ITEM 1A. RISK FACTORS
The following “risk factors” could materially and adversely affect Valvoline’s business, operations, financial position or future financial performance. This information should be considered when reading the rest of this Annual Report on Form 10-K, including Management’s Discussion and Analysis and the consolidated financial statements and related notes. These factors could cause future results to differ from those in forward-looking statements and from historical trends.
Risks related to the industries in which Valvoline operates
Because of the concentration of Valvoline’s sales to a small number of customers, the loss of one or more, or a significant reduction in orders from, its top customers could adversely affect its financial results, as could the loss of one of its distributor relationships.
Valvoline’s Global Products segment’s sales represented approximately 59% of Valvoline’s total sales in fiscal 2021. Five key DIY retail channel customers together accounted for 28% of Global Products' fiscal 2021 sales and 43% of the Company’s outstanding trade accounts receivable as of September 30, 2021. One of these key customers accounted for approximately 11% of Global Products' fiscal 2021 sales. Valvoline’s volume of sales to these customers fluctuates and can be influenced by many factors, including product pricing, competition for shelf space, purchasing patterns and promotional activities. For example, Valvoline has had mixed results with its DIY retail channel customers shifting shelf distribution towards private label lubricant products, which has negative impacts on Global Products' retail channel DIY branded lubricant sales. Additionally, many of Valvoline’s retail customers have changed their promotional strategies, increasing the frequency and number of brands promoted at any given time, including private label, which has further negatively impacted branded lubricant sales within the retail channel. In response to these market dynamics, Valvoline has strengthened its consumer messaging, optimized pricing in relation to these promotional strategies and focused its efforts on increasing synthetic lubricant sales; however, if those strategies are not effective, or if Valvoline is unable to adapt to changing market dynamics, Valvoline’s results of operations could be negatively affected. The loss of, or significant reduction in orders from, one of Valvoline’s top five retail customers or any other significant customer could have a material adverse effect on its business, financial condition, results of operations or cash flows, as could customer disputes regarding shipments, fees, merchandise condition or related matters. Valvoline’s inability to collect accounts receivable from one of its major customers, or a significant deterioration in the financial condition of one of these customers, including a bankruptcy filing or a liquidation, could also have a material adverse effect on Valvoline’s financial condition, results of operations or cash flows.
Valvoline also relies on independent distributors to sell and deliver its products. The consolidation of distributors, loss of a relationship with a distributor, significant disagreement with a distributor, or significant deterioration in the financial condition of a distributor could also have a material adverse effect on Valvoline’s financial condition, results of operations or cash flows.
Valvoline faces significant competition from other companies, which places downward pressure on prices and margins and may adversely affect Valvoline’s business and results of operations.
Valvoline operates in highly competitive markets, competing against a number of domestic and international companies. Competition is based on several key criteria, including brand recognition, product performance and quality, product price, product availability and security of supply, ability to develop products in cooperation with customers and customer service, as well as the ability to bring innovative products or services to the marketplace. Certain key competitors, including Shell/Pennzoil, BP/Castrol and Exxon/Mobil, are significantly larger than Valvoline and have greater financial resources and more diverse portfolios of products and services, leading to greater operating and financial flexibility. As a result, these competitors may be better able to withstand adverse changes in conditions within the relevant industry, retail market dynamics, the prices of raw materials and energy or general economic conditions. In addition, competitors’ pricing decisions could compel Valvoline to decrease its prices, which could negatively affect Valvoline’s margins and profitability.
Valvoline continues to see increasing competition from private label competitors, which has negatively impacted branded lubricant sales in the retail channel as price gaps between private label and branded products has grown. Further competition from private label competitors, including the entry of new private label competitors, or additional
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competition in markets served by Valvoline, could adversely affect margins and profitability and could lead to a reduction in market share. Also, Valvoline competes in certain markets that are relatively flat to declining, such as the U.S. passenger car motor oil market. If Valvoline’s strategies for dealing with these markets and leveraging market opportunities are not successful, its results of operations could be negatively affected.
Rising and volatile raw material costs and supply-chain constraints or disruptions could adversely affect Valvoline’s results of operations.
Increases in raw material prices, including those from inflationary pressures or from supply chain constraints such as those experienced in fiscal 2021 for base oils and additives, have in the past and may continue in the future to adversely impact Valvoline’s costs, results of operations and the valuation of its inventory. In fiscal 2021, results were impacted by significant rising raw material costs, a substantial portion of which were passed through to customers through a series of price increases. Pricing actions generally lag material cost increases as many customer contracts are negotiated, with a smaller but meaningful portion indexed to accommodate changes in base oil prices. Although Valvoline expects lingering price-cost lag to impact the first half of 2022, the Company is making progress passing these cost increases through and expects to execute additional pricing actions in the first half of fiscal 2022. Valvoline may not always be able to raise prices in response to increased costs of raw materials or may experience a lag in passing through such cost increases, as the ability to pass on the costs of such price increases is largely dependent upon market conditions. Likewise, reductions in the valuation of Valvoline’s inventory due to market volatility may not be recovered and could result in losses.
Valvoline purchases certain products and raw materials from suppliers, often pursuant to written supply contracts. If those suppliers are unable to meet Valvoline’s orders in a timely manner or choose to terminate or otherwise avoid contractual arrangements, Valvoline may not be able to make alternative supply arrangements or may face increased costs from alternative suppliers. For base oils, Valvoline’s suppliers are primarily large oil producers, many of whom operate oil lubricant production and sales businesses as part of their enterprise. There are risks inherent in obtaining important raw materials from actual or potential competitors, including the risk that applicable antitrust laws may be inadequate to mitigate Valvoline’s exposure to these risks. Valvoline purchases substantially all of its lubricant additives from four key suppliers.Because the industry is characterized by a limited number of lubricant additives suppliers, there are a limited number of alternative suppliers with whom Valvoline could transact in the event of a disruption to its existing supply relationships; for example, due to disruptions to its suppliers' operations caused by natural disasters, severe weather conditions, climate change, significant changes in trade regulations, increases in costs, or any deterioration in the financial viability of or relationships with its key suppliers.
In fiscal 2021, certain of Valvoline's suppliers began to experience disruptions in their supply chain as demand overwhelmed supply related partially to pandemic shutdowns and adverse weather events along the Gulf Coast, notably the unprecedented freezing in Texas, that impacted many chemical suppliers in those areas. Valvoline worked with its key suppliers to manage through the challenges and is continuing to monitor the constraints, expecting some lingering impacts in the first half of fiscal 2022. Should conditions such as supply chain congestion or availability related to severe weather or climate conditions worsen, become more severe or last for an extended period of time, Valvoline's supply of raw materials or other products could impact its ability to meet customer demands.
Also, domestic and global government regulations related to the manufacture or transport of certain raw materials may impede Valvoline’s ability to obtain those raw materials on commercially reasonable terms. If Valvoline is unable to obtain and retain qualified suppliers under commercially acceptable terms, its ability to manufacture and deliver products in a timely, competitive and profitable manner or grow its business successfully could be adversely affected.
Demand for Valvoline’s products and services could be adversely affected by consumer spending trends, declining economic conditions, industry trends and a number of other factors, all of which are beyond its control.
Demand for Valvoline’s products and services may be affected by a number of factors it cannot control, including the number and age of vehicles in current service, regulation and legislation, technological advances in the automotive industry and changes in engine technology, including the adoption rate of electric or other alternative engine technologies, changing automotive OEM specifications and longer recommended intervals between oil changes. In addition, during periods of declining economic conditions, consumers may defer vehicle maintenance.
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Similarly, increases in energy prices or other factors may cause miles driven to decline, resulting in less vehicle wear and tear and lower demand for maintenance, which may lead to consumers deferring purchases of Valvoline’s products and services. All of these factors, which impact metrics such as drain intervals and oil changes per day, could result in a decline in the demand for Valvoline’s products and services and adversely affect its sales, cash flows and overall financial condition.
Failure to develop and market new products, services and production technologies could impact Valvoline’s competitive position and have an adverse effect on its business and results of operations.
The lubricants industry is subject to periodic technological change and ongoing product improvements. To maintain margins and remain competitive, Valvoline must successfully innovate and introduce new products, improvements or services that appeal to its customers and global consumers. Changes in additive technologies, base oil production techniques and sources, and the demand for improved performance by OEMs and consumers place particular pressure on Valvoline to continue to improve its product offerings. In addition, the adoption of electric vehicles is increasing and is expected to increase at a faster pace in future years as certain states and international governments implement limits on the sale of vehicles with internal combustion engines, which reduces demand for lubricants, but expands the opportunity for other products and services required by electric vehicles, including coolants, fluids and greases. If Valvoline is unable to develop and market products and services for electric vehicles, its business and results of operations could be adversely impacted. As automotive technologies evolve, Valvoline could be required to comply with any new or stricter laws or regulations, which could require additional expenditures by Valvoline or its suppliers and could adversely impact business results.
Valvoline’s efforts to respond to changes in consumer demand in a timely and cost-efficient manner to drive growth could be adversely affected by difficulties or delays in product development and service innovation, including the inability to identify viable new products, successfully complete research and development, obtain regulatory approvals, obtain intellectual property protection or gain market acceptance of new products or service techniques. Due to the lengthy development process, technological challenges and intense competition, there can be no assurance that any of the products or services Valvoline is currently developing, or could develop in the future, will achieve substantial commercial success. The time and expense invested in product development may not result in commercial products or provide revenues. Valvoline could be required to write-off its investments related to a new product that does not reach commercial viability. Moreover, Valvoline may experience operating losses after new products are introduced and commercialized because of high start-up costs, unexpected manufacturing costs or problems, or lack of demand.
Damage to Valvoline’s brand and reputation could have an adverse effect on its business.
Maintaining Valvoline’s strong reputation with both consumers and customers is a key component of its business. Product liability claims, false advertising claims, product or service complaints or recalls, its inability to ship, sell or transport affected products and governmental investigations could result in substantial and unexpected expenditures and affect consumer or customer confidence in Valvoline's products and services, which may materially and adversely affect its business operations, decrease sales and increase costs. Additionally, as consumers are shifting to more environmentally-conscious electric and hybrid vehicles, the inability of Valvoline to continue its development of new products and services to adapt to those changing demands could affect the Company's reputation as an environmentally friendly choice for vehicle care and could reduce demand for its products. Further, legislators, consumers, investors and other stakeholders are increasingly focusing on environmental, social and governance policies of companies. This focus could result in new or increased legislation or disclosure requirements. In the event that such requirements result in increased costs or a negative perception of the Company, there could be an adverse effect on the business or its results of operations.
Valvoline manufactures and markets a variety of products, such as automotive and industrial lubricants and automotive coolants and chemicals, and provides automotive maintenance services. If allegations are made that some of Valvoline’s products have failed to perform up to consumers’ or customers’ expectations or have caused damage or injury to individuals or property, or that Valvoline’s services were not provided in a manner consistent with its vision and values, the public may develop a negative perception of Valvoline and its brands. In addition, if Valvoline’s franchisees, Express Care and joint venture operators experience service failures or do not successfully operate their quick lube service centers in a manner consistent with Valvoline’s standards, its brand, image and reputation could be harmed, which in turn could negatively impact its business and operating results. In addition, if
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any party with whom Valvoline has a sponsorship relationship were to generate negative publicity, Valvoline's brand image could be harmed. A negative public perception of Valvoline’s brands, whether justified or not, could impair its reputation, involve it in litigation, damage its brand equity and have a material adverse effect on its business. In addition, damage to the reputation of Valvoline’s competitors or others in its industry could negatively impact Valvoline’s reputation and business.
Risks related to executing Valvoline’s strategy
The proposed separation of Valvoline’s two business segments, Retail Services and Global Products, could be disruptive to Valvoline’s business and operations, and there can be no assurance that it will provide business benefits or that it will be consummated within any specified time period or at all.
On October 12, 2021, Valvoline announced that, following a comprehensive review of strategic alternatives by Valvoline’s Board of Directors (the “Board”) and executive management, it is pursuing the separation of its two business segments, Retail Services and Global Products (the “Proposed Separation”). Valvoline is working with its outside advisors on determining the best way to accomplish the Proposed Separation. No timetable has been established for the completion of the Proposed Separation, and Valvoline does not intend to disclose further developments with respect to this process, unless and until the Board approves a specific transaction or action. There are many factors that could impact the structure or timing of, or Valvoline’s determination to proceed with, the Proposed Separation, including global economic conditions, tax considerations, market conditions and changes in the regulatory or legal environment, any of which could adversely impact the value of the Proposed Separation to Valvoline’s shareholders.
The Proposed Separation, if consummated, involves risks, including potential difficulties associated with the separation of operations, services and personnel, potential disruption in Valvoline’s operations or businesses, the potential loss of, or inability to recruit, key employees and potential adverse effects on relationships with key customers and other business counterparties. In addition, Valvoline will incur significant expense in connection with pursuing the Proposed Separation. Pursuing the Proposed Separation will require significant amounts of management time and effort, which may divert management’s attention from other aspects of Valvoline’s business operations. If Valvoline does not successfully manage these risks, Valvoline’s business, financial condition and results of operations could be adversely affected.
The Proposed Separation may not achieve the intended results, or results may take longer to realize than expected. Unanticipated developments could delay, prevent or otherwise adversely affect the Proposed Separation, including disruptions in general market conditions, the capital markets or other developments. The anticipated benefits of the Proposed Separation are based on a number of assumptions, some of which may prove incorrect. In addition, Valvoline cannot assure that it will be able to complete the Proposed Separation within any specified timeline, or at all. Delays or failure to consummate the Proposed Separation could negatively affect Valvoline’s business, financial condition and results of operations.
Valvoline has set aggressive growth goals for its business, including increasing sales, cash flow, market share, margins and number of Retail Services stores, to achieve its long-term strategic objectives. Execution of Valvoline’s growth strategies and business plans to facilitate that growth involves a number of risks.
Valvoline has set aggressive growth goals for its business to meet its long-term strategic objectives and improve shareholder value by aggressively growing Retail Services organically and through acquisitions, and developing Global Products with the goal of becoming a more service-driven business. Valvoline’s failure to meet one or more of these goals or objectives could negatively impact its business and is one of the most important risks that Valvoline faces. Aspects of that risk include, among others, changes to the global economy, failure to identify acquisition targets or real estate for new stores to grow Retail Services, construction costs or delays limiting new store growth, failure to develop products or services for electric vehicles, changes to the competitive landscape, including those related to automotive maintenance recommendations and consumer preferences, continued private label growth, entry of new competitors, failure to grow the Valvoline brand internationally, attraction and retention of skilled employees, failure to successfully develop and implement digital platforms to support the Company’s growth initiatives, the potential failure of product innovation plans, failure to comply with existing or new regulatory
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requirements, failure to maintain a competitive cost structure and other risks outlined in greater detail in this “Risk Factors” section.
Valvoline's performance is highly dependent on attracting and retaining appropriately qualified employees in its service center stores, manufacturing plants and distribution centers, research and development facilities, and corporate offices. A tight labor market in fiscal 2021 and continuing into fiscal 2022, has led to challenges in staffing service center stores due to labor shortages as a number of trends conflate reflecting changing demographics, governmental policies, employee sentiment, and technological change. In response, Valvoline made labor investments and enhanced its recruiting programs to attract new employees. As trends in the labor market evolve, the Company may experience future challenges in recruiting and retaining talent in various locations. Valvoline operates in a competitive labor market, and failure to recruit or retain qualified employees in the future, or the Company's inability to implement corresponding adjustments to its labor model, including compensation and benefit packages, could impair the Company's ability to grow and meet its strategic goals.
Valvoline may be unable to execute its growth strategy, and acquisitions, joint ventures, strategic alliances and investments could result in operating difficulties, dilution and other harmful consequences that may adversely impact Valvoline’s business and results of operations.
Acquisitions, particularly for the Retail Services business segment, are an important element of Valvoline’s overall growth strategy. Valvoline had strong acquisition growth in fiscal 2021, and has developed a pipeline of future viable targets expected to complement the segment's strong growth initiatives. An insufficient quantity of strategic acquisition targets in the marketplace, or the inability of Valvoline to successfully acquire those targets, may have a negative impact on Valvoline's future results. In addition, building strategic alliances for distribution and manufacturing, particularly in international markets, including through joint venture partnerships, product distribution and toll manufacturing arrangements, are also an important element of Valvoline’s overall growth strategy. Valvoline expects to continue to evaluate and enter into discussions regarding a wide array of potential strategic transactions, and to continue to grow its Retail Services business organically and through acquisitions. An inability to execute these plans could have a material adverse impact on Valvoline’s financial condition and results of operations. In addition, the anticipated benefits of Valvoline’s acquisitions may not be realized and the process of integrating an acquired company, business, or product may create unforeseen operating difficulties or expenditures.
Valvoline’s acquisitions, investments and strategic alliances could also result in dilutive issuances of its equity securities, the incurrence of debt, contingent liabilities or amortization expenses, impairment of goodwill or purchased long-lived assets and restructuring charges, any of which could harm its financial condition, results of operations and cash flows.
The business model for Valvoline’s Retail Services business, including its relationships with franchisees, presents a number of risks.
The Retail Services business is made up of a network of both company-operated and franchised stores. Valvoline’s success relies in part on the financial success and cooperation of its franchisees. However, Valvoline has limited influence over their operations. Valvoline’s franchisees manage their businesses independently and are responsible for the day-to-day operations of approximately 55% of Retail Services stores as of September 30, 2021. Valvoline’s royalty, product, and other revenues from franchised stores are largely dependent on franchisee sales. Valvoline’s revenues and margins could be negatively affected should franchisees experience limited or no sales growth, or if the franchisee fails to fulfill its obligations under negotiated business development, franchise, or supply agreements with Valvoline. If sales or business performance trends worsen for franchisees, their financial results may deteriorate, which could result in, among other things, store closures, delayed or reduced royalties and purchases and reduced growth in the number of Retail Services stores.
Valvoline’s success also depends on the willingness and ability of its independent franchisees to implement major initiatives, which may require additional investment by them, and to remain aligned with Valvoline on operating, promotional and capital-intensive reinvestment plans. The ability of Valvoline’s franchisees to contribute to the achievement of Valvoline’s overall plans is dependent in large part on the availability of funding to its franchisees at reasonable interest rates and may be negatively impacted by the financial markets in general or the creditworthiness of individual franchisees. The size of Valvoline’s largest franchisees creates additional risk due to their importance to Retail Services' growth strategy, requiring their cooperation and alignment with Valvoline’s initiatives.
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Valvoline is the primary supplier of products to all Retail Services stores. The growth and performance of Valvoline’s lubricants and other product lines depends in large part on the performance of its Retail Services business, potentially amplifying the negative effect of the other risks related to the Retail Services business model.
Valvoline shares in ownership of joint ventures, which may limit its ability to manage third-party risks associated with these projects.
For financial or strategic reasons, Valvoline conducts a portion of its business through joint ventures. Valvoline's joint ventures, particularly its existing 50/50 joint ventures with Cummins in India, China and Argentina, are an important part of the Company's international growth strategy. In its joint ventures, while Valvoline shares influence over the operation of the joint venture and its assets, it does not have a controlling interest or vote. Therefore, joint ventures may involve risks such as the possibility that a joint venture partner in an investment might become bankrupt, be unable to meet its capital contribution obligations, have economic or business interests or goals that are inconsistent with Valvoline's business interests or goals, or take actions that are contrary to Valvoline's direction or to applicable laws and regulations.
Further, Valvoline is a supplier to certain of its joint venture partners that sell to their end customers. If Valvoline’s relationship with one or more of its partners were to deteriorate, it could negatively impact Valvoline’s ability to reach and penetrate certain global markets and achieve its growth goals. In addition, joint venture partners could take actions that violate the terms of its investment agreements with Valvoline, or Valvoline may be unable to gain concurrence with its joint venture partners to take desired actions with its investments. Additionally, actions by joint ventures, joint venture partners or other third-parties could expose Valvoline to claims for damages, financial penalties and reputational harm, any of which could have an adverse effect on its business and operations. Although joint ventures may generate positive cash flows, in some cases they may be unable or unwilling to make distributions to the joint venture partners.
Risks related to operating Valvoline's business
Valvoline’s significant global operations subject it to risks, which could adversely affect its business, financial condition and results of operations.
Valvoline expects its non-U.S. sales to continue to grow as the Company continues to invest in international markets. Sales outside of the U.S. represented 26% of the Company's consolidated sales in fiscal 2021. The Company has multiple manufacturing locations outside of the United States, which includes its blending and packaging plant in China that began production in fiscal 2021. Accordingly, its business is subject to risks related to the differing legal, political, cultural, social and regulatory requirements and economic conditions of many jurisdictions.
The global nature of Valvoline’s business presents difficulties in hiring and maintaining a workforce in certain countries. Fluctuations in exchange rates could affect product demand and may adversely affect the cost of transacting in other countries. In addition, other countries may impose additional withholding taxes or otherwise tax Valvoline’s income, or adopt other restrictions on trade or investment, including currency exchange controls. The imposition of new or additional tariffs or other significant changes in trade regulations are also risks that could impair Valvoline’s financial performance and increase operating costs which Valvoline may not be able to recapture.
Certain legal and political risks are also inherent in the operation of a company with Valvoline’s global scope. For example, it may be more difficult for Valvoline to enforce its agreements or collect receivables through other legal systems. There is a risk that non-U.S. governments may nationalize private enterprises in certain countries where Valvoline operates. Social and cultural standards in certain countries may not support compliance with Valvoline’s corporate policies including those that require compliance with substantive laws and regulations. Also, changes in general economic and political conditions in countries where Valvoline operates are a risk to Valvoline’s financial performance and future growth. As Valvoline continues to operate its business globally, its success will depend, in part, on its ability to anticipate and effectively manage these and other related risks. There can be no assurance that the consequences of these and other factors relating to Valvoline’s global operations will not have an adverse effect on its business, financial condition or results of operations.
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Adverse developments in the global economy or in regional economies and potential disruptions of financial markets could negatively impact Valvoline’s customers and suppliers, and therefore have a negative impact on its results of operations.
A global or regional economic downturn may reduce customer demand or inhibit Valvoline’s ability to produce and sell products. Valvoline’s business and operating results are sensitive to global and regional economic downturns, credit market tightness, declining consumer and business confidence, fluctuating commodity prices, volatile exchange rates, changes in interest rates, sovereign debt defaults and other challenges, including those related to international sanctions and acts of aggression or threatened aggression that can affect the global economy. With 76% of Valvoline’s sales coming from North America in fiscal 2021, Valvoline is particularly sensitive to the risk of an economic slowdown or downturn in that region. In the event of adverse developments or stagnation in the economy or financial markets, Valvoline’s customers may experience deterioration of their businesses, reduced demand for their products, cash flow shortages and difficulty obtaining financing. As a result, existing or potential customers might delay or cancel plans to purchase products and may not be able to fulfill their obligations to Valvoline in a timely fashion. Further, suppliers may experience similar conditions, which could impact their ability to fulfill their obligations to Valvoline. A weakening or reversal of the global economy or a substantial part of it could negatively impact Valvoline’s business, results of operations, financial condition and ability to grow.
Pandemics, epidemics or disease outbreaks, such as the novel coronavirus, may disrupt Valvoline’s business and operations, which could materially affect Valvoline’s financial condition, results of operations and forward-looking expectations.
Disruptions caused by pandemics, epidemics or disease outbreaks, such as COVID-19, in the United States or globally, could materially affect Valvoline's results of operations, financial condition and forward-looking expectations. The ongoing COVID-19 pandemic continues to impact Valvoline's business, particularly as it relates to congestion in the supply chain and related cost and sourcing challenges, as well as the disruption in the labor market. The extent to which the pandemic will continue to impact Valvoline's business results and operations remains uncertain considering the rapidly evolving environment, 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 mandates, implemented at the local and federal levels designed to slow and contain the spread of COVID-19, among others.
Valvoline has seen a marked improvement in miles driven and demand in the Company's key markets during fiscal 2021 compared to the prior year lows at the peak of COVID-19 restrictions. However, the spread of new or worsening COVID-19 variants could result in the resurgence of lockdowns or stay-at-home guidelines which would continue to place pressure on Valvoline’s business, results of operations, liquidity, financial condition, and forward-looking expectations, particularly if these impacts continue for an extended period of time. Valvoline has also experienced uneven recovery within its international markets in fiscal 2021 as COVID-19 outbreaks exhibit patterns of improvement and resurgence worldwide, particularly in southeast Asia. As this uneven recovery continues, and depending on the severity and duration of additional outbreaks, Valvoline may voluntarily elect or be required to temporarily close or reduce operations at its lubricant blending and packaging plants as well as its service center stores.
Worsening conditions in the severity and spread of COVID-19, or other pandemics, epidemics, or disease outbreaks, could adversely affect Valvoline’s ability to implement its growth plans, including, without limitation, delay the construction or acquisition of new Retail Services service center stores, or negatively impact Valvoline’s ability to successfully execute plans to enter into new markets; reduce demand for Valvoline’s products and services; cause Valvoline to experience further inefficiencies in the supply chain, including but not limited to, the delivery of products and services to Valvoline’s customers, receipt of raw materials from suppliers or increased costs of raw materials; reduce sales or profitability; negatively impact Valvoline’s ability to maintain operations; or lead to significant disruption of global financial markets, which may reduce the Company’s ability to access capital and, in the future, negatively affect the Company’s liquidity.
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Valvoline uses information technology systems to conduct business, and a cyber security threat, privacy/data breach, or failure of a key information technology system could adversely affect Valvoline’s business and reputation.
Valvoline relies on its information technology systems, including systems which are managed or provided by third-party service providers, to conduct its business. Despite employee training and other measures to mitigate them, cyber-security threats to its information technology systems, and those of its third-party service providers, are increasing and becoming more advanced and breaches could occur as a result of denial-of-service attacks or other cyber-attacks, hacking, phishing, viruses, malicious software, ransomware, computer malware, social engineering, break-ins, security breaches or due to error or misconduct by its employees, contractors or third-party service providers. A breach of or failure of Valvoline’s information technology systems, including systems in which data is stored in or may be transferred across third-party platforms, could lead to the loss and destruction of trade secrets, confidential information, proprietary data, intellectual property, customer and supplier data, and employee personal information, and could disrupt business operations which could adversely affect Valvoline’s relationships with business partners and harm its brands, reputation and financial results. Valvoline’s customer and vendor data may include names, addresses, phone numbers, email addresses and payment account information, among other information. Depending on the nature of the customer data that is compromised, Valvoline may also have obligations to notify users, law enforcement or payment companies about the incident and may need to provide some form of remedy, such as refunds for the individuals affected by the incident. Valvoline could also face fines and penalties should it fail to adequately notify affected parties pursuant to new and evolving privacy laws in various jurisdictions in which it does business, as outlined in greater detail in the "Regulatory, legal, and financial risks" section below.
Business disruptions from natural, operational and other catastrophic risks could seriously harm Valvoline’s operations and financial performance. In addition, a catastrophic event at one of Valvoline’s facilities or involving its products or employees could lead to liabilities that could further impair its operations and financial performance.
Business disruptions, including those related to operating hazards inherent in the production of lubricants, natural disasters, severe weather conditions, climate change, supply or logistics disruptions, increasing costs for energy, temporary plant and/or power outages, information technology systems and network disruptions, cyber-security breaches, terrorist attacks, armed conflicts, war, pandemic diseases, fires, floods or other catastrophic events, could seriously harm Valvoline’s operations, as well as the operations of Valvoline’s customers and suppliers, and may adversely impact Valvoline’s financial performance. Although it is impossible to predict the occurrence or consequences of any such events, they could result in reduced demand for Valvoline’s products; make it difficult or impossible for Valvoline to manufacture its products, deliver products and services to its customers, or receive raw materials from suppliers; lead to increased costs of raw materials; or create delays and inefficiencies in the supply chain. In addition to leading to a serious disruption of Valvoline’s businesses, a catastrophic event at one of Valvoline’s facilities or involving its products or employees could lead to substantial legal liability to or claims by parties allegedly harmed by the event.
While Valvoline maintains business continuity plans that are intended to allow it to continue operations or mitigate the effects of events that could disrupt its business, Valvoline cannot provide assurances that its plans would fully protect it from all such events. In addition, insurance maintained by Valvoline to protect against property damage, loss of business and other related consequences resulting from catastrophic events is subject to significant retentions and coverage limitations, depending on the nature of the risk insured. This insurance may not be sufficient to cover all of Valvoline’s damages or damages to others in the event of a catastrophe. In addition, insurance related to these types of risks may not be available now or, if available, may not be available in the future at commercially reasonable rates.
Regulatory, legal, and financial risks
Data protection requirements could increase operating costs and requirements and a breach in information privacy or other related risks could negatively impact operations.
Valvoline is subject to federal, state, and non-U.S. laws, directives, and regulations relating to the collection, use, retention, disclosure, security and transfer of personal data relating to its customers and employees. These laws,
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directives and regulations, and their interpretation and enforcement continue to evolve and may be inconsistent from jurisdiction to jurisdiction. For example, the General Data Protection Regulation (“GDPR”) applies to all of Valvoline’s activities conducted from an establishment in the European Union ("EU") and may also apply to related products and services that Valvoline offers to customers in the EU. In addition, the California Consumer Privacy Act ("CCPA") applies to Valvoline's activities conducted in the state of California. Complying with the GDPR, CCPA, and similar emerging and changing privacy and data protection requirements may cause Valvoline to incur substantial costs or disruption to is operations.
Noncompliance with these legal obligations relating to privacy and data protection could damage Valvoline's reputation and affect its ability to retain and attract customers. Additionally, any failure or perceived failure by Valvoline or any third parties with which it does business, to comply with these privacy and data protection laws, rules and regulations, or with respect to similar obligations to which Valvoline may be or become subject, may result in actions against Valvoline by governmental entities, private claims and litigation, fines, penalties or other liabilities. Any such action would be expensive to defend, damage Valvoline’s reputation and adversely affect business, operating results, financial position and cash flows.
The impact of changing laws or regulations or the manner of interpretation or enforcement of existing laws or regulations could adversely impact Valvoline’s financial performance and restrict its ability to operate its business or execute its strategies.
New laws or regulations, or changes in existing laws or regulations or the manner of their interpretation or enforcement, could increase Valvoline’s cost of doing business and restrict its ability to operate its business or execute its strategies. This risk includes, among other things, compliance with a myriad of U.S. and non-U.S. tax laws and regulations; anti-competition laws and regulations; product compliance regulations, including the EU’s Registration, Evaluation, Authorisation and Restriction of Chemicals (“REACH”) regulation; anti-corruption and anti-bribery laws, including FCPA and the U.K. Bribery Act; anti-money-laundering laws; economic sanctions and export control laws and regulations, including those administered by the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”); customs laws; and other laws governing Valvoline’s operations.
Although Valvoline has implemented policies and procedures to ensure compliance with these laws and regulations, it cannot be sure that its policies and procedures are sufficient or that directors, officers, employees, representatives, distributors, consultants and agents have not engaged and will not engage in conduct for which Valvoline may be held responsible, nor can Valvoline be sure that its business partners have not engaged and will not engage in conduct that could materially affect their ability to perform their contractual obligations to Valvoline or even result in its being held liable for such conduct. Violations of the these laws or regulations may result in severe criminal or civil sanctions or penalties, or significant changes in existing laws and regulations may subject Valvoline to other liabilities, which could have a material adverse effect on its business, financial condition, cash flows and results of operations.
Valvoline’s substantial indebtedness may adversely affect its business, results of operations and financial condition.
Valvoline has substantial indebtedness and financial obligations. As of September 30, 2021, Valvoline had outstanding indebtedness of $1.7 billion, with a borrowing capacity remaining under its existing credit facilities of $586 million. Valvoline may incur substantial additional debt from time to time to finance working capital, capital expenditures, investments or acquisitions, or for other general corporate purposes.
Valvoline's substantial indebtedness could adversely affect its business, results of operations and financial condition by, among other things: requiring Valvoline to dedicate a substantial portion of its cash flows to pay principal and interest on its debt, which would reduce the availability of its cash flow to fund working capital, capital expenditures, acquisitions, execution of its growth strategy and other general corporate purposes; limiting Valvoline’s ability to borrow additional amounts to fund working capital, capital expenditures, acquisitions, debt service requirements, execution of its growth strategy and other general corporate purposes; making Valvoline more vulnerable to adverse changes in general economic, industry and regulatory conditions and in its business by limiting its flexibility in planning for or reacting to changing conditions; placing Valvoline at a competitive disadvantage compared with its competitors that have less debt and lower debt service requirements; making Valvoline more vulnerable to increases in interest rates since some of its indebtedness is subject to variable rates of interest; and making it more difficult for Valvoline to satisfy its financial obligations.
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In addition, Valvoline may not be able to generate sufficient cash flows to repay its indebtedness when it becomes due and to meet its other cash needs. If Valvoline is not able to pay its debts as they become due, it could be in default under the terms of its indebtedness. Valvoline might also be required to pursue one or more alternative strategies to repay indebtedness, such as selling assets, refinancing or restructuring its indebtedness or selling additional debt or equity securities. Valvoline may not be able to refinance its debt or sell additional debt or equity securities or its assets on favorable terms, if at all, and if it must sell its assets, it may negatively affect Valvoline’s ability to generate revenues.
Valvoline’s pension and other postretirement benefit plan obligations are currently underfunded, and Valvoline may have to make significant cash payments to some or all of these plans, which would reduce the cash available for its business.
In connection with Valvoline’s separation from Ashland, Valvoline assumed certain of Ashland’s historical pension and other postretirement benefit plans and related liabilities. The most significant of these plans, the U.S. qualified pension plans, are estimated to be underfunded by $37 million as of September 30, 2021. The funded status of Valvoline's pension plans is dependent upon many factors, including returns on invested assets, the level of certain market interest rates and the discount rate used to determine pension obligations. Valvoline has taken a number of actions to reduce the risk and volatility associated with the U.S. pension plans, however, changing market conditions or laws and regulations could require material increases in the expected cash contributions to these plans in future years. Specifically, unfavorable returns on plan assets or unfavorable changes in applicable laws or regulations could materially change the timing and amount of required plan funding. In addition, a decrease in the discount rate used to determine pension obligations could result in an increase in the valuation of pension obligations, which could affect the reported funded status of Valvoline’s U.S. pension plans and future contributions. Similarly, an increase in discount rates could increase the periodic pension cost in subsequent fiscal years. If any of these events occur, Valvoline may have to make cash payments to its U.S. pension plans, which would reduce the cash available for its business. Finally, Valvoline’s policy to recognize changes in the fair value of the pension assets and liabilities annually and as otherwise required through mark to market accounting could result in volatility in Valvoline’s earnings, which could be material.
Valvoline may fail to adequately protect its intellectual property rights or may be accused of infringing the intellectual property rights of third parties.
Valvoline relies heavily upon its trademarks, domain names and logos, as well as upon trade secrets, to market its brands and to build and maintain brand loyalty and recognition. Valvoline also relies on a combination of laws and contractual restrictions with employees, customers, suppliers, affiliates and others, to establish and protect its various intellectual property rights. For example, Valvoline has generally registered and continues to register and renew, or secure by contract where appropriate, trademarks and service marks as they are developed and used, and reserve, register and renew domain names as appropriate. Effective trademark protection may not be available or may not be sought in every country in which Valvoline’s products are made available and contractual disputes may affect the use of marks governed by private contract. Similarly, not every variation of a domain name may be available to or be registered by Valvoline, even if available.
Valvoline generally seeks to apply for patents or for other similar statutory protections as and if it deems appropriate, based on then-current facts and circumstances, and will continue to do so in the future. No assurances can be given that any patent application Valvoline has filed or will file will result in a patent being issued, or that any existing or future patents will afford adequate or meaningful protection against competitors or against similar technologies. In addition, no assurances can be given that third parties will not create new products or methods that achieve similar results without infringing upon patents Valvoline owns. Furthermore, the terms of patents are finite and the patents that Valvoline owns will eventually expire after the statutory term of patent protection ends in the jurisdiction where such patents are issued.
Despite these measures, Valvoline’s intellectual property rights may still not be protected in a meaningful manner, challenges to contractual rights could arise and third parties could copy or otherwise obtain and use Valvoline’s intellectual property without authorization, including its trade secrets and other confidential intellectual property. The occurrence of any of these events could result in the erosion of Valvoline’s brands and limit its ability to market its brands using its various trademarks, cause Valvoline to lose such trade secrets, as well as impede its ability to
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effectively compete against competitors with similar products and services, any of which could adversely affect its business, financial condition and results of operations.
From time to time, Valvoline has been subject to legal proceedings and claims, including claims of alleged infringement of trademarks, copyrights, patents and other intellectual property rights held by third parties. In the future, third parties may sue Valvoline for alleged infringement of their proprietary or intellectual property rights. Valvoline may not be aware of whether its products do or will infringe existing or future patents or other intellectual property rights of others. In addition, litigation may be necessary to enforce Valvoline’s intellectual property rights, protect its trade secrets or determine the validity and scope of proprietary rights claimed by others. Any litigation or other intellectual property proceedings of this nature, regardless of outcome or merit, could result in substantial costs and diversion of management and technical resources, or loss of rights in Valvoline’s intellectual property, any of which could adversely affect Valvoline’s business, financial condition and results of operations.
Valvoline has incurred, and will continue to incur, costs as a result of EHS and hazardous substances liabilities and related compliance requirements. These costs could adversely impact Valvoline’s cash flow, its results of operations or financial condition.
Valvoline is subject to extensive federal, state, local and non-U.S. laws, regulations, rules and ordinances relating to pollution, protection of the environment and human health and safety, as well as the generation, storage, handling, treatment, disposal and remediation of hazardous substances and waste materials. Valvoline has incurred, and will continue to incur, costs and capital expenditures to comply with these laws and regulations.
EHS regulations change frequently, and such regulations and their enforcement have tended to become more stringent over time. Accordingly, changes in EHS laws and regulations and the enforcement of such laws and regulations could interrupt Valvoline’s operations, require modifications to its facilities or cause it to incur significant liabilities, costs or losses that could adversely affect its profitability. Actual or alleged violations of EHS laws and regulations could result in restrictions or prohibitions on plant operations as well as substantial damages, penalties, fines, civil or criminal sanctions and remediation costs.
Valvoline’s business involves the production, storage and transportation of hazardous substances. Under some environmental laws, Valvoline may be strictly liable and/or jointly and severally liable for environmental damages caused by releases of hazardous substances and waste materials into the environment. For instance, under relevant laws and regulations Valvoline may be deemed liable for soil and/or groundwater contamination at sites it currently owns and/or operates even though the contamination was caused by a third party such as a former owner or operator, and at sites it formerly owned and operated if the release of hazardous substances or waste materials was caused by it or by a third party during the period it owned and/or operated the site. Valvoline also may be deemed liable for soil and/or groundwater contamination at sites to which it sent hazardous wastes for treatment or disposal, notwithstanding that the original treatment or disposal activity accorded with all applicable regulatory requirements.
The Company’s Amended and Restated Articles of Incorporation (the “Articles”) designate the Fayette County Circuit Court of the Commonwealth of Kentucky as the sole and exclusive forum for substantially all disputes between the Company and its shareholders, which may limit a shareholder’s ability to bring a claim in a favorable judicial forum for disputes with the Company and its directors, officers or employees.
The Company’s Articles specify that the Fayette County Circuit Court of the Commonwealth of Kentucky shall be the sole and exclusive forum for any derivative action or proceeding brought on behalf of the Company, any action asserting a breach of a fiduciary duty, any action asserting a claim arising pursuant to the Kentucky Business Corporation Act, or any action asserting a claim governed by the internal affairs doctrine. This exclusive forum provision does not apply to suits brought to enforce any duty or liability created by the Exchange Act or by the Securities Act of 1933, as amended.
The Company believes that the exclusive forum provision in the Articles benefits the Company by providing increased consistency in the application of Kentucky law for the specified types of actions and may benefit the Company by preventing it from having to litigate claims in multiple jurisdictions (and incur additional expenses) and be subject to potential inconsistent or contrary rulings by different courts, among other considerations. The exclusive forum provision in the Articles, however, may have the effect of discouraging lawsuits against Valvoline's
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directors, officers or employees as it could increase a shareholder’s cost to bring a claim or limit a shareholder’s ability to bring a claim in a judicial forum that it finds favorable for such claims. In connection with any applicable action brought against the Company, it is possible that a court could find the forum selection provisions contained in the Articles to be inapplicable or unenforceable in such action. If a court were to render such a finding, the Company may incur additional costs to resolve the action in other jurisdictions, which could adversely affect our business, financial condition or results of operations.
Risks related to Valvoline’s separation from Ashland
The Distribution could result in significant tax liability to Ashland, and in certain circumstances, Valvoline could be required to indemnify Ashland for material taxes pursuant to indemnification obligations.
Ashland obtained a written opinion of counsel to the effect that the Distribution should qualify for non-recognition of gain and loss under Section 355 of the Internal Revenue Code of 1986, as amended (the “Code”). The opinion of counsel does not address any U.S. state, local or non-U.S. tax consequences of the Distribution. The opinion assumes that the Distribution is completed according to the terms of the agreement entered into between Ashland and Valvoline (the “Separation Agreement”) and relies on the facts as described in the Separation Agreement, the Tax Matters Agreement, other ancillary agreements, the information statement distributed to Ashland’s shareholders in connection with the Distribution and a number of other documents. In addition, the opinion is based on certain representations as to factual matters from, and certain covenants by, Ashland and Valvoline. The opinion cannot be relied on if any of the assumptions, representations or covenants is incorrect, incomplete or inaccurate or is violated in any material respect.
The opinion of counsel is not binding on the Internal Revenue Service (the “IRS”) or the courts, and thus there can be no assurance that the IRS or a court will not take a contrary position. Ashland has not requested, and to the best of Valvoline's knowledge does not intend to request, a ruling from the IRS regarding the U.S. federal income tax consequences of the Distribution.
If the Distribution were determined not to qualify for non-recognition of gain and loss, then Ashland would recognize a gain as if it had sold its Valvoline common stock in a taxable transaction in an amount up to the fair market value of the common stock it distributed in the Distribution. In addition, certain reorganization transactions undertaken in connection with the separation and the Distribution could be determined to be taxable, which could result in additional taxable gain. Under certain circumstances set forth in the Tax Matters Agreement, Valvoline could have joint and several liability for gain recognition relating to the separation from Ashland, and/or a substantial indemnification obligation to Ashland with respect to the tax associated with some or all of such gain, which could have a material adverse impact on Valvoline's financial condition.
Valvoline’s inability to resolve favorably any disputes that arise between Valvoline and Ashland with respect to their past relationship may adversely affect its operating results.
Valvoline may not be able to resolve disputes with Ashland, and even if it does, the resolution may not be favorable and could adversely affect Valvoline’s operating results. Disputes between Ashland and Valvoline could relate to a number of areas relating to their past relationship, including labor; tax; employee benefits, including pension liabilities; indemnification; services provided to one another; and other matters arising from Valvoline’s separation from Ashland.
Ashland has agreed to indemnify Valvoline for certain liabilities. However, there can be no assurance that the indemnity will be sufficient to insure Valvoline against the full amount of such liabilities, or that Ashland’s ability to satisfy its indemnification obligation will not be impaired in the future.
Pursuant to the terms of the Separation Agreement and certain other agreements with Ashland, Ashland agreed to indemnify Valvoline for certain liabilities. However, third parties could also seek to hold Valvoline responsible for any of the liabilities that Ashland agreed to retain, and there can be no assurance that the indemnity from Ashland will be sufficient to protect Valvoline against the full amount of such liabilities, or that Ashland will be able to fully satisfy its indemnification obligations in the future. Even if Valvoline ultimately succeeded in recovering from Ashland any
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amounts for which Valvoline is held liable, Valvoline may be temporarily required to bear these losses. Each of these risks could negatively affect Valvoline’s business, financial position, results of operations and cash flows.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
Valvoline is headquartered in Lexington, Kentucky, where the Company leases and owns over 230,000 square feet of office, research and development and warehouse space to support operations across its business. Valvoline owns and leases several additional facilities throughout North America, Europe, Australia, and Asia that comprise over 4 million square feet of blending, warehouse, office, and research and development space. In addition, Valvoline owns or leases the property associated with 719 company-operated retail service center stores under the Valvoline Instant Oil ChangeSM and Valvoline Great Canadian Oil Change brands throughout the United States and Canada, respectively. The properties leased by Valvoline generally have expiration dates ranging from less than one year to more than 20 years, with certain renewal options available.
In addition, Valvoline contracts with third parties to provide blending, packaging, warehousing, and distribution services. Valvoline believes its physical properties are suitable and adequate for the Company’s business, and none of the property owned by Valvoline is subject to any major known encumbrances. Additional information regarding lease obligations may be found in Note 5 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
ITEM 3. LEGAL PROCEEDINGS
From time to time, Valvoline is party to lawsuits, claims and other legal proceedings that arise in the ordinary course of business. For a description of Valvoline's legal proceedings, refer to Note 11 of the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market information
Valvoline common stock is listed on the NYSE and trades under the symbol “VVV.” As of November 15, 2021, there were approximately 9,000 registered holders of Valvoline common stock.
Dividend policy
Valvoline expects to continue to pay quarterly cash dividends to the holders of its common stock; however, the declaration and payment of dividends to holders of Valvoline common stock will be at the discretion of Valvoline's Board of Directors (the “Board”) in accordance with applicable law after taking into account various factors, including Valvoline’s financial condition, operating results, current and anticipated cash needs, cash flows, impact on Valvoline’s effective tax rate, indebtedness, legal requirements and other factors that the Board considers relevant. In addition, the instruments governing Valvoline’s indebtedness may limit its ability to pay dividends. Therefore, no assurance is given that Valvoline will pay any dividends to its stockholders, or as to the amount of any such dividends if the Board determines to do so.
Stock performance graph
The following graph compares the cumulative total stockholder return on a $100 investment in Valvoline common stock, the S&P MidCap 400 Index, and the S&P MidCap 400 Consumer Staples Index for the period from September 30, 2016 to September 30, 2021. This graph assumes an investment in Valvoline common stock and each index were $100 on September 30, 2016 and that all dividends were reinvested.
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Purchases of Company common stock
During the three months ended September 30, 2021, the Company repurchased nearly 1 million shares of its common stock for $27 million pursuant to the May 17, 2021 Board authorization to repurchase up to $300 million of common stock through September 30, 2024. As of September 30, 2021, $273 million remains available for share repurchases under this authorization.
Share repurchase activity during the three months ended September 30, 2021 was as follows:
ITEM 6. SELECTED FINANCIAL DATA
Not applicable as the Company applied the amendment of Regulation S-K Item 301, which became effective for the fiscal year ended September 30, 2021.
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Business Overview 32
Results of Operations - Consolidated Review 37
Results of Operations - Reportable Segment Review 40
Financial Position, Liquidity and Capital Resources 44
New Accounting Pronouncements 47
Critical Accounting Estimates 47
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and the accompanying Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K.
BUSINESS OVERVIEW AND PURPOSE
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, original equipment manufacturers (“OEM”), mass market and automotive parts retailers, small to large installers, vehicle fleets, and distributors, among others. Valvoline operates and franchises approximately 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's fiscal year ends on September 30 of each year and Valvoline has two reportable segments: Retail Services and Global Products with certain corporate and non-operational items included in Corporate to reconcile to consolidated results. Refer to Item 1 included in Part I of this Annual Report on Form 10-K for a description of Valvoline's reportable segments.
RECENT DEVELOPMENTS
On October 12, 2021, Valvoline announced that it is accelerating its continued transformation by pursuing a separation of its two reportable segments, Retail Services and Global Products. Valvoline is evaluating the alternatives to accomplish the separation, and no timetable has currently been established for its completion. The separation is expected to provide both businesses with the opportunity to pursue their respective strategic priorities, allocate capital to drive success, and create significant and sustainable value for the Company's shareholders.
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FISCAL 2021 OVERVIEW
Fiscal 2021 was a remarkable year for growth and transformation at Valvoline. The strategy to shift to a more services-driven business was strengthened as Retail Services increased its contribution to total profitability. Key operating highlights are presented below, each of which is discussed more fully in this Annual Report on Form 10-K:
27%Growth in sales 32%Increase in net income 36%Growth in diluted EPS
In addition to these results in fiscal 2021, the following key events occurred during the year:
•Completed the issuance of the 3.625% senior unsecured notes due 2031 (the "2031 Notes") with an aggregate principal amount of $535 million and used the net proceeds, together with $312 million in cash and cash equivalents on hand, to redeem its 4.375% senior unsecured notes due 2025 (the "2025 Notes") with an aggregate principal amount of $800 million and pay related expenses and fees.
•Realigned the Company's global operations into two reportable segments, accelerating the strategic shift to a services-driven business.
•Began production at the blending and packaging plant in China, which is currently producing most of the Company's lubricant volume for the China market.
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Summarized below are Valvoline's trends in consolidated sales and net income over the last two fiscal years:
Retail Services
Retail Services marked its 15th consecutive year for system-wide same-store-sales ("SSS") growth and added 132 net new stores to the system. The table below highlights the exceptional growth in Retail Services over the last two years:
(In millions, except store count) Fiscal Year 2021 Growth vs. Growth vs.
System-wide store sales $ 1,970 30 % 39 %
System-wide store count 1,594 9 % 15 %
Years ended September 30
System-wide SSS growth 21.2 % 2.3 % 10.1 %
Global Products
Global Products continued to gain share in key international markets and expanded distribution in North America, leveraging the strength of Valvoline's brand and technology. Global Products has exhibited steady growth as shown in below:
(In millions) Fiscal Year 2021 Growth vs. Growth vs.
Operating income $ 298 5 % 11 %
Lubricant sales (gallons) 160.9 16 % 7 %
COVID-19 UPDATE
Valvoline has been able to substantially maintain its operations, demonstrating growth and strong results while managing through the effects of the COVID-19 global pandemic. Management is unable to reasonably quantify the
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impact of COVID-19 on its current year results due to their breadth and variability given the current stage and duration of the pandemic. During fiscal 2021, demand has been strong amid uneven global recoveries as miles driven and volumes have improved from the depths of the pandemic restrictions in fiscal 2020. Volumes across the business are ahead of pre-COVID trends and though certain of the cost benefits experienced in the prior year that were in part believed to have been prolonged due to or as a result of the pandemic, have inverted with supply chain challenges and overwhelming demand, in addition to a tightening labor market, in fiscal 2021, Valvoline has and continues to focus on these challenges in order to minimize impacts on the business and its results. In the face of these pressures, Valvoline delivered exceptional results in fiscal 2021 and will continue to focus on passing through price increases and managing supply chain bottlenecks during the first half of fiscal 2022.
Valvoline’s wholly-owned lubricant blending and packaging plants and retail service center stores have remained operational during fiscal 2021, while managing through the lingering effects of the pandemic. The Company's priority remains the safe operation of its facilities to protect its employees, customers and business partners. The drive-through, stay-in-your-car service experience and masking requirements continue to minimize contact between store teams and customers. Procedures in Valvoline's global plants and offices also continue to promote social distancing and masking requirements. Valvoline has established a return-to-office protocol for its corporate headquarters in Lexington, Kentucky, allowing employees that have been vaccinated to voluntarily return-to-office beginning in July 2021, with global offices following similar protocols. Management is continually monitoring the circumstances surrounding the pandemic and following government guidelines supported by COVID-19 trend data to make decisions regarding the safe operation of its offices and facilities.
The COVID-19 pandemic has continued to evolve and its future impact on Valvoline will depend on a number of factors, including and among others, the ultimate duration and severity of the pandemic and the success of vaccinations, boosters, and restrictive measures on containing the spread and resurgences of the virus. 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.
Results for Fiscal 2020 compared to Fiscal 2019
For comparisons of Valvoline's consolidated results of operations and cash flows for the fiscal years ended September 30, 2020 to September 30, 2019, refer Item 7 of Part II of the Annual Report on Form 10-K for the fiscal year ended September 30, 2020, filed with the SEC on November 24, 2020.
Use of Non-GAAP Measures
To aid in the understanding of Valvoline’s ongoing business performance, certain items within this document are presented on an adjusted, non-GAAP 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 Annual Report on Form 10-K 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
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•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 income tax and interest costs related to Valvoline’s tax and capital structures, respectively. 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, and 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 markets (in particular, interest rates), 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
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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.
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 same-store sales ("SSS"); system-wide store sales; 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. GAAP.
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 sales in its Consolidated Statements of Comprehensive Income, management believes system-wide and franchised SSS comparisons, store counts, and total system-wide store sales 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.
RESULTS OF OPERATIONS
Consolidated review
The following summarizes the results of the Company’s operations for the years ended September 30:
(In millions) Amount % of Sales Amount % of Sales Amount % Change
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Sales
The following reconciles the year-over-year changes in sales:
(In millions) 2021 Change
Volume and mix $ 330
Currency exchange 39
Acquisitions 72
Change in sales $ 628
Total sales increased from both segments delivering balanced contributions led by the substantial volume growth compared to the prior year COVID-19 lows, in addition to delivering robust expansion from the pre-pandemic period due to strong ongoing demand across the business whereby sales in each region improved over this period. Strong SSS, unit growth, and benefits from acquisitions completed during the past year drove increased sales from Retail Services. In addition, the pass through of raw material cost increases from across the business, currency exchange, and favorable mix from the shift to synthetics and branded products contributed further to the growth in sales during the year.
Gross profit
The following reconciles the year-over-year changes in gross profit:
(In millions) 2021 Change
Volume and mix $ 170
Change in LIFO reserve (55)
Price and cost (29)
Currency exchange 12
Acquisitions 19
Change in gross profit $ 117
Gross profit improved driven by higher volumes in both reportable segments from the prior year unfavorable impacts of the COVID-19 pandemic, in addition to growth from the pre-pandemic period in fiscal 2019. These volume benefits combined with favorable mix due to the ongoing shift to synthetics and branded product sales, growth from acquisitions in Retail Services, and favorable currency exchange were partially offset by rising raw material costs that led to the negative impact of LIFO adjustments and lagged the pass through in pricing.
The decline in gross profit margin compared to the prior year was primarily the result of significant raw material cost increases that began earlier in the year and drove significant price-cost lag and unfavorable LIFO adjustments, in addition to labor investments made in Retail Services, which more than offset mix benefits. The lingering effects of price-cost lag and supply-chain bottlenecks are expected to continue to adversely impact margins in the first half of the next fiscal year as the Company executes incremental pricing actions to drive cost recovery during fiscal 2022.
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Net operating expenses
Details of the components of net operating expenses are summarized below for the years ended September 30:
(In millions) Amount % of Sales Amount % of Sales Amount % Change
Net legacy and separation-related income (24) (0.8) % (30) (1.3) % 6 (20.0) %
Equity and other income, net (44) (1.5) % (34) (1.4) % (10) 29.4 %
The increase in selling, general and administrative expenses was primarily due to higher advertising expenses that were restricted in the prior year due to the severity of the COVID-19 pandemic, increased variable compensation driven by the Company’s strong performance, in addition to investments made to support future growth, including acquisitions of service center stores in Retail Services and investments in information technology and sales, and to a lesser extent unfavorable currency exchange. These increases were partially offset by a decline in travel expenses that reflected a full year with significant restrictions in place during the COVID-19 pandemic.
Net legacy and separation-related income was lower primarily as the current year adjustments of tax-related indemnity obligations related to the settlement of tax examinations resulted in lower reductions than the prior year adjustments for the change in utilization expectations of certain legacy tax attributes.
The increase in equity and other income, net was primarily driven by increased equity and royalty income attributable to the improved performance of the Company's unconsolidated joint ventures, in addition to recoveries related to the settlement of a Retail Services legal matter, and an increase in international subsidies realized during the year.
Net pension and other postretirement plan income
Net pension and other postretirement plan income increased $67 million from the prior year primarily due to the gain on pension and other postretirement plan remeasurement of $72 million compared to a gain of $22 million in fiscal 2020. This increased gain was primarily attributed to higher interest rates in the current year remeasurement. In addition, lower interest cost recognized throughout the year drove higher recurring non-service income.
Net interest and other financing expenses
Net interest and other financing expense increased $18 million during fiscal 2021 compared to the prior year. The increase was driven by higher debt extinguishment costs of $17 million as the expenses associated with the current year redemption of the 2025 Notes exceeded those incurred in connection with the extinguishment of the 5.500% senior unsecured notes due 2024 with an aggregate principal amount of $375 million (the “2024 Notes") in the prior year.
Income tax expense
The following summarizes income tax expense and the effective tax rate during the years ended September 30:
Effective tax rate percentage 22.7 % 29.7 %
Lower income tax expense from the prior year was principally driven by benefits associated with resolving tax examinations in the current year through settlement and statute lapses. This decrease in expense coupled with prior year income tax expense recognized to establish a $30 million valuation allowance on certain legacy tax attributes led to a lower effective tax rate in fiscal 2021.
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EBITDA and Adjusted EBITDA
The following reconciles net income to EBITDA and Adjusted EBITDA for the years ended September 30:
Net interest and other financing expenses 111 93
Depreciation and amortization 92 66
Net pension and other postretirement plan income (126) (59)
Net legacy and separation-related income (24) (30)
LIFO charge (credit) 41 (15)
Business interruption recovery (3) (2)
Compensated absences benefits change — (11)
Acquisition and divestiture-related costs — 2
Adjusted EBITDA (a) $ 634 $ 495
(a)Net pension and other postretirement plan income (expenses) includes remeasurement gains and losses and recurring non-service pension and other postretirement net periodic income, which consists of interest cost, expected return on plan assets and amortization of prior service credit. Refer to Note 10 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for further details.
Adjusted EBITDA increased$139 million, or 28%, compared to the prior year. Retail Services provided exceptional SSS growth due to increased transactions and improved average ticket, in addition to benefits from recent acquisitions. Global Products had strong volume growth and product demand across all regions, in addition to increased contributions from its unconsolidated joint ventures and favorable currency exchange. These benefits were partially offset by increased operating expenses principally to support growth, and to a lesser extent, unfavorable margin impacts primarily attributed to price-cost lag as raw material costs were declining in the prior year and rose significantly during the current year.
Reportable Segment Review
During the third quarter of fiscal 2021, the Company realigned its global operations to manage its business through the following two reportable segments:
•Retail Services - services the passenger car and light truck quick lube market in the United States and Canada with a broad array of preventive maintenance services and capabilities performed through Valvoline’s retail network of Company-operated, independent franchise, and Express Care stores that service vehicles with Valvoline products.
•Global Products - sells engine and automotive products in more than 140 countries and territories to mass market and automotive parts retailers, installers, and commercial customers, including original equipment manufacturers, to service light- and heavy-duty vehicles and equipment.
The Company's realignment supports its strategic initiatives to transition to a services-driven business and enhances the ability to leverage Valvoline's brand equity and product platforms across geographies. Valvoline's segments represent components of the Company for which separate financial information is available that is utilized on a regular basis by the chief operating decision maker in allocating resources and evaluating performance of the business. Adjusted EBITDA is the primary measure used in making these operating decisions, which Valvoline defines as segment operating income adjusted for depreciation and amortization and certain key items impacting comparability.
In connection with the realignment, the Company changed its allocation of certain indirect expenses for such costs to be recognized in each segment based on the estimated utilization of indirect resources. Costs to support
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corporate functions and certain non-operational and corporate activity that is not directly attributable to a particular segment are not included in the segment operating results regularly utilized by the chief operating decision maker. This activity is separately delineated within Corporate to reconcile to consolidated results.
Results of Valvoline’s reportable segments are presented based on how operations are managed internally, including how the results are reviewed by the chief operating decision maker. The structure and practices are specific to Valvoline; therefore, the financial results of its reportable segments are not necessarily comparable with similar information for other comparable companies.
Prior period segment financial information presented herein has been recast on a basis that is consistent with the realignment of Valvoline’s global operations. Refer to the disclosures below for comparisons of Valvoline's reportable segment results for fiscal years 2021 to 2020 and 2020 to 2019 under the current basis of reporting.
Retail Services
Management believes the number of company-operated and franchised service center stores as provided in the following tables is useful to assess the operating performance of the Retail Services reporting segment.
System-wide stores (a)
For the years ended September 30
Closed (6) (7)
Number of stores at end of period
For the years ended September 30
The Retail Services system unit growth over the prior year was the result of 63 net openings and 69 acquired stores, which along with the conversion of 50 net stores within the system from franchised to company-operated, combined to add132 net new company-operated and franchised stores in fiscal 2021. Organic growth was driven by 30 new company-operated service center store openings, with 39 new store openings from franchisee expansion in key markets.
The following summarizes the results of the Retail Services reportable segment for the years ended September 30:
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Favorable (Unfavorable)
Financial information
Key items — — —
Same-store sales growth
Company-operated (d) 19.6 % 2.6 % 9.6 %
(a)Measure includes Valvoline franchisees, which are independent legal entities and Valvoline does not consolidate the results of operations of its franchisees.
(b)Valvoline does not generally allocate activity below operating income to its operating segments; therefore, the table above reconciles operating income to adjusted EBITDA.
(c)Operating margin is calculated as operating income divided by sales, and adjusted EBITDA margin is calculated as adjusted EBITDA divided by sales.
(d)Beginning in fiscal 2021, Valvoline determines SSS growth as sales by U.S. Retail Services service center stores, with new stores, including franchise conversions, excluded from the metric until the completion of their first full fiscal year in operation. Previously, SSS growth was determined as sales by U.S. Retail Services service center stores, with stores new to the U.S. Retail Services system excluded from the metric until completion of their first full fiscal year in operation. Prior period measures have been revised to conform to the current basis of presentation.
2021 compared to 2020
Retail Services sales increased 38% during fiscal 2021 and nearly 50% from pre-pandemic 2019 driven by SSS performance and unit additions. System-wide SSS grew 21.2% compared to the prior year driven by increased transactions and high single-digit growth in average ticket. Transactions benefited from customer base expansion in addition to recovery from the most significant restrictions and limited travel during the onset of the pandemic in the prior year. Average ticket increases were driven by pricing and mix improvements, including the shift to synthetics and higher non-oil change services. Year-over-year system-wide unit growth of 9% also contributed to volumes and sales through the addition of 132 net new stores.
Operating income and adjusted EBITDA growth were primarily due to strong SSS performance, from an increase in transactions and higher average ticket from the ongoing shift to synthetics, in addition to unit growth primarily driven by acquisitions made during the year. This growth was partially offset by reinstated advertising spending that was restricted by the pandemic in the prior year, as well as incremental labor investments made during the year.
2020 compared to 2019
Fiscal 2020 sales increased over 2019 due to growth in system-wide SSS and average ticket, as well as 6% unit growth. These benefits were partially offset by the adverse effects on sales and volumes from limited travel in
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response to the COVID-19 pandemic. Fiscal 2020 operating income and adjusted EBITDA increased over 2019 due to benefits of mix improvements and lower expenses due to controlled spending, partially offset by deleverage in labor costs earlier in the fiscal year as a result of the COVID-19 slow-down in volumes.
GlobalProducts
The following tables summarizes the results of the Global Products reportable segment for the years ended September 30:
Favorable (Unfavorable)
Financial information
Sales by geographic region
Key items:
Acquisition-related gain — — (4)
Business interruption expenses — — 6
Depreciation and amortization 29 25 25 16% —%
Volume information
(a)Valvoline includes the United States and Canada in its North America region. Mexico is included within the Latin America region.
(b)Valvoline does not generally allocate activity below operating income to its operating segments; therefore, the table above reconciles operating income to adjusted EBITDA.
(c)Operating margin is calculated as operating income divided by sales, and adjusted EBITDA margin is calculated as adjusted EBITDA divided by sales.
2021 compared to 2020
Global Products sales increased in fiscal 2021 related to higher volumes across all regions, as the Company continued to gain share in key international markets through the enhancement of its supply chain capabilities and investments in brand marketing, as well as expanded distribution in North America. Sales growth exceeded volume growth, demonstrating pass-through pricing progress, which contributed to the increase in sales during the year in addition to favorable currency exchange benefits.
Operating income and adjusted EBITDA increased in fiscal 2021 due to sales growth driven by higher volumes across all regions, product mix benefits, improved equity and royalty income, as well as currency exchange. These benefits were partially offset by price-cost lag in the second half of fiscal 2021 due to significant raw material cost increases and higher operating expenses to support market share growth. Valvoline is currently executing incremental pricing actions to drive cost recovery during fiscal 2022.
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2020 compared to 2019
Global Products sales decreased during fiscal 2020 primarily related to reduced volume due to the COVID-19 pandemic across all regions as well as unfavorable currency exchange that more than offset the benefits from the Eastern European acquisition completed in late fiscal 2019. Operating income and Adjusted EBITDA increased in fiscal 2020 driven by improved margins combined with expense reductions that offset the impact of lower volumes. These improvements were largely the result of favorable product and channel mix in addition to lower raw material costs and benefits from the operating expense reduction program.
FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES
Overview
The Company closely manages its liquidity and capital resources. Valvoline’s liquidity requirements depend on key variables, including the level of investment needed to support business strategies, the performance of the business, capital expenditures, borrowing arrangements, and working capital management. Capital expenditures, acquisitions, share repurchases, and dividend payments are components of the Company’s cash flow and capital management strategy, which to a large extent, can be adjusted in response to economic and other changes in the business environment. The Company has a disciplined approach to capital allocation, which focuses on investing in key priorities that support Valvoline’s business and growth strategies and returning capital to shareholders, while funding ongoing operations.
Cash flows
Valvoline’s cash flows as reflected in the Consolidated Statements of Cash Flows are summarized as follows for the years ended September 30:
Cash, cash equivalents, and restricted cash - beginning of period $ 761 $ 159
Cash provided by (used in):
Investing activities (400) (222)
(Decrease) increase in cash, cash equivalents, and restricted cash (530) 602
Cash, cash equivalents, and restricted cash - end of period $ 231 $ 761
Operating activities
The increase in cash flows provided by operating activities during fiscal 2021 compared to 2020 was primarily driven by higher cash earnings, partially offset by higher income tax payments of $28 million and unfavorable changes in working capital, which included the effects of factoring $15 million of receivables in the current year compared to $59 million of receivables in the prior year.
Investing activities
The increase in cash flows used in investing activities for fiscal 2021 compared to 2020 was primarily due to increased investments in Retail Services growth through the expansion of its store network via acquisitions of service center stores. Valvoline invested approximately $365 million in Retail Services through the acquisition and opening of 120 and 30 company-operated service center stores, respectively, which compared to 35 and 36, respectively, in the prior year. These increased investments are expected to continue driving growth and
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transforming the business model and were partially offset by franchisee repayments of COVID-19 relief loans extended in the prior year, in addition to proceeds from the sale of service center stores to franchisees.
Valvoline is currently forecasting approximately $180 million to $200 million of capital expenditures for full year fiscal 2022, funded primarily from operating cash flows.
Financing activities
The increase in cash flows used in financing activities for fiscal 2021 compared to 2020 was primarily due to:
•Returning $74 million more in cash to shareholders through increased share repurchases and dividends in the current year. These increases were due to share repurchase activity being resumed following the suspension in the prior year at the onset of the COVID-19 pandemic to preserve liquidity along with the 11% increase in the dividend rate in the current year.
•Increasing net repayments on borrowings in the current year where the net proceeds from the $535 million 2031 Notes and cash and cash equivalents were used to redeem the $800 million 2025 Notes, and the prior year net proceeds primarily related to the issuance of the 4.250% senior unsecured notes due 2030 with an aggregate principal amount of $600 million (the "2030 Notes").
Free cash flow
The following table sets forth free cash flow and discretionary cash flow and reconciles cash flows from operating activities to both measures. As previously noted, free cash flow has certain limitations, including that it does not reflect adjustments for certain non-discretionary cash flows, such as mandatory debt repayments. Refer to “Use of Non-GAAP Measures” within this Item 7 for additional information regarding this non-GAAP measure.
For the years ended September 30
Cash flows provided by operating activities $ 404 $ 372
Less: Maintenance capital expenditures (36) (30)
Discretionary free cash flow 368 342
Less: Growth capital expenditures (108) (121)
The increase in free cash flow over the prior year was driven by higher cash flows provided by operating activities, in addition to modestly lower growth capital expenditures due in part to supply-chain driven delays in new company store openings. These increases were partially offset by higher maintenance capital expenditure requirements during the year.
Valvoline is currently forecasting $260 million to $300 million of free cash flow for full year fiscal 2022 primarily due to the Company's overall growth opportunities, partially offset by an increase in expected capital expenditures driven by new company store construction due to the supply chain challenges during fiscal 2021.
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Debt
The following table summarizes Valvoline’s debt as of September 30:
Trade Receivables Facility (b) 59 88
China Construction Facility 39 18
Debt issuance costs and discounts (14) (19)
Current portion of long-term debt 17 —
(a)Issued 3.625% senior notes in January 2021 with the net proceeds of $528 million, together with cash and cash equivalents on hand, used to fully redeem the 2025 Notes, with a total aggregate redemption price of $840 million. The combination of these transactions reduced Valvoline's gross leverage and cost of capital and lowers ongoing interest expense.
(b)Amendment in fiscal 2021 to extend maturity to April 2024 and modify the eligibility requirements for certain receivables, which increased the remaining borrowing capacity. The amendment also reduced the minimum required borrowing to the lesser of (i) 33% of the total facility limit or (ii) the borrowing base from the availability of eligible receivables, in addition to permitting up to a 30 consecutive day annual exemption from this requirement. Other relevant terms and conditions of the Trade Receivables Facility were substantially unchanged under this amendment.
Inclusive of the interest rate swap agreements, approximately 87% of Valvoline's outstanding borrowings as of September 30, 2021 had fixed rates, with the remainder bearing variable interest rates. As of September 30, 2021, Valvoline was in compliance with all covenants of its debt obligations and had a combined total of $586 million of remaining borrowing capacity under its Revolver and Trade Receivables Facility. Credit facilities in place in China had approximately $24 million of combined borrowing capacity remaining, $23 million under the China Working Capital Facility and $1 million under the China Construction Facility. Refer to Note 8 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of this Annual Report on Form 10-K for additional details regarding the Company’s debt instruments.
Material cash requirements
The Company's material cash requirements include the following contractual obligations and commitments as of September 30, 2021:
(In millions) Total Less than 1 year 1-3 years 3-5 years 5 years and more
(a)Includes interest expense on both variable and fixed rate debt assuming no prepayments. Variable interest rates have been assumed to remain constant through the end of the term at the rates that existed as of September 30, 2021.
(b)Includes estimated funding of pension plans for fiscal 2022, as well as projected benefit payments through fiscal 2031 for Valvoline’s unfunded pension plans. Excludes benefit payments from pension plan trust funds.
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Pension and other postretirement plan obligations
During fiscal 2021, the Company made cash and non-cash contributions of approximately $14 million to its U.S. non-qualified and non-U.S. pension plans. Refer to Note 10 of the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K for additional information relating to the Company's pension and other postretirement plans.
Dividend payments and share repurchases
During the year ended September 30, 2021, the Company paid $91 million of cash dividends for $0.500 per common share and repurchased approximately 5 million shares of its common stock for $127 million. Approximately 4 million shares were repurchased for $100 million to complete the November 12, 2020 Board authorization with the remainder of share repurchases made pursuant to the May 17, 2021 Board to repurchase up to $300 million of common stock through September 30, 2024 (the "2021 Share Repurchase Authorization").
On November 11, 2021, the Board approved a quarterly cash dividend of $0.125 per share of common stock. The dividend is payable December 15, 2021 to shareholders of record on November 29, 2021. Additionally, the Company repurchased approximately 0.5 million shares for an aggregate amount of $16 million from October 1, 2021 through November 15, 2021 pursuant to the 2021 Share Repurchase Authorization. The Company has $257 million in aggregate share repurchase authority remaining under the 2021 Share Repurchase Authorization as of November 15, 2021.
The dividend and share repurchase authorization is part of a broader capital allocation framework to deliver value to shareholders by first driving growth in the business, organically and through acquisitions, and then returning excess cash to shareholders through dividends and share repurchases. Future declarations of quarterly dividends are subject to approval by the Board and may be adjusted as business needs or market conditions change. The timing and amount of any share repurchases will be based on the level of Valvoline's liquidity, general business and market conditions and other factors, including alternative investment opportunities.
Summary
As of September 30, 2021, cash and cash equivalents totaled $230 million, total debt was $1.7 billion, and total remaining borrowing capacity was $586 million. Valvoline’s ability to generate positive cash flows from operations is dependent on general economic conditions, the competitive environment in the industry, and is subject to the business and other risk factors described in Item 1A of Part I of this Annual Report on Form 10-K. If the Company is unable to generate sufficient cash flows from operations, or otherwise comply with the terms of its credit facilities, Valvoline may be required to seek additional financing alternatives.
Management believes that the Company has sufficient liquidity based on its current cash and cash equivalents position, cash generated from business operations, and existing financing in place, to meet its required pension and other postretirement plan contributions, debt servicing obligations, tax-related and other material cash and operating requirements for the next twelve months.
NEW ACCOUNTING PRONOUNCEMENTS
For a discussion and analysis of recently issued and adopted accounting pronouncements and the impact on Valvoline, refer to Note 2 of the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K.
CRITICAL ACCOUNTING ESTIMATES
The preparation of Valvoline’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, sales and expenses, and the disclosures of contingent matters. Significant items that are subject to such estimates and assumptions include, but are not limited to, employee benefit obligations, business combinations, income taxes, and customer incentives.
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Although management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, actual results could differ significantly from the estimates under different assumptions or conditions. Valvoline’s significant accounting policies are discussed in Note 2 of the Notes to Consolidated Financial Statements in Item 8 of Part II of this Annual Report on Form 10-K. The Company believes the accounting estimates listed below are the most critical to aid in fully understanding and evaluating the reported financial results, and require the most difficult, subjective, or complex judgments, resulting from the need to make estimates about the effects of matters that are inherently uncertain.
Employee benefit obligations
Actuarial assumptions
Significant assumptions the Company must review and set annually and at each measurement date related to its pension and other postretirement benefit obligations are:
•Expected long-term return on plan assets — The expected long-term return on plan assets assumption reflects the long-term average rate of return plan assets are expected to earn. This assumption is determined considering each plan's asset allocation targets and overall expected performance, including evaluation of the most recent long-term historical returns, as applicable. The weighted-average long-term expected rate of return on assets assumption was 4.34% for fiscal 2021. In fiscal 2021, the global pension plan assets generated an actual weighted-average return of 6.39%, primarily driven by the market performance of the plan assets of the U.S. qualified pension plans based on the Company’s investment strategy to hedge the movement in liabilities related to changes in discount rates with investments of a matched duration that provide offsetting returns aligned with changes in interest rates. The expected return on plan assets is designed to be a long-term assumption, and therefore, actual returns will be subject to year-to-year variances. The U.S. qualified pension plans comprise the most significant portion of plan assets, and for fiscal 2022, the expected rate of return on assets assumption for the U.S. qualified pension plans will be 4.10%. The expected long-term return on plan assets assumption has no impact on the reported net liability or net actuarial gains or losses upon remeasurement, but does impact the recurring non-service net periodic income recognized ratably throughout the year.
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Valvoline’s pension plans hold a variety of investments designed to diversify risk. Plan assets are invested in equity securities, government and agency securities, corporate debt, and other non-traditional assets such as hedge funds. The investment goal of the pension plans is to achieve an adequate net investment return to provide for future benefit payments to its participants. Target asset allocation percentages as of September 30, 2021 for the U.S. qualified pension plans were 83% fixed income and 17% equity investments. The U.S. qualified pension plans are managed by professional investment managers that operate under investment management contracts that include specific investment guidelines, requiring among other actions, adequate diversification and prudent use of risk management practices such as portfolio constraints relating to established benchmarks. Valvoline’s investment strategy and management practices relative to plan assets of non-U.S. plans generally are consistent except in those countries where investment of plan assets is dictated by applicable regulations. Holding all other assumptions constant, a hypothetical 1.00% change in the expected long-term return on plan assets assumption for the U.S. qualified pension plans would impact fiscal 2021 recurring non-service pension income by $19 million.
•Discount rate — Reflects the rates at which benefits could effectively be settled and is based on current investment yields of high-quality corporate bonds. Consistent with historical practice, the Company uses an actuarially-developed full yield curve approach, the above mean yield curve, to match the timing of cash flows of expected future benefit payments from the plans by applying specific spot rates along the yield curve to determine the assumed discount rate. Valvoline’s fiscal 2021 expense, excluding actuarial gains and losses, for both U.S. and non-U.S. pension plans was determined using the spot discount rate as of the beginning of the fiscal year. The service cost and interest cost discount rates for fiscal 2021 pension expense were 1.55% and 1.91%, respectively, and 3.03% and 1.83%, respectively, for other postretirement expense. The weighted-average discount rate at the end of fiscal 2021 was 2.70% for the pension plans and 2.67% for the postretirement health and life plans.
The following table illustrates the estimated impact on hypothetical pension and other postretirement expense that would have resulted from a one percentage point change in discount rates in isolation of impacts on other significant assumptions in the years ended September 30:
Pension benefits
Increase in benefit obligation $ 247 $ 263
Increased return on plan assets (a) (211) $ (218)
Estimated hypothetical increase in expense 36 45
Other postretirement benefits
Increase in benefit obligation 5 5
Total estimated hypothetical increase in expense $ 41 $ 50
•Mortality — The mortality assumption for Valvoline's U.S. pension and other postretirement plans is utilizes the Society of Actuaries PRI-2012 mortality base tables and a mortality improvement scale that follows the 2021 Trustees Report of the Social Security Administration Intermediate Alternative as reflected in the MSS-2021 improvement scale. Valvoline's international plans utilize mortality assumptions similar to the U.S., whereby the assumptions are generally based upon country-specific base mortality tables updated for the most currently available improvement scales that have been published by reliable authorities in each
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jurisdiction. Valvoline believes the updated mortality improvement scales provide a reasonable assessment of current mortality trends and is an appropriate estimate of future mortality projections.
Other assumptions, including the rate of compensation increase and healthcare cost trend rate, do not have a significant impact on Valvoline's pension and other postretirement benefit plan costs and obligations based upon current plan provisions that have generally frozen benefits and limited costs.
Business combinations
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Income taxes
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Customer incentives
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Valvoline is exposed to market risks arising from adverse changes in:
•Currency exchange rates;
•Inflation and changing prices;
•Interest rates; and
•Credit risk.
These market risks are described further below. In addition, refer to Item 1A of Part I in this Annual Report on Form 10-K for additional discussion of these and other risks, including the potential risks associated with the COVID-19 pandemic.
Currency exchange risk
A significant portion of Valvoline’s operations and sales occur outside the U.S. and are denominated in currencies other than the U.S. Dollar. The Company’s results can be significantly impacted by changes in currency exchange rates. Valvoline’s currency risk is primarily related to the Euro, Australian Dollar, Canadian Dollar and Chinese Yuan with respect to sales, profits, and assets and liabilities denominated in currencies other than the U.S. Dollar. Valvoline believes its currency risk is modest as its sales are primarily derived from the United States with 74% during fiscal 2021, 75% during fiscal 2020, and 74% during fiscal 2019.
To manage exposures and mitigate the impact of currency fluctuations on the Company's operations, Valvoline uses derivatives not designated as hedging instruments consisting primarily of forward contracts to hedge non-functional currency denominated balance sheet exposures. These contracts are recorded within the Consolidated Balance Sheets as assets or liabilities at fair market value based upon market price quotations. Changes in the fair value of these derivatives are recognized in income to offset the gain or loss on the hedged item. The Company utilizes derivative instruments that are purchased exclusively from highly-rated financial institutions.
For purposes of analyzing potential risk, sensitivity analysis is used to quantify hypothetical changes in fair value of the Company's derivative portfolio and does not reflect the related gain or loss on the underlying exposure. A 10% appreciation or depreciation in the value of the U.S. Dollar against non-U.S. currencies from the prevailing market rates would have resulted in a corresponding increase or decrease of $14 million as of September 30, 2021 in the
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fair value of open derivative contracts. The Company expects that any increase or decrease in the fair value of the portfolio would be substantially offset by increases or decreases in the underlying exposures.
The U.S. Dollar was weaker in fiscal 2021 compared to the prior year based on changes in currency exchange rates. This resulted in a favorable year-over-year impact of 2% on sales as non-U.S. currencies translated into more U.S. Dollars. The net effects of currency fluctuations on the Company's consolidated financial statements has generally not been material.
Inflation and changing prices
Increases in raw material prices, including those from inflationary pressures or from supply chain constraints such as those experienced in fiscal 2021 for base oils and additives, have in the past and may continue in the future to adversely impact Valvoline’s costs, results of operations and the valuation of its inventory. In fiscal 2021, results were impacted by unprecedented rising raw material costs, a significant portion of which were passed through to customers through a series of price increases. Pricing actions generally lag material cost increases as many customer contracts are negotiated, with a smaller but meaningful portion indexed to accommodate changes in base oil prices. Valvoline may not always be able to raise prices in response to increased costs of raw materials or may experience a lag in passing through such cost increases, as the ability to pass on the costs of such price increases is largely dependent upon market conditions. Likewise, reductions in the valuation of Valvoline’s inventory due to market volatility may not be recovered and could result in losses.
Interest rate risk
The Company is subject to modest interest rate risk in relation to its variable-rate debt. Inclusive of the Company's interest rate swap agreements, outstanding borrowings with fixed rates are 87% as of September 30, 2021. The increase in interest expense for the year ended September 30, 2021 from a hypothetical 100 basis point increase in variable interest rates would be approximately $2 million.
In addition, the Company is exposed to market risk relative to the impact of changes in interest rates and investment returns on its pension and other postretirement plans. Declines in the discount rates used in measuring the Company's pension and other postretirement plan obligations result in a higher obligation and decrease the funded status. The pension plans hold a variety of investments designed to diversify risk, protect against declines in interest rates, and achieve an adequate net investment return to provide for future benefit payments to its participants. These investments are subject to variability that can be caused by fluctuations in general economic conditions. Decreases in the fair value of plan assets and discount rates increase net pension and other postretirement plan expense and can also result in requirements to make contributions to the plans. Pension and other postretirement plans were underfunded by $197 million at September 30, 2021 as the projected benefit obligation exceeded the fair value of plan assets.
Concentrations of credit risk
The Company is potentially subject to concentrations of credit risk on accounts receivable and financial instruments, such as derivative instruments and cash and cash equivalents. Credit risk includes the risk of nonperformance by counterparties, and the maximum potential loss may exceed the amount recognized within the Consolidated Balance Sheets. Exposure to credit risk is managed through credit approvals, credit limits, selecting highly-rated financial institutions as counterparties to transactions and monitoring procedures.
Valvoline’s business often involves large transactions with customers for which the Company does not require collateral. If one or more of those customers were to default on its obligations under applicable contractual arrangements, the Company could be exposed to potentially significant losses. Moreover, a prolonged downturn in the global economy could have an adverse impact on the ability of customers to pay their obligations on a timely basis. The Company believes that the reserves for potential losses are adequate. As of September 30, 2021, there was not a significant concentration of credit risk related to financial instruments.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Financial Statements and Supplementary Data Page
Report of Independent Registered Public Accounting Firm 55
Consolidated Statements of Comprehensive Income 57
Consolidated Balance Sheets 58
Consolidated Statements of Stockholders’ Equity (Deficit) 59
Consolidated Statements of Cash Flows 60
Notes to Consolidated Financial Statements 61
Note 1 - Description of Business and Basis of Presentation 61
Note 2 - Significant Accounting Policies 61
Note 3 - Fair Value Measurements 72
Note 4 - Acquisitions and Divestitures 74
Note 5 - Leasing 76
Note 6 - Equity Method Investments 77
Note 7 - Intangible Assets 79
Note 8 - Debt 80
Note 9 - Income Taxes 83
Note 10 - Employee Benefit Plans 87
Note 11 - Litigation, Claims and Contingencies 93
Note 12 - Stock-Based Compensation Plans 94
Note 13 - Earnings Per Share 96
Note 14 - Accumulated Other Comprehensive Income 96
Note 15 - Reportable Segment Information 97
Note 16 - Supplemental Balance Sheet Information 101
Note 17 - Subsequent Events 102
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Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Valvoline Inc. and Consolidated Subsidiaries
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Valvoline Inc. and Consolidated Subsidiaries (the Company) as of September 30, 2021 and 2020, the related consolidated statements of comprehensive income, stockholders’ equity (deficit) and cash flows for each of the three years in the period ended September 30, 2021, and the related notes and financial statement schedule listed in the Index at Item 15(a) (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2021 and 2020, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2021, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of September 30, 2021, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated November 19, 2021, expressed an unqualified opinion thereon.
Adoption of New Accounting Standard
As discussed in Note 2 to the consolidated financial statements, the Company changed its method for accounting for leases in 2020.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosure to which it relates.
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Valuation of Employee Benefit Obligations
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2016.
Cincinnati, Ohio
November 19, 2021
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Valvoline Inc. and Consolidated Subsidiaries
Consolidated Statements of Comprehensive Income
Years ended September 30
Selling, general and administrative expenses 520 442 449
Net legacy and separation-related (income) expenses (24) (30) 3
Equity and other income, net (44) (34) (40)
Net pension and other postretirement plan (income) expenses (126) (59) 60
Net interest and other financing expenses 111 93 73
NET EARNINGS PER SHARE
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
COMPREHENSIVE INCOME
Other comprehensive income (loss), net of tax
Currency translation adjustments 7 7 (12)
Unrealized gain (loss) on cash flow hedges 2 (1) —
Other comprehensive loss — (3) (21)
See Notes to Consolidated Financial Statements.
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Valvoline Inc. and Consolidated Subsidiaries
Consolidated Balance Sheets
As of September 30
(In millions, except per share amounts) 2021 2020
Assets
Current assets
Cash and cash equivalents $ 230 $ 760
Prepaid expenses and other current assets 53 46
Noncurrent assets
Property, plant and equipment, net 817 613
Goodwill and intangibles, net 775 529
Equity method investments 47 44
Deferred income taxes 14 34
Other noncurrent assets 194 132
Liabilities and Stockholders’ Equity (Deficit)
Current liabilities
Current portion of long-term debt $ 17 $ —
Trade and other payables 246 189
Accrued expenses and other liabilities 306 255
Total current liabilities 569 444
Noncurrent liabilities
Employee benefit obligations 258 317
Deferred income taxes 26 1
Operating lease liabilities 274 231
Other noncurrent liabilities 252 172
Commitments and contingencies
Stockholders’ equity (deficit)
Paid-in capital 35 24
Retained earnings (deficit) 90 (110)
Accumulated other comprehensive income 8 8
Total stockholders’ equity (deficit) 135 (76)
Total liabilities and stockholders’ equity (deficit) $ 3,191 $ 3,051
See Notes to Consolidated Financial Statements.
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Valvoline Inc. and Consolidated Subsidiaries
Consolidated Statements of Stockholders’ Equity (Deficit)
Common stock
(In millions, except per share amounts) Shares Amount
Dividends paid, $0.424 per common share — — — (80) — (80)
Stock-based compensation, net of issuances — — 6 — — 6
Other comprehensive loss, net of tax — — — — (21) (21)
Dividends paid, $0.452 per common share — — — (84) — (84)
Stock-based compensation, net of issuances — — 11 — — 11
Repurchase of common stock (3) — — (60) — (60)
Cumulative effect of adoption of new leasing standard, net of tax — — — 1 — 1
Other comprehensive loss, net of tax — — — — (3) (3)
Dividends paid, $0.500 per common share — — 1 (91) — (90)
Stock-based compensation, net of issuances — — 10 — — 10
Repurchase of common stock (5) — — (127) — (127)
See Notes to Consolidated Financial Statements.
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Valvoline Inc. and Consolidated Subsidiaries
Consolidated Statements of Cash Flows
Years ended September 30
Cash flows from operating activities
Adjustments to reconcile to cash flows from operations
Loss on extinguishment of debt 36 19 —
Depreciation and amortization 92 66 61
Pension contributions (5) (11) (10)
(Gain) loss on pension and other postretirement plan remeasurements (72) (22) 69
Stock-based compensation expense 14 12 9
Other, net 4 (5) (5)
Change in assets and liabilities
Payables and accrued liabilities 95 (3) 37
Other assets and liabilities (110) (81) (27)
Total cash provided by operating activities 404 372 325
Cash flows from investing activities
Additions to property, plant and equipment (144) (151) (108)
Notes receivable, net of repayments of $3 million in 2020 17 (31) (2)
Acquisitions of businesses, net of cash acquired (282) (40) (78)
Other investing activities, net 9 — —
Total cash used in investing activities (400) (222) (188)
Cash flows from financing activities
Payments of debt issuance costs and discounts (7) (16) (2)
Premium paid to extinguish debt (26) (15) —
Repurchases of common stock (127) (60) —
Cash dividends paid (91) (84) (80)
Other financing activities (11) (4) (7)
Total cash (used in) provided by financing activities (536) 450 (71)
(Decrease) increase in cash, cash equivalents and restricted cash (530) 602 63
Cash, cash equivalents and restricted cash - beginning of year 761 159 96
Cash, cash equivalents and restricted cash - end of year $ 231 $ 761 $ 159
Supplemental disclosures
Income taxes paid $ 72 $ 44 $ 25
See Notes to Consolidated Financial Statements.
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Valvoline Inc. and Consolidated Subsidiaries
Notes to Consolidated Financial Statements
NOTE 1 – DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
Description of business
Valvoline Inc. (“Valvoline” or the “Company”) is a global vehicle and engine care company that powers the future of mobility through innovative services and products for electric, hybrid, and internal combustion powertrains. Established in 1866, Valvoline’s heritage spans 155 years, during which it has developed recognition across multiple service and product channels. Valvoline's services performed at its retail stores, Valvoline-branded passenger car motor oils, and complementary products are designed to serve evolving maintenance needs and improve vehicle and engine performance and lifespan.
Valvoline operates and franchises approximately 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.
Basis of presentation and consolidation
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and Securities and Exchange Commission (“SEC”) regulations. The financial statements are presented on a consolidated basis for all periods presented and include the operations of the Company and its majority-owned and controlled subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Certain prior period amounts have been reclassified in the accompanying consolidated financial statements and notes thereto to conform to the current period presentation.
NOTE 2 – SIGNIFICANT ACCOUNTING POLICIES
Valvoline’s significant accounting policies, which conform to U.S. GAAP and are applied on a consistent basis in all periods presented, except when otherwise disclosed, are described below.
Use of estimates, risks and uncertainties
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosures of contingent matters. Although management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, actual results could differ significantly from the estimates under different assumptions or conditions.
Valvoline has substantially maintained its operations throughout the novel coronavirus ("COVID-19") pandemic to-date and has continued precautionary measures to protect the Company's employees and customers and manage through the currently known impacts on its business. Given the unprecedented nature of the pandemic, the extent of future impacts cannot be reasonably estimated at this time due to numerous uncertainties, including the ultimate duration and severity of the pandemic.
Cash and cash equivalents
All short-term, highly liquid investments having original maturities of three months or less are considered to be cash equivalents.
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Receivables and allowance for credit losses
Valvoline invoices customers and recognizes a receivable within its Consolidated Balance Sheets once the Company performs a service or transfers control of a product, at which point its right to consideration becomes unconditional and only the passage of time is required before payment of that consideration is due. As the majority of the Company’s performance obligations are satisfied at a point in time and customers typically do not make material payments in advance, nor does Valvoline have a right to consideration in advance of control transfer, the Company has no contract assets or contract liabilities.
Valvoline adopted guidance in fiscal 2021 that changes the recognition of credit losses from an incurred or probable loss methodology to a current expected credit loss model, which results in the immediate recognition of losses that are expected to occur over the life of the financial instruments, principally trade and other receivables. Allowances are maintained to estimate expected lifetime credit losses that are based on a broad range of reasonable and supportable information and factors, including the length of time receivables are past due, the financial health of its customers, macroeconomic conditions, and historical collection experience. If the financial condition of its customers deteriorates or other circumstances occur that result in an impairment of customers’ ability to make payments, the Company records additional allowances as needed. The Company writes off uncollectible receivables against the allowance when collection efforts have been exhausted and/or any legal action taken by the Company has concluded.
Inventories
Inventories are primarily carried at the lower of cost or net realizable value using the weighted average cost method. In addition, certain lubricants are valued at the lower of cost or market using the last-in, first-out (“LIFO”) method to provide matching of revenues with current costs. Inventory costs include materials, labor and manufacturing overhead related to the purchase and production of inventories. The Company regularly reviews inventory quantities on hand and the estimated utilization of inventory. Excess and obsolete reserves are established when inventory is estimated to not be usable based on forecasts, product demand, life cycle, or utility.
Property, plant and equipment
Property, plant and equipment is recorded at cost and is depreciated using the straight-line method over the estimated useful lives of the assets. Buildings generally have useful lives of ten to twenty-five years and machinery and equipment typically have two to thirty year useful lives, dependent on the nature and utility of the assets. Building and leasehold improvements are depreciated over the shorter of their estimated useful lives or the period from which the date the assets are placed in service to the end of the lease term, as appropriate. Depreciation expense is recognized in Cost of sales or Selling, general and administrative expenses within the Consolidated Statements of Comprehensive Income based on the function the underlying asset supports. Property, plant and equipment is relieved of the cost and related accumulated depreciation when assets are disposed of or otherwise retired. Gains or losses on the dispositions of property, plant and equipment are included in the Consolidated Statements of Comprehensive Income and generally reported in Equity and other income, net.
Property, plant and equipment carrying values are evaluated for recoverability at the lowest level of identifiable cash flows when impairment indicators are present. Such indicators could include, among other factors, operating losses, unused capacity, market value declines and technological obsolescence. Recorded values of asset groups of long-lived assets that are not expected to be recovered through undiscounted future net cash flows are written down to fair value, which generally is determined from estimated discounted future net cash flows (assets held for use) or net realizable value (assets held for sale).
Leases
Certain of the properties Valvoline utilizes, including its retail service center stores, offices, blending and warehouse facilities, in addition to certain equipment, are leased, with a small portion subleased primarily to Valvoline's franchisees. In fiscal 2020, Valvoline adopted new guidance related to leases using the optional transition approach, with prospective application from adoption on October 1, 2019 and the financial statements prior to
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adoption reported in accordance with the previous guidance. Valvoline's policies under the new guidance are outlined below.
Valvoline determines if an arrangement contains a lease at inception primarily based on whether or not the Company has the right to control the asset during the contract period. For all agreements where it is determined that a lease exists, the related lease assets and liabilities are recognized within the Consolidated Balance Sheets as either operating or finance leases at the commencement date.
The lease liability is measured based on the present value of future payments over the lease term, and the right-of-use asset is measured as the lease liability, adjusted for prepaid lease payments, lease incentives, and initial direct costs (e.g., commissions). Valvoline's leases generally have terms ranging from less than one year to more than 20 years, and leases with an initial term of 12 months or less are included in the measurement of its right-of-use asset and lease liability balances. The lease term includes options to extend or terminate the lease when it is reasonably certain that the option will be exercised.