Good morning, ladies and gentlemen, welcome to today's Valvoline Second Quarter 2023 Earnings Conference Call and Webcast. My name is Jaqueta. I will be your moderator for today's call. Operator Instructions. I would now like to pass the conference over to your host, Elizabeth Russell. Elizabeth, please go ahead.

Thanks, Jaqueta. Good morning, and welcome to Valvoline’s Second Quarter Fiscal 2023 Conference Call and Webcast. This morning at approximately 7 AM Eastern Time, Valvoline released results for the second quarter ended March 31, 2023. This presentation should be viewed in conjunction with that earnings release, a copy of which is available on our Investor Relations website at investors.valvoline.com. Please note that these results are preliminary until we file our Form 10-Q with the Securities and Exchange Commission. On this morning's call is Sam Mitchell, our CEO; Lori Flees, our President of Retail Services; and Mary Meixelsperger, our CFO. As shown on Slide 2, any of our remarks today that are not statements of historical facts are forward-looking statements. These forward-looking statements are based on current assumptions as of the date of this presentation and are subject to certain risks and uncertainties that may cause actual results to differ materially from such statements. Valvoline assumes no obligation to update any forward-looking statements unless required by law. In this presentation and in our remarks, we will be discussing our results on an adjusted non-GAAP basis unless otherwise noted. Non-GAAP results are adjusted for key items which are unusual, non-operational or restructuring in nature. We believe this approach enhances the understanding of our ongoing business. A reconciliation of our adjusted non-GAAP results to amounts reported under GAAP and a discussion of management's use of non-GAAP and key business measures is included in the presentation appendix. The information provided is used by our management and may not be comparable to similar measures used by other companies. As a reminder, the retail services business represents the company's continuing operations, and the former Global Products segment is classified as discontinued operations for the purposes of GAAP reporting. On Slide 3, you'll see the agenda for today's call. We'll begin by discussing the closing of the sale of Global Products that we announced on March first along with an update on the return of proceeds planned. We will then talk about our second-quarter highlights, share operational insights and end with a review of our second-quarter results. Now I'd like to turn the call over to Sam.

Thanks, Elizabeth, and thank you all for joining us today. As we announced on March 1, the sale of the Global Products business is now complete. Our teams have done an excellent job completing the transaction while remaining focused on delivering a strong Q2. The total cash purchase price for the sale was $2.65 billion, with approximately $2.38 billion of net proceeds after taxes and other transaction expenses. In Q4, we announced the Board has authorized a $1.6 billion share repurchase. Through April, we have returned $336 million through open-market share repurchases this fiscal year, with just over $200 million of that coming from the current authorization. After thoughtful consideration, management and our Board of Directors concluded that a modified Dutch auction tender would allow us to most efficiently and expeditiously return the sale proceeds to our shareholders. We expect to proceed with a tender offer of up to $1 billion, subject to market conditions. We are excited to focus on driving growth and increasing the value of the new Valvoline. The new Valvoline is a pure-play automotive retail business that is high-growth, high-margin and with a high return on invested capital. The new Valvoline is primed to deliver long-term value to our shareholders through our best-in-class retail platform. We are focused on growing system-wide store sales, increasing units through both company-operated and franchised additions and evolving the service portfolio over time. This algorithm has a long runway to take us into the future. Turning to Slide 8. Let's take a look at some key highlights from the quarter. The top-line growth continues to be strong with almost $660 million in system-wide store sales for the quarter, which is an increase of 18.5% compared to the prior year. For same-store sales, we continue to see consistent growth across our network with an overall growth of 13.5%. As we expected, we saw improved profit performance in Q2 with a 25.5% increase in adjusted EBITDA over the prior year, and a 19% increase over Q1. This comes on adjusted revenue growth of 19% over the prior year and 4% over Q1. Additionally, we continue to be on track for unit additions with 19 company-operated and 16 franchise locations added this quarter, bringing our total store count to 1,781. Slide 9 provides a look at our growth over recent years. We have seen substantial growth across key metrics including store count, same-store sales growth, system-wide sales, and EBITDA. We continue to see resiliency and strength in the demand for the quick, easy, and trusted preventive maintenance service we provide to our customers. We have a great track record of growth and that will continue in fiscal year 2023. Now I will turn it over to Lori to look at more details of our Q2 results and share some operational insights.

Thanks, Sam. As Sam said, consumer demand is strong for our quick, easy, trusted service. Our VIOC customer base has nearly doubled over the last five years, growing at a 12% compound annual growth rate. This is driven in part by additional units, but a significant component is from the growth of our same stores. In Q2, our system-wide same-store sales growth was 13.5%. Our same-store sales growth is consistent across company-operated and franchise locations. This balanced growth is a direct result of the partnerships we have with our franchisees and the strength of our SuperPro process, which enables a consistent delivery of a high-quality customer experience. We're pleased with the drivers of Q2 same-store sales. Approximately 30% of the Q2 same-store sales increase was driven by transactions. On ticket, we're continuing to see the benefit of lapping prior pricing actions taken during fiscal year 2022, and we remain confident in our ongoing pricing power. We continuously monitor pricing and take actions to optimize it across geographies. Additionally, our non-oil change service penetration continues to improve and drive further ticket growth. With the continued customer-base growth, our ongoing pricing power, and the tailwind from premiumization and non-oil change revenue service penetration, we remain confident in both our fiscal '23 and long-term same-store sales growth target. Turning to Slide 12. As expected, we saw EBITDA margin improvement, both sequentially and year-over-year. The sequential quarter-over-quarter improvement in EBITDA margins of 330 basis points was driven by increased volume and improved cost leverage with higher utilization of our stores and lower G&A expense. The year-over-year improvement in EBITDA margins of 130 basis points demonstrates the recovery of our margins through the pricing actions taken in the last 12 months, as well as continued transaction growth. Our stores are well staffed to gear up for the summer drive season, and we continue to anticipate a full-year EBITDA margin of 25.5% to 26.5%. Our EBITDA performance is underpinned by the growth of our mature stores as shown on Page 13. We continue to see solid leverage and growth in our mature store group. Since fiscal year 2019, our most mature stores have continued to grow top-line at a 10.1% compound annual growth rate while delivering an even higher EBITDA CAGR of 11.5%. The top-line growth of the mature stores has similar drivers as our overall performance, with growth in transactions, pricing, and non-oil change revenue penetration. Our continued growth along with a focus on ongoing operational efficiencies will enable us to continue to drive leverage and improve our mature store EBITDA. Let's take a look at the impact of our new stores on Slide 14. New stores are an important part of our long-term growth algorithm. Today, only 35% of vehicle owners live within 10 minutes of a Valvoline service center. New units enable us to broaden access to our proposition. Typically, our ground-up stores ramp to the revenue of a mature store performance in years three through five. Recently our new-store ramps have outperformed early expectations in both speed and size of the ramp. New acquisition stores typically have a faster ramp to maturity, but the size of the ramp is generally less than that of a ground-up. As all our new units mature, we expect to see at least $70 million of incremental EBITDA. While we continue to focus on ways to improve returns by driving down investment costs and improving performance, the strength of consumer demand along with our highly predictive real-estate modeling gives us confidence in our ability to drive return on invested capital through new franchise and company units. Now I will turn it over to Mary to discuss our Q2 financial results.

Thank you, Lori. The sale of Global Products is an important milestone for Valvoline. As Sam shared, Valvoline is now solely a retail automotive services business focused on preventative maintenance with nearly 1,800 stores across the U.S. and Canada. Accordingly, as of April 28, our GICS classification code has been updated to the automotive retail industry within the consumer discretionary sector. We will no longer be within the chemicals commodity sector. In addition to the change in industry classification, I want to highlight a few of the large financial impacts recorded during the quarter as a result of the transaction. The sale of Global Products generated $2.38 billion of net proceeds after taxes and other transaction expenses. We also recognized an after-tax book gain of $1.2 billion. With the proceeds from the sale of the Global Products business in hand, our cash position is very strong with a cash and cash equivalents balance of $2.3 billion at the end of the quarter. Additionally, the proceeds received from the sale are being invested in liquid assets. Our investment philosophy for the proceeds is safety and liquidity first, then yield. Through March 31, we have earned $8.3 million of interest income related to the investment of the sale proceeds. With the tender offer, we anticipate returning up to $1 billion of the after-tax proceeds from the sale in addition to the $336 million already returned through share repurchases through April 30. Another $300 million to $400 million of the proceeds will be used for the tax payment related to the gain on sale, followed by an additional $600 million for debt repayment. Our Q2 results are summarized on Slide 17. Adjusted EBITDA improved 25.5% to just over $87 million for the quarter. This is in line with our historical first-half results. Gross profit improvements were driven by increased transactions and higher average ticket from pricing actions and non-oil change service penetration as well as unit growth. SG&A investments increased by $4.8 million from the prior year, primarily related to investments in advertising, process improvements, and talent to support our future growth. While SG&A dollars increased modestly, we saw improved SG&A leverage driven by the increased sales volume. Now, I will turn it back over to Sam.

Thanks, Mary. We are pleased with our Q2 results and remain on track for a strong fiscal '23 performance. Completion of the sale of Global Products was an important milestone for Valvoline. As we have said, we plan to continue returning proceeds to shareholders and expect to initiate a tender offer for up to $1 billion of our common stock. Our team is doing tremendous work and we are excited to focus on the new Valvoline, as we continue to drive value for our shareholders. Now I'll turn the call back to Elizabeth to open the line for Q&A.

Thanks, Sam. Before we start the Q&A, I want to remind everyone to limit your questions to one and a follow-up, so we can get to everyone on the line. With that, Jaqueta, please open the line.

Operator Instructions. The first question comes from the line of Simeon Gutman with Morgan Stanley. You may proceed.

Hi. Good morning everyone, it's Simeon. I wanted to ask Sam about company versus franchised growth over time. Curious if it's a part of the strategy or target that you are going to identify or if you're going to keep it open-ended and see how the business evolves over time.

Yes, Simeon. As we communicated last fall that we have an aggressive growth target to grow the network to 3,500 stores, and we expect both company and franchise stores to be part of that to achieve that, but we have an especially strong focus on accelerating our franchisee growth. And so that includes working with our current partners and accelerating their growth plans. We're making good progress there, but we also expect to attract new partners to help us accelerate growth in certain markets. So while we haven't set a specific target for that mix, we do expect that the franchise growth will accelerate to a point where it will exceed the company's store growth on an annual basis, but this is a long-term plan that we will be working on over the next five years.

The follow-up question is about transactions. You mentioned a breakdown of 70% price and 30% transactions. I am unsure if that terminology was used last quarter. Can you discuss how transactions have trended and whether weather had any impact on those numbers? Additionally, how do consumers feel based on transactions? I'm not certain if that's a reliable measure because price seems robust and the top line is strong, but I'm curious if there’s anything to infer from the transaction level. Thank you.

Simeon, this is Lori, I'll go ahead and answer that question. We saw weather at the end of Q1, which actually pushed a little bit of volume in January. But overall, we had transaction growth in every month. We are lapping significant price changes or increases that we made in fiscal year 2022, so that will be the bulk and we made those changes in Q3 of last year. So you'll see the ticket component of growth that lapping finish but the transaction growth was very strong. There was pockets of weather that shifted things around within months, a little bit between months, but overall, we saw good transaction growth across all regions and across all months.

I would add to that, Simeon, that we're really pleased with Q2 transaction growth. With the pricing increases that we had been passing through, we had seen a larger portion of our comp being sourced from ticket versus transactions, and we thought that seeing the transaction growth in Q2, where close to 30% of the total comp was really encouraging. And we're really pleased with what we're seeing and customer retention and new customer acquisition.

Yes. Thanks, everyone.

Thank you. The next question comes from the line of Steven Zaccone with Citi. You may proceed.

Hi, good morning everyone, thanks for taking my question. I wanted to follow up on Simeon's question just talking about same-store sales. So the first half, clearly above the full-year guidance range. Can you talk a little bit more detail about the second-half expectations, just because it moderates on a one-year basis? That commentary about ticket versus transaction, how should we expect the balance to be between ticket and transactions in that second-half same-store sales?

Sure. Steve, this is Mary. We did take some pretty aggressive price increases last year that primarily impacted the second half of the year. So we are expecting to see that lapping those price changes will drive some of the moderation in comp in the back half versus what we saw in the front half. We expect over time, over the long-term time to see balance between price ticket and transactions. And we believe that we'll start seeing more of that balance in the back half of the year in terms of our overall comp-store sales as we're looking forward. But again, we expect to see more balanced over time, as we're balancing through some of these pricing actions that we took in the latter part of last year.

I think the good news is, is that we're continuing to see the strength from the consumer, the back half of the year, we do higher volume in our stores as we think about the summer drive season. And so the trends that we're seeing in the business are really solid, both in terms of the transactions, the share growth that we're seeing and then the strength in the ticket. As we've talked about at the beginning of the year, we got a strong focus on added services and we continue to see good performance from our team and effectively presenting and executing those services.

Yes. I'm sorry. I'll add on. When we say 70-30% is transaction and 70% is ticket, that ticket increase is not all price. There is a component of price in there, but there's also continued tailwinds for premiumization as well as our non-oil change revenue service penetration. And those latter two points will continue through this year. We've made significant investments in training and process, as well as ensuring we have the right equipment that is working in every store, and our team is trained to use it. So we believe strongly that the ticket part of the growth will continue. It's just the piece that the price lap will subside. And when you look at our guidance for FY23, we definitely will be within guidance and so you can sort of see that that will moderate as Mary had said.

Great. Thanks for all the detail on that. Then the follow-up I had is just about the margin improvement in the second half of the year because clearly good execution here in the second quarter. I know you don't guide to gross margin versus SG&A, but can you just help us think through some of the building blocks? Like should the back half of the year follow a similar pattern with more SG&A leverage driving the EBITDA margin improvement? Thanks very much.

Yes, Steve, we will definitely experience margin benefits in the second half of the year from both SG&A leverage and gross margin leverage as we anticipate higher volumes. This will also reflect the full impact of our pricing strategies and other adjustments to improve overall gross profit. When Lori discussed our full-year EBITDA margin guidance of 25.5% to 26.5%, you can infer what the second half needs to achieve in order to reach that target. We expect to see significant margin improvement both sequentially and year-over-year during that period. Lori, do you have any additional thoughts?

No, I agree. And we've made some investments from a technology standpoint. For example, in store scheduling, we'll be rolling out the second wave of that later this year. But those things just help us ensure that labor is scheduled to meet the demand, but we don't overspend on labor, that helps us from a gross profit perspective. And then on the SG&A, we always get leverage on the basic expenses of running our stores when more volume comes in. So we always see leverage increasing quarter-over-quarter as volumes go up.

Great. Thank you very much.

Thank you. The next question comes from the line of Mike Harrison with Seaport Research Partners. You may proceed.

Hi. Good morning. I wanted to ask a little bit about what you're seeing on raw-material costs. It looks like base oil came down again kind of early mid-April. That flow-through on your gross margin should be a positive for your company-owned stores, but I was wondering if you can help us understand the timing on how that flows through to franchisees and how that franchisee impact of lower raw-material costs will affect your gross margins.

Sure, Mike, I'll discuss the company store aspect, and then maybe Lori can address the franchise side. From the company store viewpoint, we are starting to experience some benefits from lower base oil costs. However, we are facing some pressure on the pricing for used oil. As you may remember, we sell all of our used oil, and it has typically acted as a natural partial hedge against changes in product costs. However, there has been significant weakness in the overall base oil market, which is leading to a decrease in base oil costs, and as a result, we are noticing some pressure on the reclaimed oil value we receive in the market. Still, I anticipate some modest benefits in the latter half of the year. I believe this aligns with our previous guidance regarding the business. Lori, would you like to discuss the impact on franchises?

Yes. On the franchise pass-through, we have a contractual agreement around certain thresholds of how quickly we pass those through. Because of the used oil pricing decline as the base oils are coming down, we're working with our franchise partners to pass that through fairly quickly as we start to realize it. We do have pockets where delivery fees are continuing to be higher just as our distributor partners struggled to keep staffed, and so we're still managing the overall cost portfolio pretty tightly both on behalf of our company stores and on behalf of franchisees. But I wouldn't expect us to have a negative or positive impact on the base oil within our financials. Our intent is to pass on the benefit to the franchisees as soon as we realize it.

All right, perfect. And then just curious, you have this slide that shows the growth in your customer base. Can you maybe talk a little bit more about where these new customers are coming from? I'm curious if you're still benefiting from some of the dealerships out there that may be struggling with labor constraints and with service times having to be planned out maybe weeks in advance.

Yes, that's a great question. We continue to attract new customers from independent service providers, other service providers, and dealerships. When we analyze the vehicles we serve daily, approximately 67% are customers we have seen within the past year, about 20% are new, and the remaining customers are those we have served previously but not in the last 12 months. Among the new customers, around 40%, which is similar to the overall population that still visits dealerships, are coming to us following their last oil change at a dealership, and this trend has remained steady throughout the year. Once these customers experience our quick, easy, and transparent service, it fosters a strong relationship, and we are very pleased with their retention.

Excellent. Thanks very much.

Thank you. Your next question comes from the line of Laurence Alexander with Jefferies. You may proceed.

Hi, this is Dan Rizzo on for Laurence. Thank you for taking my question. When you talk about non-oil change services, is there a particular service that you guys focus on that you have some sort of advantage versus some competitors?

It's a great question. We need to prioritize safety items, such as lights, windshield wipers, and cabin air filters. These essentials are typically offered by most reputable quick lube providers, and they don’t require much time while providing significant convenience to our customers. There are specific times of the year when we see an uptick in other services that set us apart from other quick lubes. For instance, we always experience a surge in air conditioning recharge services during this season. In the colder months, battery replacements tend to increase. We test every battery that comes into our service centers and provide customers with a report, which builds their confidence. When a battery shows a health indicator of red or yellow, it makes discussions about replacing it with Valvoline much easier. We offer many OEM preventative maintenance services that customers could get at a dealership, but at 25% to 40% lower prices, which is very appealing. Our service is quick; customers don’t have to leave their cars with us. They can drive in, and we can complete those services relatively fast, allowing them to save money. The services that differentiate us include more OEM offerings, battery replacements, AC recharge services, and some of these are seasonal.

That's actually very helpful, thanks. And then my second question is, is labor sourcing an issue, or is it a diminishing issue, or how should we think about it just as things kind of evolve here from a macro perspective?

Yes. Talent retention, acquisition and retention is obviously a critical focus for our business. We've been spending a significant amount of time implementing recruiting tools that are shortening the time of hire from application to hire in seven days. And those are serving us very well in the market. We've also been very focused on onboarding and training changes so that we can have a higher retention rate in the first 90 days. Really happy with the results that the team has driven, where we're at a low attrition rate relative to last year and the year before for the current period, and we're well staffed. So we typically need to staff up in every store to hit the drive season. At the present time, we need less than one hire per store to hit the demand that we're expecting in the summer. So we're very well staffed. Now that doesn't mean we don't have pockets of opportunity. There are certain markets where our attrition is higher than where we want it to be and/or the pipeline is not as robust as we would want it to be. In those cases we work local solutions with the team in the market to try to remedy that. But as a system, we're really happy with where we are from a staffing standpoint and just the level of experience and training that that team already has going into this part of the year.

Thank you very much.

Thank you. The final question comes from the line of Jason English with Goldman Sachs. You may proceed.

Good morning everyone. Thank you for completing the deal and for your reclassification in the GICS code. I have a few questions as the staples analyst. The same-store sales guidance for the second half of the year, based on your first-half performance and full-year outlook, is between 4% and 11%. I believe I calculated that correctly. Can you explain the factors that might lead you to achieve results at the lower end compared to the higher end of that range?

So in terms of the low end, I think you'd have to see a pretty dramatic macro shift that's not already reflected in the broader macro numbers for us to come in at the low end that would put it probably imply some trade-down for us from premium oil changes to non-premium. We think that's probably unlikely. I would think more toward the midpoint in terms of where we think we're going to be in the back half relative to continue both ticket strength that could be impacted by trade-down if we saw a deeper impact on consumers than what we're seeing today, along with continued strength in transactions similar to what we saw in the second quarter.

Yes. I'll just add. I think trade-down is one. I think the other piece is that we're also always looking at miles driven and interval. And just given concerns around recession and whether or not it affects people's summer plans either to the positive or to the negative as it relates to miles driven is something that we're watching. We haven't seen any signs of the customer changing their behavior. But we also recognize the forward-looking economic forecast has some uncertainty on the consumer side. So that's something that we're watching. We don't see anything coming through. We see very strong resiliency in demand. The other thing is new customer acquisition. We are finding ways to optimize our marketing spend, shifting it to digital channels for new customer acquisition, but we do see competitors in certain markets, particularly on the dealership side, using oil change or preventative maintenance as a way to get people back into the dealership to shop for cars during this period. And so the ability for us to attract new customers without heavy discounting of our proposition is something that also could impact us more in the summer period. Again, we don't see those impacts, but given where the inflation and consumer sentiment is, those would be the things that would move us to the lower end of that range.

All that said, we're feeling good about where the business is today and as Lori mentioned, the store staffing is strong, and the current performance is solid. So we'd expect to have a very good summer.

Yes, I think that came through open, the responses to the questions. So thank you for that. And back to the base oil question from earlier. I don't recall you guys talking about all truly related to resale of used oil as either positive or negative contributors. This is the first time I recall you guys talking about it as a negative offset. Why is it different now? Why would it be moving different from base oil than we have in the past, and be an offset to the benefit that you otherwise wouldn't have had historically?

That's a great question, Jason. The long-term relationships between base oil and crude oil, as well as between base oil and used oil, have changed due to the conflict between Russia and Ukraine and the sanctions on Russian oil. This has impacted the upstream supply chain for both base oils and used oils. We've discussed used oil in the past, but it's been a while. In my seven years with the company, there have been times when we've had to pay to remove used oil from our facilities rather than getting paid for it. It's always been a factor in our business, but it hasn't been significant enough to warrant much focus on it until now. Currently, there is softness in the base oil market, which is affecting the re-refined base oil markets and putting pressure on used oil pricing faster than what we're seeing in the conventional base oil markets. I don't have much more insight beyond that, other than that we are experiencing less significant pass-through on the reductions in base oil than we would have expected, partly due to the pressure on used oil pricing in the market. We're working hard because we believe used oil is a valuable commodity. More refineries are opening up in the U.S., and we think demand will increase over time. We produce high-quality used oil in our facilities that can be sold, and we believe there are good opportunities there. However, in the short term, we anticipate some offset pressure as we move forward.

Okay. Thanks for all the color. I appreciate it.

Thank you. There are no additional questions waiting at this time. So I would now like to pass the conference back over to the management team for any additional or closing remarks.

All right. Well, thank you all for joining us today. We're excited to move forward with the new Valvoline following the close of the sale of the Global Products business, and with our plans to return the proceeds to shareholders through a tender offer in place, we are focused on driving growth and high returns on capital as a pure-play automotive retail business. I'd like to thank our store team members and franchise partners for all the work they do to drive our business. We appreciate your time today. Thank you.

That concludes today's conference call. Thank you for your participation, you may now disconnect your line.