Valvoline Inc. — Q1 FY2023 Form 10-Q
Business context and period: The quarter ended December 31, 2022. Valvoline’s continuing business operates and franchises preventive automotive service centers. Its former Global Products segment is classified as discontinued operations and held for sale; the company expected its sale to Aramco for $2.65 billion, subject to customary adjustments and closing conditions, in early calendar 2023.
Key financial results
| Metric | Q1 FY2023 | Prior-year quarter |
|---|---|---|
| Continuing-operations revenue | $332.8 million | $287.3 million |
| Gross profit / margin | $118.8 million / 35.7% | $112.2 million / 39.1% |
| Operating income / margin | $29.3 million / 8.8% | $52.0 million / 18.1% |
| Income from continuing operations | $27.0 million | $34.2 million |
| Net income, including discontinued operations | $81.9 million | $87.0 million |
| Diluted EPS: continuing / total | $0.15 / $0.46 | $0.19 / $0.48 |
| Adjusted EBITDA from continuing operations (non-GAAP) | $73.3 million | $72.4 million |
| Continuing-operations operating cash flow | $48.5 million | $37.7 million |
| Continuing-operations free cash flow (non-GAAP) | $8.6 million | $5.7 million |
Cash, debt and liquidity: At December 31, continuing-operations cash and cash equivalents were $21.0 million and total debt was $1.88 billion. Remaining borrowing capacity under facilities expected to remain in place after the sale was $324.6 million. Approximately 78% of outstanding borrowings, including swaps, had fixed interest rates. The company reported compliance with debt covenants and said it expected liquidity to meet requirements for the next 12 months.
Material changes and management commentary
- Revenue rose 16%, supported by 11.9% system-wide same-store sales growth, pricing, premiumization, non-oil services, increased vehicles served, acquisitions and 111 net new stores versus the prior year.
- Gross profit increased 6%, but margin declined 3.4 percentage points. Management attributed pressure to inflation in product and labor costs, delivery and additive costs, passing through cost increases at company-operated stores, and a higher mix of company operations.
- Operating income and continuing-operations income declined despite revenue growth. Management cited increased pension and postretirement non-service expense, higher borrowing costs, and higher legacy and separation-related charges. Adjusted EBITDA increased 1%, as sales growth was largely offset by inflation and business investments.
- The quarter included a $26.5 million income tax benefit from releasing valuation allowances on legacy tax attributes, alongside a $24.4 million legacy/separation expense for the increased estimated indemnity obligation to the former parent. Management expected indemnity payments to begin in fiscal 2023. The reported effective tax rate was an unusual benefit of 291.3%; the company estimated a fiscal 2023 effective rate of 25.5%–26.5%, excluding discrete items.
- Continuing-operations operating cash flow improved, but total company operating cash flow was negative $8.7 million, versus positive $31.8 million a year earlier, largely reflecting discontinued-operations cash flows of negative $57.2 million. Continuing-operations capital expenditures were $39.9 million.
- The company returned $109.2 million to shareholders during the quarter through $87.4 million of repurchases and $21.8 million of dividends. It said it expected to discontinue the dividend as its focus shifts following the Global Products sale, while continuing to return value through repurchases. Subsequent to quarter-end, it repurchased 1.6 million shares for $54.9 million through January 31, 2023.
Outlook, risks and contingencies
- The company expected the Global Products divestiture to close in early calendar 2023. Following the transaction, Valvoline planned to continue purchasing substantially all lubricants and certain ancillary products for its stores from Global Products under a long-term supply agreement.
- Management identified economic conditions, competition, operating performance, working capital, and the ability to generate cash and comply with debt terms as factors affecting liquidity. It stated that insufficient cash generation or covenant compliance could require additional financing.
- The company was evaluating the effect of the Inflation Reduction Act’s corporate alternative minimum tax. It also anticipated a significant impact on retained earnings and cash-flow timing from the 1% excise tax on share repurchases after December 31, 2022.
- About 31% of outstanding debt and interest-rate swaps were under LIBOR-based arrangements that matured after LIBOR cessation without fallback provisions. The company planned reference-rate modifications for swaps in connection with the divestiture and credit agreement transition.
- Ordinary-course legal claims were disclosed; management said recorded liabilities were not material and pending matters were not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether and when the Global Products sale closed, the final proceeds and adjustments, and the resulting debt repayment and capital allocation.
- Whether continuing-operations margins and cash generation recover from inflationary cost pressure and elevated growth capital expenditures.
- The timing and cash cost of the legacy tax indemnity, the realization of the related tax attributes, and the ongoing tax-rate effect.
- Actual post-sale leverage, interest expense, liquidity and covenant headroom under the amended credit facilities.
- The scale and timing of share repurchases, the expected dividend discontinuation, and the effect of the repurchase excise tax.