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Aug. 4, 2022, 5:18 p.m. EDT


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The following discussion and analysis should be read in conjunction with the Annual Report on Form 10-K for the fiscal year ended September 30, 2021, as well as the condensed consolidated financial statements and the accompanying Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I in this Quarterly Report on Form 10-Q.


Valvoline Inc. is a global vehicle and engine care company that continuously powers the future of mobility through innovative services and products for electric, hybrid and internal combustion powertrains. Valvoline has consistently led the way innovating and reinventing its services and products for changing technologies and customer needs throughout its 155-year history. Valvoline operates a fast-growing, best-in-class network of service center stores, which are well positioned to serve evolving vehicle maintenance needs with Valvoline's iconic products. In addition to its quick, easy and trusted quick lube oil change services and the legendary Valvoline-branded passenger car motor oils, Valvoline provides a wide array of lubricants, chemicals, fluids, and other complementary products and services, including leading the world's supply of battery fluids to electric vehicle manufacturers, with each solution tailored to help extend vehicle and engine range and efficiency.

Valvoline provides vehicle and engine care solutions to a range of customers, including end consumers, OEMs, mass market and automotive parts retailers, small to large installers, vehicle fleets, and distributors, among others. Valvoline operates and franchises more than 1,600 service center locations and is the second and third largest chain in the United States ("U.S.") and Canada, respectively, by number of stores. With sales in more than 140 countries and territories, Valvoline's solutions are available for every engine and powertrain, including high-mileage and heavy-duty applications, and are offered at more than 80,000 locations worldwide.


Valvoline is focused on the following key business and growth strategies in fiscal 2022:

Executing the strategic separation of Valvoline's two business segments, Retail Services and Global Products, to create sustainable value for the Company's stakeholders and best position the segments for continued long-term success by allowing Retail Services to continue its growth and focus on leveraging its world class service model and providing Global Products with the opportunity to focus and allocate capital to its own strategic priorities;

Aggressively growing Retail Services through organic service center expansion, opportunistic acquisitions, and franchisee growth, while rapidly diversifying and expanding retail service offerings and capabilities through a quick, easy, and trusted customer experience delivered by hands-on experts;

Accelerating Global Products market share growth through continued development of and investment in key global emerging and high value markets by fully leveraging brand equity and product platforms to drive speed, efficiency, and value across the business and customer interactions, while increasing penetration of Valvoline's full product portfolio;

Expanding capabilities to serve future transport vehicles by continuing to develop relationships with electric vehicle OEMs and leveraging innovation in the delivery of future services and products in direct and adjacent markets; and

Building a strong foundation enabled by data and technology to make Valvoline easy to do business with.


Strategic separation

On July 31, 2022, the Company entered into a definitive agreement to sell its Global Products business to Aramco for a cash purchase price of $2.65 billion, subject to customary adjustments with respect to working capital and net indebtedness. The transaction is subject to standard closing conditions, including regulatory approvals and is expected to close in late calendar year 2022 or early 2023. The Global Products reportable segment generated sales of approximately $1.6 billion in fiscal 2022 to-date from its engine and automotive products sold in more than 140 countries and territories to retailers, installers, and commercial customers to service light- and heavy-duty vehicles and equipment. The Global Products business is expected to be classified as held for sale and will be reflected in Valvoline's financial statements as discontinued operations beginning in the fourth quarter of fiscal 2022 until closing of the sale.

Once the transaction closes, Valvoline will retain the Valvoline brand for all retail services purposes globally, excluding China and certain countries in the Middle East and North Africa, while Aramco will own the Valvoline brand for all product uses globally. Based on this brand-sharing arrangement, there will be no licensing fees between the parties. In addition, Valvoline will procure motor oil and related products from the Global Products business through a long-term supply agreement that will be effective following the close of the transaction.

Estimated net proceeds of approximately $2.25 billion, after taxes and other expenses, are expected to be utilized to accelerate the return of capital to shareholders through share repurchases with the remainder used for debt reduction and to invest in growth opportunities in Retail Services. Valvoline expects to redeem the 2030 Notes at par based on underlying asset sale covenants and repay certain other indebtedness specifically related to Global Products, including the Trade Receivables Facility. Valvoline anticipates enhancing its capital structure through targeting a 2.5 to 3.5 times adjusted EBITDA net leverage ratio to allow for both investment in the business as well as delivery of returns to shareholders through share repurchases.

COVID-19 update

Valvoline has substantially maintained its operations, demonstrating growth and strong results, while managing through the effects of the COVID-19 global pandemic to-date. Valvoline's global offices and locations have established protocols based on continuous monitoring of the circumstances and trend data surrounding the pandemic and follow government guidelines to make decisions regarding the safe operation of its offices and locations.

In late June 2022, Valvoline updated its protocols for its U.S. employees, easing its restrictions to more broadly allow travel for business, as well as access to its global headquarters in Lexington, Kentucky. Employees are encouraged to reconnect and collaborate on-site in locations and circumstances where protocols support in-person work, while the flexibility and convenience for employees to work remotely has been maintained in many locations.

During the third quarter and year-to-date periods in fiscal 2022, China has experienced increased cases of COVID-19 that have led to reinstated restrictions, which have impacted operations and demand locally, in addition to the global supply chain. During April 2022, the Chinese government implemented strict control measures in response to the resurgence of COVID-19, which resulted in a temporary shut-down of Valvoline's local operations. Limited operations were maintained during most of April 2022, and the local blending and packaging facility resumed operations by late April, near its full capacity, which was impacted by local supply chain constraints as a result of the restrictions. Recoveries were slow and uneven, though began to improve late in the third quarter of fiscal 2022, while management continues to closely monitor the impacts and circumstances.

Management is unable to reasonably quantify the impact of COVID-19 on its current year results. The continually evolving COVID-19 pandemic remains uncertain and its future impact on Valvoline will depend on a number of factors, including among others, the duration and severity of the spread of COVID-19, emerging variants, vaccine and booster effectiveness, public acceptance of safety protocols, and government measures, including vaccine and mask mandates, among others. While the Company cannot predict the duration or the scale of the COVID-19 pandemic, or the effect it may continue to have on Valvoline's business, results of operations, or liquidity, management continuously monitors the situation, the sufficiency of its responses, and makes adjustments as needed. For more information, refer to Risk Factors included in Item 1A of Part I in Valvoline's Annual Report on Form 10-K for the fiscal year ended September 30, 2021.


The following were the significant events for the third fiscal quarter of 2022, each of which is discussed more fully in this Quarterly Report on Form 10-Q:

Valvoline continued to deliver top-line growth illustrating the strength of Valvoline's brand and operational performance in the current inflationary environment. Net income grew 2% to $99 million and diluted earnings per share increased 4% to $0.55 in the three months ended June 30, 2022 compared to the prior year period.

Retail Services sales grew 16% over the prior year period driven by system-wide same-store-sales ("SSS") growth of 9.9% and the addition of 121 net new stores to the system from the prior year. Operating income decreased 1% and adjusted EBITDA increased 1% over the prior year period. Top-line growth in the current quarter was impacted by higher product costs due to the inflationary environment, and sequential improvements form the prior quarter were largely due to pricing actions taken during the period.

Global Products sales increased 24% compared to the prior year quarter driven by volume growth of 9% and the continued progress of price pass-through of raw material cost increases. Operating income improved 11% and adjusted EBITDA increased 7% from the prior year due to top-line growth that was moderated by inflationary cost pressures and price-cost lag.

The Company returned $60 million to its shareholders during the quarter through payment of a $0.125 per share cash dividend to deliver $22 million and repurchases of Valvoline common stock of $38 million.

Use of Non-GAAP Measures

To supplement the financial measures prepared in accordance with U.S. GAAP, certain items within this document are presented on an adjusted basis. These non-GAAP measures, presented both on a consolidated and reportable segment basis, have limitations as analytical tools and should not be considered in isolation from, or as an alternative to, or more meaningful than, the financial statements presented in accordance with U.S. GAAP. The financial results presented in accordance with U.S. GAAP and reconciliations of non-GAAP measures included within this Quarterly Report on Form 10-Q should be carefully evaluated.

The following are the non-GAAP measures management has included and how management defines them:

EBITDA - defined as net income/loss, plus income tax expense/benefit, net interest and other financing expenses, and depreciation and amortization;

Adjusted EBITDA - defined as EBITDA adjusted for certain unusual, infrequent or non-operational activity not directly attributable to the underlying business, which management believes impacts the comparability of operational results between periods ("key items," as further described below);

Segment adjusted EBITDA - defined as segment operating income adjusted for depreciation and amortization, in addition to key items impacting comparability;

Free cash flow - defined as cash flows from operating activities less capital expenditures and certain other adjustments as applicable; and

Discretionary free cash flow - defined as cash flows from operating activities less maintenance capital expenditures and certain other adjustments as applicable.

These measures are not prepared in accordance with U.S. GAAP and management believes the use of non-GAAP measures on a consolidated and reportable segment basis provides a useful supplemental presentation of Valvoline's operating performance, enables comparison of financial trends and results between periods where certain items may vary independent of business performance, and allows for transparency with respect to key metrics used by management in operating the business and measuring performance. The non-GAAP information used by management may not be comparable to similar measures disclosed by other companies, because of differing methods used in calculating such measures. For a reconciliation of the most comparable U.S. GAAP measures to the non-GAAP measures, refer to the "Results of Operations" and "Financial Position, Liquidity and Capital Resources" sections below.

Management believes EBITDA measures provide a meaningful supplemental presentation of Valvoline's operating performance due to the depreciable assets associated with the nature of the Company's operations and interest costs related to Valvoline's capital structure. Adjusted EBITDA measures exclude the impact of key items, which consist of income or expenses associated with certain unusual, infrequent or non-operational activity not directly attributable to the underlying business that management believes impacts the comparability of operational results between periods. Adjusted EBITDA measures enable comparison of financial trends and results between periods where key items may vary independent of business performance. Key items are often related to legacy matters or market-driven events considered by management to be outside the comparable operational performance of the business.

Key items may consist of adjustments related to: legacy businesses, including the separation from Valvoline's former parent company and associated impacts of related indemnities; significant acquisitions or divestitures; restructuring-related matters; and other matters that are non-operational or unusual in nature. Key items also include the following:

Net pension and other postretirement plan expense/income - includes several elements impacted by changes in plan assets and obligations that are primarily driven by changes in the debt and equity markets, as well as those that are predominantly legacy in nature and related to prior service to the Company from employees (e.g., retirees, former employees, current employees with frozen benefits). These elements include (i) interest cost, (ii) expected return on plan assets, (iii) actuarial gains/losses, and (iv) amortization of prior service cost/credit. Significant factors that can contribute to changes in these elements include changes in discount rates used to remeasure pension and other postretirement obligations on an annual

basis or upon a qualifying remeasurement, differences between actual and expected returns on plan assets, and other changes in actuarial assumptions, such as the life expectancy of plan participants. Accordingly, management considers that these elements are more reflective of changes in current conditions in global financial markets (in particular, interest rates) and are outside the operational performance of the business and are also primarily legacy amounts that are not directly related to the underlying business and do not have an immediate, corresponding impact on the compensation and benefits provided to eligible employees for current service. Adjusted EBITDA includes the costs of benefits provided to employees for current service, including pension and other postretirement service costs.

Changes in the last-in, first-out ("LIFO") inventory reserve - charges or credits recognized in Cost of sales to value certain lubricant inventories at the lower of cost or market using the LIFO method. During inflationary or deflationary pricing environments, the application of LIFO can result in variability of the cost of sales recognized each period as the most recent costs are matched against current sales, while preceding costs are retained in inventories. LIFO adjustments are determined based on published prices, which are difficult to predict and largely dependent on future events. The application of LIFO can impact comparability and enhance the lag period effects between changes in inventory costs and relating pricing adjustments.

Details with respect to the composition of key items recognized during the respective periods presented herein are set forth below in the "EBITDA and Adjusted EBITDA" section of "Results of Operations" that follows.

Management uses free cash flow and discretionary free cash flow as additional non-GAAP metrics of cash flow generation. By including capital expenditures and certain other adjustments, as applicable, management is able to provide an indication of the ongoing cash being generated that is ultimately available for both debt and equity holders as well as other investment opportunities. Free cash flow includes the impact of capital expenditures, providing a supplemental view of cash generation. Discretionary free cash flow includes the impact of maintenance capital expenditures, which are routine uses of cash that are necessary to maintain the Company's operations and provides a supplemental view of cash flow generation to maintain operations before discretionary investments in growth. Free cash flow and discretionary free cash flow have certain limitations, including that they do not reflect adjustments for certain non-discretionary cash flows, such as mandatory debt repayments. The amount of mandatory versus discretionary expenditures can vary significantly between periods.

Key Business Measures

Valvoline tracks its operating performance and manages its business using certain key measures, including system-wide, company-operated and franchised store counts and SSS, and lubricant volumes 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.

Sales in the Retail Services 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 activity and end of period store counts. SSS is defined as sales by U.S. Retail Services service center stores (company-operated, franchised and the combination of these for system-wide SSS), with new stores including franchised conversions, 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. Retail Services sales are limited to sales at company-operated 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 stores as revenue in its Condensed Consolidated Statements of Comprehensive Income, management believes system-wide and franchised SSS comparisons and store counts are useful to assess market position relative to competitors and overall store and segment operating performance.

Management believes lubricant volumes sold in gallons by its consolidated subsidiaries is a useful measure in evaluating and understanding the operating performance of the Global Products segment. Volumes sold in other units of measure, including liters, are converted to gallons utilizing standard conversions.

        Consolidated review
        The following summarizes the results of the Company's operations for the period
        ended June 30:
                                                                     Three months ended June 30                                                                   Nine months ended June 30
                                                             2022                                  2021                                    2022                              2021
        (In millions)                            Amount           % of Sales           Amount           % of Sales                           Amount              % of Sales            Amount           % of Sales
        Sales                                  $   957              100.0%            $  792              100.0%                        $       2,701              100.0%            $ 2,146              100.0%
        Gross profit                           $   276               28.8%            $  259               32.7%                        $         770               28.5%            $   734               34.2%
        Net operating expenses                 $   138               14.4%            $  128               16.2%                        $         394               14.6%            $   348               16.2%
        Operating income                       $   138               14.4%            $  131               16.5%                        $         376               13.9%            $   386               18.0%
        Net income                             $    99               10.3%            $   97               12.2%                        $         267               9.9%             $   252               11.7%

        The following provides a reconciliation of the increase in sales from the prior
                                             Year-over-year changes
                                   Three months ended         Nine months ended
        (In millions)                June 30, 2022              June 30, 2022
        Volume and mix         $         44                  $              215
        Price                           123                                 326
        Currency exchange               (13)                                (22)
        Acquisitions                     11                                  36
        Change in sales        $        165                  $              555

The increases in sales were driven by benefits across both reportable segments, primarily driven by pricing actions taken to pass through cost increases along with volume growth from continued strong demand for Valvoline's products and services. Retail Services increased sales were led by system-wide SSS growth as well as store expansion from unit additions and acquisitions. Global Products sales increased with top-line growth across its regions driven by pass-through pricing in addition to record volumes.

The changes to reportable segment sales and the drivers thereof are discussed in further detail in the "Reportable Segment Review" section below.

Gross profit

The table below provides a reconciliation of the increase in gross profit from the prior year:

                                                 Year-over-year changes
                                       Three months ended         Nine months ended
        (In millions)                    June 30, 2022              June 30, 2022
        Volume and mix             $        20                   $              102
        Change in LIFO reserve               9                                    9
        Price and cost                     (11)                                 (74)
        Currency exchange                   (3)                                  (5)
        Acquisitions                         2                                    4
        Change in gross profit     $        17                   $               36

The increases in gross profit were primarily driven by higher volumes within both reportable segments along with a modest increase due to favorable mix across geographies and products within Global Products. A reduction in the LIFO charge for the current year periods, as well as unit growth through acquisitions also provided benefits to gross profit. These benefits were partially offset by product and labor inflationary cost pressures, in addition to unfavorable currency exchange.

The declines in gross profit margin rates for the current year periods compared to the prior year were primarily the result of higher raw material costs and the dilutive impact from passing through cost increases. Management continues to closely monitor the raw material cost environment and make progress in passing through cost increases.

The changes to reportable segment gross profit and the drivers thereof are discussed in further detail in the "Reportable Segment Review" section below.

Net operating expenses

The table below summarizes the components of net operating expenses for the period ended June 30:

                                                                        Three months ended June 30                                                           Nine months ended June 30
                                                                2022                                      2021                                      2022                                      2021
        (In millions)                              Amount               % of Sales           Amount            % of Sales              Amount               % of Sales           Amount            % of Sales
        Selling, general and
        administrative expenses                $        138                   14.4  %       $  136                   17.2  %       $        410                   15.2  %       $  382                   17.8  %
        Legacy and separation-related
        expenses                                         11                    1.1  %            1                    0.1  %                 20                    0.7  %            2                    0.1  %
        Equity and other income, net                    (11)                  (1.1) %           (9)                  (1.1) %                (36)                  (1.3) %          (36)                  (1.7) %
        Net operating expenses                 $        138                   14.4  %       $  128                   16.2  %       $        394                   14.6  %       $  348                   16.2  %

Expenses, including travel, advertising and promotions, supporting growth led to increases in selling, general and administrative expenses of $2 million and $12 million for the three and nine months ended June 30, 2022, respectively, compared to the prior year periods. Additionally, expected credit losses on receivables due to the disruption of business in Russia and increased costs associated with information technology investments and transitions combined for $10 million of the year-over-year increases in selling, general and administrative expenses for the nine months ended June 30, 2022.

Legacy and separation-related expenses increased in the current year periods compared to the prior year primarily due to the costs incurred in planning the separation of the Retail Services and Global Products segments. These costs include legal, tax and accounting, and other professional advisory and consulting fees, which the Company expects will continue to be incurred during the balance of fiscal 2022 and into fiscal 2023 as the businesses separate.

The increase in Equity and other income, net during the three months ended June 30, 2022 compared to the prior year was primarily driven by higher equity and royalty income attributable to the improved performance of the Company's unconsolidated joint ventures in India and Latin America that more than offset challenges in China due to COVID-19 lockdowns. Equity and other income, net was flat for the nine months ended June 30, 2022 compared to the prior year due to . . .

Aug 04, 2022


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