But our primary focus is still on the waste fats at this time.

Tom, this is Randy. It's on the waste fats. And really, you know, that's the reason, as John continues to stress to people, it's logistics. We're not at the end of a rail line in Cheyenne or Dickinson or Artesian, New Mexico. We're sitting on the Gulf of Mexico where we can bring in animal fat out of Brazil, Argentina, Australia. We have a half million tons of fat in Europe today, if it works, can arbitrage in here depending on FX spread. So that's what's driving the location is Darling's access. It's just not North America. It's Europe. It's our presence in Australia. It's our presence in China. It's our presence in South America. We have a visibility to origination that is second to none here. And once we're, as John said, with the terminals that are going in, You know, we're putting in a little more storage because the longer lead time and boat load quantities, you know, lots of flexibility here will allow us to be the best guy on the block.

Okay. Thanks for the detail, guys.

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

Thanks, Matt. Appreciate it. Appreciate everybody's time today. Hope you stay safe. Have a wonderful holiday season in the upcoming time with your families. And hopefully, as Jim gets forward here, we'll have some upcoming events in our IR area. We'll keep you posted and look forward to talking to you soon again. Stay safe.

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