Valvoline Inc., supplier of premium branded lubricants and automotive services, has reported financial results for its third fiscal quarter ended June 30, 2020, revealing June sales up year-over-year as miles driven increased, even as the overall quarter was down from 2019.

“We continue to closely monitor the latest developments surrounding COVID-19 and remain focused on the health and safety of all of our stakeholders,” said Sam Mitchell, CEO. “The durable, non-cyclical nature of our business was clearly on display this quarter. Lockdowns in response to COVID-19 caused meaningful impacts on our results in April and May. As the restrictions eased and miles driven trends improved, we finished the quarter with June overall sales growing by 10% year-over-year. Quick Lubes and Core North America sales were each up 16% in June. International saw significant sequential improvement in June while still below prior year. Margin improvement in Core North America was particularly strong in the quarter due in part to reduced raw material costs, which we expect to moderate as we began to pass through these lower costs to our customers in the latter part of Q3, impacting Q4 margins.

“Our results this quarter demonstrate the resiliency of our business model and show that we have taken the steps necessary to effectively manage our operational response and maintain financial flexibility during the crisis.” 

Third-Quarter Results

All comparisons made to the same prior-year period unless otherwise noted.

Reported third-quarter 2020 net income and EPS were $59 million and $0.32, respectively. These results included pension and other post-employment benefit (OPEB) after-tax income of $7 million ($0.04 per diluted share) and an after-tax charge of $1 million (negligible EPS impact) of legacy and separation-related expenses. Reported third-quarter 2019 net income and EPS were $65 million and $0.34, respectively. These results included after-tax pension and OPEB income of $2 million ($0.01 per diluted share) and after-tax expense of $3 million ($0.02 per diluted share) of restructuring and related expenses and $4 million ($0.02 per diluted share) of business interruption expenses related to the temporary shutdown of one of Valvoline’s plants due to a fire at a nearby third-party facility.

Third-quarter 2020 adjusted net income and adjusted EPS were $53 million and $0.28, respectively, compared to adjusted net income of $70 million and adjusted EPS of $0.37 in the prior-year period. Adjusted EBITDA in the quarter was $106 million, a 16% decrease compared to the prior-year period, and included an increase in variable compensation expense of $10 million recorded in Unallocated and Other due to improving earnings expectations.

Operating Segment Results

Quick Lubes

• SSS declined 8.0% overall, 5.0% for company-owned stores and 10.0% for franchised stores
• Operating income decreased $12 million to $36 million; EBITDA decreased $10 million to $47 million
• Quick Lubes ended the quarter with 1,432 total company-owned and franchised stores, a net increase of 13 during the period and 80 versus the prior year

Quick Lubes’ system-wide SSS grew 7.1% in June, returning to near pre-COVID-19 growth rates and building on growth of 7.4% in the prior-year period. Total sales grew 16% and segment EBITDA grew 8% in June.

While June saw sales and EBITDA growth, segment profitability for the quarter declined versus the prior year primarily driven by a 6% decrease in total sales in the quarter. Valvoline continues to invest in network expansion as part of its long-term strategy, including the addition of 80 net new stores versus the prior year, a 6% increase.

The rapid recovery during the quarter was driven in part by strong in-store execution and new customer acquisition. Given the strong Q3 exit rate, the Company launched a new advertising campaign in early Q4 with an emphasis on its safety-focused, stay-in-your-car service model.

Core North America

• Lubricant volume declined 21% to 19.0 million gallons, primarily driven by a significant reduction in lower-margin installer channel volume
• Branded premium mix increased 660 basis points to 59.7%
• Operating income increased $13 million to $51 million; adjusted EBITDA increased $9 million to $55 million

The improvement in segment gross margin year-over-year was primarily driven by favorable mix and benefits of the operating expense reduction program launched last year as well as short-term favorable price-cost lag, despite lower volume. Segment profitability benefited from margin improvement and from reduced discretionary expenses.

The majority of the volume decline for the quarter was in the installer channel, driven primarily by impacts from COVID-19. Retail channel volume was less impacted by COVID-19 due to a rapid recovery in the DIY category during the quarter. The recovery in the retail channel, in addition to promotional timing benefits, and partial restocking in the installer channel contributed to 6% growth in overall segment volume in June versus the prior-year period. 

International

• Lubricant volume declined 20% to 11.5 million gallons
• Lubricant volume from unconsolidated joint ventures declined 28% to 7.9 million gallons
• Operating income decreased $8 million to $12 million; adjusted EBITDA decreased $9 million to $14 million

The International segment saw varied levels of recovery from the COVID-19 crisis during the quarter. The majority of the volume decline for the quarter versus the prior-year period was in Latin America and the unconsolidated joint venture in India, where, in both regions, recovery is lagging due to extended COVID-19 impacts. Partially offsetting this decline was strong growth in China for the quarter. The EMEA region, principally Europe, and Asia-Pacific region, including unconsolidated joint ventures, ended the quarter with volume growth in June versus the prior-year period.

The decline in segment EBITDA for the quarter was largely due to lower volume and decreased profit contribution from unconsolidated joint ventures.

Balance Sheet and Cash Flow

• Total debt of approximately $2.0 billion and net debt of approximately $1.2 billion
• Year-to-date cash flow from operations increased 27% and free cash flow each increased 26% from the prior year to $271 million and $177 million, respectively
• Total liquidity of just over $1.3 billion, including cash and cash equivalents on hand of $751 million and borrowing capacity of $553 million

For the current quarter, cash flow from operations increased $37 million versus the prior-year period, despite the challenging environment. On July 23, the Board of Directors committed to a total cash dividend of $0.113 per share payable on September 15 to shareholders of record as of August 31.

Outlook

“The resiliency of our business model drove a strong recovery across our segments during Q3, as miles driven trends improved from the unprecedented declines caused by early-stage COVID-19 restrictions,” said Mitchell. “Looking forward to Q4, the quarter is off to a good start based on our early view of July results, including same-store sales growth that is expected to come in ahead of June levels. Barring any unexpected impacts from COVID-19, for Q4 we anticipate same-stores sales growth to be in the high-single digits, leading to our 14th straight year of growth. While uncertainty related to COVID-19 remains, given current trends we expect our FY20 adjusted EBITDA to be in the range of $475 million to $485 million, in line with last year. Reaching these expectations would be an impressive achievement given the significant negative impact that COVID-19 has had on our results this year.”

Mitchell continued, “The stability of our preventative-maintenance business model, the strength of our balance sheet and the endurance and talent of our people reassures me that we will not only weather the remainder of the COVID-19 crisis, but come out stronger. We are better positioned than ever to execute our long-term strategy of becoming a more service-centric company by growing in Quick Lubes, developing opportunities in International and funding these initiatives by maintaining strong cash generation in Core North America.”

Valvoline’s outlook for adjusted EBITDA is a non-GAAP financial measure that excludes or will otherwise be adjusted for items impacting comparability. Valvoline is unable to reconcile adjusted EBITDA to GAAP net income for fiscal 2020 without unreasonable efforts, as the Company is currently unable to predict with a reasonable degree of certainty the type and extent of certain items that would be expected to impact GAAP net income in fiscal 2020 but would not impact non-GAAP adjusted EBITDA.

Conference Call Webcast

Valvoline will host a live audio webcast of its fiscal third quarter 2020 conference call at 9 a.m. ET on Tuesday, August 4, 2020. The webcast and supporting materials will be accessible through Valvoline’s website at http://investors.valvoline.com. Following the live event, an archived version of the webcast and supporting materials will be available.

Basis of Presentation

Certain prior year amounts have been reclassified to conform to current year presentation. In addition, the Company adopted the new lease accounting standard, effective at the beginning of fiscal 2020, using the optional approach to transition. Under this method, financial information related to periods prior to adoption were not adjusted and will be as originally reported under the previous leasing standard. The effects of adopting the new lease standard were recognized as a cumulative net of tax adjustment that decreased opening retained deficit by approximately $1 million. The most significant impact of adoption was the recognition of incremental lease assets and liabilities of $219 million and $214 million, respectively. The Company expects the impact of adoption to be immaterial to its statements of consolidated income and cash flows on an ongoing basis.

Key Business Measures

Valvoline tracks its operating performance and manages its business using certain key measures, including system-wide, company-owned and franchised store counts and same-store sales; Express Care store counts; lubricant volumes sold by unconsolidated joint ventures; and total lubricant volumes sold and percentage of premium lubricants sold. Management believes these measures are useful to evaluating and understanding Valvoline’s operating performance and should be considered as supplements to, not substitutes for, Valvoline’s sales and operating income, as determined in accordance with U.S. GAAP.

Sales in the Valvoline Quick Lubes reportable segment are influenced by the number of service center stores and the business performance of those stores. Stores are considered open upon acquisition or opening for business. Temporary store closings remain in the respective store counts with only permanent store closures reflected in the end of period store counts and activity. SSS is defined as sales by U.S. Quick Lubes service center stores (company-owned, franchised and the combination of these for system-wide SSS), with new stores excluded from the metric until the completion of their first full fiscal year in operation as this period is generally required for new store sales levels to begin to normalize. Differences in SSS are calculated to determine the percentage change between comparative periods. Quick Lubes revenue is limited to sales at company-owned stores, sales of lubricants and other products to independent franchisees and Express Care operators and royalties and other fees from franchised stores. Although Valvoline does not recognize store-level sales from franchised or Express Care stores as revenue in its Statements of Consolidated Income, management believes system-wide and franchised SSS comparisons and store counts, in addition to Express Care store counts, are useful to assess the operating performance of the Quick Lubes reportable segment and the operating performance of an average Quick Lubes store.

Lubricant volumes sold by unconsolidated joint ventures are used to measure the operating performance of the International operating segment. Valvoline does not record lubricant sales from unconsolidated joint ventures as International reportable segment revenue. International revenue is limited to sales by Valvoline’s consolidated affiliates. Although Valvoline does not record sales by unconsolidated joint ventures as revenue in its Statements of Consolidated Income, management believes lubricant volumes including and sold by unconsolidated joint ventures is useful to assess the operating performance of its investments in joint ventures.

Management also evaluates lubricant volumes sold in gallons by each of its reportable segments and premium lubricant percentage, defined as premium lubricant gallons sold as a percentage of U.S. branded lubricant volumes for the Quick Lubes and Core North America segments and as a percentage of total segment lubricant volume for the International segment. Premium lubricant products generally provide a higher contribution to segment profitability and the percentage of premium volumes is useful to evaluating and understanding Valvoline’s operating performance.