Valvoline Inc. — Q3 FY2017 Form 10-Q
Reporting period: Three and nine months ended June 30, 2017. Valvoline completed its separation from Ashland on May 12, 2017; historical periods include pre-separation allocations and are not fully comparable with standalone results.
Financial performance
| Metric | Three months | Nine months |
|---|---|---|
| Sales | $534 million, up 7% from $499 million | $1.537 billion, up 7% from $1.435 billion |
| Gross profit / margin | $197 million / 36.9%, versus $199 million / 39.9% | $580 million / 37.7%, versus $567 million / 39.5% |
| Operating income | $104 million, versus $113 million | $341 million, versus $313 million |
| Net income | $56 million, versus $75 million | $199 million, versus $208 million |
| Diluted EPS | $0.27, versus $0.44 | $0.97, versus $1.22 |
| Adjusted EBITDA (non-GAAP) | $129 million, versus $123 million | $388 million, versus $347 million |
Quarterly sales gains reflected pricing, volume, product mix, and acquisitions. Higher base-oil and other product costs compressed gross margin; management also cited raw-material pressure in Core North America and International. Adjusted EBITDA benefited substantially from higher pension and postretirement income, so its increase did not reflect broad-based improvement across operating segments. Quarterly segment operating income was $48 million in Core North America (down from $58 million), $34 million in Quick Lubes (up from $32 million), and $18 million in International (down from $20 million).
Cash flow, liquidity, and debt
- Nine-month operating cash flow was $157 million, down from $186 million. Capital expenditures were $43 million; reported free cash flow was $114 million, versus $154 million.
- Cash was $132 million at June 30, including $94 million held by foreign subsidiaries. Working capital was $242 million; cash, cash equivalents, and receivables equaled 103% of current liabilities.
- Total debt was $733 million, compared with $743 million at September 30, 2016. The company had $75 million outstanding under its receivables securitization facility, $436 million of remaining revolver capacity, and was in compliance with debt covenants.
- Financing cash outflows included $50 million of share repurchases and $30 million of dividends. The company had $100 million remaining under its $150 million repurchase authorization.
Material changes and unusual items
- On May 12, Ashland distributed its remaining Valvoline shares, ending its ownership. Valvoline recorded $15 million of separation costs in the quarter and $27 million year to date; it expected approximately $30 million for FY2017.
- Net interest and other financing expense was $10 million for the quarter and $28 million year to date; no such expense was reported in the comparable 2016 periods.
- Non-service pension and postretirement income was a significant contributor to reported results. Year-to-date results included an $8 million remeasurement gain following benefit changes; the quarter included $16 million of pension and postretirement benefit income.
- Quick Lubes sales increased 17% in the quarter and 19% year to date, supported by store acquisitions and operating growth. The Time-It Lube acquisition added 28 stores; other Quick Lubes acquisitions also contributed.
- EPS comparisons require care: weighted-average shares were 204 million in 2017 versus 170 million in 2016, reflecting the IPO and separation share structure. The filing also corrected an immaterial prior-period EPS calculation error.
Outlook, risks, and contingencies
- Management forecast FY2017 capital expenditures of approximately $70–$80 million and stated that operating cash flow and available resources should meet expected requirements, subject to assumptions including operating results, working capital, pension funding, and taxes. No specific earnings guidance is provided in the filing.
- After quarter-end, Valvoline issued $400 million of 4.375% senior notes due 2025 and contributed approximately $395 million to its U.S. qualified pension plan. Management expected this to reduce the plan’s underfunding and pension-related volatility; it also expected a noteworthy pension remeasurement gain in FY2017’s fourth quarter.
- Key risks include raw-material cost and margin pressure, substantial indebtedness and covenant restrictions, stand-alone operating costs and transition-service arrangements, and the possibility that the Ashland distribution fails to qualify for intended tax treatment. Under specified circumstances, Valvoline may have to indemnify Ashland for taxes and related expenses.
- The company reported ordinary-course legal, commercial, tax, product-liability, and environmental matters. It stated recorded losses were not material and believed potential additional losses would not be material, while noting outcomes are uncertain. Tax authorities could also cause material changes in uncertain tax positions; the company could not estimate their impact.
Important facts for investors to verify
- Whether pricing and cost actions can offset higher base-oil and other input costs and restore gross margins.
- How much reported and adjusted earnings depend on pension income, and the actual outcome of the expected fourth-quarter pension remeasurement.
- The post-quarter effect of the $400 million notes issuance and pension contribution on debt, interest expense, and liquidity.
- Progress and ongoing costs of operating independently from Ashland, including remaining transition services and tax-related obligations.
- Whether Quick Lubes acquisition-led growth translates into durable margins and cash generation.