Valvoline Inc.

Thank you all for joining and welcome to Faveline's Q4 2022 earnings conference call and webcast. All lines have been placed on mute to prevent any background noise and after the speaker's remarks there will be a question and answer session. If you would like to ask a question during this time simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question please press star two and for operator assistance at any time, please press Start Zero. Thank you. I will now turn the conference over to your host, Sean Cornett from Investor Relations. So please go ahead when you're ready, Sean.

Thanks, Priya. Good morning, and welcome to Validine's fourth quarter fiscal 2022 conference call and webcast. On November 15, 2022, at approximately 7 a.m. Eastern Time, Valvoline released results for the fiscal year and fourth quarter ended September 30, 2022. 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-K with the Securities and Exchange Commission. On this morning's call is Sam Mitchell, our CEO, Laurie Fleece, our President of Retail Services, and Mary Michelsperger, our CFO. As shown on slide two, any of our remarks today that are not statements of historical fact 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 known. 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. 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. This information provided is used by our management and may not be comparable to similar measures used by other companies. The announcement that Valvoline signed a definitive agreement to sell its global products business resulted in the former global product segment being classified as discontinued operations for purposes of GAAP reporting, with the retail services segment becoming the company's continuing operations. Results of continuing operations are comparable to those previously discussed on a pro forma basis at the time of the announcement. On slide three, you'll see the agenda for today's call. We'll start with an update on the sale of global products that we announced in August and an introduction to the post-transaction babbling, where our company will be focused fully on retail services. We'll then talk about our growth strategy for the business and end with a review of fourth quarter and full year results and guidance. I'd like to turn the call over to Sam.

Thanks, Sean, and thank you all for joining us today. The sale of global products marks the completion of Valvoline's transformation from a complex story with two very different businesses into a simple, pure play retail services business that is best in class in the industry. Valvoline's global products and retail services are two differentiated businesses that have their own investment attributes, growth, and profit drivers and strategic priorities. With the success of our retail strategy over the past several years, retail services has grown to a point where it can thrive as an independent business. Today's call will focus largely on retail services, including our strategy for growth and value creation. The new Valvoline is a high growth, high margin, less capital intensive business that has less operating risk given the high percentage of franchise stores. We will have a focused capital structure and capital allocation strategy. This will drive the ability to make more targeted investments to capture opportunities in an evolving car park, including the growth of electric vehicles. At the same time, investors will benefit from increased transparency and clarity due to the simple nature of our new business model. Our team has been hard at work to complete the separation. We continue to anticipate the closing will occur in early calendar 2023. Total proceeds from the transaction will be $2.65 billion in cash. and approximately $2.25 billion net proceeds. We intend to use the majority of the anticipated net proceeds to accelerate the return of capital to shareholders through share repurchases with the remaining portion used for debt reduction. Today, we announced the Board's authorization of a $1.6 billion share repurchase to effectuate this return with the goal to complete the share repurchases within 18 months. Turning to slide six, let's look at the new Valvoline. We have a 150-year history and one of the world's most recognized brands, a brand customers trust for convenient, preventive automotive services. With over 1,700 retail locations across the US and Canada, Valvoline has more sales than any other preventive auto maintenance company in North America. These locations, 54% of which are franchised, have delivered 16 consecutive years of same-store sales growth. System-wide sales, which have been growing at a 19% CAGR over five years, are now nearly $2.4 billion for fiscal 2022. Looking to slide seven, the new Valvoline is expected to generate faster growth, higher margins, and 20% plus EPS growth. taking Valvoline into the top tier of consumer retail growth stocks. We expect our financial and operating metrics to improve significantly post-separation, which will compound value to shareholders. In simple terms, our plan is to grow top-line revenue at 14 to 16 percent, adjusted EBITDA between 16 and 18 percent, and deliver adjusted EPS growth between 22 and 26 percent per year over the next five years. We are forecasting adjusted EBITDA margins to steadily improve with a range of 26% to 29% over the forecast period. We have multiple levers to create value and drive strong growth, including continuing to focus on growing our core business through winning market share and improving service penetration, focusing on accelerating our franchise growth while continuing organic growth via new store development and M&A, leveraging our assets and core capabilities into incremental service offerings as the car park evolves, and maintaining an enhanced capital structure and improved capital allocation policy by returning excess cash to shareholders. We will talk more about each of these growth levers. Valving is a highly attractive investment opportunity. Our compelling value proposition has three broad components, growth, brand, and performance. We're going to accelerate franchise growth, expanding our already scaled footprint and platform as one of the largest preventive maintenance companies in North America. Auto care is a growing, highly fragmented market with significant white space for expansion. We see potential for our differentiated model of providing convenient and trusted service to our customers as a driver to more than double our 1,700 plus retail locations across North America to over 3,500 units. We're confident that our model of quick, easy, trusted service will allow us to continue winning market share while generating attractive margins and significant cash flows in the years to come. Turning to slide nine, we are already a leader in a uniquely attractive industry, preventive automotive care. This market is economically resilient with low cyclicality and established long-term growth drivers. There are over 275 million cars in the U.S. with increasing age and vehicle complexity driving the need for auto care and increased service spend. Additionally, total miles driven continues to grow. This market provides essential services required in any economic environment for any car type. our preventive maintenance business through ongoing improvements in service performance and investments in network expansion, while continuing to develop capabilities for an evolving car park. While there has been a lot of press over the past 12 months on electric vehicles, the reality is that it will take decades for electric vehicles to represent a substantial portion of the car park in North America. With our strong brand, skilled platform, and convenient and trusted service, we are confident we can continue to win share in the evolving auto care market. We have a simple and proven business model. When you look at the core metrics for retail services over the past seven years, they are impressive. We've grown units from 1,068 stores in 2016 to 1,715 in 2022. Our system-wide sales have grown from 880 million to $2.4 billion in the same time period, an average 10% system-wide store sales growth annually, same store sales growth annually. From a profit perspective, both segment sales and segment EBITDA have grown at over 20% CAGR from 2016 to 2022. These results demonstrate the strength of the business model that Valvoline has built. Looking at slide 11, we highlight our mature company stores, which are defined as stores opened prior to October 2018. Recall, we have aggressively added stores over the past five years, hence only about 60% of our store base is mature. The mature stores have provided substantial growth in recent years, with per store revenue growing from $1 million in fiscal 2018 to $1.5 million in fiscal 2022. while per store EBITDA has grown from nearly $330,000 to over $500,000 in the same time period. Additionally, we have a strong pipeline of stores that are working towards that mature store status. We believe there is more than $50 million of incremental EBITDA growth in the years ahead simply from our non-mature stores transforming into mature stores. We expect our same-store sales growth, which includes mature and non-mature stores, to continue this trajectory by compounding at 6% to 9%. Turning to slide 12, we talked about the considerable white space in our fragmented industry to further expand our footprint. We believe we can easily double our store count over the long term through franchise growth and company store additions and continue to win share from our competitors. Our data-driven approach to site selection provides a highly predictive real estate model that allows us to choose ideal locations to maximize store growth. Having a large geographic coverage allows us to maximize cash-on-cash returns today, which is incredibly attractive, while focusing on stores that are equipped to evolve with the car park. Simply put, we still have a long runway on our growth trajectory. Now I'd like to turn it over to Lori Fleece, President of Retail Services. Lori joined us about seven months ago and has jumped right in and is already adding value. Lori's going to talk about our growth strategy in addition to our focus in fiscal 2023. Lori?

Thanks, Sam. I appreciate the opportunity to be on the call today. I'm humbled to be part of this amazing team and I'm excited to share where we're headed and our focus for fiscal 2023. We have a simple but highly effective model for delivering value same store sales growth coming from both transaction and ticket plus growth and units. Combined with incremental sales from service expansion together drive higher revenue margins and free cash flow. will execute on this formula, with a continued commitment to operational excellence to ensure we capture growth long into the future. Now let me break these down in more detail starting on slide 15. First, we're confident that we'll drive, that we'll deliver six to nine percent in same store sales growth with growth in both transactions or the vehicles we serve and the average ticket. Looking at transaction growth for our mature company stores, we've delivered four percent compound annual growth rate over the past five years in the number of vehicles served per day. which is faster than the do it for me oil change industry. And we expect this growth will continue for three reasons. First, as Sam mentioned, the age and complexity of vehicles is driving growth for preventive maintenance service providers. Second, our value proposition of quick, easy, trusted service could not be more relevant to consumers and has enabled us to gain market share from non-quick lube operators. And last, We have significant capacity available in our existing stores and are innovating ways to improve upon our service speed, which will increase vehicle throughput and delight our customers. In the past seven years, we've grown from an average of 40 to 50 vehicles served per day for our mature stores, and we do not see any barriers to getting to 55 in the next 12 to 24 months and to 60 within the next five years. In FY23, our newly formed central operations team is working to implement equipment, technology, and supply chain solutions that will simplify work in our stores and enable faster service delivery. On slide 16, you'll see the other driver of same-store sales, which is ticket growth. We've increased ticket growth by 5% compound annual growth rate over the past five years. and we have three key levers to drive continued ticket growth. First is the shift to synthetics, which drives a higher ticket and margin rate. We anticipate the shift in synthetic to add over a dollar to ticket annually, accounting for approximately one-third of the expected growth from ticket. Second is growth in non-oil change revenue. As we offer additional services to our customers, and continue to improve the sales penetration of these services we offer will capture increased ticket. And last, pricing leverage. We test and analyze pricing elasticity as well as benchmark our service pricing against both Quick Lube and other competitors to ensure we are appropriately priced for the service experience we offer. In FY23, our team is focused on driving more consistent penetration of non-oil change services across our stores. In October, we rolled out new reporting and training to our store managers specific to this area because of the variation we see in store results and stemming from how services are presented. This training is now cascading to all team members, and we're seeing some very promising initial results. Let's turn to the next slide. The next part of our formula is unit growth. As Sam said, we have significant opportunity to increase our geographic coverage and store density across our network. On geographic coverage, today approximately 70% of our customers live within 10 miles of the store they visit. However, data shows that only 35% of the car park is within 10 minutes of a VIOC location. Given convenience is an important driver for consumers, we clearly have an opportunity to expand our geographic coverage. And we also have opportunity to increase our store density in key markets. As with most retailers, store share drives market share. Today, we estimate our market share in our strongest markets like Louisville, Kentucky, is over three times our network's average market share. And this relationship is consistent when comparing store share across our network with our top markets. therefore showing we have significant store infill opportunities in many key markets. So to drive an accelerated growth in units, we will focus on both franchise and company store growth. Let's look at our franchise growth plans first on the next slide. Our franchise growth will play a key role in our network expansion. In the past two years, we've added about 50 new franchise units each year, not including transfers. And our objective is to triple this by 2027. While franchise stores deliver about one third of the EBITDA of a company owned store, they deliver a very attractive capital return to Valvoline due to the minimum investment required. And they deliver approximately 30% cash on cash return to our franchise partners. We're working on a number of efforts to drive franchise growth, including recruiting new franchise partners, recruiting new franchise partners, which will include additional private equity firms, partnering with our current franchisees to drive more growth, and identifying specific geographies to transition to franchise territories. While this is a multi-year focus, we're already making investments in this area. After seeing significant M&A pipeline growth on the company store side with the creation of our business development team, we've expanded their focus to include franchise geographies and are starting to see the pipeline benefit. And last month, we met our franchise partners who on average have been Valvoline partners for 25 years to discuss how we can shift company focused real estate capabilities to support high priority market growth for key franchisees. And we'll continue to pursue growth on the company store portfolio as well. allocating capital to priority markets that will provide the strongest shareholder return. We plan to build on our scaled platform by targeting 100 new company stores per year and maintaining at that level. We generate three times more EBITDA per store at these company-owned locations than franchise stores, whilst generating returns on invested capital in excess of 15%. We also benefit from the flexibility that company stores provide in piloting new service offerings as well as technology in a controlled environment. Our balanced approach between owned locations and franchise stores allows us to balance the financial benefits of each model, drive accelerated growth across our platform, and strengthen our franchisee value proposition by proving out initiatives and company stores before asking franchise partners to invest and implement. Turning to slide 20, the third lever in our business model is non-oil change service penetration and expansion. We remain committed to evolve with the car park while also driving non-oil change service growth. Currently, about 25% of sales come from non-oil change services. This includes providing fluid flushes, tire rotations, and parts replacement. As I previously mentioned, this is the core focus of ticket growth. But another positive impact on services growth is our fleet business, which has been growing at a faster rate than our consumer business. A fleet vehicle is serviced more frequently than a consumer vehicle, and the ticket is approximately 25% higher on average driven by non-oil change services. Today, our existing stores can serve light duty fleet vehicles, and we're developing the capabilities to serve medium duty vehicles across our network. We have a strong inside and regional sales team to both increase penetration within the existing fleet accounts, like element, enterprise, and lease plan, as well as grow our fleet customer base overall. And we will continue to expand into new services to meet the needs of an evolving car park. This summer, we expanded our EV service pilot to two markets. While EV penetration of the car park is around 1% nationally, We're learning more about our customers' expectations as we complete inspections, tire rotations, cabin air filter replacement, 12-volt battery replacement, as well as wiper and key fob battery replacement for EV owners. Which leads me to how we think about our service evolution as shown on slide 21. We are staying close to the car park electrification forecast and the key enablers of the market's evolution towards EV. Our primary focus in the near term is to grow market share and increase our customer base. We'll use the customer data to understand how powertrain preferences change and leverage our brand to test and launch appropriate new services to customers. We believe that our quick, easy, and trusted experience will be relevant to customers regardless of the vehicle they drive. And we know that a more complete store network makes us an attractive partner to fleet customers and other players across the automotive OEM and services landscape. The car park evolution will take time, and it will certainly vary by geography. Valvoline has the financial flexibility, expertise, and resources to evolve with it, and we have already gotten started. With that, I'll turn it over to Mary to discuss earnings, results, and guidance. Mary?

Thanks, Lori. The announcement that Valvoline signed a definitive agreement to sell its global products business resulted in the former global products segment being classified as discontinuing operations for purposes of GAAP reporting, with the retail services segment becoming the company's continuing operations. The historical financial statements have been recast based on the accounting rules governing assets held for sale and discontinued operations. to reflect these statements consistently with the go-forward business that will remain. As part of this work, we were required to reassign indirect SG&A expenses, including those formerly unallocated expenses, to continuing and discontinued operations. We also evaluated the treatment of the sale of products to our independent franchisees and express care operators following revenue recognition guidance and determined that the new Valvoline is acting as an agent in the sale of product to our independent partners. The historical continuing operations financial statements have been recast to include this agency accounting treatment, reducing sales, increasing operating margin rate with no impact to profitability. Finally, the historical financial statements have also been recast to include the sales and cost impacts of the supply agreement that will be in place between the two businesses once the sale of global products is completed. Results of the continuing operations are comparable to those previously discussed on a pro forma basis at the time we made the announcement. Slide 24 bridges the historical segment results for retail services to Valvoline adjusted EBITDA from continuing operations after the impact of the changes previously described. Recall that our previous guidance for retail services segment EBITDA for fiscal year 22 was $415 to $425 million. We delivered $421.6 million of segment EBITDA for the fiscal year. The bridge from segment adjusted EBITDA to continuing operations adjusted EBITDA accounts for the retail services portion of the split of shared corporate costs previously unallocated to the segments of approximately $40 million, and dis-synergy related to the new supply agreement markup and separation-driven SG&A increases, combining for a total of just over $60 million. Adjusted EBITDA from continuing operations for fiscal year 22 of $315.7 million is consistent with the range discussed in our Q3 conference call. The balance of my comments will focus on the adjusted recast results from continuing operations. Results for the fourth quarter from continuing operations saw sales increase in the mid-teens and adjusted EBITDA increase 11%. Sales for the quarter were primarily driven by ticket. We did see strengthening transaction momentum during the quarter that has continued into the new fiscal year. The adjusted EBITDA margin rate reflects the favorable impact of the change in reporting of product sales to independent operators previously discussed. The impact of this agency accounting change increased Q4 adjusted EBITDA margins by over 400 basis points. The business did take an additional price increase on most services in the month of September after assessing the competitive environment. Now let's look at the results for the full fiscal year. We continue to see strong sales momentum and saw about a 20% increase in sales over the prior year. Also, we completed our 16th consecutive year of same store sales increases. Adjusted EBITDA increased by 14% year over year and adjusted EBITDA margin was just under 26%. Slide 26 provides a summary of our GAAP results for Q4 in the full year. Our consolidated and continuing and discontinued operations gap results include the effects of several significant accounting matters which impacted both Q4 and the full year. For simplicity, I'll focus on the full year impacts with more detailed information provided in the appendix to this presentation. First, gap operating income from continuing operations reflects the impact of non-recurring expenses related to the separation and the benefit from a legacy Ashland-related matter. For the year, these combined for approximately $20 million in expenses in 22 and benefits of $24 million in the prior year. Second is the year-end remeasurement of our pension and other post-retirement plans, which impacted income from continuing operations by a $44 million loss compared to a gain of $74 million in the prior fiscal year. Finally, a favorable adjustment recognized in income from discontinued operation impacts our consolidated GAAP net income for an income tax benefit of approximately $99 million. This adjustment relates to the realization of the book tax basis differences in the non-U.S. entities that will be sold with the global products business. Slide 27 highlights our fiscal year 2023 guidance. We expect top line growth of 14 to 18 percent driven by expected same store sales growth of 8 to 12 percent and unit growth of 8 to 9 percent. We expect adjusted EBITDA to grow by 17 to 24 percent with guidance of 370 to 390 million. This reflects the lapping of the weaker earnings we saw in Q2 and Q3 of fiscal 22 where we saw a larger lag in pricing versus rising product and labor costs. We expect CapEx to be $170 to $200 million in fiscal year 23. This includes amounts for additional new store growth, increased maintenance and technology costs, including some deferred costs from fiscal year 22 and one-time costs related to the separation. We are also guiding to adjusted net income of $160 to $180 million. We're guiding to adjusted net income rather than adjusted EPS as market conditions will dictate the method and speed by which we return net proceeds from the sale of global products to shareholders. Slide 28 visually shows a summary of the baseline fiscal year 22 results from continuing operations and our fiscal year 23 guidance for sales and EBITDA. I want to provide an update to our capital allocation strategy that we believe will enhance value creation at Valvoline. Today, we announced a new $1.6 billion share repurchase authorization expected to be executed over 18 months. Our purchases will be made subject to general business and market conditions, including the closing the sale of the global products business, and we will evaluate all structures for executing the buyback programs. We also reiterate our intention to eliminate the dividend after the close of the sale of global products as we shift to share repurchases as the primary form of capital returns to shareholders. Our plan is the dividend declared and paid this quarter will be the last. From an ongoing capital structure perspective, we will target a net leverage ratio of 2.5 to 3.5 times last 12 months EBITDA, including leases and pension obligations. I'll now turn the call back over to Sam for closing remarks.

Thank you, Mary. I want to take a minute and thank our team at Valvoline across retail services, global products, and supporting resource groups for their hard work over the past year. Fiscal year 2022 was a busy year given our corporate strategic actions in addition to the challenging macroeconomic backdrop. At Valvoline, we say it all starts with our people, and frankly, they have delivered over the past year. With the sale of global products on track to close in early calendar 2023, I'm excited about what the new Valvoline can deliver for our shareholders. We have built a business model that generates significant, consistent, and predictable profit, cash flow, and return on invested capital. Our focus on making car care easy by delivering a superior, quick, easy, and trusted customer experience continues to drive loyalty and new customer growth. and we carry excellent momentum into fiscal 2023. The growth opportunities are tremendous. We have plans in place to build on our competitive advantages by growing our store network with an increased focus on franchising, leveraging technology, and developing new capabilities for an evolving car park. The new Valvoline presents a high performing, fast growth retail service business investment opportunity I will now turn the call back over to Sean to begin the Q&A session.

Thanks, Sam. We'll start the Q&A. We do have some extra time on the call, but I want to remind everyone to limit your questions to one and maybe just a couple of follow-ups so that we can get to everyone on the line. With that, Rekha, please open the line.

Thank you. Reminder, to ask a question, please press star then one on your telephone keypad. If you change your mind, please press star two. We have the first question from Simeon Gutman of Morgan Stanley. Please go ahead when you're ready.

Yes, hi, guys. This is Michael Kessler on for Simeon. Thank you for taking our questions. First, I wanted to ask for an update on the pricing backdrop in retail services, and you alluded to the price cost lag, which has been ahead in the last couple quarters, as it was seen pretty volatile base oil pricing. So can you just kind of let us know how that's trending, how you feel about pricing and the cost of goods backdrop in retail services, and if there's any embedded improvement as we move through this upcoming fiscal year? Thank you.

Hi, Michael. This is Mary. We have seen substantially more stability in the product pricing over the last several months, and we're encouraged by that. We actually saw one base oil cost reduction that will modestly help us in fiscal 23. In addition to that, we did take an additional price increase across the company store portfolio in September. to pick up some additional costs that we had primarily in both labor and product in terms of kind of meeting the full recovery of the margins. And I'm happy to report that on a per transaction basis, our margins have fully recovered here in the fourth quarter and we expect to see continued margin improvement into the new fiscal year. That margin improvement will be driven by a couple things. One is just more efficiencies with sales growth, but we'll also be lapping those tough couple quarters that you referenced in Q3 that will overall be helping the margin rate with the full pricing realization. So that's kind of where we're sitting today.

Laurie, why don't you comment on the pricing environment from a consumer perspective?

So the pricing, particularly in September, typically when we roll out pricing, it takes a little while for us to get the full price increase through. And our ability to do that was very strong this time. And we have not seen any impact on transactions. Or we closely monitor our customer feedback also. and we are not seeing any increased commentary around price. And this is giving us a lot of confidence that we're priced appropriately. We continue to benchmark our pricing and run tests in different stores just so that we can be responsive to where we place our pricing with the market. But we feel really good right now about the price realization that we've captured through September and into the new fiscal year.

Okay, that's helpful. Thank you. Maybe just a related follow-up. The, you know, bridging to the mid to maybe even high end of the longer-term EBITDA margin guidance, is that fully or mostly dependent on the stability in these factors that you guys are talking about right now, or is there also other components as it relates to, I don't know if it's a new store maturation, is those kind of move up the curve that gets you to the mid to higher end? And is that something that ultimately gets achieved when the business reaches kind of a level of maturity on store count and the underlying growth, or that's something that can be achieved even as we move into that direction?

Yeah, the biggest driver in, uh, driving that margin improvement over time is same-store sales growth. And so the performance of the business model, winning new customers and driving ticket performance, increased service penetration, this is what has been driving the mature store performance. And so you saw that leverage in the information we shared in the presentation with growing top-line sales but also strong EBITDA increases. in this period. So as these newer stores that we've added over the last five years become mature, there is a significant addition that they make to both bottom line profit, but also begin to enhance the EBITDA performance, overall margin performance for the business. So we do expect over this long-term guidance to see the margin performance grow from that lower range to the higher range, 26% to 29% over time. with increasing leverage in the system.

Sam, I'll just add to that. I definitely agree with what Sam is saying. The other piece of this is the mix between franchise and company stores. As we shift our reporting of revenue to an agency reporting, the mix of margin between franchise on a rate basis, between franchise and company stores, will actually start to shift as we grow the franchise new unit development, our margin rate will increase. And therefore, that's where you see the higher end of the range are delivering the same store sales and starting to increase the focus of new unit growth more skewed to the franchise side.

And Michael, the final piece, of course, is SG&A leverage. We expect our SG&A growth and investments on a year-over-year basis over the future, you know, three to five years, will be at a substantially lower rate than what we expect our top-line growth to be. So we do expect to see overall rate enhancements through SG&A leverage.

Got it. Thank you. Just a real quick last one. Just the delta between the prior long-term pro forma targets and the ones you laid out today, the only difference fundamentally is the agency accounting and there's nothing else that's like changing under the surface or an underlying level. Is that right?

That's substantially right, Michael. We've gotten much more refined in the work that we've done in terms of the 23 plan since we spoke last. So there are some modest underlying changes, but for the most part, the biggest difference is just the move to agency accounting, which does not affect profitability, but reduces sales and increases margin rate.

Understood. Thank you.

Thank you. We now have Mike Harrison of Seaport Research Partners. Please go ahead when you're ready.

Hi. Good morning. Good morning, Mike. A lot to digest here. I really appreciate that you guys laid out the growth algorithm in such detail. I'm curious, you referenced some investments or focus on trying to increase speed of service and trying to get increasing number of vehicles per day. You mentioned you didn't see any barriers to getting to 60 vehicles per day. Can you elaborate on some of the changes that you're making? And I'm curious, at your best stores, how many vehicles per day are you averaging?

Thanks for the question. I'll cover some of this and then Sam can add. As it relates to speed, there are a number of things that we have piloted in our highest volume locations, including to starting the service outside of the bay and also moving additional services that don't require the pitted floor into, you know, into the parking area. And that is allowing us to move the oil change customers quickly through our stores. We're also looking at, you know, we're looking at our capacity on a per bay basis. We have two bay stores, we have three bay stores, we have four plus bay stores. And we're actually looking at our capacity by bay and then staffing relative to demand. And what we recognize is that obviously during the peak time period, which is middle of the day and then on the weekends, we have to find ways to get cars through the bay quickly. And so lot management, similar to other service providers, for example, in fast food, it's all about lot management and using technology and tools to allow our teams to manage the cars and get them through the cervix experience faster is a key unlock that we've already started and will continue to roll out.

Just to add to that, Laurie also mentioned in her presentation the formation of our central ops team, which is all about how to support the stores so that our store personnel can stay completely focused on how that team is operating to service our customers and delivering that quick, easy, trusted experience. And we know from our research that speed is of the essence when it comes to satisfying customers and that our satisfaction drops when we take too long if our service performance and wait times are too long. So we're going to continue to focus on the speed of service, making sure that we're as convenient as possible And there's operational opportunities that help us with that speed component. But we also feel that the market, the drive for convenience, the need for convenience and what consumers are looking for is something that really plays to our business model, the stay-in-your-car business model. And so from our store ops to our marketing programs that help consumers understand what valving can do for them, That's what's driven our growth from 40 cars a day to 50 cars a day. And as we said, we see no barriers to going to 60 cars per day. Our stores have that capacity.

And Mike, the top third of our stores do about 70, see about 70 cars served per day. And the absolutely best performing stores in the chain are seeing over 100 vehicles a day. and still growing. So when we start to see a store that's really capping out, we'll look at one of the increase in density in adding a store in the area to be able to continue to capture that market share. But frankly, we've continued to see, you know, strong same store sales performance at those highest volume transaction volume stores continue, so I think the work that we're doing is continuing. One of those central services that we've been doing for a while is a central call center so that we don't ask our store personnel to answer the phones. We do that through a central call center, and that's been very effective. And that's similar types of central operation services. We'd like to move inventory management to be more centrally supported. other types of services that we can do from a central ops perspective to really keep the store management and employees completely focused on the customer experience.

All right. All of that makes a lot of sense. Thank you. And then I had a couple of questions related to the non-oil change revenue slide. I believe it's slide 21. I'm a little bit surprised to see that the fiscal 22 growth in non-oil change revenue was pretty modest. I assume there was some pricing in there. I also know that you guys had talked in the past about having some issues, maybe COVID related, where your stores weren't staffed appropriately and maybe you were missing some opportunities around non-oil change revenue. So maybe just kind of talk about where you see that opportunity from the $21 ticket in 22 to move that higher near term.

Yeah, I definitely, the trend in FY22 was impacted by the price increases that we made on the oil change side. We had taken some service some non-oil change service increases in FY21. So we, for some of our core visuals and in FY22, we didn't make as many price increases on a percentage basis. So a lot of the difference in the growth rate is driven by the oil change pricing increases that happened in FY22. And that will continue in FY23 because we, have pricing increases that we've taken in FY22 that we haven't fully lapped. So you'll see a bit of that. However, this is the reason why non-old chain service penetration is a big focus. We see a difference between top quartile and last quartile stores of about 80% difference. And this gets down to, one, the turnover on our team. because these services, other than the basic visuals, the more extended services like fluid flushes do require you to have the right training to both sell and educate the customer on the service, but also to complete the service. And with our turnover that we experienced this year, which many retailers did, we had we had a lot of training that we needed to do such that our team could confidently recommend and perform the services. So we see that piece of it coming back in FY23. Our turnover has flattened. Our retention is improving. And so that allows us to have more experienced store team members there to serve the customers.

All right. And then last question I had is around the supply agreement that you have with the global products business. I'm curious to understand how prices pass through from global products. Is that based on an index? Does the new owner of global products have some kind of power to push pricing through unilaterally or is there kind of a third party determination on what's happening with those finished lube prices. Thank you.

Yeah, Mike, thanks for the question. So the supply agreement is essentially a cost plus agreement, which operates similar to an index. But we basically have pricing adjusted monthly based on historical costs that both businesses are very familiar with, as we've operated historically as a single business. We have several ways to test the pricing within the contract terms. On the third anniversary of the contract, we can take incremental volume out to bid to make certain that the pricing for the volume is consistent with what we could see in the market from other suppliers. Our intention is, and we believe we will have a very, very good long-term relationship with babbling global products. We've historically had a great supply chain relationship with the businesses and we expect that to continue. But there are several mechanisms by which we can test the market moving forward. So I feel really good about the way that the supply agreement is positioned and think that it will be a long and mutually beneficial relationship between the parties.

And sorry, just to clarify, the cost plus, is that a cost plus some penny margin or cost plus some percent margin?

It's a cost plus penny margin.

Excellent. Thank you very much.

You know, Mike, I would clarify that on other ancillary products, it is a cost plus percentage. So on things like wipers and filters and, you know, batteries, It's actually a cost plus percentage. But on the vast majority of the supply agreement, which is in the lubricant space, it's a cost plus penny margin.

All right. Understood. Thank you.

Thank you. We now have the next question from Jeff of JPMorgan. Your line is now open.

Thanks very much. On tape 4, you show same-store sales growth for company-owned stores and franchisees. And the franchisees grew 15.5% in 2022, and the company-owned stores grew 11.5%. Why the 400 basis point difference?

Yeah, hi, Jeff. Good morning. It's primarily driven geographically. We've actually seen, you know, in the new fiscal year, we've seen some reversal in that trend with companies' same-store sales growth outperforming franchise same-store sales growth. So it really is dependent on what you're up against from a comparable perspective, and you almost have to go back and look since the beginning of COVID, where COVID hit franchise territories up in the Northeast much more severely than it did other company markets. And so when those markets are up against that, they had stronger sales performance. And so most of the variations are geographic. I would also say that we saw some of our franchisees respond more quickly passing through pricing than what we did at the corporate level. And we've talked about the impact that we had last year and the lessons that we've learned from that moving forward. But I would tell you, it's primarily a geographical impact. And over time, if you look at the performance, very consistent between company and franchise.

Do you have any cost-cutting programs Now that you've separated off this big part of your business, is there any overhead that can be taken out or you're efficient enough?

Overall with SG&A and the investments that we have in place, we feel good about the SG&A and the investments that we have with our team and the capabilities that we're building with regard to the evolving car park and preparation for the future. Our starting point, I think, is appropriate, but I think over time what we're going to see as we grow, we're going to see some significant leverage in that SG&A and benefit from the investments that we have made. So that, again, gives us confidence in that forecast for our future EBITDA margin improvement.

And Jeff, I would add, you know, we're keenly focused on expenses with the separation and to ensure that we're not adding unnecessary expenses and looking for opportunities to contain costs or reduce costs. especially across the shared service areas that are going to be now dedicated and focused just to the retail business going forward. So the good news is the business that we're selling requires a full staffing, so there really isn't any stranded costs that we have to deal with as part of the sale of the business. But we will be, you know, keenly focused in making certain that we're, you know, as efficient and cost-focused in terms of maintaining our SG&A, reducing our SG&A over time, as Sam said, going forward.

You know, maybe as a last question, you know, what's a little bit puzzling about your returns is, you know, obviously there's a lot of price this year. because there's a lot of raw material inflation. And there's also a growth component because you build new stores. And those statistics are hard to disentangle in order to see what actually your volume changes are. Like on an organic basis, excluding the benefits from the new stores you build What are your volumes doing either for the quarter or the year?

We actually saw, Jeff, from a same-store sales growth across the year, pretty balanced growth between transactions and tickets. So, you know, with a 13.7% same-store sales growth, about half of that for the year came from transactions overall and about half of it came from ticket overall. Does that answer your question?

Yes, it does. Thank you very much.

Yeah, I think I'll just add, if you look at page 15, you'll see what the mature stores, you can break down what mature stores did on a vehicle served per day, which was about 5%, a little bit more than, around 5% growth. And then the ticket growth on page 16 was also for our mature stores. And you should assume that our new stores would have a higher growth rate in transactions as they're ramping up. And I think on ticket it would be comparable for the most part.

So a lot of that growth probably on an annual basis came in the first quarter, year over year, where the comparisons were most easy. What's it been more recently?

In terms of transaction growth in our mature stores, we're actually seeing... This quarter. Yeah. In the start of Q1, so what we're seeing right now, or Q4?

Well, actually, comment on Q4, and then we'll talk currently.

Yep. That would be great.

Yeah. In Q4, we saw... Q4. Yeah. Yeah. slightly higher ticket growth because of the price increases that we took lapping Q4 of last year, but there was transaction growth. And then as we move into Q1, it would be similar. We have significant ticket growth because of the price changes that were made year over year, but we are still seeing very healthy transaction growth in October. So the start of the year, you know, continues to look similar to Q4 in terms of the underlining momentum.

Okay, great. Thank you so much.

Thank you, Jeff. We now have Lawrence Alexander of Jefferies. Your line is now open.

So good morning. Most of my questions have been answered. So two simple ones. One is, as you think about the sort of initiatives that you're using to drive ticket growth, what parts of the business model or the service offering are you pushing on that is most differentiated from your competitors? And the second one is, you know, thank you for the stats on the best performing stores. Can you give us a sense for the SKU? That is, you know, how many significantly underperforming, easy to fix stores are there? Or is it more like the broad middle swath that you need to improve operations incrementally?

First, some opening comments on it is that, you know, what's been really encouraging is that when you look at same store sales performance, across the quartiles, we've seen positive momentum in both the high-end, the high-performing stores, and even the lower-end stores. Now, some stores, in terms of their absolute growth opportunity, are more limited because of demographics. But we continue to see opportunities for improvement in execution. And Laurie commented earlier on just the importance of staffing and training, the importance of retention. Because we know that when we've got the right team in the store, that we can significantly impact the ticket performance and even the speed performance too, which drives transactions. So our focus in fiscal 23 is definitely to address some of those stores that we see opportunities for significant improvement. And that comes through leadership, but also the support that those stores are getting from the corporate team too. keeping them focused on what's most important but you know when it comes to the differentiation of what we do versus competitors it is a combination of these things that have to do with a great customer experience and that comes back to you know our mantra of quick easy and trusted and so that means that we are that we are fast that we provide that convenience staying in your car Trusted presentations, in other words, how we interact with the customer, how we present the services that they're due for is so important. And this is where technology really comes into play because we've built the database that includes the customer's previous transactions with us. We have the owner's manual online for each of the OEMs. And we even bring in data from the outside if they've had services done elsewhere. So this means that we're not presenting services that the customer doesn't need. We're focused on what that car needs to be properly maintained. And when we do this right, we just continue to build loyalty with that customer because they're not getting it anywhere else. Valving does this better than anybody else. And this is the model that's been delivering that 10%. same store sales growth performance. And what's encouraging to me is that we see opportunities to get better at what we do. And that is our focus in fiscal 23 and beyond.

Thank you.

Thank you. We now have our next question on the line from Jason Sender of Citi. Please go ahead when you're ready.

Hi, good morning. Thanks for taking the question. Just one for me. On the capital allocation, Mary, can you just remind us how you arrived at that 2.5 to 3.5 leverage ratio target, just in context of the big opportunity ahead of you guys to add stores and get to 3,500 and the expectation that you're going to accelerate store growth into the future? Thanks.

Sure, Jason, and thanks for being on the call today. You know, as we look at the long-term leverage ratio, we're weighing, you know, the prudence of managing the business and the balance sheet in, you know, what is kind of an economically uncertain time with return of capital to shareholders and investments in the business. And we also are looking at just from an overall our credit rating perspective, what we think, where we'd like to see our debt capital credit rating such that we're able to keep a very reasonable overall cost of capital in the overall business. So the combination of those things basically triangulated us to believing that two and a half to three and a half time times kind of a fully loaded leverage ratio including capital leases and pension, unfunded pension liabilities was the right way for us to position the balance sheet. I will tell you coming right out of the gate, we'll be at the higher end of that ratio, maybe a little bit over it because of the share repurchase activity while we're seeing EBITDA grow in terms of the return of capital from the transaction to shareholders. but over time, I expect over the long term that we'll manage well within that two and a half to three and a half times, and we think that's a prudent place for us to manage the balance sheet.

Great. Thanks so much.

Thank you. As a reminder, is Star one to ask any further questions today? We now have A follow-on question from Mike Harrison, the Seaport Research Partners. Your line is open.

Hi. Just a couple more quick ones. First of all, at one point you guys had talked about some potential plans to monetize the real estate holdings. of your stores, are there any plans in place to do that? And if so, can you provide us with any details on how much capital that might be able to generate?

Mike, that certainly is an opportunity for the retail business going forward for us to look at. It's not a massive opportunity. But it is one, you know, probably a few hundred million dollars. We haven't yet done all of the work, updated all of the work around that. We're pretty busy right now with the separation of the businesses and the sale of global products closing that we expect in the early calendar quarter. But I hope that we can give you a better update on what that opportunity is, you know, probably in the next 12 to 18 months. but it certainly is an opportunity for the retail business prospectively.

Understood. And then my other question is just on the cadence of earnings as we kind of go through fiscal 23. I don't believe you provided a Q1 EBITDA guidance number, but I'm maybe just curious as we're comparing for retail services, to the $115 million in Q4, would your expectation be that it's higher in Q1?

We certainly expect year-over-year improvements in Q1 versus last year. And we expect there to be strong improvements versus Q2 because we're lapping a week or quarter from last year. And then we certainly expect a strong performance in the back half of the year as well. I would say sequentially you're going to see Q2 sequentially be a little stronger than Q1, and then with continuing strong performance in the back half of the year.

All right. Thanks very much.

Thank you. For any further questions, please press star followed by 1. We have had no further questions on the line, so I'd like to hand it back to the Valvoline team for some closing remarks.

All right, thank you. Well, I appreciate everyone's time this morning. Certainly it is an exciting time for the company in preparing for the new Valvoline. We continue to be on track for a close in early calendar year 2023. We've also had a number of approvals, regulatory approvals, that have come through for us, including CFIUS, Hart-Scott-Rodino in the U.S., and we continue to make progress on the international front, too. So we're confident in a close in the coming months. Just want to say, too, that we've really laid out the fact that Valvoline has got a proven business model. We've performed in... very challenging markets and continued to drive same-store sales performance, increasing the network of stores. And we operate in a very attractive preventive maintenance market. And so the confidence that we have in the future of this business is very high. We've got the right team in place. We have the right strategy and the right plan. And so Valvoline, the new Valvoline, presents an outstanding opportunity for investors to invest in a company that delivers consistent and predictable profit, cash flow, and return on invested capital with significant growth opportunities. Thank you.

Thank you all for joining. That does conclude today's call. Please enjoy your day. You may now disconnect your lines.