Darling Ingredients Inc. (DAR) Q2 2012 Earnings Report, Transcript and Summary

Good morning, everyone, and welcome to the Darling International Conference Call to Discuss the Company's Second Quarter 2012 Financial Results. With us today are Mr. Randall Stuewe, Chairman and Chief Executive Officer of Darling International; and Mr. John Muse, Executive Vice President, Finance and Administration. [Operator Instructions] This call is being recorded, and your participation implies consent to our recording this call. If you do not agree to these terms, simply drop off the line. I would now like to turn the call over to Ms. Melissa Gaither, Director of Investor Relations for Darling International. Please go ahead, ma'am.

Thank you, Mike. Good morning. Thank you for joining us to review Darling's Second Quarter 2012 Earnings Results. Randy Stuewe, our Chairman and CEO, will begin today's call with an overview of our second quarter financial performance and discuss some of the trends that impacted the outcome. John Muse, Executive Vice President, will then provide you with additional details about the financial results. Randy will conclude the prepared portion on the call with some general remarks about the business, after which time we will be happy to answer your questions. Before we begin, I need to remind everyone that this conference call will contain certain forward-looking statements regarding the business operations of Darling and the industry in which it operates. These statements are identified by words such as may, will, begin, look forward, expect, believe, intend, anticipate, should, estimate, continue, momentum and other words referring to events to occur in the future. These statements reflect Darling's current view of future events and are based on its assessment of and are subject to a variety of risks and uncertainties beyond its control, including disturbances in world financial, credit, commodities, stock markets and climatic conditions; a decline in consumer confidence and discretionary spending; the general performance of the U.S. and global economies; global demands for biofuels and grain and oil seed commodities, which have exhibited volatility and can impact the costs for feed for cattle, hogs, and poultry, thus affecting availability of rendering feedstocks; risks including future expenditures; results relating to Darling's joint venture with Valero Energy Corporation to construct and complete a renewable diesel plant in Norco, Louisiana and possible difficulties completing and obtaining operational viability with the plant; risks relating to possible third-party claims of intellectual property infringement; economic disruptions resulting from the European debt crisis and continued or escalated conflict in the Middle East, each of which could cause actual results to differ materially from those projected in such forward-looking statements. Other risks and uncertainties regarding Darling, its business and the industry in which it operates are referenced from time to time in the company's filings with the Securities and Exchange Commission. Darling is under no obligation to and expressly disclaims any such obligations to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. With that, I would like to turn the call over to Randy.

Thanks, Melissa. Good morning, everyone. Thanks for joining us. It's my pleasure to welcome you to our earnings call to discuss our financial results for the company's second quarter. Let's review our second quarter operating performance before hitting on some major headlines that may affect our business. Most notably, from a volume perspective, we operated at a modestly higher rate than first quarter due to improving beef and poultry slaughter and the addition of new accounts. However, our bakery volumes remained weak most of the second quarter due to continued downtime by commercial bakeries. The good news is we ended the quarter with momentum building and volumes returning closer to seasonal and expected levels. Used cooking oil collection volumes were flat compared to the first quarter 2012, with restaurant traffic still showing signs of economic pressure and theft continuing to be a major problem in most metropolitan areas. Also, the competitive landscape for used cooking oil continues to be challenging, with some margin compression. Pricing for proteins, fats and greases held nicely early in the quarter and improved on a sequential basis relative to the first quarter but peaked in early May. On the fats and greases side, inventories from first quarter were sold, but prices remained lower compared to last year due to slow export demand, primarily from Europe, and reduced feed demand from hot weather, smaller herd sizes and improved availability of corn oil from the ethanol industry. Our protein selling prices improved over first quarter but were negatively impacted by the closure of the Indonesia market for ruminant meat and bone meal, especially impacting our West Coast operations. Lower energy cost, primarily natural gas, helped to somewhat offset the lag in our selling prices. Now let's address some of the major headlines affecting our business and on most of your minds. The first of which is the severe drought impacting the Midwest and other parts of the country. Although we did not see the impact of these extreme conditions during the quarter, it is a critical factor for us going forward. Indications early in the second quarter pointed to the largest corn crop in history for North America, only to reverse sharply with the onset of extremely dry conditions. While typically a rally in either corn or soybean market has a favorable impact on our non-formula business, we continued to see a significant lag in our finished product pricing, causing our normal pricing relationships to be out of sync at this time. Fundamentally, this should change, but it's important to note that we actually saw prices for our products decline late in the second quarter, and now they remain at substantial historical discounts to their competing ingredients. Our Diamond Green Diesel project is approximately 59% complete, with commissioning targeted for early first quarter 2013. We anticipate a phase startup beginning in December. Most notably, our commercial team continues to make progress identifying customers and markets for this product, and our confidence continues to grow on its full commercial acceptance. To again put this in perspective, if Diamond Green Diesel had been operating at planned capacity in second quarter 2012 and assuming the feedstock cost equivalent to our selling price of fat delivered in Norco, Louisiana and selling price for ultra-low sulfur diesel at the Gulf, minus $0.10 a gallon, plus a full rim value, our EPS would've been positively impacted 8% to 10% -- $0.08 to $0.10 per share during the quarter. With that, I'd like to turn it over to John. And after John's comments, I'll conclude with some closing comments before Q&A.

Thanks, Randy. For the second quarter of 2012, the company reported net sales of $436.7 million compared to $470.6 million for the year-ago period. A $33.9 million decrease in sales primarily resulted from lower selling prices of our finished products and lower raw material volumes. During the second quarter 2012, as compared to the second quarter 2011, net prices declined more than 10%, primarily due to lower export demand from European biodiesel, as Randy mentioned. The decrease was slightly offset by an increase in prices of meat and bone meal and feed grade poultry meal due to improved poultry feed demand domestically. Net income for the 2012 second quarter decreased to $36.2 million or $0.31 per share on a fully diluted basis as compared to a net income of $52.2 million or $0.44 per share for the 2011 comparable period. As noted in our press release, the $16 million decrease in net income for the second quarter resulted primarily from lower raw material volumes and lower finished product prices. 2012 second quarter net income compared to the 2012 first quarter were lower as finished product prices declined after a short rally early in the quarter. In addition to the decrease in pricing, our aggregate expenses for depreciation and SG&A increased in the 2012 second quarter compared to prior quarterly average. The increase in depreciation expense was primarily due to capitalized capital projects. Going to the segment level, rendering generated net sales of $371.5 million for the second quarter of 2012 as compared to $392.7 million in the second quarter of 2011. Bakery by-product sales contributed $65.2 million during the quarter compared to $77.9 million in the year-ago period. Interest expense was $5.8 million for the 2012 second quarter compared to $7.7 million in the year-ago quarter, a decrease of $1.9 million, which primarily was due to a decrease in debt outstanding as a result of prior year and current year payoffs of the company's revolver and term debt facility. Other income was $0.3 million in the second quarter 2012 as compared to an expense of $0.9 million for the second quarter 2011. This increase is primarily due to insurance recovery proceeds from a prior year bylaws received in the 2012 second quarter compared to such proceeds in other periods. Relative to the company's investment in our Diamond Green Diesel joint venture with Valero, on the balance sheet, we reported an investment of $46.4 million at June 30 as compared to $21.7 million on December 31, 2011. And the statement of operations has a loss of $656,000 for the second quarter. This loss is largely due to non-capitalizable expenses as we proceed through the construction phase. Okay, now I'm going to the 6 months ended June 30. The company reported net income of $64.8 million or $0.55 per share as compared to $98.8 million or $0.87 per share for the 2011 period. The $34 million decrease resulted primarily from lower finished product prices and decreases in raw material volumes, which was partially offset by decreases in our energy costs. Net sales for the 6-months period ended June 30 were $823 million as compared to $910 million last year. The decrease is primarily attributable to lower finished product prices and decreases in volume. Okay, now let's provide some additional balance sheet detail. On June 30, the company had working capital of $113 million or a working capital ratio of 1.84:1 as compared to a working capital of $92 million and a working capital ratio of 1.73:1 on December 31. Increase in working capital is primarily due to an increase in our cash. At June 30, the company had unrestricted cash of $72.3 million and funds available under our revolving credit facility of $389 million as compared to unrestricted cash of $38.9 million and funds available under the revolver of $391 million at December 31, 2011. On our capital expenditures, capital expenditures of $53.5 million were made during the first 6 months of 2012 as compared to $27.9 million in the first 6 months of 2011, an increase of $25.6 million. This resulted from our ERP project software purchase, as well as planned capital projects for the company. I will now turn the call back over to Randy.

Hey, thanks, John. It's clear that the current macro environment prevents a -- presents a series of potential challenges and opportunities, which must be effectively navigated. We have strong momentum heading into the back half of the year. For our team, operating in cyclical headwinds is not new to us. We are managing our operations with a keen eye on continuing to fortify our market position, creating value-added opportunities and building our world-class renewable fuels plant, all while maintaining a focus on helping our suppliers and customers improve their businesses. Finally, we announced this week that we are hosting our first investor and analyst event, taking place in New York City on September 12. The formal presentations will take place in the morning, with an optional tour of our premier Newark facility in the afternoon. Visiting the rendering process plant may not be on your bucket list, but we encourage you to attend this, as you'll get a much better understanding of how we recycle food by-product waste streams into valuable ingredients for feed, fuel and fertilizer. Please be sure to RSVP and reserve your spot. We look forward to seeing many of you in September. With that, Mike, I'd like to go ahead and open this up to questions and answers.

[Operator Instructions] The first question we have comes from Farha Aslam of Stephens.

[indiscernible] First, a question on your end product prices. It looks like protein prices are following soybean meal higher, but your yellow grease and tallow prices are lagging corn and soy oil. Could you just share with us kind of your thoughts on why such a lag and if you expect them to catch up?

Yes, and I think it's probably a question here that will answer many of it for the rest of the analyst on the call. As you look at the earnings number versus what you guys were trying to model out there, there's a couple, probably 3 or 4, salient points that need to flow through and help you understand here. The first thing is, is that if you look at -- remember, a portion, mid-20%, 25% of our tonnage comes out of the poultry industry. And if you look at the feed grade, pet food spread on poultry in Q1 versus Q2, you would see that in Q1, on the upgraded or value-added ingredients per the Jacobsen sheet, we got about $272 a ton. And in second quarter, we only received $225-a-ton premium. So you got about a -- almost a $50-a-ton discount that happened quarter-over-quarter there that flows straight through the P&L. On the meat and bone meal side, as long as we're staying on proteins, yes, while we did see the Illinois Midwest values improve and, to a degree, track soybean meal, what didn't flow through or what did -- you didn't pickup in it was the substantial discounts that happened and the disruption of trade flows when the Indonesian market closed on us. And if you go back and saw what we added into the Q was there was the -- not only the Illinois meat and bone meal price, but the California meat and bone meal price. And if you look at that, you would see that in first quarter, California was actually a premium to Illinois; and in second quarter, it actually became a discount of $73 a ton. So it became full freight off, if you will, the freight from the West Coast back to the Midwest consumers of that product because of the export restrictions that happened. On the fats and greases, I think for the most part, they were pretty much unchanged on average over first quarter. They are lagging their equivalency of caloric value against corn. But most importantly, they peaked in May and came off fairly substantially here in June. Most of that is driven off of -- primarily off of just very, very slow exports for that product today. As we've said, the hot weather -- I mean, you got a smaller herd size out there year-over-year, whether you're talking cattle or you're talking chickens. And so those 2 combinations really put a little pressure on it. At the same time, as we've said all along, yellow grease or cooking oil yellow grease, tallow cooking oil blends have a real issue in standard biodiesel processes. And so we just did not see the biofuel demand that probably most anticipated there, all the more good reason for Diamond Green Diesel to be able to take that product. So really, at the end of the day, if you take those 3 bullet points there: the pet food feed grade spread; the fat demand driven by lower exports; and then the meat and bone meal discounts, it becomes pretty easy to reconcile for the quarter. Now the question you had, Farha, is: Do you see it improving? I think the answer is we think so because, fundamentally, it should. It's too cheap, all of our ingredients are. We're seeing here in July and August, we're seeing improvements in the meat and bone meal markets, the poultry markets. The fat side, we have yet to see much improvement yet. In fact, it's even staying at a discount today. So I mean, on a corn basis equivalent from calories, if you're only serving the feed market, the fats and greases should be priced somewhere between $0.45 and $0.47. And then we're receiving in FOB plant in the Midwest today somewhere between $0.35 and $0.39. So there's a pretty significant historical lag here that needs to probably improve, we hope.

And your reason for that lag, that's what I'm trying to understand. Why do you think the lag is occurring?

Two things. One, reduced feed demand and biofuel demand that was there and no exports. So our export plants -- I mean, while we're the largest in the country, our export plants, because they're not able to ship overseas, there's no business, are shipping back to the interiors, putting pressure on it. And then more importantly is, as the ethanol grind is out there, you're seeing, I would say, somewhere between 50% and 70% of the ethanol plants now have corn oil extraction systems on it, which are now producing corn oil. The issue there is, is corn oil, because of the amount of wax is in it, has a somewhat hard time going into classic biodiesel processes. So it's feeding for -- it's competing for the same share of stomach in the feed business that our fats and greases were. And so you're seeing corn oil being offered openly at $0.35. There is no market for it to biofuel or overseas at this time. We're excited about it because it becomes just another feedstock that works very, very well with low-cost clean up within our Diamond Green Diesel operation.

Okay. And then my final question is could you just talk about why the export situation, why there's not export demand for oils? And has the Indonesian situation been offset by the tight supplies of soybean meal here in the U.S.?

Well, 2 things. Those are 2 separate questions. I mean, the predominant driver, when -- there were -- there's 2 primary markets that come out of this, that the U.S. ships to for fats and greases out of the country that we participate in. Predominantly, to the poultry markets in the Caribbean and South America. Those have been slow. Clearly, I can't give you a reason why other than just to say they've been slow. The biggest price driver to our plants on the coast had been Europe's reluctance to step forward and to buy cooking oil again to make biofuel. It continues to be a somewhat of a dysfunctional regulatory environment over there that you can go into all kinds of discussion as whether it will return or not return. But the missing link between today and last year is Europe on the fats. On the protein side, for meat and bone meal, we did get the Indonesian market back open now to what we call integrated or packer grade material, so that should take some pressure off of the market to move some material out, and we should see some improvements there. But that is -- that's been slow to come. And most of anything is the Indonesian market shut off, even material that was loaded couldn't go. So there was a multitude of material on the West Coast for many, many shippers that had to find homes and be offloaded. And so we think that, that problem is starting to rectify itself. Given the higher values of the grains in the world, we are seeing some new export destinations in the PacRim come open for us, that weren't traditionally there. And I think it's going to be a recovery, but I don't want to say -- I think it'll be somewhat slow as it moves forward. But once we get the -- some of the material back out of here to Indonesia via the packers, we should see the traditional relationships of at least meat and bone meal improve here pretty nicely.

Next, we have John Quealy of Canaccord Genuity.

A couple of questions. First, sticking with biodiesel for a moment. If you look at some of the government data -- and Randy, I appreciate your comments about Europe -- but if we can come back domestically for a minute, it looks like some government data suggest the industry, including some renewable diesel, is right around -- right under 600,000 gallons through June, right on track with what should be the mandate this year, but we haven't got it finalized. Can you comment a little bit more on domestic trends in biodiesel? Are you seeing the softness there as well?

It's somewhat of a confusing market right now. I've seen the data. I would say we're right on target for production this year, maybe a little bit ahead from where I thought we would be. There seems to be still a lot of confusion out in the marketplace about what I'm going to call RIN fraud or RIN gate, whatever you want to, out there. From a physical production standpoint, the business was running pretty solidly. We have seen RINs come off in value here. We've have one of the most volatile ULSD markets here in the quarter, if you know dropping down to $80 a barrel up to $93. So pricing was moving all over the place. Biofuel demand, or at least classic biodiesel demand, seems to be about where it should be. It's really hard to say. We participate in that. We have a small plant in Butler, Kentucky, and that goes to a very targeted non-road fuel market. So we don't have complete transparency there. The comments I can make that -- as I said in my earlier comments, that -- is that we feel more and more comfortable about the value of renewable diesel, that it really doesn't get linked into that biodiesel bucket more and more, as we're seeing more and more interest from major refiners to take a portion of our production as a blend stock for upgrading different refinery streams. So to a degree, the pricing looks to be very solid at ultra-low sulfur diesel, minus freight plus full RIN. The question of it becomes, ultimately, where it ends up to upgrade, who's product and what fuel stream.

And then -- and I know this is all speculation, but before the Senate went out on break, they added back the biodiesel tax incentive to the Extenders Bill. Who knows if that gets done in December, but can you talk about, if it were to be done on a retroactive basis for the '12 period, do you think it would firm up biodiesel prices and, more importantly, facts for you folks moving into the '13 period? I know it's speculation, but if you can comment on the relationship, that'd be helpful.

I -- to be very honest, I don't know. I kind of share the skepticism with you. I did see the Tax Extenders package go, and I just don't have a feeling. I mean, you're going to come back with a lame duck session of Congress whether or not it'll get moved through along with depreciation tax credits, et cetera, so I'd prefer to stay away from that because I really don't know the impact. I know that once we have seen -- when the tax credit went away, we've seen a lot of the small producers of biofuel out there disappear. So it would probably create new demand again, not always from our perspective being what we consider to be ethical demand from the standpoint of grease theft out there. So personally, from my perspective, I'm not a fan of that credit coming back in.

Okay. And my last question just for John on SG&A. Are we expecting a step-down next year? Or how should we think about run rates as you guys have to move through a little bit of headwind here in the back half of the year on the red side? But looking out more broadly to '13, what SG&A run rates look like to you?

John, as we reported in the first quarter, we're at $37.4 million. Second quarter, we should have been down a little more than we were because of the $1.8 million charge that we had in the first quarter on the incentive programs being accounted for. On an equity basis, we're at $36.9 million. We'll be in that $37 million -- $36.5 million to $37 million range for another quarter or 2. And then as we move forward, though, on our ERP project, we'll start seeing the items that can be capitalized today being moved over to expense because during the development phase, the majority of that can be capitalized. We'll see going into '13 an increase in the $2 million to $2.5 million a quarter range during '13 for the ERP project over our base that we have so far this year.

And the next question we have comes from William Bremer, the Maxim Group.

Can you give us the status of the Diamond Green Diesel initiative, construction, where are we, are we on track there?

Okay, yes, as I mentioned in the comments there, right about 60% complete. We've had a great summer here of construction time, with very few weather disruptions. The plant, basically, all the steel is up. We are now into the piping; electrical instrumentation phase should go well; all major equipment has been delivered; all major vessels installed. We -- as we said, we expect to be able to bring the tank farm up sometime here late in fourth quarter, then going to bring up pretreatment either in December, early January. And then the Ecofining unit will come online towards the back half of January; February, at still at a turndown rate; and then up to full speed in March. So we are on schedule from where we thought we would be and really don't see any issues right now ahead of us.

Okay, great. And then back to Indonesia, you said it's starting to open up a little bit. How much of that is going to affect the third quarter? And do you anticipate that to flow into the fourth at all?

What I can comment there is, is it had very little impact on July because it was just last week or 1.5 weeks ago that we did get it opened. So if you will, July was over predominantly in this business. You're sold anywhere from 2 to 4 weeks out and export sometimes a little further. So it has -- probably has little impact on August. But hopefully, we'll get a bit of improvement in September and then carry some really nice momentum into the fourth quarter.

And the next question we have comes from Ken Zaslow of BMO Capital Markets.

So Randy, the first question I have is, you said in your prepared remarks you're seeing strong momentum into the back half of the year. What do you mean by that?

Well, we're seeing bakery volumes come back strong, pretty much back to where they were. Our rendering volumes of fat and bone across the country are remaining very, very good. The poultry numbers are strong. The slaughterhouse numbers remain very strong. This time of year, you're starting to pick up the deadstock side again, although second quarter was a fairly low deadstock time, other than the back end of it. So the rendering volumes are remaining good to improving here. So from a volume perspective, we're good. From an energy side, we're in good shape. From a meat and bone meal and poultry meals side, we're starting to see the prices improve. We've seen August in meat and bone meal improve very nicely over where it was in July. The fats and greases are the weak sister right now. But at the end of the day, those, in my opinion, Ken, have to come up. It's just too cheap. And then that will stimulate demand as it cools down here a little bit.

Do you expect sequential improvement in operating profit? Is that the implication?

I would say so. Yes, I think the -- all of the optics out there are that we should have a pretty good third quarter driven by volume, low-energy cost and improving finished product prices. So the only -- the red flag out there that would be there is, is that yellow grease price and whether or not that actually starts to come up -- I mean, relative to corn today, it's a $0.10-a-pound discount. Why? Reduced feed demand, reduced exports and this -- and the weight of corn oil out there on it.

A couple of follow-ups. One is you said even last year, you had, obviously, an issue with the extreme heat, but you guys put in some processes to actually limit the impact. What is your take on that? Is that actually working?

Yes, I mean, there's been a lot of operational improvements that our team has done around the horn here. So we're getting the tonnage through this year, so I think we're in much better shape. But the downside is that in any year -- I'm saying the good news is we're getting the tonnage through. The bad news is we're still producing high-acid fats in a superhot summer here, and there's a very limited market for those fats still without Diamond Green Diesel running.

Okay. And then are you hearing or seeing any on the chicken side in terms of the production cuts and timing? It sounds like you're not.

We are not. I think that there are still quite a bit of denial in that industry, some would call it they were forward-hedged and ownership, et cetera, et cetera. But at the end of the day, they're still hoping that their model of raising consumer prices, strong exports will offset a portion or most of their ingredient costs. I think history would say that it'll probably take some production cuts to get it back in balance. But at the same time, the competing proteins out there of pork and beef, they still have the lowest price consumer protein out there. So they're holding in there pretty well. Yes, you've seen the egg set numbers. You've seen the placements. It doesn't look like there's any near-term cuts coming.

Yes, I agree with you on that. The bakery margins -- I know you talked about pricing volumes, but bakery prices, they're still pretty highly correlated because with the chickens, it doesn't have any more. It's still highly correlated to corn. Any pullback in the pricing in there? How do we think about the bakery pricing?

It's been very solid. It's been very volatile, as you can imagine with the market. What people still have to remember is the corn market didn't move until the 4th of July, or maybe it was the 5th of July. So by then, you've got 3 weeks or whatever production sold out. You're now into August. So you're only starting to feel the benefit of the 8 1/4 [ph] futures market, plus you've got a little bit of southern corn harvest going on right now that impacts the basis level in the Southeast. But at the end of the day, the prices are starting to move through pretty nicely.

Okay, and the last question is, in your 10-Q, you guys have said that the anticipated increase in your $8.1 million related to the project scope changes, what is project scope changes?

Oh, in -- you are referring to Diamond Green Diesel?

Yes, Diamond. What is project scope changes? Are you guys making it bigger, smaller, what does it mean?

It's the 8.8 of which we would have 1/2 of that, some of that is just related to as we move into the construction and everything, we -- as you start laying it out on me, getting it finalized, we see that we may want to put in a second molder [ph] or whatever into that process to make it more robust. Nothing major. On a $400 million project, $8 million more is pretty minor.

And I guess you call it next code for cost overrun.

I just want to make sure that you guys won't do anything call [ph]. But since I think we've hit bottom of earnings, and that things should starting moving up, that sounds great.

And the next question we have comes from JinMing Liu of Ardour Capital.

First question is relate to the impact of corn oil from ethanol facility. Randy, can you share with us what -- at what quantity or level of that kind of impact is -- what I'm trying to understand is what's the volume of the corn oil from ethanol production flat in the market today? I mean, my calculation is over 1 billion pounds at this moment.

It's really hard to pinpoint, JinMing, what the exact impact is of corn oil. The majority of your 100 million-, 110 million-gallon plants now have all installed the system. The process recovers out of the steep liquor, the corn oil. It's a high-wax product. So it -- traditionally, while some biofuel users have learned how to blend a portion of it and the majority of them haven't, and so it sits out there just trying to be sold to the feed markets. It's a very good product into the feed markets, but nonetheless, we estimate that somewhere between 1 billion and 1.5 billion pounds of new product has come on the market here in the last year, 1.5 years. We think it will peak out around 2 billion, maybe 2.5 billion over the next year. But at the end of the day, basically, what's coming on the market is the amount of fat that Diamond Green Diesel was going to take off the market. So that -- we're all fighting for the same customer today until Diamond Green Diesel comes up.

Okay. Lastly, just there currently are some attempts to modify the Renewable Fuel Standard. What's your view on that?

There's 2 pieces of the Renewable Fuel Standard that are under discussion there. One is, obviously, that the cries for the -- a mandate modification or reduction on the ethanol side. I mean, we've just seen the USDA numbers come out now. We're talking about a 10.8 billion bushel corn crop. They've taken yields down to, I think, 1.27 billion. Most feelings are that they're even lower than that. More surprising, the soybean numbers are even lower than what the market might have been anticipating. The process for reducing or modifying the RFS is not as straightforward as the media wants you to believe it. It's just not ask and it will happen. It's very political. You've got multiple sides asking for modification. Obviously, the petroleum refiners, along with the food and consumer protein companies, would like to see it modified. At the same time, you have the functionality built in the system between the physical and the RIN side to offset this. It is a process where it can be requested, whether it's state governors. How that works is then it goes to the deputy administrator, at which time they can decide, publish a rule, and then it's got to go to public comments. So the reality is that you probably won't see an ethanol mandate or waiver of any type here till late fall, maybe early next year, at least in the way I read the tea leaves today. On the biofuel, biomass-based diesel side, that is the only product in the RFS that the EPA administrator does not have the authority to reduce below 1 billion gallons. What we're waiting on there is the 2013 volume, which was supposed to have been released last November. We're being told that, that volume will be released here sometime in August. And so we should be ready to go. It won't be any less than 1 billion. We're hoping that it is improved to 1.28 billion gallons that was recommended, but time will tell.

Okay. Relate to your Diamond Green project, do you have to register your fuel with EPA to be certified as advanced biofuel or -- to take credit or does simply register your fuel to take its credit?

Yes, there is multiple certifications there, but the Section 211 certification for the facility has already been received. We are now applying for green status or certification status on the gas derivatives off of the process. And so that's underway. We've not received EPA certification on those yet, but the fuel has been certified. Most notably, it's been approved, both in an R5 and an R100 fashion in many pipelines now. So our commercial team continues to do just really a nice job getting the plant ready to operate.

And next, we have Dan Mannes, Avondale Partners.

A couple of follow-ups. First, on the volume front, can you give us a little bit of color on maybe what you're seeing in the third quarter in terms of the deadstock, particularly relative to last year, when you had a lot of deadstock? And two, maybe think a little bit on your outlook on the cattle side, given the high grain prices and what may be coming down the pipe there?

Yes, I think as we look around the horn, poultry volumes remain very strong, some addition of new customers in those segments have helped. The cattle side, we're seeing our packer plants are -- that service really -- the slaughter industry running very, very full right now as cattle come to market ahead of the anticipated higher grain costs. The deadstock side, it's lower than it was a year ago because there's just less animals out there. But it's still pretty typical for this time of year, Dan.

Okay. So I mean, just the way you're talking, it sounds like Q2 to Q3, it sounds like we're going to see a real normal volume lift, and pricing should be improving somewhat, though maybe a little more back-end loaded in Q3. So maybe Q4 is the quarter where we'll really see maybe a more material improvement. Is that sort of the way that things look like they're going to play out?

That would be the way I see it lining out the -- as I said, I think the only risk you may have improving prices as you carry momentum out of third quarter here that I think the question on all of our minds is what is the ultimate volume then that you'd carry into either fourth quarter or in the first quarter of '13, next year. That would be the only flag that I see out there. But right now, all signs are there's plenty of animals, and business is good.

Sure. And you mentioned, I think on Diamond Green Diesel, it would have been about $0.08 to $0.10 over the quarter as a whole. But you also mentioned a good deal of volatility both on ULSD, as well as from our view on RINs. Can you talk maybe about the volatility you've seen? If you mark that to market, what would the profitability have been on an annualized basis peak to trough during the quarter because it seems like it's been fairly wide depending on what they look at it?

Yes, as we benchmarked it and looked at fat prices, RINs and ULSD at the Gulf and trying to look at it, we looked at it, and I'm going to give you a range. It would have been, on an annualized basis $140 million to $170 million of EBITDA. That's running through the first half, through June of 2011 here. We did get -- we did -- if you think about it, we would've gotten the benefit of the lower fat prices even though ULSD came down and even though the RINs backed off a little bit.

On an earnings base, I think at one point, maybe you had said the number could have been as high as $0.50. I assume that's the high end that's close [ph] to the 170 [ph]. Where could it have been on the low end, and what's reasonable for us to think about going forward, and I know this is completely hypothetical?

On an EPS basis, we're seeing between 30 and 40 would have been kind of the quarter year-to-date average. I think as we've looked at this thing and is at -- John, do you have a comment on?

Looking at the second quarter numbers, whether you use B100 or the low sulfur diesel, you're net 30 to 40 range, which is strong for the year.

Got it. And then as we think to next year, I mean, given the schedule you kind of laid out, is it fair to assume -- I mean, first quarter is going to be tough for you to have a tone of a profitability. So should we think maybe half year, 2/3 of a year, in terms of real production and profitable production?

I think, obviously, a lot of variables go into that, but from an operating standpoint, as we've said all along, you're going to get 9 months of solid operating performance there from a startup in first quarter. I mean, when you're talking to these large-scale petroleum facility like this one, it does -- some have some ability to turn down the hydrotreater. But once everything is up and running, then you're going to be optimizing in second quarter, and running full out, hopefully, third quarter on.

Got it. And then just one final one, just to jump this in. You did mention the competitive environment on the cooking oil side on restaurant services. Can you talk a little because it looks like margins were a little bit more compressed than we've seen in the past. Has it actually gotten worse, or are there any other trends we should be paying attention to on the restaurant side?

There's a couple things there. One, this is a business that we spend a lot of time in over the last 10 years, converting it to a service business and a customer-focused business. As the small biofuel guys begin to pop up out there, there has been a tremendous disruption in the flow of that business, from theft to going from a charge business to a pay business. There is no doubt as the numbers flow-through that our volume has been impacted by a combination of theft, competition and then, ultimately, higher prices for the consumer product at the restaurant level and then, ultimately, what I'm going to call low oil volume fryers. You're seeing some -- all different kinds of moves there. But predominantly, it's been a combination of theft and what I'm just going to call market disruption from competition. We had taken a very stand-back approach to date on that in the sense of preserving margin here. We continue to pretty much have that approach. But at the end of the day, it is a feedstock that we're going to use and want, and there is a very nice earning potential within Diamond Green Diesel. If you reflect back on 2, 3, 4, 6 calls ago, we said one day, when Diamond Green Diesel gets closed, it could change the way we procure raw material. We're initiating that in order to, if you will, in a classic sense, take back the streets, control the feedstock, and then value add it in a different market. Today, we were only competing for feedstock against the feed market. Now we're going to go compete against feedstock for our fuel market given us opportunities to create value for customers and, ultimately, if we're successful, grow the business.

And next, we have Roman Kuznetsov of Gates Capital Management.

It's actually Jeff. I have 3 things. First, on the Griffin, can you speak a little bit about the Griffin formulas? I mean, for example, in 2011, when corn was around $7, you got a big windfall, amounts about $8, or are you going to see the same windfall? Or I recall that those contracts have been -- of those formulas had been restructured in some way. So can you give a little clarity around that? Secondly, regarding capital allocation, can you talk about the acquisition landscape and when you might consider returning capital to shareholders in the absence of that? And then third, a couple of cash flow items. Do you expect working capital to be a source or use, or where you expect that to be for 2012? Can you give a CapEx update at the parent company? And maybe update us on your gas hedge position and what your thoughts are on that.

Okay, Jeff, this is John. I'll take the first one on the bakery. During the first quarter, EBITDA was $13.3 million for the bakery. Second quarter, we were up to $16.5 million. As we've seen the volume come back a little stronger here going into the summer months, and now we've seen corn prices going up, we are still seeing the bakery business tracking, the corn and the corn value, so we would expect to see bakery do very well in third quarter with the higher corn prices. And then we'll see where that goes from there. But the relationship to corn and bakery is still intact from a formula basis, for how we're buying it and how the product is moving into the feed market.

Jeff, what was your second question again?

Acquisitions, and I assume that Diamond Green Diesel is your focus this year, but in the absence of an acquisition, when you might -- first of all, what's the acquisition landscape look like, and when might you be ready to execute one from an operational perspective? And then in the absence of that, when might you consider returning capital to shareholders?

Well, first off, I think from an acquisition standpoint, there have been some public processes that have been going on out there. We've looked at some stuff. It's been at multiples well beyond our comfort level. So we have stepped back. Cash continues to build here from a board perspective. We've got a lot of neat opportunities in house that we're working on right now, with Diamond Green Diesel being a major use of capital, along with some -- our standard capital plan out there. The -- I think it becomes safe to say, given the momentum we have into third and fourth quarter here, and then on into next year, given where the world grain prices are, there's probably some pretty significant volatility that's going to continue to happen up through next year as people try to sort out is it corn or soybeans and what hemisphere do they plant, and what do they harvest. So Jeff, from our perspective, you know us long enough, we continue to build the war chest. The company, the management team, the operations team is ready to grow again. We're just trying to find something that we believe to be fairly valued to help us grow again. We have multiple opportunities that are out there internally that will be potential uses of cash. I mean, Diamond Green Diesel comes to mind. If we truly do have that model right, and from both margins and operatings, it's one that we think can be expanded pretty rapidly. But from that perspective, that would be cash generated within a JV that would expand that one. So ultimately, John and I, as in the past, are building a war chest, looking for something to do with it. And you know as well as I do, if we don't find something to do with it, then we're probably going to have to bring it back to the shareholders in time here.

And the housekeeping items on working capital in '12, CapEx plan update for '12 and the gas hedges?

Sure. On the CapEx, working capital levels normally don't move that much as far as inventory and receivables. But CapEx, we were at, through the first 6 months, around $53 million. We think we'll be in that $98 million to $100 million on CapEx for the year. And then we'll probably be putting in around $35 million to $40 million going into Diamond Green Diesel through the rest of the year. And then we'll have a little bit moving into first quarter of next year. That funding -- the majority of that funding is -- will hit right toward the end of the year, we'll have our normal funding for the structure. But we will start building inventory, raw material, feedstock going into Diamond Green Diesel during the fourth quarter. So you'll -- that will pick up, the funding will pick up in the fourth quarter more so than what you'll see in the third quarter, Jeff. On the natural gas and diesel, we've been -- as you can see, we look very favorably with natural gas still kind of staying at a fairly low level, not seeing any real changes there going forward. And as far as diesel fuel, we're still looking at that as a risk as to where prices could go up a little bit with that going forward.

But how far forward have you bought on gas? What's your gas position?

We don't disclose that. As you can see in our Q, we do have forward positions out there, but we don't report as to how far out we are.

Next, we have Tyson Bauer of KC Capital.

Would have been nice, given the export market was gone, if we had a facility out there to take 10% of the fat out of the marketplace. And to that point, we talked about the direct impact that DDG and a lot of conjecturing speculation with the indirect impact would be in a scenario like we've seen this year, without having the export market there to take some of that excess supply off the domestic market. Do you have a sense of what that could be just maybe in vague terms as we go forward?

Well, the way to think about it is, is that you have -- we have these plants from Tacoma to San Francisco to L.A. to Houston to New Orleans, to Tampa to Newark, to Detroit, that are all export-capable, and they are -- they also happen to sit in cities that are fairly expensive to live in and operate in. And when exports dry up for those predominantly fat exports, they have to ship back to the interiors, given the consolidation in the railroad and the higher freight rates to bring material back into the demand markets, the domestic demand markets, you're $50 to $75 a ton in most cases. So when you sit there and think about it, those plants typically command anywhere from $0.04 to $0.05 a pound, $80-to-$100-a-ton premium when exports are going full blast. So the way I look at it, it's a pretty simple reconciliation without exports there on a pretty significant portion of our volume. It's somewhere between $75 and $100 a ton versus where we were -- were getting a year ago.

Okay. And then had we had the plant up and running and absorbing at least between Appalachia and the Rockies at the Midwest kind of fats, tallows, corn oil, do we pick up say $0.04 or $0.05, that maybe we've been lagging here recently on those fat prices?

Yes, obviously, the business case study will be easy, and you guys will be able to second-guess it a year from now pretty darn good. But the reality is, is that if you take that pressure off the domestic market, you should trade back to that more normalized relationship with corn within the feed market, and then you would still have the $0.08-to-$0.10-a-pound or $0.08-to-$0.10-a-gallon earnings within Diamond Green Diesel to a degree.

Okay. Should we really start to see the feed formulas come to fruition and getting back in the balance kind of the September, October timetable, as a love affair within us or some of these other producers have locked in kind of their feed use with the feed mills or the current cycle animals going through the growing till they get slaughtered, so will start to really pick that up in the fall and get back to a balanced situation?

I think that's well said. I think there's an interesting phenomena that happened here, and that is we're -- typically, from a feed mill procurement standpoint, you are always looking at replacement, what's next week cost me. There was some forward ownership, and I would tell -- still tell you that most of them are working off their forward ownership, which is, to a degree, a form of denial here of the higher prices coming. So I think ultimately, it's got to cool down for the - for all animals, whether we're talking our pet food side or whether we're talking our cattle feed and chicken feed side to improve here. So hopefully, September, October will have a cool down, and the feeding side will pick up a little bit.

And your pilot plant in Florida, can you provide some update, whether you're going to go ahead with that technology and go forward? Or is there a date on the calendar in which you'll make a decision?

The intent there is, yes, we're moving forward. There is some construction going on down there, again, with an intent here towards the end of the year here to be in a position to move forward there. So we are very pleased with what we've seen down there. It's going to create, hopefully, a new market for both our suppliers and the finished products. It's gone a little slower than we wanted but as in all new technologies that happens. So stay tuned, and we'll give you a little more update on that as we go forward.

And last question for me. On the RIN side, is it correct you can overproduce in a given year and carry that forward, so there's somewhat of a natural hedge in relation to actual production other than meeting the physical demand or blending requirements?

Yes, I think that's right.

And next year, we can really see a robust RIN market because we don't have that excess to carry forward?

I'm reading it the same way you are, but RINs are under pressure right now. Production seems to be running ahead, so we'll see.

Next, we have Farha Aslam of Stephens.

Just Randy, some color about that Indonesia market, just so we can understand the impact and how it's going to go away for the second half of the year. When did Indonesia put the ban on, and when did they take it off? And how much have prices improved on the West Coast?

Yes, the Indonesian band kind of correlated with the case of BSE out there in California I think in April if I'm right. I may be off a few weeks here or there. So the market immediately shut off. All shipments that were headed there, if they had a bill of lading, I believe they were allowed in. If they didn't have a bill of lading, meaning they were being loaded on anywhere in the country, whether it's in the interior or on the ports, that material had to be redirected back. And that's the stuff that put just a ton of pressure on pricing, especially on the West Coast, as there's very limited consumers, predominantly the small poultry industry on the West Coast, to consume that production. And so a lot of that material had to be loaded back in railcars and shipped back to the Southeast United States at $75-to-$100-a-ton discounts. Here, about 2 weeks ago, the consulate in Indonesia coordinated at what I'm going to call a semi-reopening of the Indonesian market, but they limited it to fully integrated slaughterhouses, meaning that the rendering happens on site. So as you can imagine, that will be a Cargill, a Tyson, a JBS, a National Beef. That is just underway. I do believe AFS is now certifying that material to head overseas. So you're kind of in a period of time here where the market will realign and move that material out, where a portion of it has always been independent rendering and captive rendering that have been shipping in Indonesia. But now it will all go back to packer material. Obviously, we're not happy with that. We think it's a wrong decision on the part of the Indonesian government and, to a degree, our own government in allowing it, but it's just going to take a time to work through. From our perspective, any material that we get out of here will ultimately help the values here.

So have you seen those West Coast values return? And kind of to what degree have those West Coast values returned?

They have moved up from where they were in the second quarter by $50, $60 a ton so far, but they're still lagging in soybean meal. Instead of being 150 under soybean meal, now you're only 75 to 100 under soybean meal. So we still got -- from our perspective, there's still historically and fundamentally a lot of upside here if we can get the supply-demand balance back in sync.

But you're -- so you have more upside, but you're already getting sort of a $50 to $60 per ton benefit?

Yes, the trade flow disruptions pass through, so you're now back in sync there. But without -- traditionally, I want to say we export about 2 million tons of that product as an industry. That's very key in keeping a balance here. If the poultry industries is rolling in the United States, a lot of meat and bone meal can disappear. When the poultry industry contracted, that made it even more important to move that product offshore. So it's kind of a double-edged sword here, but at the end of the day, it is improving.

Well, this concludes our question-and-answer session. I would now like to turn the conference back over to Mr. Stuewe for any closing remarks. Sir?

Okay, thanks, Mike. I appreciate everybody joining us, and we look forward to bringing you all up to speed on our third quarter performance in November. So take care and be safe. Thank you.

You also take care, sir, and we thank you and the rest of management for your time. The conference call has now concluded. At this time, you may disconnect your lines. Thank you, and have a nice day.