Good morning. And welcome to the Darling Ingredients Inc. Conference Call to discuss the company's First Quarter 2023 Results. After the speakers’ prepared remarks, there will be a question-and-answer period, and instructions to ask a question will be given at that time. Today's call is being recorded. I would now like to turn the call over to Ms. Suann Guthrie. Please go ahead.

Thank you. Thank you for joining the Darling Ingredients first quarter 2023 earnings call. Here with me today are Mr. Randall C. Stuewe, Chairman and Chief Executive Officer; Mr. Brad Phillips, Chief Financial Officer; Mr. John Bullock, Chief Strategy Officer; and Ms. Sandra Dudley, Executive President of Renewables and U.S. Specialty Operations. Our first quarter 2023 earnings news release and slide presentation are available on the Investor Relations page under Events and Presentations tab on our corporate website, and will be joined by a transcript of this call once it is available. During this call, we will be making forward-looking statements which are predictions, projections and other statements about future events. These statements are based on current expectations and assumptions that are subject to risks and uncertainties. Actual results can 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. I will now hand the call over to Randy.

Thanks, Suann. Good morning, everybody, and thanks for joining us for our first quarter 2023 earnings call. We have had a very solid start to the year. All business units performed as expected and our DGD system attained full rate during the month of March. Looking at our segments in detail, for the first quarter 2023, we ended the quarter at $418.4 million in combined adjusted EBITDA. The Feed Ingredients segment ended the quarter at $213.1 million, our Specialty Food Ingredients segment earned $73.2 million, while our Fuel segment earned $153.6 million in EBITDA, with approximately $129.3 million attributed to Diamond Green Diesel. Turning to the Feed Ingredients segment in detail. Globally, raw material volumes were up 39% compared to first quarter 2022. While we saw a decline in global fat prices, protein prices remain strong around the world. While lower fat prices will modestly impact the segment, it will be more than offset by higher earnings in Diamond Green Diesel in future quarters. Integration of our recent acquisitions remains a key focus. I'm pleased to report that once again we realized sequential gross margin improvements. We continue to make improvements at our recently acquired Eastern USA plants that will improve reliability and efficiency, as well allow us to produce and market higher value finished products. We are pleased with the progress and believe by year end, we will be nearly complete. Turning to our Specialty Food Ingredients segment. The global collagen and gelatin business remains robust. We closed on the Gelnex acquisition on March 31st, and integration work has already started. Together, we believe we have the strongest and most robust collagen system in the world with a pipeline of new products for years to come. Moving to our Fuel segment. Diamond Green Diesel is running very well and set another sales record in first quarter. We have achieved a milestone with the DGD system operating at 1.2 billion gallons annually. It should be noted that March shipments were light with ship loadings moving into Q2. With lower fat prices and inbound logistics running smoothly, second quarter is shaping up to be a record for Diamond Green Diesel. Now with this, I'd like to hand the call over to Brad to take us through the financials, then I'll come back and discuss my outlook and thoughts on the balance of 2023. Brad?

Okay. Thanks, Randy. Net income for the first quarter 2023 totaled $185.8 million or $1.14 per diluted share compared to net income of $188.1 million or $1.14 per diluted share for the 2022 first quarter. Net sales were $1.79 billion for the first quarter 2023 as compared to $1.37 billion for the first quarter 2022 or a 31% increase in net sales. Operating income increased 10% to $255.8 million for the first quarter of 2023 compared to $232.9 million for the first quarter of 2022, primarily due to a $78.4 million increase in gross margin. As Randy said, the gross margin continued to sequentially improve for all segments. Darling's share of Diamond Green Diesel's earnings increased $22.5 million quarter-over-quarter, which more than offset depreciation and amortization increasing $36.8 million, SG&A increasing about $33.4 million and $4.5 million in additional restructuring costs primarily related to the Peabody closure. Total other expenses increased approximately $21.7 million quarter-over-quarter with an increase in interest expense of $34.7 million, partially offset by an increase in foreign currency gains of $6.1 million and an increase in other income of $6.9 million, which was primarily due to casualty loss insurance proceeds received for the prior year Tacoma plant fire. Now turning to income taxes. The company recorded income tax expense of $27 million for the first quarter of 2023 with an effective tax rate for the first quarter of 12.4%, which defers from the federal statutory rate of 21% due primarily to biofuel tax incentives and the relative mix of earnings among jurisdictions with different tax rates. The company also paid $39 million of income taxes in the first quarter. For 2023, we are projecting an effective tax rate of 14% and cash taxes of approximately $140 million for the remainder of the year. The balance sheet…

Thanks, Brad. Again, Darling is off to a tremendous start for 2023. Raw material volumes are in line with expectation, integration activities are on target, energy prices in Europe have moderated, our global collagen and gelatin business is quite strong, and Diamond Green Diesel is expected to perform very well with lower raw material prices, strong green premiums and robust global demand. The earning power of our unique vertically-integrated business we have built will become very evident over the next few quarters. Finally, we remain committed to our financial management policy that we have previously discussed. DGD is now nearly delevered and dividends should become a reality very soon. Leverage post our Brazilian acquisition has peaked and we will target a 2.7 leverage ratio by year-end along with the goal of investment grade for 2024. Other than our previously-announced Miropasz bolt-on acquisition in Poland, which is expected to close by year-end, our M&A activity has been paused so we can concentrate on integration, value creation and deleveraging. I have high expectations for the second quarter. And if the operating environment continues, we are estimating combined adjusted EBITDA to be in the range of $485 million to $525 million. For the year, we are once again reconfirming our guidance of $1.875 billion combined adjusted EBITDA. Now with that, let's go ahead and open it up to Q&A, please.

[Operator Instructions] And our first question will come from Manav Gupta of UBS.

Congrats on a very good quarter. Great to see continuous improvement in the Feed gross margin. Randy, you have got some push back on your recent M&A deals, but looks like things are really falling in place now. Those deals are giving you a big volume bump, which far exceeds market expectations. My question is with regards to demand for your products which support these higher volumes. Do you think the demand for fats, proteins and UCO will actually hold up well for the next 12 to 24 months? And can we actually see an increase in demand for your products, both Feed and Food, in the medium to longer term?

And John Bullock, and all kind of tag team this a little bit here on some thoughts here. But yes. I mean, global demand for proteins remain incredibly strong out there. Pet food demand remains strong, pricing premiums are as expected. Clearly, the fats and oils business around the world seems to have come off a little bit with palm oil leading the way and soy following and then waste fats can't -- other than the CI premium, can attain a considerable premium above the two biggest fats and oils in the world. With that, demand is good. I mean, Diamond Green Diesel is running at capacity. And so at the end of the day, that's different than, if you will, the fourth quarter as we were continuing to struggle with logistics down in Port Arthur. So yes, demand is going to continue to be very strong whether it comes from domestic or import, it will depend on the arbitrage. But most importantly, as a management team, we want people to understand the concept and the strategy that we built Diamond Green Diesel under. The one piece of information that people just continue to ignore is that Darling doesn't supply 100% of Diamond Green Diesel. It can't. It's too big. Our system has the ability globally to supply up to about half if we want to, if we don't have better markets. It's not near that today. So what's that mean to the Feed segment and to the overall business? It's very simple. We have told shareholders for years that every penny the fat prices move up or down is somewhere around $10 million, $11 million annually in US dollar EBITDA. So fat prices are down, I don't know, $0.12, $0.15, let's call it, that that's $150 million to $165 million of EBITDA. So easy math, $0.10 a pound with standard yields in a Diamond Green Diesel plant for us, call it, $0.90 a gallon of potential improvement in margin. Half of that is $0.45, and so if you just capture half or two thrids then times 1.2 billion gallons, you've got somewhere between $500 million and $700 million of EBITDA improvement, which we get half of. So in the sense of basic amateur investment thesis, if you give somebody $150 million and they're going to give you back $300 million or $400 million, that's a pretty good investment. So we want people to focus on the system and that was the system that we built. Diamond Green Diesel, it's collective demand drives a larger share of earnings for Darling. John, anything you want to add to this?

Yes. I think you mentioned it in your kind of statement there, Manav. The reason we scaled is because we know what the value of low CI fats are in the world, and the Valley deal and the FASA deal. We massively scaled our ability to have low CI fats available for Diamond Green Diesel. We're either going to get it in the form of higher fat prices in our core system or we're going to get it at Diamond Green Diesel in the form of higher margins at Diamond Green Diesel. So basically, we're going to win no matter how the cards are dealt.

The next question will come from Tom Palmer of JPMorgan.

I know there's -- and you just walked through a little bit. Some moving pieces, right, feedstock pricing and what that means for both the base business and at Diamond Green Diesel. But in the past, you've provided within your guidance some outlook for EBITDA per gallon at DGD and then also kind of what you're thinking in terms of base business earnings. I didn't hear that today. And again, I know there are some moving pieces, especially with the feedstock pricing. But do you have any kind of rough construct of how that $1.875 billion EBITDA outlook splits between the two sides of the business?

That's the part that we want people to focus on the system rather than trying to segment down to Food, Feed and Fuel. It's a dynamic situation, and as John Bullock said, we win under either scenario. So at the end of the day, that's where we're coming out, saying 485. So how do I get 485? Well, that's 1.875 minus 418 divided by 3, last time I checked. And then at the end of the day, we believe that the lower fat prices will have some opportunity for bigger gallons in Diamond Green Diesel in Q2. As I also made in my earlier comments, boat loadings are not always linear and some gallons moved from Q1 to Q2, so that's where we're giving the larger guidance. But we're largely on target. And as we said, it will move from one side of the ledger to the other side of the ledger as we go forward.

And maybe I could just quickly follow up on the gallons comment. So if I look at the last couple of years, last quarter, there was about a $20 million under shipment relative to production and then last year, it was a bit closer to $30 million. So is there inherently in the business, just given it's so much bigger, that kind of accumulated $50 million in inventory, is a portion of that just paid going forward, there's always going to be a little bit more inventory being held? I'm just trying to get a sense of how much when you're kind of talking about this unwind coming in terms of shipment timing we should be thinking about, is it that $20 million or is there this larger pool closer to $50 million that should unwind as the year plays out?

No, and I'll let Sandy comment a little bit. But as I go back and look at -- been in the business for 40 years and like I said, ships come and go, bill or ladings get created, and if you miss a day and you don't recognize it. Also, you have to understand when Darling ships to the Diamond Green Diesel system, until it's unloaded, it doesn't get recognized in our business. So there's always those pieces in here. But obviously, if I look at the $418 million and I look at the bill lading dates here, maybe it would have added, I don't know, $15 million, $20 million to the quarter in Q1. So that's about as granular as we can get there. But no, inventory is going to build and go as we load rail or we load barge or we load ship here, so nothing there to try to overthink.

And our next question comes from Derrick Whitfield of Stifel.

Congrats on a solid start to the year. For my first question, I wanted to focus on EBITDA guidance. And I apologize, Randy, but really want to better frame the set up for your business and the value of your business. From our perspective, every segment is outperforming our model and margins in Q1 and you seemingly have tailwinds now in nearly every segment, including Gelnex's margin contribution in Food, Valley's margin uplift in Feed and your 4:1 net-net EBITDA gain in DGD margins as a result of lower fat prices. Having said that, isn't it reasonable for us to think that your 2023 guidance of $1.875 billion is relatively conservative?

My personal opinion is that it is, but I want to keep in mind that the marketplace is still inverted on fats, proteins around the world as the world expects bigger crops of everything again this year. Ultimately, as we've tried to tell people, our Diamond Green Diesel system has a very significant competitive advantage, and I think it's been obvious with the other releases of earnings out there. And so what we're trying to do is make sure that we believe that the Diamond Green system -- we're trying to forecast. I mean we gave earlier guidance in the year of what, Sandy, about 1.2 billion gallons and $1.25? Right now, those margins on a spot basis are quite a bit higher. Why? Because of higher feed -- or low feedstock. But at the end of the day, we're kind of sitting there going the -- in the Feed segment, clearly, our operations team has done a tremendous job of bringing in that system and getting it aligned with the normal Darling operations. Our Brazilian operations are performing very well. Our gelatin and collagen business around the world is doing very well, and we're about to add another six or seven plants in the system here in the second quarter with Gelnex being integrated in, and then our green energy business in Europe. So I mean, yes, there are a bit of tailwinds here but not really. These are just solid operations that are going on now with proper risk management. John, anything you want to add to that?

I think what oftentimes, we look -- we're a margin management company, right? There's no doubt about it that as fat prices go up and down, that's going to have an impact on our core rendering business. But we have an embedded offset inside the system now that actually may be an embedded offset with the multiplier and lower price times. So at the end of the day, we're able to manage our raw material costs around our system in all of our marketplaces. And the only place where we've got any type of an embedded tremendous impact or even -- not a tremendous impact, but an impact on our core rendering businesses, the fat segement and now we've embedded an offset that insulates us from that. So at the end of the day, markets are going to go higher, markets are going to go lower. But we feel very, very good about how we position the company to have sustainable EBITDA no matter what the market conditions are out there.

And perhaps with my follow-up, with respect to Gelnex. Could you speak to, A, what you've learned about the assets now that you've integrated it into Darling and B, the potential synergies you see between it and Rousselot?

I spent the last three weeks with the Gelnex team. I can tell you that the Gelnex organization is as good an organization as I've ever seen in my life. These are top professionals, it's well managed, excellent, excellent group of employees, their plans are tremendous, their marketing efforts are tremendous, they're just a tremendous organization all the way around. We cannot be more excited to bring Gelnex into the Darling family.

And our next question will come from Dushyant Ailani of Jefferies.

My first one is on the Feed segment. It looks like you're seeing recovery in the margins, which is good. I guess my question is, how do we think about base recovery? I know previously, you've talked about 1,000-day integration. But could that timeline be sooner, what's a good gross margin to think about for Feed segment on normalized margin?

Say, we have continuing improvements yet to be still gained in our system, so yes, you've noticed. I mean, there is a -- definitely -- Randy pointed out our operations guys and what's transpired there in the last two quarters, we expect will continue. So let's say in the mid-20% level, which is somewhere in the ballpark where we were back before Q3 last year.

I mean clearly, you guys want to focus on Valley, but also the Brazilian rendering system down there. We've had to put procurement, risk management and spread management systems in place down there as the markets have kind of moved around here. So it's going to normalize out in the mid-20s, as Brad says, and it seems to be very manageable right there. We've still got work to do in the Eastern Shore plants, as I call them now. Their margins still have some opportunity to be expanded there as we learn to make different products and learn to operate plants more reliably. And then we still got some raw material agreements that have to be modified in the coming year, year and a half. But for the most part, as I said, that integration by year end should be very, very near complete other than a couple of raw material procurement agreements. I mean in Q1, between a fire that we had in Tacoma last summer and then in November, the fire we had in Ward, South Carolina, I expect that there was somewhere between $5 million, maybe up to $10 million of additional expenses flowing through the system there related to transportation and loss of margin. So the system is very complex around the world. But overall, it's been, I think -- you're seeing it in the margin management as we move forward, being done quite well.

And my second question is, in your slides, you mentioned there's going to be a modest improvement or you expect a modest improvement in fat prices in the back half of the year. So how do you think about DGD margins then, is 2Q going to be a peak in margins for DGD?

So I always said here and I have to be, I don't know, a little bit calm. You can't have it both ways. You can't tell me all this renewal diesel capacities coming online and fat prices are going to -- continue to go down. And then the other side is you can’t tell me fat prices are going to go down and we earn a better margin at DGD, so it doesn't work that way. So long story short, and I'll defer to Sandy here a little bit, is we believe that margins for the balance of the year in DGD will remain strong. It's kind of hard to always forecast beyond the next 60 days as we've seen April now, but I wouldn't call them by any means of peak. What would you say, Sandy?

I think I would say that we don't know what feedstock prices will do. But as John had mentioned, we have a great system. And so if we see feedstock prices go down, we'll benefit in DGD. If we see feedstock prices go up, we'll benefit in our base business. So at this point in time, I don't know where they're going to go. But I know that we're going to have an advantage and it's going to be great for us.

And I think the other thing we would say is that the system -- we have a global system. We're bringing fats out of Brazil, because it's the best market from our rendering plants that's helping margins there. And we're shipping our first boat out of Europe, which should be a wake-up call to everybody in Europe. The fat prices have bottomed in Europe now as Diamond Green comes in and pulls away from the HVO or the RD guys in Europe. So that's the reason we believe fat prices have bottomed, and we think margins will remain quite strong in DGD for the balance of the year.

And our next question comes from Ryan Todd of Piper Sandler.

Maybe following up on the the feedstock markets within the renewable diesel business. I mean, the market seemed to absorb the addition of DGD Phase III without too much pain. You've got some very large capacity additions either ramping or likely to come online by the end of the year. Are you seeing any signs of material tightness on the low CI feed part of your business, improvements on the supply side at all that have helped on with that, and any other kind of knock-on effects of some of the additional R&D capacity in the market that you see within that business?

And Sandy could help me here a little bit. From my seat, the answer is not really. I mean clearly, we have shown that by locating Port Arthur and St. Charles on the water, we have the ability to originate from everywhere in the world. And that took some pressure off of the Diamond Green Diesel 3 start-up. The second thing was, clearly, we had some logistical inbound unloading challenges there that have now been remedied. And so ultimately, if you say, well, what rate were you running before and what rate are you running now? It's quite a bit higher from where we were in Q4, and ultimately, we're cleaning up the amount of railcars and inbound tonnage that we had. So Sandy, what else do you want to add to that?

Since DGD 3 has been online and we always were when we bring in a new facility online, what that feedstock market is going to look like. We haven't had any issues getting feedstock. Now our mix has maybe changed a little bit. We brought in some more international supplies. Some of those are actually Darling supplies by our FASA entity, and we've looked throughout the world and found other supplies as well. We also were able to obtain more Valley supply or supplies through our Valley entity that we bought. So we just -- we've grown as Darling, and in turn, we're able to better serve DGD for that.

Are you willing to roughly say like how much of the feed is in this last quarter came from international sources?

I don't think that's something that we share.

No, that will move around from from quarter-to-quarter, month-to-month. I mean, clearly, I think that the big piece in what you're seeing like in the margin improvement in the Feed segment is the Valley protein’s material was headed offshore the majority was before. Now it has the ability to go there. Relative to your other question, Ryan, on the other guys out there, we have no visibility to them. We read you guys's report and apparently, there's a lot of capacity out there that we've never sold a pound to. And we get to see -- and then the soybean guys that I'm still close to are selling a little bit of RBD to them, and then they all claim to have pre-treatment system. So that's all we see here.

Maybe on a totally separate note, a follow-up on your -- you said quite a bit of this in your earlier remarks. But as we think about your use of cash in the near term, you've got a leverage target by the end of the year that you'd like to hit. You're currently buying back some stock. As we think about the likelihood of a dividend, which you mentioned, do you need to hit that debt target before the end of the year before you anticipate being able to roll out a dividend, or how do you look at the, I guess, the priorities over the next -- over the remainder of this year in terms of that use of excess cash?

So we do, as our partner said, looking at dividends from the JV, which is in concert obviously with our deleveraging theme by the end of the year. We do are in sync in terms of the outlook here in the near term of possibly looking at cash dividends starting before, let's say, before Q2 is over but certainly here at mid-year. From the JV with the margins that we're seeing now, we feel very confident in that. So that's combined with what the base business is looking at. I mean, we want to be down in that clearly below 3 times. I mean if you're looking at investment grade, the rating agencies look at that a little bit different than our bank covenants do. So they add back some other things into that equation. So we want to be clearly below 3 times to give us that leverage and story with the rating agencies going into 2024. So I think we would not be looking at the dividend. I think, Randy, back to shareholders here in '23, we're going to be -- get below 3 times, be sustainable there, then evaluate our options from there.

And clearly, if we're carrying that momentum into '24, it's a different set of opportunities that exist for us.

The next question is from Andrew Strelzik of BMO Capital Markets.

First, I wanted to ask on Gelnex. When you closed the acquisition, you guided to the contribution to this year being kind of on the lower end of that $75 million to $100 million that you maybe had originally talked about. What pushed you to the lower end? How should we think about the cadence of the contribution through the year? And is there any reason to think we don't exit this year kind of in that $100 million, $130 million range for '24 that the kind of annualized numbers would have implied?

John can help me here. I mean clearly, in Q2 on Gelnex, we've got the way purchase accounting and mark-to-market inventory, just like we did with FASA and Valley had an impact. There's a pretty good impact here as we bring over a lot of work-in-progress inventory that's been produced at Gelnex. We closed on it on March 31, so that's in. If you're a student of the balance sheet, you will see it out there in the working capital or inventories. And I suspect we'll get some earnings in Q2 from Gelnex. We've annualized the rate right now, I think, conservatively at $75 million, but that $75 million is net of the inventory impact. Brad or John, maybe you want to add anything?

No, they're running extremely strong. Obviously, the parent market value adjustment associated with inventory will have an impact on Q2, but the business is running extremely strong and we fully expect to get what we've guided out there in terms of earnings out at Gelnex. It's fabulous operation, fabulous organization and fabulous assets.

And that $75 million is not an annualized full year, that's the remainder.

That's the remainder of this year.

On the all-in guidance, EBITDA guidance for the year. So I understand the math that you did kind of as you thought about 2Q, it does imply a little bit softer back half. Is that simply a function of the shift that you talked about of the shipments from 1Q to 2Q? It sounds like also Gelnex then in the back half would be stronger, so I guess any other reason to think that the back half on a quarterly run rate basis would be softer than what you're guiding for 2Q?

I don't know how to answer that, to be honest with you, other than the sense that we see a really solid Q2 coming here and then we'll see from there. But we don't have any reason to not believe we won't hit the $1.875 billion, whether that's $485 million, $485 million, $485 million, or rather that's $525 million and $445 million, who knows. But we're confident in our in our forward forecast with what we see today but to try to call Q4 today, I have no idea.

Completely understand that. I guess I was just trying to make sure I understood the puts and takes of…

Just if there's anything to keep in mind…

No, I understand. And I guess the answer is no. There's no assumption of shipments shifting from quarter-to-quarter. It's Randy's rendering math.

The next question is from Adam Samuelson of Goldman Sachs.

This is actually Guillermo stepping in for Adam. I only have a follow-up on the integration efforts within the Food segment. If you could quantify the synergies realized in the first quarter and your expectation for the rest of the year?

I don't know that we've ever -- we’ve never put a synergy number out there. That business is spread out all over the United States in four or five different regions, so there was no expectations there. At the end of the day, we're running at where we thought we would be and we still believe we have some more upside there, as I said. So ultimately, we've done a lot of different things in that business from rightsizing people, rightsizing raw material procurement contracts or improving them, lowering energy costs, reliability, excess trucking, excess wastewater disposal. We're making lots of progress and that's in the -- and we're at our target that we showed the Board. We're at our business case and where we thought we would be. Now the rest of this is upside to us.

And if I could squeeze in another one in regards to the buybacks. How should we think about the pace of the buybacks relative to the amount that you did in the first quarter as you also are trying to delever the balance sheet?

So the $44 million in the first quarter, obviously, the softness in the stock price and early on in the quarter. We just -- as we've done the last couple of years, just remained opportunistic there. That's not to say we'll remain at that cadence the remainder of the year. We'll just kind of see where the stock level is, and we're truly opportunistic there just in weighing that versus our deleveraging strategy here.

The next question comes from Sam Margolin of Wolfe Research.

You might not want to answer this question based on an answer to a previous one, but I'll give it a try. It seems like China is a story on the low CI materials supply front. And Darling has a presence in China, I'm not sure a lot of people appreciate that. But you're there, you're on the ground, I think you know the country pretty well. And it would be great to get a sense of sort of what the addressable market is, the untapped market of UCO or rendered fat in China, because it seems like it could be pretty meaningful just given the context of oncoming RD capacity and balances?

I'll let Sandy take that and address. I mean, you guys can see the boats coming in, so I mean, there's no secret there.

Yes, I'm not exactly sure what the volume would be, because I think there's more than we ever expected that there would be. As prices have gone up over time, that's brought about more fats and oils around the world that are available to us. One of the nice things that we're seeing out of Asia is that there are low CI fats, that there are ISCC fats, and that's a real benefit to us. And that's a nice thing as we're trying to look to go to the European market because that's one of the things that they're searching for. And so I think that the market's bigger than we ever anticipated. But to know the exact amount, I don't know.

One more little piece there. I mean, obviously, I highlighted that we're bringing cat 3 fat from Europe into the US now. And someone asked to ask why would you be bringing cat 3 fat other than the economics work? Why do the economics work? Because we have Chinese biodiesel now coming into Europe and making fats cheaper there. So as Sandy said, the marketplace is far more dynamic than I think probably one year, year and half ago we probably understood, and so it's all interconnected now. But I think the key point that we want to say is the procurement team at Diamond Green clearly is looking for low CI fats around the world. Sandy highlighted ISCC certified, which is critical to making sure everything is legitimate there. And the question is, we're not sure how big it is around the world, it continues to grow. Ultimately, if you become in the commodity business a high priced island, you magically find lots of extra coconuts available to you.

And then this is just a follow-up on Valley, because it sounds like the integration is going well. I think you said it was on plan or according to plan. And there was some capital associated with, I guess, taking the facilities that you acquired up to the Darling standard, but you're in a good place now as far as margins and earnings power. And so the question is, is the Valley integration actually maybe going to be a little bit more capital light than you anticipated, which then accrues to the balance sheet and the pace of deleveraging?

No, I think in 2022, we rebuilt or improved the reliability through big equipment replacement in like six plants. And then by June 1 here, I think we'll have three more done here. And then by the end of the year, I think with Ward being rebuilt, that will be the fourth one. So we're a little over from where we thought we would. It's not giant money, maybe $10 million this year and then a little more next year as we finish out the system. So I wouldn't characterize it as capital light. I would just say, at the end of the day, it's pretty much on target. As we remind people, given the antitrust side of closing this acquisition, while we got to visit the plants, they were really pretty quick walk-throughs and you can't really sound or see the inside of some of the equipment. Is it a little worse than we thought? Absolutely, and that was shown in our prior numbers as we struggled to keep the reliability of the system. But the team has done just a tremendous job of moving the ball forward here, and I think we're set to run now. We're feeling really good about it.

The next question comes from Paul Cheng of Scotiabank.

Randy you have good insight in the RVO and the LCFS market and have a lot of contact in the government. So just curious that is there any insight you can share about how EPA may revise or not revise on the RVO proposal and also, how is the California LCFS market that quite the changes that, what do you think they may do?

Sandy, do you want to take that?

Yes. I probably need a little bit more help on what you're -- the RVO and the LCFS markets here. So with regard to the RVO, I think that what we saw is it was a little bit disappointing. I think that we're hopeful. There's been a comment period where the industry, et cetera, has provided additional feedback, comments, information to EPA regarding what actually is out there. And so we're hopeful that maybe we'll see a bump up here when it comes out in June 14th. In terms of CARB, I think that CARB is a very positive thing. As you know, they're going through their scoping plan. And in terms of things for Darling, it's very positive as they're looking at increasing their reduction targets from 20% to 25% or 30% in 2030. The other things that they're doing is they're also looking at proposing an LCFS obligation for interstate flights, which should be really great and especially as we're building an SAF facility or converting our facility to SAF, we're really interested in that. And then one of the other things that they're also doing is they're looking at an acceleration mechanism. And so if the credit bank gets too high and we did see recently where the credit bank increased, that there would be an alternative mechanism that increases the stringency there. And we think that those are all positive things for us. And then maybe just a little bit back about the RVO. I think that we've had a lot of things with regard to like the Inflation Reduction Act that was a positive step forward. And I think that if we don't get those volumes with the RVO and get that stepped up then what we may see is we may see some stranded assets. And that would be unfortunate. We would see that in terms of crushing plants potentially. We would also see maybe some missed opportunities in terms of SAF. And so I think it's very important that EPA is listening to folks about what the volume should be.

And second question is that I think Sandy and Randy, both of you have said, you stopped seeing a lot of the international low CI feed getting into the US. So it does not look like the availability of the low CI feedstock is a issue anymore, contrary to maybe just a year ago that was [resolved]. And so from that standpoint, what will be the criteria or the decision making process, what will factor into -- other will factor into whether that you want to expand DGD into DGD 4?

It's kind of interesting because a year and half ago, everybody on this call was clamoring about the fact that there was going to be low CI fat available in the world and why in the devil would we make Diamond Green Diesel 3. And our answer was there's so much fat available at $0.20 a pound. But when we get to $0.50 a pound, you may find it to be a different world, because higher prices in set more reclamation of waste fats around the world, and that's exactly what we've seen. We're very comfortable now with the Diamond 1, 2 and 3 systems where we are in relationship to the marketplace. Our focus has been on converting part of our processing capacity to SAF because we think that's the higher value, higher-margin area. I should remind everybody, though, that we do have the space available in Port Arthur to make Diamond Green Diesel 4, and to build Diamond Green Diesel 4, we essentially preset ourselves so that we have the ability to expand. Haven't really gone into that process at this point in time, but we're certainly capable of doing it, and we'll watch the market as it develops forward over the next year or so and then make a determination on where we are. But we like the size we're at right now, we like our focus on converting the SAF to the higher value. And we'll see as this fat market develops going forward if the stuff is available. The one point that I think we've talked about a lot here that we cannot overemphasize though. The reason this all works for Diamond Green Diesel is we have a complete operating plant. We have the supply chain, the logistics capability and the pre-treatment capability. So as these low CI fats become available, we can actually take this material and convert it into high value renewable diesel. The fact of the matter is, the vast majority of our competitors out there can't do that. So we know they're building plants but they aren't building plants that are designed to compete with Diamond Green Diesel.

No, that's fully understand, I agree. But I still want to -- just try and to say that, okay, what will be the peak condition or that what trigger you and Valero decided to go for DGD 4, what is the precondition in order for that to happen?

We do a complete analysis anytime we go through this. We will go through the same analysis we've always gone through, which is a tremendous economic analysis. We now understand the engineering and construction extremely well. We just have to take a look at the conditions. I don't know that I'm going to necessarily give you a list of the five things that we're going to look for, but the one thing I can tell you, as we always say is Darling is a for-profit operation. And so the most important thing is when we can identify returns that we can get on our investment, that will be the number one precondition on us making an investment.

And I think it's pretty simple. I think the pause in number four for the venture has been, let's see the demand develop, let's make sure it's real. And at the end of the day, we believe it's real. Clearly, we're arbitraging or giving ourselves optionality into SAF, as John said. We believe that is the next new horizon green pasture, and anybody that even starts to talk about adding whether it's 1 billion gallons in the US or 1.5 billion or 2 billion, the promises that have been made in that global SAF market, whether it's Europe or here, far outweigh any capacity that's been contemplated. So at the end of the day, this thing is set very nicely for the future. And if clearly, the SAF demand is there, which we believe it will be, that will help us then move forward to that next step of looking at number four. Clearly, the decision before was -- and I was as guilty as anybody. I told John and Sandy, I said, I want to make sure there's enough feedstock in the world because I was starting to believe you guys that we're going to have a feedstock war. We now know that's not true, and now we're waiting to see the SAF market develop such that we can go larger in that and that would drive clearly number four. And potentially, I think the most likely would be an SAF unit at number one and two in St. Charles would precede any decision on number four.

Can I just ask a real short question for John. The interest rates, what you guys exercised, did you exercise at the beginning of the quarter? In other words there, are we going to see incremental interest expense in the second quarter versus the first?

Yes, that was done, Paul, right at the end of the first quarter in conjunction with the funding of Gelnex. So the effect from that [Multiple Speakers]. There was no interest…

No interest savings in Q1 from that.

So what's the second quarter versus the first quarter impact from this swap?

Interest expense, there will be $1.2 million savings there. But then obviously, we have a debt increase there. So we're still saying for the full year, about $230 million of interest expense.

The next question is from Matthew Blair of Tudor, Pickering Holt.

Randy, congrats on the strong results. I wanted to follow up on your comment, the DGD second quarter is shaping up to be a record. Was that on just total volumes or total EBITDA contribution? If it's on EBITDA, it looks like that would translate to an EBITDA margin of roughly $1.75, maybe $1.80 per gallon, so quite a step-up from Q1. So I just wanted to…

Yes. I mean, clearly, with the system running 1.2 billion gallons divided by four 300 million gallons now should being produced, maybe a little more, and being depending on shipments and timing of boats. But clearly, we gave earlier guidance of $1.25 for the year, that's kind of what we saw coming into the year in February. The margins now are clearly somewhere between $1.5 and $2. So what we can capture that, it's too early to say. Sandy, anything you want to throw there?

The only thing I would say is that, obviously, we're seeing lower feedstock cost than what we saw in the first quarter. As Randy and John had mentioned, our unit are running full so they're running very well, and we'll continue to push those units as hard as we can to see what they can do. So I think it's a combination of those things.

Unfortunately, we have lost Mr. Blair's connection, so I will move on to Ben Kallo of Baird.

Randy, on SAF, I know it's early in the game. But could you just talk about a kind of commercial discussions, sales discussions and how you think that plays out as long term agreements, or is it too early to tell?

We've been talking to a number of parties, and we were talking to a number of parties actually even before we made our investment decision. We continue to do that. I don't think that we're ready to set anything in stone, and it will probably be closer to when we're coming online for we make any agreements. In terms of agreements, we've always talked about the Inflation Reduction Act was really important in spurring us to make the decision to move to SAF. And now, what we're seeing is we're seeing the premiums that we thought we would, and so that's very positive. But we have no parties in particular right now, we continue to talk to a wide range of both.

I mean clearly, that market is rapidly developing, led by European procurement now. It will spill over into the US as we move into later '23, early '24. And then the commercial team is going to have to decide, do you sell a little bit more or sell all of it, and then move on to the decision to build the second plant. But right now, clearly, there's a lot more promises out there than have been realized yet. So we're excited about it.

So I need some Randy math, and it might be difficult. But if we looked at just margins of Q1 or however you want to do it, what you think they are for Q2 for Diamond Green Diesel, and then we translate it to after the blenders tax credit goes into the new program in IRA. Where would margins shake out for you guys there?

I don't think that we know. I don't think that we've looked at that quite yet. It's going to change how things look on our P&L, because it's going to be an offset to income tax. And so I think that you're going to have to start looking at our P&L probably a little bit differently and maybe there's a more focus on EPS rather than EBITDA at that time.

Randy, you talked about maybe stranded when the RVO question about stranded crush facilities. Crush facilities coming online, how does that impact you? I guess, better for feedstock. But what about if the the end market, the renewable diesel plants don't come online and the crush facilities do come online. What's that risk, is that the risk to your core business? I hope that makes sense.

I think while you can't break them completely apart, I don't know that they're totally interdependent on each other. I mean clearly, we've never seen what's about to happen in North America on the amount of crushing capacity. Remember, we're going to grow just a little bit more, not a lot. And that seed, whether it was out of Canada in the form of canola or soybeans out of the US, we're headed predominantly to China. And ultimately, the question is going to be, do those beans get crushed here, do they get crushed there, do the Chinese buy finished protein instead of raw soybeans, do they arbitrage to palm oil instead of soybean oil? There's a lot of unanswered questions here. There's probably -- I don't know, I don't even know the numbers so I'll just stay away from it, of how much crush capacity is coming online. It was all built with the belief that there would be renewable diesel demand underneath it, and that takes two forms. One would be, do you have the process to pre-treat crude soybean oil or super degum soybean oil or do you need refined bleach? The only refined bleach facility that's been built in the last years, and I don't know if I want to say five years or 10 years, has been in Quincy, Illinois by ADM. So if the pre-treatment business doesn't work for these guys, which we're skeptical of, then that soybean oil is going to have to be moved out of the country because there won't be anywhere for it to go, or the crush margins will go collapse to the point that then the beans are moving out of the country. John, anything you want to add?

No, I think that's exactly right. I mean the fact of the matter is every soybean in the world was crushed before we had the tremendous increase in crushing capacity in the United States. So for all of those facilities to be filled up with something to process, we need to raise a lot more soybeans around the world and that was always our question about the soybean expansion that was occurring out there. From a standpoint of our business model, we should be able to adjust.

Ben, the other thing is, I mean, like I said, and I got to be -- if you believe all your sell-side guys' reports on how much capacity is out there, it will use up all that soybean oil very, very quickly and then some. So I mean it's kind of one or the other here that you got to buy, but these are clearly unchartered waters for an international consumer that's been very comfortable buying boatloads of canola and soybeans in the past.

And just to sneak one in. I know we're going to over, but just Gelnex, because collagen is just become a bigger part of the business. Could you talk about how you view the growth profile, not this year, I know the run rate, but as you go forward on the top line? And then could you talk a little bit about margin and expectations there?

I'll tag team this with John. Clearly, Gelnex met the criteria of the Darling business model of a great business with a great management team with great assets, and we're 100% comfortable and confident in what we procured, and the run rate supports an accretion that we're proud of. So ultimately, as we have four facilities in Brazil, one in Paraguay and then one in Portage, Indiana, those are all going to be integrated within the system here over time. What's interesting is we didn't have a lot of overlap in customers, so there's going to be really some nice growth there. They are a lower cost operating model than we are. And while that's kind of hard for my [indiscernible] team sometimes to accept, we've done a lot to learn from them. And ultimately, they look at us from the standpoint in the collagen and peptides business, we were the leader and are the leader there. And how do we now move their product and their customer base to our quality of product and get paid for it? Clearly, as Brad and Suann and I have told people, we've been on a three year, four year plan of of adjusting our product mix from basically confectionery and pharma gelatins to collagen peptides, and they marginally have a little better margin than what we have. And you've seen that in the earnings charts that's out in the earnings call slide, probably one of the greatest stories out there. And we don't see any slowing of that; number one, with volume growth; number two, with margin improvement; and number three, with the portfolio of collagen and peptide products that we have ready to launch here in the next one to two years. John, anything you want to add?

I think oftentimes what's overlooked is we really focus on the products that we sell and is there going to be demand for those, and are those going to be high value products that we can obtain good margins on. And quite frankly, what we see in the collagen space, both on the gelatin side and on the hydrolyzed collagen side is exactly that. Same thing we saw with renewable diesel when we looked at the low CI benefits associated with that product. These are high value premium products that have a great natural role in either the Food or the Fuel systems, and that's going to translate into excellent, excellent margins, excellent, excellent profitability in that segment of the business. We're very excited about the future of collagen.

The next question will come from Tony Bancroft of GAMCO Investors, Inc.

Congratulations on the great quarter. You've talked about this in the past, Randy, maybe you could just remind us and maybe potentially update us if anything has changed. But from a 30,000-foot view, how much demand is there for Diamond Green Diesel? And I realize a lot of variables, but if you sort of -- obviously, you've sort of talked about what the constraint is, at least at year end, on capacity. And then if you maintain sort of, whatever you want to call it, regulatory growth rate and the demand, sort of the overall demand. How do you see -- I mean, could it be a Diamond Green Diesel or SAF 8? And in either using either of those, or both of those, can you sort of maybe just walk us through how you look at this? I mean every one of these has been a home run, so I think as an investor, you just want to try to understand what sort of the -- is there a terminal value, is there a run rate, is there a sweet spot for this? Maybe you can give some comments on that.

Yes, and I think that's fair enough. Clearly, trying to understand the global potential for global demand, it's clearly been improving, increasing and becoming more transparent over the last couple of years. Sandy, do you want to kind of give some sweet spots there?

So I think that there are a number of things going on. And as I think about it, there's no better time to be in biofuels. So first of all, and we've talked about it a little bit earlier in this call, is CARB scoping plan, and they're looking to increase the stringency of that plan. They're also potentially looking to add a potential jet mandate within the state, which would be great. That's just more demand for us. We have a number of states that are now looking at LCFS programs. We have a potential LCFS obligation for jet in British Columbia. I think that recently, we've seen that now we may have some mandates for SAF, for maritime fuels, et cetera, in Europe, and so I think that we're seeing more things globally there. And then even within the states on the SAF side, we're seeing that various tax credits are being passed, and these are in like non-LCFS type states. So you have one in Illinois, there's one in Washington that's now been passed. So there's just so much that is creating more demand, adding more dollars to the supply chain, et cetera, that makes these products possible. And so I haven't ever seen this much excitement within our industry.

Tony, it's one of those things. You're looking around the world, and they're -- we came through a pretty strong inflation period. We came through some headwinds around the world, but yet the one unwavering thing was the commitment to decarbonization that we've seen in the world. It is not slowing. I sit there and wonder if our SAF production actually stays in the US or it goes to Europe. We don't know yet, but we know the demand's out there. And SAF demand, whether you're talking the LCFS and California market, is clearly going to set the tone here at the end of the year by what they do under rescoping and whether they include SAF. But ultimately, if you take the 2% and 3% mandates, and I know they always seem so small when you say 2% or 3%. But on 50 billion gallons, and it really creates a kind of a trajectory for the next three to five years, it feels pretty darn good and makes us feel pretty confident as being the first mover and with the best assets located in the world to serve that demand.

And I guess just a follow-up on what you just said there at the end. Is your moat just too deep? I mean you guys are the best, you compete the best on CI, you beat the asset cost, input, you name it. Is the moat too deep, is there something that could be out there as transformational that would cause you to have less competitive advantage? I mean, how do you -- you wake up every day, how do you sort of look at that?

I feel very confident. I always -- in the sense, I always like to be careful with questions and analysis about the unintended or the unknown here. I mean, the challenge in this is clearly -- I think we've said years ago, we don't really produce a gallon of fuel, we produce a gallon of compliance. And at the end of the day, when you're competing against or potentially one day competing against people that have a choice to either produce or buy and offset in the form of a carbon credit or a RIN or an LCFS credit, economics may not always be perfect in those imperfect world. So if you say what keeps me awake at night, it's when people do uneconomical things and rather than say how profitable they were in their renewable diesel plant, they talked to you about avoidance of compliance costs. And so that's the only thing. But ultimately, I see the SAF side way offsetting anything of what I'm going to call the generic commodity producers of RD around the world now. Sandy, anything you want to add?

I think you hit it, Randy. I mean, I think we're really excited about SAF. It's a kind of the next step in the progression that we've taken at Diamond Green, and I think the market is huge.

And I guess lastly, with -- again, you guys sort of being a leader in this industry and your partnership with Valero. Long term, five years from now, 10 years from now, how do you see that partnership evolve? I mean you talked about a dividend, but every other energy majors essentially bought what you and Valero have, and you're still the best-in-class. But how does Valero look at you in the long term?

We have a tremendous relationship with the folks at Valero. Obviously, a great relationship with Joe and Lane has been sitting on our Diamond Green Diesel Board for the last several years. We were very excited to see him be named as a replacement for Joe. He's a great guy. Our relationship throughout the Valero organization is fabulous. I think that's the -- as I've always said, the biggest thing that's a miracle of Diamond Green Diesel is this is the first time the ag industry and the petroleum industry have figured out how to get married and how the marriage last, and it's a fabulous marriage that we have with those folks. We love the people at Valero, really respect them bone deep in terms of how we work with them. So we see that relationship just moving forward fabulously.

The next question comes from Ben Bienvenu of Stephens.

Just a quick one on the integration on Valley, obviously, making solid progress there. You had really strong pricing realization in the Feed business, even in the backdrop of what it seems like temporarily dipping fat prices. One of the things you talked about is increasing realized fat values by selling to Diamond Green Diesel. Can you talk about where you are in that process and kind of what contribution there might have been to 1Q and what incremental contribution there is going forward?

I mean clearly, the Eastern Seaboard or Valley integration has been as challenging or more challenging than we had hoped. I mean, we're clearly down the road and I think we're past the critical points there. But you start looking at reliability and that comes in the form of capital investment in equipment. We're doing that. I would say that we've got a lot of attrition takeover and staffing. I mean, we've clearly raised the cost within Valley from a people standpoint because we want a better quality person and we're going to provide really good health and wellness benefits to keep those people, and that's been underway over the last year as we kind of celebrate our one year anniversary. Overall, when you look at the business, there was a lot of things going on in that business that worked completely transparent to us on day one. The system was running 130 hours a week and having no time for maintenance. When you do that, you run to fail. What do you do when you run to fail? Well, you have to have bigger maintenance departments and those are the most expensive people within the factory. So as you increase reliability, you don't have to have that. You have better uptime. And what else happens when you break down? Now you transport it to the next plant. And if the next plant doesn't have capacity, they transport it to the next plant. And then by the time it gets to the third plant, it's really not very good material and it causes you to have bad wastewater but then upsets the entire system. So the domino effect it has, I think we have won the battle with the dominos here. And part of that's culture, part of it's investment,…

The next question comes from Jason Gabelman of TD Cowen.

I just wanted to ask about growth, particularly in the core ingredients business after you fully integrate the Valley Protein, and Gelnex and FASA. You're still investing in the business, so I'm wondering what is the organic growth potential over the next couple of years? And you've mentioned there's more feedstock raw materials out there available than what you have previously thought. Does that open up the potential for M&A once the balance sheet is back to a target level?

I mean clearly, if we look back to the model that we did when we did the acquisitions in '14 and '15, we followed up with looking at our global footprint. And then, if you will, optimizing the logistics, meaning lowering the transportation cost. So two things. One, we have to grow with our suppliers. Two, we have an obligation to make sure that the system remains low cost by having plants in the right place. We are in the process of -- we'll be starting up, I think in August, a major expansion in Turlock, California. We have a second line going into Boise, Idaho. We're in the permitting process of a brand new plant in Nebraska. We're looking at one or two plants on the Eastern seaboard in the US. We've got a couple of green energy plants going in in Europe, and I think we've got another expansion going on or potential expansion of another rendering plant in Brazil today, with two more in the process of starting up. So globally, it's an organic build out now for the next one to two years. And from there, once -- as you said, once the balance sheet and once we have visibility in Diamond Green Diesel and what we're doing there, I think our strategy has been very, very transparent to the world of how we invest capital. We do have to always get through the cycles. But at the end of the day, when we make investment decisions, we look at five and 10-year average pricing, not the moment in time. And so ultimately, we're going to continue to build out feedstock to support the Diamond Green system, and two, grow with our customers. And that's one thing Valley didn't do on the eastern side, was maintain adequate capacity as their customers were growing. So we’ve got some work to do there, but that’s in our capital plan.

And just to clarify, what's the total number of plants? You kind of discussed them [piece meal], but the total number and any thoughts on EBITDA contribution over the next couple of years from that organic growth?

I don't know. I think I probably rattled off with six or seven, or 8 plants. I'd hesitate to give an EBITDA at this time until I see where -- what time and starting of them is. So we'll get back to you on that.

And next, we have William Lewis Baldwin of Baldwin Anthony Securities.

Just a quick one here. I wanted to get a feel, if I could on what the transit ban and the level of protein exports, the exports of protein coming out of the US. Is that -- how important is that to your protein business, Randy and has that been growing, or what's the prospects for that as far as your export markets?

So yes, it is a component of what we do. We move a lot of containers. We're actually one of the larger container shippers in the world with the containers that we move. So yes, we move a lot of proteins offshore, have some very, very good markets in some of our specialized proteins offshore to Asia. So it's a component. It's not obviously a tremendously large volume versus our overall volume, but it's a component of our demand. And we really have an excellent, excellent network and an excellent reputation in Asia on our products.

I mean clearly, the value of the dollar, the other currencies all tend to play into some years are bigger than other years. But I would tell you, we are clearly seeing increased demand for proteins in Asia, predominantly China today, and we're working hard. I mean, one of the -- if you say, okay, everybody wants to talk negative about what we bought with the Valley plants, they had a very strong marketing network in Asia today. And that's really been -- that's been helpful to us as we balance around. Europe continues to modify rules around what can be exported versus what has to be destroyed or put into green energy. So very global market for animal byproducts. But as I said earlier, clearly, China is going to have to wrestle with what happens in the oilseed complex in North America. And I suspect that's going to open up more opportunities to alternative proteins to Asia over the coming years.

Do we find ourselves competitive in the specialized proteins, the value added proteins in the world markets despite where the dollar is?

Absolutely. The United States as well as Europe, we move a lot of those products out of Europe, too, but we're primary sources for those for the world.

So I guess it could be fairly safe to say then is as demand for proteins grows worldwide on a secular basis that this market for Darling could continue to grow?

We have a strong focus in the pet food market and a lot of these specialized proteins. And the pet food market continues to be extremely resilient through the inflationary period here with very, very good demand. So we feel very, very good about the demand profile for a lot of our specialized products.

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

All right. Thank you. Thanks, everybody, for your questions. Thanks, Tony. We'll see you tomorrow. We're attending a few more conferences in May, which are listed on our Web site. As always, if you have any additional questions, reach out to Suann. Stay safe. Have a great day, and that concludes our call. Thank you very much.

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