Valvoline Inc (VVV) 2017 Q2 法說會逐字稿

Good morning. My name is Carol and I will be your conference operator today. At this time I would like to the Valvoline Inc. second-quarter conference call and webcast.

(Operator Instructions)

At this time I would like to turn the call over to Jason Thompson, Vice President of Finance.

Thank you, Carol. Good morning and welcome to Valvoline's second-quarter fiscal 2017 conference call and webcast.

Valvoline released results for the quarter ended March 31, 2017 at approximately 5 p.m. Eastern time yesterday, April 25. And this presentation and remarks should be viewed in conjunction with that earnings release.

These results are preliminary until we file our Form 10-Q with the Securities and Exchange Commission. A copy of the news release has been furnished to the SEC in a Form 8-K.

With me on the call today are Valvoline's Chief Executive Officer Sam Mitchell and Mary Meixelsperger, Chief Financial Officer.

As shown on slide 2, our remarks include forward-looking statements as such term is defined under US securities law. We believe that such statements are based on reasonable assumptions but cannot assure that such expectations will be achieved.

In this presentation and in our remarks we will be discussing our results on an adjusted basis. Adjusted results exclude key items which are unusual, nonoperational or restructuring in nature. We believe this approach enhances understanding of our ongoing business.

As you can see on slide 3, Valvoline delivered reported EPS of $0.35, an increase of $0.02 versus prior year. Operating income grew 13% to $117 million and net income grew 4% to $71 million.

Let me briefly discuss some notes on reporting. A few items related to the separation are driving differences in our year-over-year comparisons.

First is interest expense. This represents the creation of Valvoline's capital structure that was established in 2016. We did not have interest expense in the prior year's second quarter.

Also related to our capital structure is recurring pension-related income which is higher this year than it was in the prior year. The pension and other OPEB plans that we assumed from Ashland did not transfer to Valvoline until September 2016. Prior to this, we were allocated a portion of the pension of OPEB income based on our participation in the plans.

Next are key items. We incurred pretax separation cost this quarter of $6 million. In Q2 of fiscal 2016 we were required to do a mark-to-market remeasurement of certain pension and OPEB plans which resulted in a non-cash pretax loss of $5 million.

Also in Q2 of fiscal 2016 we incurred pretax acquisition-related costs of $1 million. Again, our adjusted results for both quarters exclude these key items.

We will also be discussing EBITDA from operating segments, which is simply the contribution to our total EBITDA from our three operating segments of Core North America, Quick Lubes and International. We believe that both adjusted results and EBITDA from operating segments are meaningful to investors, so we will be focusing on those for the remainder of the call.

Now let me briefly review our adjusted results for the quarter which are shown on the next slide. Adjusted EPS for fiscal Q2 2017 was $0.37, an increase of 6% over prior year. The table on slide 4 shows that the contribution to adjusted EPS from our operating segments was flat year over year at $0.34.

Pension- and OPEB-related income net of interest expense provided a $0.02 benefit. Overall volume grew 3%. Gross profit also grew 3%.

Solid business performance was partially offset by rising raw material costs. As part of our disciplined approach to managing our unit margins, we have implemented pricing actions to pass through these cost increases. Gross profit growth was offset by planned increases in SG&A leading to EBITDA from operating segments that was consistent with prior year.

Now let me turn things over to Sam to cover more details of the results of our operating segments. Sam?

Thanks, Jason, and good morning everyone. As you can see Valvoline had a solid second quarter.

Core North America grew branded premium mix, we had good growth in Valvoline Instant Oil Change and another quarter of strong volume gains in International. I'd like to go further into each of the segments to discuss the details of these results.

Let me start with Core North America. As you can see on slide 5, volume declined 5% but there are some important items affecting that change.

Branded volume was in line with Q2 last year. The volume decline for the segment was primarily in our non-branded business. Overall our non-branded business is roughly 25% of Core North America's volume but only represents approximately 10% of profitability. So while it is never ideal to lose volume, this impact is not significant to segment earnings.

Importantly, within our branded volume we grew our mix of premium products, which is a key element of how we grow our unit margins over time. As you might have seen posted base oil prices increased during Q2 and most recently increased again this month. As a reminder, a meaningful portion of our business has pricing that is formula based using an index tied to base oil.

For the business with market-based pricing we have taken actions to pass these increases through and I'm pleased with our progress and remain confident in our ability to continue to execute price increases to protect unit margins. There was a lag impact related to passing through cost increases and the timing of the most recent increases will have a modest impact on both Q3 and Q4.

Looking forward, innovation will drive the business in Core North America. Innovation and targeted marketing and services as well as products and packaging like the example we show on slide 6 will generate competitive advantage for Valvoline.

We are introducing our advanced Bay Box to support our installer customers. This packaging solution is a total system, consisting of a unique box with several innovative features and a custom rack designed to only hold Valvoline products. The Bay Box will help our installer customers drive value in their businesses.

The benefits to our customers include improved working capital and inventory control and the ability to finish services faster and with less waste. The benefits to Valvoline are the chance to grow volume and premium mix, strengthen relationships with current customers and capture new business opportunities. Innovations like this strengthen the Valvoline brand and create value for our customers.

The Quick Lubes segment continued its trend of growing sales and profits in Q2. As we show on slide 7, the growth was driven in part by the contribution from new stores as we continue to expand our retail presence.

In Q2 we added 32 stores to our Valvoline Instant Oil Change network, primarily the 28 Company stores from the Time-It Lube acquisition as well as some franchise additions. Over the last 12 months we have added 56 stores to our system. In April we acquired nine of our franchise stores in San Antonio, Texas. Like the Time-It Lube acquisition this gives us more opportunities to accelerate our growth in Texas.

We also continued our same-store sales growth which system-wide was up nearly 4% compared to last year. Because this is a notable change from Q1, let me expand on a couple of external factors that can impact same-store sales.

First is the number of sales days. As we reported last quarter, we had an extra day in Q1, adding incremental sales that contributed approximately 100 basis points to comps.

Next is weather. Bad weather, of course, can negatively impact of miles driven and, therefore, the time between service intervals can be a bit longer. This primarily occurs during the winter season.

For example, we saw favorable driving conditions in Q1 and more challenging conditions in Q2. We don't lose customers due to weather, but it impacts the timing of their business. Bottom line, weather can be a factor in our business but it is manageable.

Getting back to the results of the business, the timing of promotions also impacted sales in Q2. Overall our first-half same-store sales are up 6.4%, in line with full-year guidance. Growth in the Quick Lubes business continues to be a core priority for Valvoline, and I'm pleased with the progress we are making.

Our International segment delivered another quarter of strong volume growth. Like Q1 the volume growth in Q2 was broad-based, covering both emerging and mature markets.

Slide 8 show some of the key growth drivers. We had another strong quarter in Europe due to the success of our channel development efforts. Since 2015 we have added 10 new distributors in Europe, some replacing poor performers and others allowing us to penetrate the market.

In China we are also continuing to see the benefits of our distribution expansion as we added new distributors while growing volume with our top 50 distributors. We are putting more effort into building our brand internationally, as well. Our sponsorships and advertising are reaching broad groups in key markets like China and India.

A few items are contributing to the flat year-over-year EBITDA in International. Like the Company overall, International saw increases in SG&A and raw material costs. The segment did well, passing the raw material cost increases through, so unit margins were in line with prior year.

We also had some additional expenses related to tax matters from prior years. Without these added costs, EBITDA would have grown in the high single-digit range.

You might have also seen the other important press release issued yesterday announcing the final separation of Valvoline from Ashland. The separation will mark a significant milestone in the history of Valvoline.

The Board and I along with the rest of the management team are truly thankful to everyone who has worked so hard and contributed so much to completing the separation. The separation also marks the beginning of an exciting future for Valvoline.

Slide 9 shows the benefits of the separation for our business. We will benefit from being one global team focused on Valvoline's business. This will enable us to be more nimble operationally, able to move faster in the pursuit of opportunities that we see.

In addition, we have the ability to reinvest to drive growth as we will be in control of our balance sheet and how we allocate capital. We are investing in our businesses to capture organic and inorganic growth opportunities. As we have shared, two of our top priorities are growing our Quick Lubes business through acquisitions and ground-up stores as well as building our digital infrastructure and capabilities. We will also be returning capital to shareholders through our dividend which we plan to grow over time and our recently announced share repurchase program.

With that, I will turn it over to Mary for a detailed look at our second-quarter results and more on our share repurchase program.

Thanks, Sam. As Jason described earlier, fiscal Q2 EBITDA from the operating segments was in line with prior year at $115 million. The main changes within year-over-year EBITDA can be seen on the bridge on slide 10.

Volume/mix was the largest driver, adding $8 million but was offset by increased SG&A and a reduced margin contribution. As we mentioned on our Q1 earnings call, the first half of fiscal 2016 benefited from favorable price cost lag while raw material costs have increased this year. These impacts are captured in the $4 million decline in margin for the quarter.

As planned, SG&A increased primarily due to new public Company costs. Valvoline's total adjusted EBITDA was $132 million, and includes the impact of non-service pension and OPEB income which was $17 million in the quarter.

Turning to corporate items on slide 11, our effective tax rate in the quarter was 34.9%, in line with our full-year guidance. Year-to-date cash provided by operating activities was $70 million, a decline of $21 million from the same period last year. The decline was primarily driven by $24 million of additional interest and pension and OPEB contributions.

Year-to-date CapEx totaled $27 million, resulting in free cash flow of $43 million. We ended the quarter with total debt of $737 million, giving us net debt of $602 million. The key item this quarter was separation cost of $6 million.

Turning to guidance, we are reiterating our full-year expectations. This includes adjusted EPS of $1.36 to $1.43 per share and free cash flow of $130 million to $150 million.

In Q3 we expect EBITDA from operating segments of $106 million to $111 million.

Turning to slide 12, we announced yesterday that our Board has authorized a share repurchase program. This will allow us to repurchase up to $150 million worth of our shares through the end of calendar year 2019. Our intention is to be opportunistic in the execution of the program over the life of the authorization.

Over the long term, we believe that the strength of our business enables us to continue generating significant operating cash flow to fund profitable growth both organically and inorganically and to return cash to shareholders while maintaining balance sheet flexibility. We believe this balanced approach presents the greatest value creation opportunity for our shareholders. This program combined with our intention to grow Valvoline's dividend over time demonstrates the Board and management's confidence in the strength of Valvoline's business and its cash flows.

Now let me turn things back to Sam to wrap up. Sam?

Thanks, Mary. I'm pleased with our Q2 results. Our business model is fundamentally strong, which keeps us on pace to reach our full-year goals.

As we have said before, 2017 is a foundational year. The separation has been well executed and we are ready to perform as a standalone Company.

We have got a talented team of hands-on experts. We are totally focused on our customers, delivering great products, great service and technology innovation. It all adds up to a very bright future.

With that I will hand it over to Jason to open the line for Q&A.

Thanks, Sam. Okay, Carol, we can go ahead and start Q&A with the first question.

I would just like to remind everybody to keep their line of questioning to one question with one follow-up, please.

(Operator Instructions) Olivia Tong, Bank of America Merrill Lynch.

Hi guys, this is actually Chris Carey from Olivia's team. Thank you for the question.

Just a first question just on unit margins, can you provide a bit more color on the relative contribution of the premium mix versus pure price increases for the quarter? The gross profit per gallon was a bit better in Core North America versus where we were, and I'm just trying to understand how much of that is related to driving more premium mix versus just pure price increases and how you see that trending for the remainder of the year.

Yes, when you think about this year we've been in an inflationary environment really for the last year. So any improvements that we are seeing in our unit margins are really driven by the premium mix. In an inflationary environment like we are in, typically we are executing those price increases to certainly cover the amount of the cost increases, and that is, in fact, what we are doing.

But we are also getting, get a little bit of a negative lag effect as we execute those increases. So I'm really pleased with, well, number one, the tremendous growth and progress that we've made on our premium mix. The teams across all of our businesses are doing an excellent job there, but I'm also happy with the progress that we are making and executing price increases to keep up with those cost increases.

Okay, thanks. And just following that same line, just on the Q3 EBITDA outlook it was a bit softer relative to our expectation.

So I wonder if you could talk through the key drivers, assumptions for base oil increases and your ability to price to offset those and if there was any pull-forward from Q3 into Q2 in your numbers. Thank you.

The outlook on EBITDA, it's impacted somewhat by the increasing base oils because we have seen a number of increases. We have been executing pricing to offset that. There will be an increase, price increase that we are executing really our second market-based increase in Q3.

Nonetheless, though, we have seen a recent additional base oil increase combined with additive increases that are impacting us. And so we most recently have announced another market-based increase that will take effect in Q4. So it's really the impact of that lag effect that hits us both in Q3 and Q4 that is moderating our EBITDA results.

Okay, thanks very much. I will pass it on.

Bill Chapell, SunTrust.

Thanks, good morning. Just a couple on the Quick Lubes business.

First, just trying to understand your commentary on the same-store sales in the quarter. It didn't sound like there was anything weather or day related, so this is kind of a clean number. Is that fair to say?

And then as I am looking towards next quarter, does that include Oil Can Henry's? And will that have an impact on same-store sales?

So actually during the quarter while there wasn't any impact from sales days, my commentary around weather was to point out that we did have some relatively bad weather compared to prior year that contributed to a lower same-store sales performance from our system.

And the key point on the weather is that it impacts miles driven, so it just pushes out the timing in which we see our customers. And so we will point that out when it has an impact, it can have an impact during those winter quarters. But I see it as something that's pretty manageable.

Weather is not a huge factor for us, it's just something that we've got to be on top of and make sure we are adjusting our labor appropriately. And the good news is about the results, it shows you that same-store sales continue to increase and that's been from a combination of continuing to win new customers and also the ability to improve our ticket, too. Those are both factors.

And Bill, on your question on Oil Can Henry's, Oil Can Henry's stores will not come into our comp until fiscal 2018. Our methodology is that we wait until the first full 12, first fiscal year beginning after the first full 12 months of operations before we include in the comp.

Just making another point on Oil Can Henry's is it's been now a year since we made that acquisition, and I couldn't be more pleased with how well that integration has gone. Those stores performing very well for us.

The team is doing an excellent job out there. They felt some of that weather impact during the first part of Q2, but overall the store execution, that store level execution is really strong and doing a great job serving our customers there. And we are seeing the results.

Got it. And just as a follow-up, on the acquisition of the franchisees this month, should we expect more of those or could you may be give a little color around that?

Yes, this one was an opportunistic acquisition in that, number one, one of our smaller franchisees was interested in retirement. So we began discussions with the franchisee quite a while ago.

But it's also pretty strategic for us, too, because as I noted in my comments, we see Texas in the Southern region as very attractive for store growth. And in combination with the Time-It acquisition along with growing in San Antonio and then, of course, taking a look at some of the larger markets and developing plans for Dallas and Houston we are very bullish on opportunities for growth of Company stores in Texas.

Got it. Thanks so much.

Mike Harrison, Seaport Global Securities.

Good morning. This is Jacob on for Mike.

You guys noted the share repurchase program would be opportunistic. Are you guys potentially in a position to deploy capital in May should the shares get a little dislocated from the Ashland distribution?

First of all, with the share repurchase program let me reiterate some of the key objectives. It's another opportunity to create value for shareholders. We see this three-year program as fitting within our overall capital allocation strategy reflecting our strong cash flow.

And we have a disciplined approach that we have put in place to participate in the market over time. But we did put it in place now to give us that opportunity to participate in any opportunities in the short term, including the share distribution phase in May.

Okay. And then as a follow-up on the same-store sales growth, what's the cadence you expect for the back half of the year and could you remind us what the comps look like compared to what the comps look like for Q1 and Q2? Are they easier, harder?

Well, let me address that and Mary can add anything to make sure we provide good understanding here. Q1 was particularly strong. We were in the high single digits and then, obviously, Q2 we were in the mid single digits.

And as we look at the back half of the year and the programs that we have in place and continued strong execution of our teams out in the stores, I'm very confident in the performance of our stores and same-store sales growth in the second half given those programs and the momentum that we have in that business. So just reiterating the ability to deliver consistent same-store sales growth. Typically it is going to be in that mid-single-digit range.

Okay, thank you.

The only thing I would add is we are not adjusting our guidance there. We had guided to a 5% to 7% same-store sales comp for the full year, and we still believe our full-year comps will fall in that range.

All right. Thank you for answering the questions.

Simeon Gutman, Morgan Stanley.

Hi guys, this is Ben Zerman on for Simeon. Thanks for taking my question.

Just one real quick on core North America gross profit per gallon. Is the right way to think about it in terms of the pass-through lag if base oil prices increase towards the beginning or the middle of January and your corresponding price hike didn't go into effect until March 1, is the right way to think about it that roughly a month and a half you had to absorb margin on the side of your business where you are negotiating through buyers?

It's not quite that simple. We have provided some direction on this before and you really have to break down Core North America when you take a look at the volume.

A good portion of Core North America does price off of an index and adjust on a quarterly basis. And that's primarily our sales to some of our largest installers in Core North America. And then you've got more the market-based price which is primarily the DIY segment and portions of the installer channel segment.

And that's the portion that we can get some lag impact. We have pointed out in the past that can be upwards of 90 days, 90 days-plus. And so that's where we will feel some pain on that Core North America DIY segment.

Mainly it's because we are protecting promotions that we have already scheduled with the DIYers, the DIY retailers. There's also the fact that we are not -- every time the base oil moves we are not repricing our product. We are typically waiting for a couple of sustained moves, and then we will work with the retailers to execute the price increase in a way that provide some discipline in the marketplace, and we are not seeing volatility in pricing to the retailer or to the end customer.

Does that help?

Yes, it does. Just one quick follow-up, it's been a challenging retail environment the last several months. A lot of retailers are cutting costs and pushing suppliers to invest in prices.

Have you felt any of this on the DIY side of that Core North America business at all in terms of trying to push through successive price increases?

First I will comment on the environment. You know, the DIY retail business has been strong for a period of time or we are seeing strength in the Motorola category and even growth. We have seen then a slowdown over the last few months, particularly looking at the December through February period we saw some softness in the overall category.

So that did have some impact on our promotion performance and our scheduled promotions in DIY. Still pleased with our share performance overall. But we saw some of that softness and I think it's been clear as to what some of those drivers are.

A combination of delayed tax refunds and potentially a weather impact, too. But in terms of our ability to pass through pricing, we work closely with the retailers to execute those increases in a way that doesn't disrupt the business and keeps the momentum going and protects typically they are able to make moves on pricing that is going to allow them to protect their margins.

So, again, we've been very consistent, consistently performing on our ability to pass through pricing. And it has to do with the strength of the Valvoline Brand and the strength of the relationships with the retailers that allows us to do this.

All right, thank you very much.

(Operator Instructions) Dmitry Silversteyn, Longbow Research.

Good morning. I just wanted to follow up on the international business. We have seen, this is the one area where we've seen a couple of quarters now declining sales of premium brands.

So I just want to -- you mentioned a little bit in your opening remarks. But I'd just like to get me beat a little more clarity on what is going on there.

And also offsetting that, obviously, is the almost 13% growth that you have delivered volumetrically the last couple of quarters. So I am just wondering how sustainable that is into second half of the year or if this was sort of a one-time or initial fill type of a situation with a new customer?

The International business is really off to a great start this year and we see continued momentum. So we're seeing volume growth across really all of our key regions. And I was especially encouraged to see the growth in the mature region of Europe over the last couple of quarters.

And that team has really made some nice progress for us in developing our channels, upgrading our distribution and just also how we are working with our distributor partners and with some of our direct accounts, too, for driving growth and winning business in Europe. So it gives me a lot of confidence that the growth that we are seeing in International where you combine very strong growth in emerging markets and our growth markets like China and India and Mexico, parts of Latin America with strong growth coming out of Europe and solid performance out of Australia, really feel good about the ability to continue to deliver good growth internationally.

The mix is impacted somewhat by promotions and where we are seeing some of that growth. I expect the International mix to improve over time. It's just that it's moving at a little bit slower rate compared to what we see in Core North America.

But there is still plenty of opportunities for mix improvement over time. It's just that some of the new growth in certain markets where they are not using new technology, you are selling some of the older technology basically and it sells at a bit more of a lower price and a slightly lower margin, too. But the same factors that are affecting Core North America in the long term, the move to new technology, the move to more synthetics, those ultimately benefit the International business, too.

That's helpful. And then just on the volume growth in VIOC, how much of that was the Oil Can Henry and the Time-It acquisitions?

So I mean, basically same-store sales, is there a little bit more pricing in there or mix that we should be thinking about in terms of volumetric growth in VIOC?

Within the overall VIOC business sales were up 13% for the quarter. The comp store sales for company-owned stores were up just over 2%.

So we did see a substantial sales growth coming from new units that we added year over year. So the incremental new units we added year over year were in excess of 50 new units. So that's where a lot of the total top-line growth came from.

I understand that but I'm trying to take pricing out of that, I guess. If I am looking at the gallons growth that you guys report in VIOC was pretty substantial about, I think, almost 15%.

So I was just wondering how much of that was acquisitions versus organic growth. I guess, if you're same-store sales were up 2% and your pricing was up then it suggests that your volumes on same-store sales were down. Am I interpreting too much into this?

Yes, I think you are. I think at the end of the day the price cost had a slightly favorable impact to Quick Lubes for the quarter. So most of the GP benefit came from the overall volume increases across both existing stores and new stores.

Okay, thank you.

Yes, in other words we definitely had oil change per day growth in our Company stores, both Oil Can Henry's and the system.

Okay, thank you.

We have no further questions at this time. We thank everyone for attending today's conference call and webcast.

This concludes the conference. You may now disconnect.

Thanks, everyone.