Business context and reporting period
Valvoline Inc. filed this unaudited Form 10-Q for its fiscal first quarter, the three months ended December 31, 2016; comparisons are with the three months ended December 31, 2015. Valvoline sells lubricants and automotive chemicals and operates Valvoline Instant Oil Change (VIOC). Its reportable segments are Core North America, Quick Lubes and International.
The quarter followed Valvoline’s September 2016 IPO and separation steps from Ashland. Ashland retained approximately 83% of Valvoline’s shares and intended, subject to market conditions and other factors, to distribute its remaining shares after both companies released second-quarter fiscal 2017 results. Prior-period results were prepared on a stand-alone basis from Ashland records and included allocated costs, so comparability is affected by the transition to a public stand-alone company.
Financial performance and position
| Metric | Q1 FY2017 | Q1 FY2016 |
|---|---|---|
| Sales | $489 million | $456 million |
| Gross profit / margin | $185 million / 37.8% | $176 million / 38.6% |
| Operating income | $120 million | $96 million |
| Net income | $72 million | $65 million |
| Diluted EPS | $0.35 | $0.32 |
| Adjusted EBITDA (non-GAAP) | $127 million | $105 million |
| Cash from operations | $88 million | $40 million |
| Capital expenditures | $9 million | $5 million |
| Free cash flow (non-GAAP) | $79 million | $35 million |
Sales rose 7%. Reported drivers were volume (+$23 million), product mix (+$8 million) and acquisition (+$14 million), partly offset by pricing (−$11 million) and currency (−$1 million). Lubricant gallons sold increased 7% to 43.1 million. Gross margin declined 0.8 percentage points, with pricing and raw-material timing among the factors described by management.
Segment sales and operating income were: Core North America $237 million and $51 million (prior year $241 million and $53 million); Quick Lubes $127 million and $29 million ($100 million and $23 million); International $125 million and $20 million ($115 million and $16 million). Quick Lubes growth included Oil Can Henry’s, acquired in fiscal 2016; International results benefited mainly from higher volume. Core North America operating income was lower amid pricing pressure.
At December 31, 2016, cash and equivalents were $236 million, total debt was $740 million, and net debt was approximately $504 million. Debt comprised $75 million of short-term securitization borrowings and $665 million of long-term debt, including current maturities and debt issuance discounts. Working capital was $281 million, down from $349 million at September 30, 2016; liquid assets were 119% of current liabilities, versus 134%. The company reported compliance with its credit agreement covenants.
Cash from operations increased to $88 million, partly due to timing of working-capital settlements associated with the separation, including Ashland remitting $23 million of receivable collections and higher accrued liabilities for transition services, tax sharing and other billings. The $75 million drawn under the new $125 million receivables securitization facility was used to repay an equal amount of Term Loan A; the facility’s weighted-average rate while drawn was 1.5%. Cash dividends paid were $10 million, or $0.049 per share.
Material changes, outlook and risks
- Operating income included $26 million of non-service pension and postretirement income, including an $8 million remeasurement gain, compared with $2 million reported in the corresponding income-statement line a year earlier. The filing attributes the remeasurement gain to discontinued retiree health and life benefits. Separation costs were $6 million, primarily for separating ERP systems. Adjusted EBITDA was $127 million versus $105 million; it excludes the $8 million gain and adds back separation costs.
- Net interest and other financing expense was $10 million, compared with none in the prior-year quarter, reflecting Valvoline’s debt following the separation. The effective tax rate was 34.5%, compared with 32.3%.
- Management forecast fiscal 2017 capital expenditures of approximately $70–$80 million, primarily funded from operating cash flows. It expected operating cash flow and available resources, including cash and revolving credit, to be sufficient for requirements and debt covenant compliance; this depends on assumptions about results, working capital, spending, acquisitions, pension funding and taxes.
- On January 31, 2017, Valvoline completed the acquisition of 28 quick-lube stores for $48 million. The board declared a $0.049-per-share dividend payable March 15, 2017. These are subsequent events, not quarter-end transactions.
- Risks highlighted include raw-material prices and ability to recover cost increases, demand and pricing, customer retention, foreign exchange, product liability, substantial indebtedness and covenants, stand-alone-company costs, ongoing Ashland relationships and tax indemnification exposure related to the planned stock distribution, and acquisition integration and realization of benefits. Management reported no pending litigation it believed would materially adversely affect the company; it noted a reasonable possibility of losses above recorded reserves but believed potential losses would not be material. No material risk-factor changes were reported.
Important facts for investors to verify
- How much of earnings and operating-income growth reflects recurring operating performance versus pension income, remeasurement gains and separation-related items.
- Whether operating cash flow remains strong after the separation-related working-capital timing effects and Ashland settlements.
- Debt, interest costs, securitization-facility usage, covenant headroom and cash available for capital spending, dividends and acquisitions.
- Progress and timing of Ashland’s intended share distribution, and any associated tax, transition-service or stand-alone operating costs.
- Performance and integration of Oil Can Henry’s and the 28-store Time-It Lube acquisition, including the expected contribution to Quick Lubes.