Valvoline Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended June 30, 2018; filed August 2, 2018. Dollar amounts are in millions unless noted.
Business context
Valvoline markets automotive and engine products and operates and franchises quick-lube service centers. Its segments are Core North America, Quick Lubes, and International. The company reported 1,154 Valvoline-branded quick-lube stores at quarter-end and sells products in approximately 140 countries.
Financial results and key metrics
| Metric | Three months 2018 | Three months 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Sales | $577 | $534 | $1,691 | $1,537 |
| Gross profit | $201 | $197 | $603 | $580 |
| Gross margin | 34.8% | 36.9% | 35.7% | 37.7% |
| Operating income | $102 | $87 | $290 | $281 |
| Net income | $64 | $56 | $121 | $199 |
| Diluted EPS | $0.33 | $0.27 | $0.61 | $0.97 |
| Adjusted EBITDA, non-GAAP | $115 | $112 | $345 | $336 |
- Quarterly sales rose 8%; nine-month sales rose 10%. Higher pricing, favorable mix, acquisitions, and currency contributed to growth. Nine-month lubricant volumes increased 1% to 135.3 million gallons.
- Quarterly operating income increased despite lower gross margin. Nine-month net income declined substantially, primarily reflecting tax-reform-related charges and lower pension-related non-service income.
- Quarterly income tax expense was $33, at a 34.0% effective rate; nine-month expense was $154, at 56.0%. U.S. and Kentucky tax-law changes drove approximately $76 of incremental nine-month tax expense, including a $69 tax expense from U.S. tax reform impacts and $7 from Kentucky tax reform.
- Segment sales and operating income for the quarter: Core North America $264 and $41; Quick Lubes $167 and $38; International $146 and $20. Core North America operating income fell from $48, while Quick Lubes and International income increased from $34 and $18, respectively.
Cash flow, debt, and liquidity
- Nine-month operating cash flow was $181, versus $157 a year earlier. Capital expenditures were $51; management-defined free cash flow was $130, versus $114.
- Cash declined to $107 from $201 at September 30, 2017. Total debt increased to $1,257 from $1,124, including $174 under the receivables facility, $274 in term loans, and $44 drawn on the revolver. Cash and debt imply net debt of approximately $1,150.
- At June 30, $395 of revolver capacity remained after letters of credit. The company subsequently borrowed a net $86 through July 31, reducing remaining capacity to $309. Approximately $99 of quarter-end cash was held by non-U.S. subsidiaries.
- Working capital was $391. Management said liquidity was sufficient for the next 12 months and reported compliance with debt covenants at June 30. The credit agreement limits net leverage to 4.5 and requires interest coverage of at least 3.0; actual covenant ratios are not stated here.
- During the first nine months, Valvoline repurchased approximately 10 million shares for $224 and paid $45 in dividends. The quarterly dividend was $0.0745 per share.
Material changes, outlook, and risks
- Margin pressure: Higher raw-material costs, particularly in Core North America, outpaced or diluted the benefit of pricing actions. Consolidated gross margin fell 2.1 percentage points year over year in the quarter. Management cited planned SG&A investments as an additional offset to earnings growth.
- Tax outlook: Management estimated a fiscal 2018 effective tax rate of 47%–48% and a fiscal 2019 rate of 25%–26%. It expects tax reform to benefit future results overall, but estimates remain provisional and include potentially offsetting provisions.
- Investment plans: Fiscal 2018 capital expenditures were forecast at $85–$90. Valvoline announced an approximately $70 investment in a China blending and packaging plant, expected to begin production by the end of calendar 2020. The estimate includes $5–$10 of fiscal 2018 spending.
- Expansion: On July 13, 2018, the company acquired 73 Canadian franchise service centers for approximately $53, bringing its North American quick-lube system to more than 1,200 locations. This is a subsequent event, not part of quarter-end results.
- Contingency: Valvoline received an approximately $30 demand for a multiemployer pension-plan partial-withdrawal assessment related to an Ashland business sale. It is contesting the assessment; management’s estimated cost at June 30 was not material.
- Other matters: Tax obligations to Ashland totaled $78. The filing reports no pending litigation management believes would have a material adverse effect and no material changes to previously disclosed risk factors. Management cautions that forward-looking estimates are subject to risks and may differ from actual outcomes.
Investor facts to verify
- Whether raw-material inflation and delayed price recovery continue to pressure Core North America margins.
- How provisional tax-reform estimates affect reported earnings, cash taxes, and the fiscal 2018 and 2019 effective tax rates.
- Whether operating cash flow can support acquisitions, capital spending, dividends, and repurchases while debt and revolver usage rise.
- The outcome and potential cost of the contested pension withdrawal assessment and obligations under the Tax Matters Agreement with Ashland.
- Execution, cost, and expected returns from the Canadian store acquisition and China plant investment.