Hello, and welcome to Valvoline's second quarter 2024 Earnings Conference Call and Webcast. My name is Elliot, and I will be coordinating your call today. I would now like to hand over to Elizabeth Russell. Please go ahead.

Thank you. Good morning, and welcome to Valvoline's Second Quarter Fiscal 2024 Conference Call and Webcast. This morning, Valvoline released results for the second quarter ended March 31, 2024. 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 Lori Flees, our CEO and President; 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. Today, Lori will begin with a look at the key highlights from our second quarter, and Mary will then cover our financial results. With that, I will turn it over to Lori.

Thanks, Elizabeth, and thank you all for joining us today. For the second quarter of 2024, we saw growth at the top line across the network, with system-wide store sales growing over 13% to $746 million. Profitability was strong, with adjusted EBITDA improving 21% to $105 million and adjusted EPS improving over 60% to $0.37 per share. We added 38 net new stores to the network this quarter, with 14 coming from franchise. This brings our year-to-date additions to 76 in total, with 33 from franchise. Also, this quarter, we purchased approximately 1 million shares, returning just over $40 million to shareholders through share repurchases. This completes the $1.6 billion share repurchase authorization well ahead of the 18-month commitment we made at the time we closed the sale of the Global Products business. Before Mary covers the details of the quarterly results, I'd like to share some additional insights on how these results fit into our strategy. We continue to focus on driving the full potential of the existing business. One of the key metrics to this strategic pillar is same-store sales growth. As I mentioned, this quarter, we saw a 7.7% system-wide same-store sales growth. Non-oil-change revenue was the largest contributor to this growth across the system, mostly driven by increased service penetration. The team's focus on employee retention and best practice sharing continues to improve how we educate our guests on the additional services their vehicles need. The automotive manufacturer recommended services saw the highest improvement in service penetration in Q2, which is a testament to the training and tenure we built across our stores. On the transaction side, after a choppy start to January due to weather events across the country, we've recouped the volume in February and ended the quarter with modest improvement. Year-to-date, we have performed over 13.7 million services for customers system-wide. The other part of driving full potential is managing our cost to improve profitability. We're pleased with our Q2 performance in this regard. Specifically, strong labor management created significant benefit in the second quarter in our company store operations, which exceeded our expectations. Our ability to manage scheduling, especially during the weather events that happened in the quarter, continues to improve. We also saw a benefit from improved supply chain costs and store expenses for company stores this quarter. As we enter the back half of the year, we typically see significant labor leverage due to the increase in volume during the summer drive season. While we'll continue to use the labor management tools that have benefited us year-to-date, we do not expect to have as strong of a year-over-year improvement in labor efficiency for the remaining half of the year. Now I'd like to touch quickly on accelerating network growth. We're really pleased with the 38 net store additions this quarter. It brings our total network to 1,928 stores, an 8% growth over the prior year. We continue to see a balanced mix of ground-up builds and acquisitions. On the franchise side, half of the net additions this quarter were ground-ups. As we look at our pipeline for the remainder of the year, we're on track to have the store additions in line with our original guidance of 140 to 170 total additions, with 55 to 70 coming from franchise. Now I'll turn it over to Mary to walk us through our Q2 financial results.

Thanks, Lori. On Slide 5, we'll take a closer look at our top line growth for the quarter. Adjusted net sales grew to $389 million, a 13% increase over the prior year. System-wide same-store sales grew 7.7% over the prior year and 21.2% on a 2-year stack basis. The growth for the quarter continues to be consistent and balanced between company and franchise, was 7.4% and 8%, respectively, this quarter. Ticket growth contributed just over 70% to the comp. As Lori shared, increased non-oil-change revenue was the largest driver of ticket growth, with the balance coming from net pricing and premiumization. Transaction growth contributed about 30% to the comp. This includes a contribution of just over 1% to the overall comp mix coming from the net impact of leap day, the Easter holiday shift, and day mix. Slide 6 has a look at other drivers of the financial results. First, let's look at our gross margin rate. We saw expansion from 36.8% to 37.6%, an 80-basis point improvement year-over-year. This was largely driven by leverage at the labor line coming from the improvements Lori discussed earlier. Sequentially, we saw a 150-basis point expansion. This was driven by labor improvements and lower supply chain costs. SG&A, as a percentage of net sales, decreased modestly over prior year, while we saw a 140-basis point sequential decline. Top line growth drove additional leverage, while we also saw benefit sequentially from lower travel and meeting costs from the company meetings, which are held in the first quarter each year. Depreciation and amortization increased by $5 million year-over-year, causing about 50 basis points of deleverage in the gross margin rate. Overall, adjusted EBITDA margin improved 170 basis points over the prior year and 280 basis points sequentially. For the back half of the year, we expect to capture the SG&A leverage that comes with the seasonality of our business. However, we expect the gross margin labor leverage to moderate. On Slide 7, we'll take a look at our profitability metrics. For Q2, adjusted net income increased 20% to $48.3 million, driven by sales growth and margin rate improvement, which was partially offset by increased investments in SG&A. Sequentially, adjusted net income grew 25%, largely driven by improvements in gross margin and lower SG&A, as we just discussed. Adjusted EPS grew 61% from $0.23 to $0.37 per share. The increase in operating income contributed about half of the EPS growth. The balance of the change came from lower net interest expense and the reduction in average share count of about 42 million shares compared to the prior year. Turning to Slide 8. We'll look at the balance sheet and cash position. During the quarter, we returned just over $40 million to shareholders via share repurchases. As Lori mentioned earlier, that completes the $1.6 billion authorization. In March, we also announced a tender offer to repurchase the $600 million of 2030 senior notes. That tender offer was completed following the end of the quarter with final settlement made in April utilizing cash and cash equivalents and borrowings under the revolving line of credit. In Q2, we earned interest income of $4.6 million on the remaining invested net proceeds from the sale of the Global Products business. This is not expected to recur in the back half of the year now that the debt tender offer is complete. This fulfills the remaining commitments we made regarding the uses of the proceeds from the sale of the Global Products business. Turning to the cash flow statement. Year-to-date cash flows from operating activities were $92.1 million, a decline of $81 million over the prior year. As a reminder, the establishment of the supply agreement with Valvoline Global Operations in the prior year drove a one-time benefit, which represents most of this decline. Additionally, the implementation of our new ERP system during the quarter delayed billings to our franchise partners, creating a short-term increase in accounts receivable that we expect will normalize in the back half of the year. As we noted in our press release, we expect to report a material weakness related to the ERP system implementation that went live on January 1. We have implemented enhanced manual controls intended to ensure the financial statements for Q2 are accurate. A plan to remediate is already underway, and we expect this to be completed by fiscal year-end. Turning to Slide 9. We'll take a look at our guidance for fiscal year '24, which we are narrowing from our original outlook. With half the year complete, substantially in line with our expectations, we believe it is appropriate to narrow our guidance. For same-store sales growth, we expect 6% to 8% for the year, with net revenue of $1.6 billion to $1.65 billion. For adjusted EBITDA, we are narrowing the range to $430 million to $455 million. Finally, for adjusted EPS, the updated range is $1.45 to $1.65 per share. I'll now turn it back over to Lori to wrap up.

Thanks, Mary. We delivered strong profit growth for the quarter, added 38 new stores and completed the $1.6 billion share repurchase authorization. I'd like to take a minute to thank our team and our franchise partners for their continued hard work in the first half of fiscal 2024. I also want to give a special shout-out to the team in Ottawa, Tennessee. I've recently spent time working and training alongside that team, so I could officially achieve my topside certification. Now I'll turn the call back over to Elizabeth to begin Q&A.

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

First question comes from David Bellinger with Mizuho.

First one is on the comp guidance and trimming the upper end of the range. So is that simply reflective of a continuation you've seen in the first half of the year and not something indicative of any deceleration you've seen in Q3 to date? Just help us frame the reasoning behind the guidance change on the comp sales line.

Thanks, David, for your question. So the year-to-date same-store sales comp of 7.4% did reflect about a 60-basis point benefit from leap day. And we're not expecting any change, nor have we seen any underlying change in the business tempo with the start of our third quarter. We're really just adjusting down the top end of the range in order to set expectations for pretty consistent performance in the back half versus the front half. I would say that the back half, we are comping up against some really strong transaction growth from the prior year back half. And so we're going to monitor that closely. But overall, we're really expecting pretty consistent performance expectations in the back half versus the front half.

That's helpful. Appreciate that. And then just my second question is longer-term in nature, on the go-forward use of capital here, so the buyback exhausted in this Q2 period. Can you talk through any potential new buyback capacity with the senior notes now potentially out of the way? And also how you would think about any potential trade-offs in terms of repurchasing equity versus added new store growth or even some kind of acquisition strategy? Just help us think through all of that.

A really good question, David. Again, I'll just reiterate our capital allocation priorities. We're first focused on growth. That growth is coming through new store builds, acquisitions of new stores, and we're certainly open to looking at accretive growth opportunities in terms of that are synergistic with the underlying business. The second capital priority is around our leverage on our balance sheet. We've stated that we want a 2.5 to 3.5x leverage ratio that's kind of rating agency adjusted that basically takes into account leases and employee benefit obligations. And so we're currently trending just at the higher end of the range at about 3.7x leverage relative to our goal of 2.5 to 3.5x. And so we're going to continue to monitor that in relationship to the opportunity for future share repurchases. And of course, our third capital allocation priority is return of excess capital to shareholders via share repurchases. So we'll continue to monitor that closely with our Board and report to our investors on a quarterly basis.

We now turn to Simeon Gutman with Morgan Stanley.

Were there any markets without weather, and is there a difference in the spread in run rate? Also, you mentioned weaker labor efficiency in the second half. Is that due to a comparison or because you're anticipating higher labor costs?

I'll cover the first one and ask Mary to join. Thanks, Simeon, for the questions. On geography, it was very unusual in January. It actually hit across the board across most, I would say, the majority of our geographies. So when you look at the comp performance, there weren't significant swings across the network. So I would just say it was unusual, and I think most retailers have the same experience as we did in January. I would say we were very pleased with the return of the traffic in February. And so as I mentioned, when we closed out the quarter, we had modest growth just given that. So I think we felt very pleased with the traffic across the geographies and the same-store sales performance.

So on the labor side, we are expecting to see labor leverage in the second half of the year, which is consistent with what we experienced last year. However, we do not anticipate the same level of incremental leverage that we saw in the second quarter. In terms of our performance, we had strong labor results in the second half of the previous year. While we expect to continue seeing labor leverage sequentially, we are not expecting anything out of the ordinary from a labor standpoint. We believe our teams will keep performing excellently in labor management, but we think the potential for the level of leverage we experienced in the first quarter will be smaller in the second half of the year.

Yes, I'll just add, Simeon. In Q1, we expect to see some improvement year-over-year in Q2, given that weather impacts tend to vary throughout the quarter and across different regions. Managing labor is a bit more challenging. However, our teams did an excellent job exceeding expectations by effectively managing and adjusting schedules around labor needs. As forecasts came in, they trimmed schedules and then added labor in the following week when we typically see traffic return, ensuring we could serve customers when they came back into the store. This proactive approach in handling seasonal winter effects was impressive, and it exceeded our expectations; we weren't anticipating such strong performance. Our teams effectively utilized the tools we've implemented, allowing us to capture that benefit.

As a follow-up, can I ask on price cost on oil, where you are in terms of pricing? It looks like base oil as a proxy is sort of stable. Curious where you are in corporate stores? And I think pricing the franchisees there. But is there any lag, meaning catch-up to go and/or benefit that's on the comp based on where your prices are?

It's been interesting. We've noticed some modest changes in our supply chain costs and product costs in the lubricants sector. We benefited from some small declines in the first half of the year. Looking ahead, we expect some modest increases in the second half, but we've also just seen another small decline recently. For these changes to significantly impact our business, they would need to be substantial. As it stands, we do not anticipate anything that would significantly affect our business in the latter part of the year. We continue to monitor the broader macro situation, especially the political issues in the Middle East, which we are keeping a close watch on. Currently, based on the updated guidance we are providing, we do not expect any unusual developments in the second half of the year.

Our next question comes from Kate McShane with Goldman Sachs.

We were wondering how we should think about the pace of store openings for the remainder of the year. And are you hearing of any issues from franchisees in opening stores just due to higher cost?

Thank you, Kate, for your question. Last year is not a good benchmark for modeling franchisee openings. In Q3, we had one net new opening, primarily affected by supply chain delays that shifted some openings to Q4. However, we are enthusiastic about the engagement of our franchise partners. So far this year, they have opened 33 new units, compared to 24 last year. In the most recent quarter, half of the net new openings were ground-up constructions. We are more confident in our forecasts for these openings now that we’ve implemented strategies to address supply chain issues. For instance, we’ve been collaborating with our franchise partners to hold essential supplies in a general warehouse to avoid delays in store openings. We’re proactively working with them to keep their plans on schedule. Given our current progress, we expect to meet our projections of 140 to 170 openings this year, with 55 to 70 coming from franchise partners. We anticipate a better balance in Q3 and Q4 compared to last year, and we don’t foresee any significant issues or surprises at this point. Some ground-up constructions may be slightly delayed due to weather impacts in January, but overall, we’re confident about our guidance.

I would like to ask about the difference in comparable sales between the company-operated stores and the franchise stores in the second quarter.

In terms of general performance, what's interesting is the comps between our franchise partners and us is more consistent than what it has been in terms of the split between ticket and oil changes. And Mary, maybe you can comment more on that.

We observed some outperformance from our franchise partners this quarter, particularly in ticket performance. Overall, the performance has been very consistent. Notably, both ticket and transactions have shown steady improvement across all four quartiles of stores, whether franchise or company-operated. This consistency is encouraging, and we expect it to continue. The adoption of our SuperPro process has been consistent across both our franchise system and company stores, which we believe is crucial for driving the uniformity in comparable store sales performance. Occasionally, we notice some variations due to marketing strategies between franchise and company stores, but overall, those differences have also remained largely consistent.

We now turn to Steven Zaccone with Citi.

This is Avanti Cheruvallath on for Steve. We wanted to ask on the low-income consumer. We've heard some commentary on tighter budgets among that cohort. Are you seeing any sort of trade down in your business or slowdown in non-oil-change revenue attached to sales? And then along those same lines, can you talk about how you provide value relative to peers if consumers are on tighter budgets?

We have focused on understanding whether lingering inflationary effects in the broader U.S. macroeconomic environment are impacting us. Honestly, we are not experiencing any negative effects. There is no sign of consumers trading down, and lower-income customers are not showing a decreased retention rate compared to higher-income customers. Therefore, we have nothing to report concerning our year-to-date results or the second quarter, but we will continue to monitor the situation closely. We've heard similar commentary from other fast-food and retail service businesses. However, our business remains unaffected so far. We possess robust demographic data regarding our consumers and their store visit frequency, backed by strong data analytic capabilities. As mentioned, we have not observed any shifts in spending behavior or retention issues among lower-income consumers.

Yes, I would like to add that when discussing no trade down, it refers to services or premium services. Looking at transactions, metrics such as miles driven or the interval between visits have remained stable. Given the current economic climate, we have been analyzing customers across various income levels to ensure nothing is overlooked. Our stores are typically placed within specific economic demographic clusters, and we've observed no significant changes. However, we've now begun examining customer-level data to ensure we proactively adapt our business to meet customer needs effectively. Your first question is about electric vehicles. Overall, the current market conditions and sales of electric vehicles have certainly slowed compared to last year. However, I believe that the long-term projections for electric vehicle adoption or the vehicle fleet will not change significantly. We are actively conducting research and developing services that are suitable for battery electric vehicles, as well as for hybrids. In fact, we currently service hybrids at a higher rate than traditional internal combustion engine vehicles. We offer several maintenance services for hybrids and continually explore additional services as the hybrid market expands. Regarding our franchise partners, the influence of electric vehicles varies; in some regions of the Midwest where electric vehicle sales are quite low, there is little impact and interest. Even in areas with higher electric vehicle sales, there are still gaps in the service provided for traditional vehicles. Our franchisees, as entrepreneurs, focus on maximizing their returns on investment, and they tend to see greater potential in serving the existing vehicle fleet, although they remain engaged with us regarding our electric vehicle services. As for the interest from new partners, I do not believe that electric vehicles are influencing their interest levels. We continue to have fruitful discussions with potential partners and have recently signed a few smaller ones, while also conversing with larger partners about joining the Valvoline franchise. Progress is ongoing, but I wouldn’t categorize electric vehicles as a significant consideration at this time for franchisees.

Congrats to Lori on getting your topside certification. I'll keep an eye out for you the next time when I'm in one of your stores.

Thanks, Mike.

Now that we're kind of past the winter months, I was wondering if we could get an update on the battery offering and how that performed during those winter months relative to your expectations? And just curious if there's some additional upside next year from the battery offering as you make that available at more of your locations?

Yes, it's a good question, Mike, and something that we've been spending a lot of time on as a management team. The battery offering is probably a more complicated service because the variety of batteries is just as diverse as the number of air filters, but they take a lot more space in the stores to store, and you certainly can't let them sit for a long time if you're not placing them in service. And so we have a last-mile delivery partner that has to deliver the batteries and frequency relative to the car parc. It also requires that we test the batteries every time they come in because not every time will a battery register red or yellow in terms of its health. And if we don't test the battery every time, we don't earn that trust to complete the service with the guest. And then the last one is that the testing devices, we continue to look at improved testing devices because as the OEMs continue to change the design of the vehicles and lower the cost, so putting more plastic around some of the nodes, it makes some of the testing devices a little bit more tricky to ensure that you can get a really accurate read. So these are all things I'm explaining because we believe there is more opportunity in battery. We have fantastic pricing relative to comparable service providers in the market. And it's an area that we're working on because we do believe there's more opportunity there, and it will be part of our plan for the remainder of this year and into next year, for sure.

All right. And then you mentioned the internal control issue, and I understand you may not want to get into too much detail here. But if you can provide any color or help us understand what the problem was and what needs to be done to fix it, that would be helpful? And maybe just give us a broader update on where you are in that ERP implementation process?

Sure, Mike. The main issue from an internal control perspective during the quarter was with our information technology general controls. We launched the new system on January 1, driven by the sale of our Global Products business. The good news is that we are implementing a system that is more tailored to retail compared to our previous system, which focused more on chemical and materials supply chain needs. However, during the new system implementation, we experienced challenges related to user access controls and documentation of monitoring controls concerning IT changes and job scheduling for the ERP system. Additionally, we encountered some system design issues affecting our business processes. I had mentioned that there were invoicing delays for our franchisees, which were linked to those design issues that we are now addressing to enhance system automation. It's important to note that our daily business operations have not been materially affected, and we have consistently been able to serve our customers and support our franchisees. The systems that are crucial for operating our stores were unaffected by this implementation. Overall, the challenges were primarily related to IT general controls.

Got it. Is the implementation complete at this point, or are there still many stores where it needs to be rolled out?

No, it's complete. It did not affect the store-level systems we operate. The financial systems and some supply chain operations were impacted. The system implementation is finished, but we are still providing enhancements. As we move forward, we will be able to use some of the new capabilities in the system to increase efficiencies and improve analytics and reporting. There are significant benefits to the new platform. In the short term, we are focused on the remediation plan for the IT general control environment, which we expect to complete by the end of the fiscal year. We are also ensuring that the core system capabilities are working as intended.

Our next question comes from Jeff Zekauskas with JPMorgan.

This is Lydia Huang on for Jeff. Could you break down your volume growth in the quarter by volume from oil change and volume from other product sales?

If you look at our same-store sales breakdown, ticket sales accounted for about 70% of our system-wide same-store sales, while transactions represented around 30%. On the ticket side, both price and penetration were the largest contributors, followed by pricing and premium mix. Overall, we feel positive because we are driving strong growth in our added services or non-oil-change revenue, which is coming from all our store quartiles, indicating continued opportunity. We are setting higher best practice standards within our system, and the average continues to improve. The team organized a competition last quarter that reignited our team's focus on added services and best practices for effectively presenting these to our guests. We are pleased with this outcome, as it not only provided a short-term boost but also enhanced the capabilities of our staff in delivering services and their presentation. We continue to see positive performance in this area.

We now turn to Bret Jordan with Jefferies.

Could you discuss which specific areas within the services category you found to have the most momentum? I understand you've been considering expanding the services menu, so what potential additions are you thinking about?

Yes. In the past year and a half, our focus has been on the fundamentals. In the last quarter, we expanded our efforts beyond those basics. Visuals are considered fundamental, including cabin air filters, air filters, wiper blades, light bulbs, and batteries. These are items we can display to customers, allowing them to see how they are performing. We can inspect them visually and convey that information to our guests, ensuring we always offer to pull each cabin air filter and explain its importance. During COVID, we had removed this step from our service process. With 1,900 stores, reintroducing this for every technician at the customer interface takes time. We are now returning to these basics. With air filters, for example, we show customers the difference between an old filter and a new one, so they can decide if it needs changing. These straightforward practices have been revitalized across our team and have significantly contributed to our improvements. In my earlier statements, I noted that this quarter, we observed an uptick in OEM recommended services, which are not needed every visit or year but at specific intervals, such as 30,000 or 50,000 miles. This quarter, we saw the highest penetration of these OEM services, reflecting the effectiveness of our training and retention efforts, as they are generally more complex than basic visual tasks. For instance, we noted substantial growth in transmission services, which we ensured our teams are trained for and equipped to perform. When we reenergized our team around additional services last quarter, it was a combination of experience, training, and motivation that led to excellent results. Oh, sorry. You asked about additional services, and I wanted to mention that we have a research and development team exploring new offerings for our store. There’s nothing to report at this moment, but we maintain clear standards for our services to ensure they are quick, easy, and trustworthy. This applies not only to our customers but also to our team. By adhering to these standards, we can deliver high-quality service consistently. We continue to evaluate potential added services, ensuring that there are sufficient opportunities across our locations for our team to gain the necessary experience to deliver these services effectively. While there’s no new information to share, we are actively assessing our service menu and planning for its expansion.

Okay, great. I think you were also considering store formats that have lower build-out costs. Could you share your current status on that process?

Yes. Our real estate and development team, along with our operations and franchise teams, has been reevaluating the store design. Previously, we decided to only construct 3-bay stores because the volume justifies it operationally in specific car parks. However, there are areas where a third bay may not be necessary for the next 4 or 5 years. To address this, the team has developed a modular design that allows for the construction of 2-bay stores while ensuring that the infrastructure for adding a third bay is already in place without disrupting daily operations. This approach minimizes any operational impact. While we won’t see immediate effects, as the stores opening this year were designed prior to this new strategy, we anticipate that next year we'll start implementing these changes. We will provide more details as we discuss our guidance for the next year. For this year, I don't expect any significant changes, but we are actively engaging with our franchisees on this topic.

Lori, I want to add that our team has been focused on reducing the costs associated with the transition capital needed when we acquire a store. We have achieved significant cost reductions in the required investments for acquisitions, which is enhancing our return on invested capital related to those acquisitions.

This concludes our Q&A. I'll now hand back to Elizabeth Russell for closing remarks.

Thank you all for your time today. We look forward to our ongoing discussions following today's call. This concludes our call for today.

Ladies and gentlemen, today's call has now concluded. We'd like to thank you for your participation. You may now disconnect your lines.