Valvoline Inc. — Q2 FY2018 Form 10-Q
Reporting period: Three and six months ended March 31, 2018. Valvoline markets automotive and engine products and operates quick-lube services through Core North America, Quick Lubes, and International segments. Dollar amounts are in millions except per-share data.
Financial results
| Metric | Q2 FY2018 | Q2 FY2017 | Six months FY2018 | Six months FY2017 |
|---|---|---|---|---|
| Sales | $569 | $514 | $1,114 | $1,003 |
| Gross profit | $207 | $198 | $402 | $383 |
| Gross margin | 36.4% | 38.5% | 36.1% | 38.2% |
| Operating income | $100 | $100 | $188 | $194 |
| Net income | $67 | $71 | $57 | $143 |
| Diluted EPS | $0.33 | $0.35 | $0.28 | $0.70 |
| Adjusted EBITDA (non-GAAP) | $122 | $115 | $230 | $224 |
- Q2 sales rose 11%, led by pricing, volume, favorable product mix, foreign exchange, and acquisitions. Gross margin declined as pricing to recover higher input costs diluted margins and lower-margin customers contributed more.
- Q2 operating income was unchanged year over year despite higher sales; planned SG&A investment and Core North America margin pressure offset gains elsewhere. Adjusted EBITDA is a company-defined non-GAAP measure.
- Six-month net income fell mainly because tax reform charges drove income tax expense to $121 million, including a provisional $67 million deferred-tax remeasurement charge. The six-month effective tax rate was 68.0%, versus 34.7%.
Segments and material changes
- Core North America: Q2 sales increased 2% to $258 million, while operating income fell to $46 million from $57 million. Cost increases, packaging-transition and promotional costs, and the lag in passing through costs exceeded pricing and mix benefits.
- Quick Lubes: Q2 sales rose 23% to $158 million and operating income increased to $38 million from $31 million. Combined same-store sales growth was 9.6%; store acquisitions, higher transactions, pricing, and premium mix supported results.
- International: Q2 sales increased 15% to $153 million and operating income rose to $24 million from $18 million. Foreign exchange, pricing, and strong unconsolidated joint-venture performance contributed.
- For the six months, sales increased 11% and operating income declined 3%. Q2 lubricant gallons sold increased 1% overall. Acquisitions contributed to growth, including 61 service-center stores acquired for $67 million during the six months.
Cash flow, debt, and liquidity
- Six-month operating cash flow was $108 million, versus $70 million; capital expenditures were $30 million, producing company-defined free cash flow of $78 million, versus $43 million.
- Cash declined to $127 million from $201 million at September 30, 2017. Cash used in investing was $91 million and cash used in financing was $93 million. Financing outflows included $123 million of share repurchases and $30 million of dividends.
- Total debt was $1.206 billion, up from $1.124 billion at September 30, 2017. Debt included $400 million of 2025 notes, $375 million of 2024 notes, $278 million of term loans, and $163 million drawn under the trade-receivables facility. The revolver had no borrowings; stated availability was $439 million, with another $12 million available under the receivables facility.
- Working capital was $403 million. Management said liquidity was sufficient for expected requirements over the next 12 months; the company was in compliance with debt covenants. Approximately $105 million of cash was held by non-U.S. subsidiaries.
Outlook, risks, and unusual items
- Management forecast FY2018 capital expenditures of $85–$95 million, primarily funded by operating cash flow. A planned China blending and packaging plant represents an approximately $70 million investment, with production expected by the end of calendar 2020; $5–$10 million was included in FY2018 capex expectations.
- Management estimated consolidated effective tax rates of 45%–46% for FY2018 and 25%–26% for FY2019. Tax-reform impacts and estimates were provisional; management expected tax reform to benefit the company over time. Kentucky tax reform impacts were still being evaluated.
- In April 2018, the company received a demand for approximately $30 million for a multiemployer pension-plan partial withdrawal assessment related to an Ashland business sale. Valvoline plans to contest it; management’s estimated cost was not material to the reported statements.
- During the six months, Valvoline repurchased more than 5 million shares for $126 million. Subsequent to quarter-end, it repurchased shares for $35 million through April 30 and had $239 million of authorization remaining. The board declared a $0.0745-per-share dividend payable June 15, 2018.
- The filing reports no material changes to previously disclosed risk factors and no pending ordinary-course legal matters management believed would materially affect the company. Disclosure controls were assessed as effective.
Important facts for investors to verify
- Whether Core North America can restore margins as input costs and pricing catch up, and whether Quick Lubes and International growth persists.
- The realized tax rate and cash-tax effects versus management’s FY2018 and FY2019 estimates, including final tax-reform and Kentucky tax impacts.
- Debt levels, receivables-facility capacity, cash accessibility, and continued compliance with credit covenants.
- The outcome and potential financial exposure of the approximately $30 million pension withdrawal assessment.
- Returns and funding priorities for the China plant, acquisitions, share repurchases, and dividends.