VALVOLINE INC. The following discussion and analysis should be read in conjunction with the Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2020 , as well as the condensed consolidated financial statements and the accompanying Notes to Condensed Consolidated Financial Statements included in Item 1 of Part I in this Quarterly Report on Form 10-Q.
BUSINESS OVERVIEW
Valvoline is a worldwide marketer and supplier of engine and automotive maintenance products and services. Established in 1866, Valvoline's heritage spans over 150 years, during which it has developed powerful recognition across multiple product and service channels. In addition to the iconic Valvoline-branded passenger car motor oils and other automotive lubricant products, Valvoline provides a wide array of lubricants used in heavy duty equipment, as well as automotive chemicals and fluids designed to improve engine performance and lifespan. Valvoline's premium branded product offerings enhance its high-quality reputation and provide customers with solutions that address a wide variety of needs. Inthe United States andCanada , Valvoline's products and services are sold through nearly 1,600 company-operated and franchised service center stores, to retailers with over 55,000 retail outlets, and to installer customers with approximately 15,000 locations. Valvoline also has a strong international presence with products sold in more than 140 countries. Valvoline serves its global customer base through its sales force and technical support organization and leverages technology, global customer relationships, and its diverse supply chain network to meet customer demands locally. This combination of scale and strong local presence is critical to the Company's success. During the third quarter of 2021, Valvoline realigned its global operations to manage its business through two reportable segments, Retail Services and Global Products, with certain corporate and non-operational activity presented in Corporate to reconcile to consolidated results. 22 --------------------------------------------------------------------------------
BUSINESS STRATEGY Valvoline is focused on the following key business and growth strategies in fiscal 2021:
•Aggressively growing Retail Services through organic service center expansion and opportunistic acquisitions, while rapidly diversifying and expanding retail service offerings and capabilities through a quick, easy and trusted customer experience delivered by hands-on experts; •Strengthening and maintaining the foundation in Global Products by leveraging investments in technology and marketing to drive speed, efficiency and value across the business and customer interactions, while increasing penetration of Valvoline's full product portfolio;
•Accelerating Global Products market share growth through continued development of and investment in key international emerging and high value markets;
•Expanding capabilities to serve future transport vehicles by continuing to develop relationships with electric vehicle original equipment manufacturers and leveraging innovation in the delivery of future services and products in direct and adjacent markets; and
•Building a strong foundation enabled by data and technology to make Valvoline easy to do business with.
RECENT DEVELOPMENTS Valvoline has been able to substantially maintain its operations to-date and demonstrated solid performance while managing through the effects of the COVID-19 global pandemic. Management is unable to quantify the impact of COVID-19 on its current results due to their breadth and variability given the current stage and duration of the pandemic. 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 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. Valvoline has established a return-to-office protocol for its corporate headquarters inLexington, Kentucky , allowing employees that have been vaccinated to voluntarily return-to-office beginning inJuly 2021 . Many non-U.S. office locations remain closed due to local infection rates, vaccination availability and rates, in addition to resurgences related to the Delta variant. Valvoline is continually monitoring the circumstances surrounding the pandemic and following government guidelines supported by COVID-19 trend data to make decisions regarding the opening of its offices and safety of its facilities and operations.
THIRD FISCAL QUARTER 2021 OVERVIEW
The following were the significant events for the third fiscal quarter of 2021, each of which is discussed more fully in this Quarterly Report on Form 10-Q:
•Valvoline reported net income of$97 million and diluted earnings per share of$0.53 in the three months endedJune 30, 2021 , an increase of 64% and 66%, respectively, over the prior year period which was unfavorably impacted by the COVID-19 pandemic. •Valvoline realigned its global operations into the following two reportable segments, Retail Services and Global Products, to accelerate its strategic shift to a services-driven business. •Retail Services sales grew 66% over the prior year driven by system-wide same-store-sales ("SSS") growth of 40.5% and the addition of 137 net new stores to the system from the prior year. Operating income and adjusted EBITDA increased 120% and 107%, respectively, over the prior year primarily due to the strong operating performance and comparisons against the unfavorable impacts from the COVID-19 pandemic in the prior year. 23 -------------------------------------------------------------------------------- •Global Products sales increased 46% over the prior year primarily attributable to higher volumes across all regions as recovery continues from the negative impacts of COVID-19. Operating income and adjusted EBITDA grew 16% and 17%, respectively, over the prior year primarily due to the benefits of volume growth that more than offset margin pressure from raw materials cost increases. •OnMay 17, 2021 , Valvoline's Board of Directors authorized the repurchase of up to$300 million of the Company's common stock throughSeptember 30, 2024 (the "2021 Share Repurchase Authorization").
•The Company returned cash to its shareholders through payment of a cash
dividend of
Use of Non-GAAP Measures
To supplement the financial measures prepared in accordance withU.S. GAAP, certain items within this document are presented on an adjusted basis. These non-GAAP measures, presented both on a consolidated and reportable segment basis, have limitations as analytical tools and should not be considered in isolation from, or as an alternative to, or more meaningful than, the financial statements presented in accordance withU.S. GAAP. The financial results presented in accordance withU.S. GAAP and reconciliations of non-GAAP measures included within this Quarterly Report on Form 10-Q should be carefully evaluated.
The following are the non-GAAP measures management has included and how management defines them:
•EBITDA, which management defines as net income/loss, plus income tax expense/benefit, net interest and other financing expenses, and depreciation and amortization;
•Adjusted EBITDA, which management defines 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, which management defines as segment operating income adjusted for depreciation and amortization, in addition to key items impacting comparability;
•Free cash flow, which management defines as cash flows from operating activities less capital expenditures and certain other adjustments as applicable; and
•Discretionary free cash flow, which management defines as cash flows from operating activities less maintenance capital expenditures and certain other adjustments as applicable. These measures are not prepared in accordance withU.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 comparableU.S. GAAP measures to the non-GAAP measures, refer to the "Results of Operations" and "Financial Position, Liquidity and Capital Resources" sections below. Management believes EBITDA measures provide a meaningful supplemental presentation of Valvoline's operating performance due to the depreciable assets associated with the nature of the Company's operations and interest costs related to Valvoline's capital structure. Adjusted EBITDA measures exclude the impact of key items, which consist of income or expenses associated with certain unusual, infrequent or non-operational activity not directly attributable to the underlying business that management believes impacts the comparability of operational results between periods. Adjusted EBITDA measures enable comparison of financial trends and results between periods where key items may vary independent of business performance. Key items are often related to legacy matters or market-driven events considered by management to be outside the comparable operational performance of the business. 24 -------------------------------------------------------------------------------- Key items may consist of adjustments related to: legacy businesses, including the separation from Valvoline's former parent company and associated impacts of related indemnities; significant acquisitions or divestitures; restructuring-related matters; and other matters that are non-operational or unusual in nature. Key items also include the following: •Net pension and other postretirement plan expense/income - includes several elements impacted by changes in plan assets and obligations that are primarily driven by changes in the debt and equity markets, as well as those that are predominantly legacy in nature and related to prior service to the Company from employees (e.g., retirees, former employees, current employees with frozen benefits). These elements include (i) interest cost, (ii) expected return on plan assets, (iii) actuarial gains/losses, and (iv) amortization of prior service cost/credit. Significant factors that can contribute to changes in these elements include changes in discount rates used to remeasure pension and other postretirement obligations on an annual basis or upon a qualifying remeasurement, differences between actual and expected returns on plan assets, and other changes in actuarial assumptions, such as the life expectancy of plan participants. Accordingly, management considers that these elements are more reflective of changes in current conditions in global financial markets (in particular, interest rates) and are outside the operational performance of the business and are also primarily legacy amounts that are not directly related to the underlying business and do not have an immediate, corresponding impact on the compensation and benefits provided to eligible employees for current service. Adjusted EBITDA includes the costs of benefits provided to employees for current service, including pension and other postretirement service costs. •Changes in the LIFO inventory reserve - charges or credits recognized in Cost of sales to value certain lubricant inventories at the lower of cost or market using the LIFO method. During inflationary or deflationary pricing environments, the application of LIFO can result in variability of the cost of sales recognized each period as the most recent costs are matched against current sales, while preceding costs are retained in inventories. LIFO adjustments are determined based on published prices, which are difficult to predict and largely dependent on future events. The application of LIFO can impact comparability and enhance the lag period effects between changes in inventory costs and relating pricing adjustments.
Details with respect to the composition of key items recognized during the respective periods presented herein are set forth below in the "EBITDA and Adjusted EBITDA" section of "Results of Operations" that follows.
Management uses free cash flow and discretionary free cash flow as additional non-GAAP metrics of cash flow generation. By including capital expenditures and certain other adjustments, as applicable, management is able to provide an indication of the ongoing cash being generated that is ultimately available for both debt and equity holders as well as other investment opportunities. Free cash flow includes the impact of capital expenditures, providing a supplemental view of cash generation. Discretionary free cash flow includes the impact of maintenance capital expenditures, which are routine uses of cash that are necessary to maintain the Company's operations and provides a supplemental view of cash flow generation to maintain operations before discretionary investments in growth. Free cash flow and discretionary free cash flow have certain limitations, including that they do not reflect adjustments for certain non-discretionary cash flows, such as mandatory debt repayments. The amount of mandatory versus discretionary expenditures can vary significantly between periods.
Key Business Measures
Valvoline tracks its operating performance and manages its business using certain key measures, including system-wide, company-operated and franchised store counts and SSS, and lubricant volumes sold. Management believes these measures are useful to evaluating and understanding Valvoline's operating performance and should be considered as supplements to, not substitutes for, Valvoline's sales and operating income, as determined in accordance withU.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 byU.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 25 -------------------------------------------------------------------------------- period is generally required for new store sales levels to begin to normalize. Differences in SSS are calculated to determine the percentage change between comparative periods. Retail Services sales are limited to sales at company-operated stores, sales of lubricants and other products to independent franchisees and Express Care operators and royalties and other fees from franchised stores. Although Valvoline does not recognize store-level sales from franchised stores as revenue in its Condensed Consolidated Statements of Comprehensive Income, management believes system-wide and franchised SSS comparisons and store counts are useful to assess market position relative to competitors and overall store and segment operating performance.
Management believes lubricant volumes sold in gallons by its consolidated subsidiaries is a useful measure in evaluating and understanding the operating performance of the Global Products segment. Volumes sold in other units of measure, including liters, are converted to gallons utilizing standard conversions.
RESULTS OF OPERATIONS Consolidated review
The following table summarizes the results of the Company's operations:
Three months ended June 30 Nine months ended June 30
2021 2020 2021 2020
(In millions) % of Sales % of Sales % of Sales % of Sales
Sales $ 792 100.0% $ 516 100.0% $ 2,146 100.0% $ 1,701 100.0%
Gross profit $ 259 32.7% $ 187 36.2% $ 734 34.2% $ 605 35.6%
Net operating expenses $ 128 16.2% $ 99 19.2% $ 348 16.2% $ 296 17.4%
Operating income $ 131 16.5% $ 88 17.1% $ 386 18.0% $ 309 18.2%
Net income $ 97 12.2% $ 59 11.4% $ 252 11.7% $ 195 11.5%
Sales
Sales for the three and nine months ended
Year over year Year over year
change change
Three months ended Nine months ended
(In millions) June 30, 2021 June 30, 2021
Volume and mix $ 171 $ 263
Price 67 98
Currency exchange 16 33
Acquisitions 22 51
Change in sales $ 276 $ 445
The increases in sales for the three and nine months ended June 30, 2021
compared to the prior year periods were primarily driven by volume improvements
across both segments, partly due to growth over the prior year impacts of the
COVID-19 pandemic when restrictions were the most severe, in addition to robust
expansion versus pre-COVID periods, demonstrating the strength of the business
and its multi-channel model. In addition to volume improvements over the prior
year, the benefits from pricing, acquisitions, currency exchange and favorable
mix from higher branded product volumes, premium oil changes and non-oil change
services contributed to the increases in sales in the three and nine months
ended June 30, 2021 .
The changes to reportable segment sales and the drivers thereof are discussed in further detail in the "Reportable Segment Review" section below.
26
--------------------------------------------------------------------------------Gross profit
Gross profit increased$72 million for the three months endedJune 30, 2021 compared to the prior year period, while gross profit increased$129 million for the nine months endedJune 30, 2021 compared to the nine months endedJune 30, 2020 . The table below provides a reconciliation of the changes: Year over year Year over year change change Three months ended Nine months ended (In millions) June 30, 2021 June 30, 2021 Volume and mix $ 77 $ 124 Change in LIFO reserve (24) (38) Price and cost 8 18 Currency exchange 5 11 Acquisitions 6 14 Change in gross profit $ 72 $ 129 The increases in gross profit for the three and nine months endedJune 30, 2021 compared to the prior year periods were primarily driven by higher volumes in both reportable segments from the prior year unfavorable impacts of the COVID-19 pandemic, in addition to strong growth from pre-pandemic periods. Additional benefits from favorable mix due to higher branded product volumes, premium oil changes and non-oil change services, in addition to acquisitions in Retail Services, the pass-through of price increases and currency exchange were partially offset by the effects of rising raw material costs, which enhanced the unfavorable impact of LIFO adjustments year-over-year. The declines in gross profit margins were primarily the result of year-over-year changes in raw material costs, which were declining in the prior year and have risen significantly during the current year. These changes in raw material costs resulted in unfavorable year-over-year LIFO inventory adjustments, negatively impacting gross profit margins to more than offset mix benefits. Margin pressure is expected to continue in the near term as announced raw material cost increases take effect, continue to impact LIFO inventory valuation, and lag the pass through in pricing. The Company is in the process of executing further pricing actions through the balance of this calendar year in response to recent cost increases.
The changes to reportable segment gross profit and the drivers thereof are discussed in further detail in the "Reportable Segment Review" section below.
Net operating expenses
The table below provides details of the components of net operating expenses:
Three months ended June 30 Nine months ended June 30
2021 2020 2021 2020
(In millions) % of Sales % of Sales % of Sales % of Sales
Selling, general and
administrative expenses $ 136 17.2 % $ 106 20.5 % $ 382 17.8 % $ 319 18.8 %
Net legacy and
separation-related expenses 1 - % 1 0.2 % 2 0.1 % - - %
Equity and other income, net (9) (1.1) % (8) (1.5) % (36) (1.7) % (23) (1.4) %
Net operating expenses $ 128 16.1 % $ 99 19.2 % $ 348 16.2 % $ 296 17.4 %
Selling, general and administrative expenses increased $30 million and $63
million in the three and nine months ended June 30, 2021 , respectively, compared
to the prior year periods. The year-over-year increases were primarily related
to restrictions on advertising in place during the pandemic last year as the
Company focused on liquidity, in addition to investments to support future
growth, and to a lesser extent, unfavorable currency exchange and increased
costs from the acquisition of Retail Services stores.
27
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Net legacy and separation-related expenses increased $2 million during the nine
months ended June 30, 2021 , compared to the prior year periods primarily related
to adjustments of indemnities estimated to be due to Valvoline's former parent.
Equity and other income, net increased $1 million and $13 million for the three
and nine months ended June 30, 2021 , respectively, compared to the prior year
periods. These increases were primarily driven by increased equity and royalty
income attributable to the improved performance of the Company's unconsolidated
joint ventures, in addition to insurance recoveries and an international subsidy
realized during the nine months ended June 30, 2021 .
Net pension and other postretirement plan income
Net pension and other postretirement plan income for the three and nine months endedJune 30, 2021 increased$5 million and$14 million , respectively, from the prior year periods. These increases were driven by lower interest cost and improved asset performance as a result of the most recent annual remeasurement of the plans.
Net interest and other financing expenses
Net interest and other financing expenses decreased$2 million during the three months endedJune 30, 2021 and increased$19 million during the nine months endedJune 30, 2021 compared to the prior year periods. The decline in the three months endedJune 30, 2021 was attributed to the decrease in borrowing activity compared to the prior year, and the increase in the nine months endedJune 30, 2021 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 2024 Notes in the prior year. Income tax expense The following table summarizes income tax expense and the effective tax rate: Three months ended June 30 Nine months ended June 30 (In millions) 2021 2020 2021 2020 Income tax expense $ 31 $ 19 $ 83 $ 68 Effective tax rate percentage 24.2 % 24.4 % 24.8 % 25.9 % The decreases in effective tax rates from the prior year periods were principally driven by favorable discrete tax benefits in the current year. In addition, tax reform legislation enacted in the prior year resulted in lower current year taxes and unfavorable discrete activity in the nine months endedJune 30, 2020 . Higher pre-tax earnings in the three and nine months endedJune 30, 2021 more than offset these benefits resulting in increased tax expense for the current year periods. From a combination of statute expirations and anticipated audit settlements in the next twelve months, Valvoline currently estimates a decrease in the range of$25 million to$35 million in indemnity obligations due to the Company's former parent, which is expected to include certain unrecognized tax benefits. 28 --------------------------------------------------------------------------------
EBITDA and Adjusted EBITDA
The following table reconciles net income to EBITDA and Adjusted EBITDA:
Three months ended June 30 Nine months ended June 30
(In millions) 2021 2020 2021 2020
Net income $ 97 $ 59 $ 252 $ 195
Income tax expense 31 19 83 68
Net interest and other financing expenses 17 19 92 73
Depreciation and amortization 24 17 68 48
EBITDA 169 114 495 384
Net pension and other postretirement plan income
(a) (14) (9) (41) (27)
Net legacy and separation-related expenses 1 1 2 -
LIFO charge (credit) 17 (7) 26 (12)
Business interruption recovery - - (3) -
Acquisition and divestiture-related costs - - - 2
Restructuring and related expenses - - - 1
Adjusted EBITDA $ 173 $ 99 $ 479 $ 348
(a)Net pension and other postretirement plan income includes remeasurement gains
and losses, when applicable, 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 7
in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I
in this Quarterly Report on Form 10-Q for further details.
Adjusted EBITDA increased $74 million and $131 million for the three and nine
months ended June 30, 2021 , respectively, over the prior year periods driven by
the strength of SSS growth in Retail Services and higher volumes across all
regions in Global Products as recovery continues from the negative impact of
COVID-19 during the prior year periods. In addition, benefits from recent
acquisitions in Retail Services and margin improvements due to favorable pricing
impacts were partially offset by the impact of rising raw materials costs and
higher operating expenses.
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 inthe United States andCanada 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 preventive maintenance products in more than 140 countries to retailers, installers, and commercial customers, including original equipment manufacturers, to service light- and heavy-duty vehicles and equipment. The Company's realignment brought its products business under one segment to enhance the ability to leverage Valvoline's brand equity and product platforms to support growth opportunities in Retail Services with vertical integration and cash generation from the Global Products segment. These 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 29 --------------------------------------------------------------------------------
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 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.
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 reportable segment.
System-wide stores (a)
Second Quarter
Third Quarter 2021 2021 First Quarter 2021 Fourth Quarter 2020 Third Quarter 2020
Beginning of period 1,548 1,533 1,462 1,432 1,419
Opened 17 13 18 29 13
Acquired 5 3 54 2 2
Closed (1) (1) (1) (1) (2)
End of period (b) 1,569 1,548 1,533 1,462 1,432
Number of stores at end of period
Second Quarter
Third Quarter 2021 2021 First Quarter 2021 Fourth Quarter 2020 Third Quarter 2020
Company-owned 698 673 663 584 548
Franchised (b) 871 875 870 878 884
(a)System-wide store count includes franchised service center stores. Valvoline
franchises are independent legal entities, and Valvoline does not consolidate
the results of operations of its franchisees.
(b)Certain franchised service center stores temporarily closed at the discretion
of the respective independent operators due to the impacts of COVID-19 and are
included in the store counts at the end of the third and fourth quarters of
fiscal 2020. As of June 30, 2020 , 5 franchised service center stores were
temporarily closed and 1 was as of September 30, 2020 . No service center stores
were temporarily closed as of June 30, 2021 , March 31, 2021 , or December 31,
2020 .
The year over year change resulted in 137 net new company-operated and franchised stores as a result of 73 net openings and 64 acquired stores. Organic service center store growth was primarily related to new company-operated service center store openings and franchisee expansion in key markets.
30
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The following table summarizes the results of the Retail Services reportable
segment:
Three months ended Nine months ended
June 30 June 30
(In millions) 2021 2020 2021 2020
Financial information
Retail Services segment sales $ 330 $ 199 $ 869 $ 629
Operating income (a) $ 97 $ 44 $ 233 $ 142
Key items - - - -
Depreciation and amortization 15 10 44 28
Adjusted EBITDA $ 112 $ 54 $ 277 $ 170
Operating income as a percentage of sales 29.4 % 22.1 % 26.8 % 22.6 %
Adjusted EBITDA margin (b) 33.9 % 27.1 % 31.9 % 27.0 %
Same-store sales growth
Company-operated (c) 36.1 % (5.2) % 20.4 % 0.3 %
Franchised (c) (d) 43.9 % (9.9) % 22.5 % 0.0 %
System-wide (c) (d) 40.5 % (8.0) % 21.6 % 0.2 %
(a) Valvoline does not generally allocate activity below operating income to its operating
segments; therefore, the table above reconciles operating income to adjusted EBITDA.
(b) Adjusted EBITDA margin is calculated as adjusted EBITDA divided by sales.
(c) Beginning in fiscal 2021, Valvoline determines SSS growth as sales by U.S. Retail
Services service center stores, with new stores, including franchised conversions,
excluded from the metric until the completion of their first full fiscal year in
operation. Previously, SSS growth was determined as sales by
service center stores, with stores new to the
from the metric until completion of their first full year in operation. Prior period
measures have been revised to conform to the current basis of presentation. (d) Valvoline franchisees are distinct legal entities and Valvoline does not consolidate
the results of operations of its franchisees.
Retail Services sales increased$131 million , or 66%, for the current quarter compared to the prior year quarter. Sales increased$240 million , or 38%, for the nine months endedJune 30, 2021 compared to the prior year period. Continued SSS growth was driven by strong operational performance, including increased transactions and average ticket from premiumization, non-oil change services, pricing, and customer base expansion, while growth was also related to lower volumes and limited travel in the prior year due to the COVID-19 pandemic. Year-over-year unit growth of 10% through the addition of 137 net new stores from acquisitions and new service center store openings also contributed to sales growth. Operating income and adjusted EBITDA increased$53 million , or 120%, and$58 million , or 107%, respectively, for the three months endedJune 30, 2021 compared to the prior year period. Likewise, operating income and adjusted EBITDA increased$91 million , or 64%, and$107 million , or 63%, respectively, for the nine months endedJune 30, 2021 . These increases were primarily related to the strong SSS performance compared to the prior year periods as described above, as well as the addition of new stores and improved margins, which were unfavorably impacted in the prior year due to the impacts of operating during the most restrictive period of the COVID-19 pandemic. 31 --------------------------------------------------------------------------------
Global Products
The following table summarizes the results of the Global Products reportable
segment:
Three months ended Nine months ended
June 30 June 30
(In millions) 2021 2020 2021 2020
Financial information
Sales by geographic region
North America (a) $ 278 $ 207 $ 755 $ 693
Europe, Middle East and Africa ("EMEA") 56 34 161 125
Asia Pacific 96 65 267 193
Latin America (a) 32 11 94 61
Global Products segment sales by geographic
region $ 462 $ 317 $ 1,277 $ 1,072
Operating income (b) $ 72 $ 62 $ 233 $ 199
Key items - - - -
Depreciation and amortization 9 7 22 19
Adjusted EBITDA $ 81 $
69
Operating income as a percentage of sales 15.6 % 19.6 % 18.2 % 18.6 % Adjusted EBITDA margin (c) 17.5 % 21.8 % 20.0 % 20.3 % Volume information Lubricant sales (gallons) 41.8 30.5 119.7 101.2
(a) Valvoline includes
is included within the
operating segments; therefore, the table above reconciles operating income to
adjusted EBITDA. (c) Adjusted EBITDA margin is calculated as adjusted EBITDA divided by sales.
Global Products sales increased$145 million , or 46%, and$205 million , or 19%, for the three and nine months endedJune 30, 2021 compared to the prior year periods. The increase in sales is due to volume growth across all regions, both as recovery continues from the negative prior year impacts of the pandemic and as increased marketing efforts drove growth from the pre-COVID-19 periods. In addition, the pass-through of cost increases, currency exchange, and branded product mix further contributed to the increases in sales. Operating income and adjusted EBITDA increased$10 million , or 16%, and$12 million , or 17%, respectively, for the three months endedJune 30, 2021 compared to the prior year period. Additionally, operating income and adjusted EBITDA improved$34 million , or 17%, and$37 million , or 17%, respectively, for the nine months endedJune 30, 2021 . The increases in operating income and adjusted EBITDA were primarily due to strong performance as sales growth was driven by higher volumes across all regions. In addition, favorable currency exchange and product mix benefits contributed to results in the current year. These benefits were partially offset by higher operating expenses driven by increases in advertising and other investments to support growth, in addition to the near-term impact of unfavorable price-cost lag, as the pass through to pricing continues to lag behind raw material cost increases. Operating income and adjusted EBITDA also benefited from increased contributions from unconsolidated joint ventures during the nine months endedJune 30, 2021 . 32 --------------------------------------------------------------------------------
FINANCIAL POSITION, LIQUIDITY AND CAPITAL RESOURCES
Overview
The Company closely manages its liquidity and capital resources. Valvoline's liquidity requirements depend on key variables, including the level of investment needed to support business strategies, the performance of the business, capital expenditures, borrowing arrangements, and working capital management. Capital expenditures, acquisitions, share repurchases, and dividend payments are components of the Company's cash flow and capital management strategy, which to a large extent, can be adjusted in response to economic and other changes in the business environment. The Company has a disciplined approach to capital allocation, which focuses on investing in key priorities that support Valvoline's business and growth strategies and returning capital to shareholders, while funding ongoing operations.
Cash flows
Valvoline's cash flows as reflected in the Condensed Consolidated Statements of
Cash Flows are summarized as follows for the nine months ended
(In millions) 2021 2020 Cash, cash equivalents, and restricted cash - beginning of period$ 761 $ 159 Cash provided by (used in): Operating activities 296 271 Investing activities (351) (143) Financing activities (483) 465
Effect of currency exchange rate changes on cash, cash equivalents, and restricted cash
5 (1)
(Decrease) increase in cash, cash equivalents, and restricted cash
(533) 592
Cash, cash equivalents, and restricted cash - end of
period $ 228 $ 751
Operating activities
The increase in cash flows provided by operating activities for the nine months
ended June 30, 2021 compared to the prior year was primarily due to higher cash
earnings, partially offset by increased tax and interest payments and
unfavorable changes in working capital, which included the effects of factoring
$59 million of receivables in the prior year.
Investing activities
The increase in cash flows used in investing activities for the nine months endedJune 30, 2021 compared to the prior year was primarily due to increased investments in Retail Services growth through the expansion of its store network via acquisition and new company-operated service center stores. During the nine months endedJune 30, 2021 , Valvoline invested nearly$330 million in Retail Services through the acquisition and opening of 107 and 21 company-operated service center stores, respectively, which compared to 21 and 14, respectively, in the prior year period when the Company focused on cash preservation during the pandemic. These increased investments are expected to continue driving growth and 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 has invested$106 million in capital expenditures in the nine months endedJune 30, 2021 and is currently forecasting approximately$160 million to$170 million for fiscal 2021. The majority of the capital investments to-date have been focused on service center store growth in the Retail Services segment, with maintenance capital representing less than 1% of year-to-date sales. 33 --------------------------------------------------------------------------------
Financing activities
The increase in cash flows used in financing activities was primarily due to:
•Returning$45 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 to preserve liquidity at the onset of the pandemic, and 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$600 million 2030 Notes.
Free cash flow
The following tables set forth free cash flow and discretionary free cash flow
and reconciles cash flows from operating activities to both measures. Refer to
the "Use of Non-GAAP Measures" section included above in this Item 2 for
additional information regarding these measures.
Nine months
ended
(In millions) 2021 2020
Cash flows provided by operating activities $ 296
Additions to property, plant and equipment (106) (94) Free cash flow $ 190$ 177 As ofJune 30, 2021 , working capital (current assets minus current liabilities, excluding long-term debt due within one year) was$511 million compared to$994 million as ofSeptember 30, 2020 . Liquid assets (cash, cash equivalents, and receivables) were 141% of current liabilities as ofJune 30, 2021 and 269% atSeptember 30, 2020 . The decrease in working capital is primarily driven by cash and cash equivalents utilized to fund investments in Retail Services expansion through acquisition along with the redemption of the 2025 Notes. Discretionary free cash flow Nine months ended June 30 (In millions) 2021 2020 Cash flows provided by operating activities $
296
Maintenance additions to property, plant and equipment (21) (19) Discretionary free cash flow $ 275$ 252
Discretionary free cash flow increased
Debt
As ofJune 30, 2021 andSeptember 30, 2020 , the Company had long-term debt (including the current portion and debt issuance costs and discounts) of$1.7 billion and$2.0 billion , respectively, comprised of loans and revolving facilities. Approximately 87% of Valvoline's outstanding borrowings, inclusive of its interest rate swap agreements, had fixed rates as ofJune 30, 2021 . InJanuary 2021 , the Company completed the issuance of the 2031 Notes and used the net proceeds of$528 million , together with cash and cash equivalents on hand, 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. 34 -------------------------------------------------------------------------------- InApril 2021 , Valvoline amended the Trade Receivables Facility to extend its maturity toApril 2024 and modify the eligibility requirements for certain receivables. The amendment also reduces the minimum required borrowing to the lesser of (i) 33 percent 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 Trade Receivables Facility were substantially unchanged under this amendment. Valvoline was in compliance with all covenants of its debt obligations as ofJune 30, 2021 and had a combined total of$586 million of remaining borrowing capacity under its Revolver and Trade Receivables Facility. Credit facilities in place inChina had approximately$25 million of combined borrowing capacity remaining,$23 million under the China Working Capital Facility and$2 million under the China Construction Facility. Refer to Note 5 of the Notes to Condensed Consolidated Financial Statements for additional details regarding the Company's debt instruments.
Dividend payments and share repurchases
During the nine months endedJune 30, 2021 , the Company paid cash dividends of$0.375 per common share for$69 million and repurchased over 4 million shares of its common stock for$100 million to complete the Board of Directors authorization onNovember 12, 2020 to repurchase up to$100 million of common stock throughSeptember 30, 2021 . The Company did not repurchase any shares of its common stock during the three months endedJune 30, 2021 pursuant to the 2021 Share Repurchase Authorization. The Company repurchased approximately 0.4 million shares of Valvoline common stock for$11 million duringJuly 2021 pursuant to the 2021 Share Repurchase Authorization, resulting in$289 million of authorization remaining. OnJuly 19, 2021 , the Board of Directors of Valvoline declared a quarterly cash dividend of$0.125 per share of Valvoline common stock. The dividend is payable onSeptember 15, 2021 to shareholders of record onAugust 30, 2021 . Dividends and share repurchases are 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, while the timing and amount of any future share repurchases will be based on the level of Valvoline's liquidity, general business and market conditions and other factors, including alternative investment opportunities.
Off-balance sheet arrangements
As ofJune 30, 2021 , Valvoline has no contractual obligations that are reasonably likely to have a material effect on the Company's condensed consolidated financial statements that are not fully recorded within the Condensed Consolidated Balance Sheets or fully disclosed in the Notes to Condensed Consolidated Financial Statements in Item I of Part I of this Quarterly Report on Form 10-Q. As part of Valvoline's normal course of business, it is a party to certain financial guarantees and other commitments, and while these arrangements involve elements of performance and credit risk, such risk is not currently considered reasonably likely to have a material effect on the Company's condensed consolidated financial statements. The possibility that Valvoline would have to make actual cash expenditures in connection with these obligations is largely dependent on the performance of the party whose obligations Valvoline guarantees, or the occurrence of future events.
Summary
As ofJune 30, 2021 , cash and cash equivalents totaled$226 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 II of this Quarterly Report on Form 10-Q and Item 1A of the Annual Report on Form 10-K for the year endedSeptember 30, 2020 . 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 to meet its required pension and other
35
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postretirement plan contributions, debt servicing obligations, tax-related and
other contractual commitments, and operating requirements for the next twelve
months.
NEW ACCOUNTING PRONOUNCEMENTS
For a discussion and analysis of recently issued accounting pronouncements and the impacts on Valvoline, refer to Note 1 in the Notes to Condensed Consolidated Financial Statements in Item 1 of Part I of this Quarterly Report on Form 10-Q.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's critical accounting policies and estimates are discussed in detail in Item 7 of Part II in Valvoline's Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2020 . Management reassessed the critical accounting policies as disclosed in the Annual Report on Form 10-K and determined there were no changes to critical accounting policies and estimates in the nine months endedJune 30, 2021 .
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