Valvoline Inc. (VVV) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Carol, and I will be your operator today. At this time, I would like to welcome everyone to Valvoline’s Third Quarter 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, we will have a question-and-answer session. [Operator instructions] At this time, I’d like to turn the call over to Mary Meixelsperger, Chief Financial Officer. Ms. Meixelsperger, please go ahead.

Good morning, and welcome to Valvoline’s third quarter fiscal 2019 conference call and webcast. Valvoline released results for the quarter ended June 30, 2019, at approximately 5 P.M. Eastern Time yesterday, July 31, and this presentation and remarks should be used in conjunction with that earnings release, a copy of which is available on our Investor Relations website at investors.valvoline.com. These results are preliminary until we file our Form 10-Q with the Securities and Exchange Commission. A copy of the news release has been furnished to the SEC on a Form 8-K. With me on the call today is Valvoline’s Chief Executive Officer, Sam Mitchell. As shown on Slide 2, 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 the 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 basis, unless otherwise noted. Adjusted results excludes 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 results to amounts reported under GAAP and a discussion of management views of non-GAAP measures was included in our earnings release. The non-GAAP information provided is used by our management and may not be comparable to similar measures used by other companies. As we turn to Slide 3, let’s review our reported financial results for the quarter. For the fiscal third quarter, Valvoline delivered reported operating income of $102 million, net income of $65 million and EPS of $0.34. Year-to-date cash flow from operating activities was $214 million. Beginning this fiscal year, Valvoline adopted the new revenue recognition accounting standard. The impact of this standard is essentially a reclassification of certain items in the income statement, primarily impacting sales, cost of sales and SG&A. For Q3, the changes amounted to a roughly $1 million after-tax expense, impacting Core North America’s profitability. In Q3 this year, there were three key items. As we announced last quarter, our Deer Park, Texas blending facility was temporarily shutdown in March and April due to a fire at a nearby major third-party petrochemical terminal. The associated business interruption cost in the third quarter was $4 million after-tax. Restructuring and related expenses tied to the program we announced earlier this year was $3 million after-tax and non-service pension and OPEB income was $2 million after-tax. In Q3 of fiscal 2018, key items included $7 million of pension and OPEB after-tax income, $3 million of after-tax expense for legacy and separation-related costs and $2 million of after-tax expense due to an acquisition-related foreign exchange loss. Now as we move to Slide 4, let’s review our adjusted results. Our adjusted operating income was $111 million, adjusted EBITDA was $126 million and adjusted EPS was $0.37. Our best-in-class Quick Lubes segment continued its strong growth trajectory. Core North America’s performance showed improved results. In International, volume softness and foreign exchange headwinds continued. Overall, our adjusted EBITDA and adjusted EPS each grew double digits, 10% and 16%, respectively. Now, let me turn it over to Sam to review our segment results.

Thanks, Mary. We are clearly pleased with our overall growth in adjusted EBITDA and EPS in Q3. Most of that growth was generated by another strong quarter of results in Quick Lubes. System-wide same-store sales growth was just under 10% in the quarter. These results continue to demonstrate our best-in-class retail services model. We added 198 net new stores to the system since last year as our steady pace of unit growth is ongoing. These additions, along with same-store sales, continue to drive overall momentum in sales and profit. In Core North America, we saw improved performance versus our year-over-year comparisons in recent quarters. However, volume and sales were still down, driven primarily by lower branded volume in the retail channel due to ongoing market dynamics in the DIY category. While we are beginning to lap the early onset of some of the DIY market challenges, the actions we implemented earlier this year also continue to show initial signs of success and help drive improved performance, including flat adjusted EBITDA. In international, volume growth remains strong in Europe, but was offset by ongoing soft volumes in other markets. Including unconsolidated joint ventures, volume grew 2%. Foreign exchange continues to negatively impact sales and profitability, but on an adjusted basis, EBITDA grew modestly. At our recent Investor Day, we presented our basic segment strategies of growing Quick Lubes, maintaining Core North America and developing International. Our results in the third quarter demonstrate the type of performance we would expect when we successfully execute against these plans over time. Let’s take a closer look at performance in Quick Lubes on the next slide. Q3 same-store sales growth was 9.7% system-wide, company stores grew 9.2% and franchise stores grew 10%. The balanced increases in transaction and average ticket continue to drive these impressive same-store sales results. Strong benefits from pricing and premium mix and growing non-oil-change revenue drove average ticket growth. Looking at the same-store sales performance over the past five years, our competitive advantages are clearly evident. Our superior industry model, driven by our investments in technology, marketing and our people, is delivering best-in-class retail results. We continued our steady pace of adding units across the system in the quarter, adding 18 company stores and seven franchise stores. In the last 12 months, we’ve added 198 new stores with more than 100 of those franchise stores in Canada through our acquisitions of Great Canadian Oil Change and Oil Changers, which are both performing well in their transitions. During Q3, we celebrated opening our 500th company store and 850th franchise store, both important milestones in a remarkable store count growth of roughly 44% since the announcement of the separation from Ashland in 2015. Based on our continued strong year-to-date performance, we are raising our full-year same-store sales guidance to 9% to 10%. We anticipate a modest slowdown in the same-store sales growth in Q4 due largely to lapping some significant pricing actions we implemented late last year. Let’s turn to the next slide. We continued to learn in our Quick Lubes business and improve our best-in-class retail model. Importantly, we continued to invest aggressively to drive a superior customer experience. As an example, the technology investments we’ve made over the past year-and-a-half have enabled the development of a breakthrough app that we feel will drive even more convenience for our customers. For the first time, customers will be able to see wait times at nearby stores directly on their devices and make the most convenient choice to service their vehicles. We anticipate being able to add even more value by delivering effective offers and helping to educate consumers on preventive maintenance for their vehicles, including non-oil-change services. We’ve recently moved from the pilot phase to starting a full roll out of the app in our company markets. Our focus on the near-term is to drive adoption of the app within our company-owned stores and then do a broader roll out to our franchisees over time. Let’s review Core North America’s results on the next slide. Performance in Q3 for Core North America improved on a year-over-year basis compared to recent quarters, but we are lapping a weaker Q3 in the prior year due to significant price cost lag. Volume declined 5%, sales were down 2% and adjusted EBITDA was flat. Adjusted EBITDA would have grown, excluding the transfer of the Great Canadian product sales to Quick Lubes and the impact of revenue recognition. Overall volume would have declined by 3%, excluding the Great Canadian shift and lower volume from the key accounts in the reorganization proceedings, primarily due to a decrease in branded volume in the retail channel. However, this volume was essentially flat versus Q2. I’m encouraged by these results as they showed progress towards addressing ongoing DIY market dynamics affecting the retail channel. We are also executing the plan to install our channel that we shared at our recent Investor Day. We’re making solid progress, adding new rooftops from the ongoing execution of our value-selling approach using tools like our guarantee program. We are also seeing early success with our Recall Awareness Program, where we are referring our Valvoline Instant Oil Change customers to our car dealer partners for needed safety recall services. Looking forward, we expect moderate price cost lag impacts in the current quarter. These are due to the full quarter effect of raw material cost increases from Q3 and our offsetting pricing actions not being fully effective until late in Q4. Let’s turn to the next slide to look at our International results. Volume grew 9% in Europe, benefiting from ongoing channel development. Soft volumes in other regions, including a sluggish heavy-duty aftermarket in China, driven by a slower manufacturing sector, offset these gains. Including JVs, volume grew 2%. JV performance, along with our improved margins, contributed to growth in adjusted EBITDA and helped offset the negative impact of foreign exchange. One highlight during the quarter was Valvoline’s Mechanic’s Week. We connected with mechanics in multiple Asian countries to conduct training in person and online with strong social media engagement. This unique grassroots brand-building effort demonstrates our commitment to supporting mechanics through our local hands-on expertise. Our goal is to grow our share in most all international markets. We are working to reinvigorate the implementation of our growth model, building channels, platforms and the brand to position us for long-term success. We expect volumes to improve in Q4 behind the product launch and related promotional events in Latin America, as well as incremental volume from our previously announced Eastern European business acquisition. We are now closed on that acquisition of a small lubricants business and plant. In addition to adding some incremental volume, this investment is expected to enhance our supply chain capabilities and access to the Central and Eastern European markets. We anticipate modest related integration cost to impact profitability in Q4. Now let me pass it back to Mary to review our financial results.

Thanks, Sam. Our adjusted results for Q3 are summarized on Slide 10. Reported sales increased 6%, with revenue recognition impacts nearly offset by a foreign exchange headwind. Pricing and favorable mix were the primary drivers of organic sales increases. Our gross margin rate on an adjusted basis was roughly flat and would have grown by 100 basis points, excluding the impact of revenue recognition changes. SG&A increased by 4%, primarily due to higher marketing and advertising expenses. The increase in equity and other income in the quarter was driven by benefits from a contract termination fee, which was recorded in the Quick Lubes segment and free trade zone incentives recorded in international. Adjusted EBITDA increased 10% with the benefits of mix, margin improvements and other income more than offsetting higher SG&A and unfavorable revenue recognition in FX. The overall impact of revenue recognition in Q3 was $1 million unfavorable to net income and the year-to-date impact was $2 million unfavorable. Let’s move to Slide 10 to discuss corporate items. Our reported effective tax rate for the quarter was 23.5%. Adjusted for key items, our effective tax rate was 23.9%. For the full-year, we continue to expect our adjusted rate to be 25% to 26%. Year-to-date cash flow from operating activities was $214 million. Year-to-date capital expenditures was $73 million, leading to free cash flow of $141 million. Net debt was flat to last quarter at $1.2 billion. Let’s turn to the next slide. Q3 included some benefits that won’t recur in Q4. Additionally, we anticipate some higher expenses in Q4, primarily due to price cost lag impacts from raw material increases announced in Q3. Based on our strong third quarter performance, we are narrowing our guidance for adjusted EBITDA to the high-end of the previous range and now expect $465 million to $470 million, narrowing adjusted EPS to match. We are raising our same-store sales guidance by 100 basis points to 9% to 10% for the full year, which would generate a two-year stacked growth of more than 17%. We’re also continuing to make good progress on our restructuring and cost-savings program, which is expected to generate approximately $40 million to $50 million in annualized pre-tax savings by the end of next fiscal year. This program gives us more flexibility to address the ongoing market dynamics impacting Core North America and to invest in growth opportunities. Now, let me turn it back over to Sam to wrap up.

Thanks, Mary. Q3 results were encouraging. Quick Lubes continued its excellent performance, driving growth for the company. Core North America’s results improved, but challenges are expected to continue as we work toward stabilizing the business. In International, we’re focused on developing market share growth by investing in our brand and capabilities. At our recent Investor Day, we presented our accelerating shift to a service-driven model supported by our growth, maintain and develop strategy to drive long-term shareholder value. We took another step in this direction in Q3 and we expect to make further progress in 2020. With that, I’ll hand it back to the operator to open the line for Q&A.

Thank you. [Operator Instructions] Our first question on the phone line comes from the line of Simeon Gutman from Morgan Stanley. Please go ahead.

Thanks. Good morning, everyone. My first question….

Good morning.

…is related to Core North America EBITDA. Can you talk about the cost savings that you’ve enacted and the reinvestment rate? Should we believe – is it safe to model the level of improvement that occurred this quarter out for the next three or so going forward, or does your reinvestment rate accelerate such that the EBITDA changed? Actually, it doesn’t look as good as it did in this quarter?

Yes. Thanks, Simeon. Simeon, we’re seeing some good progress in Core North America business and we see it in our results this quarter. When we look at our unit margins, we look at the guidance that we had provided earlier in the year. And as we prepare for 2020, we’re in the midst of liner views with each one of our major retail partners. And as we do that, we’re putting together plans for merchandising, promotion plans to continue to, what I consider, make progress in DIY. There are some new dynamics that we’ve been dealing with, new merchandising strategies that some other retailers have been exploring. But we feel like with our cost-savings program that we put in place, where we expect to achieve operating savings in the $40-million to $50-million range, that we’ve really created the flexibility for us to put together a strong plan for 2020 to address some of these dynamics. It’s a little too early to say exactly what that reinvestment rate will be. But I’m confident that we have the flexibility to both work to stabilize the Core North American business, that DIY business and be able to invest in the long-term growth of our business. So when we get to Q4, in our earnings call in November, we’ll be able to more clearly lay out those full expectations for 2020. But I do feel that with the changes that we’ve made in our merchandising plans that we’ve been implementing this quarter, the changes and improvements that we’re making on the consumer marketing side are going to lead to more stable results in the future for Core North America.

Okay. And thanks for that. And my follow-up is on the Quick Lubes business. Can you break out in this quarter the ticket versus traffic? And you mentioned that – I think you mentioned for the – within fourth quarter, you’re going to lap some pricing changes. Did you – can you quantify what that was? And does that not only affect the fourth quarter, but does it affect the subsequent quarters as well?

The Quick Lubes business, obviously, another really strong quarter of same-store sales performance. The split was really well-balanced between transaction growth, what we call, oil changes per day. We’re still seeing some good solid growth there and on the ticket side. The ticket side has been a nice mix of premium mix with non-oil-change revenue and pricing has been a benefit this year. We did take pretty aggressive action last year with some price increases that improved Q4 and benefited really throughout – it is benefiting us throughout 2019, too. It’s just – our feeling is, when we lapped that, we might see a little bit less growth on the same-store sales front. But the momentum still is quite significant that we have in that business. So as we laid out long-term guidance on Investor Day, we’re still expecting very strong same-store sales growth into 2020.

Great. Thanks, Sam.

You bet.

Our next question comes from Faiza Alwy with Deutsche Bank. Please go ahead.

Yes. Hi, good morning.

Good morning.

So my first question is, Sam, I’d love to get your take on how you’re thinking about just the cost environment at this point? It seems like these oil prices have stabilized. But I think you’re taking some pricing in 4Q within Core North America, at least on the installer side? So if you could just give us sort of the state of play there, that would be helpful?

Sure. As we shared at our last call, we did have a base oil increase that was implemented in Q3. So, again, it impacted the results in Q3. We’ll feel the full effect of that in Q4. But on a positive note, the market has been moving on pricing as has Valvoline. And that includes both the pricing actions on the installer side of the market, but also on the DIY side of the market, although, those increases won’t take effect – full effect until the latter part of Q4. But it does position us well for improved margin stability going into 2020.

Okay. And then just on fiscal 2020, I know you’re obviously in your planning process at this point and we’ll hear more in November. But I was hoping to get a little bit more of a preview sort of what are some of the things that we should think about for fiscal 2020? Should we think about, like your algorithm in line with the long-term algorithm that you laid out on Investor Day? I know there’s – there are cost savings that are coming through next year. What are some of the puts and takes from your perspective that you are thinking about?

Yes. I think going back to what we laid out on Investor Day is the best guidance we can give right now, and it will become a lot more specific when we get to our November earnings call. The business right now, when you take a look at the different segments and how our business is performing, the momentum in Quick Lubes is obvious. And in 2020, we do expect to continue that momentum. Just the example of the new consumer app that we’re rolling out is just another example of our investment in technology and improved marketing that can help drive market share growth there. The key insight that we shared at Investor Day is not just that we have a great consumer-customer experience and strong digital capabilities, but they were really growing share, not just within the Quick Lubes business, but growing our market share within total DIFM segment. And that bodes really well for our continued growth, both in transactions, as we’re delivering on the consumer need very well, but also continuing to invest in our store growth, both with company stores and with franchise stores. So that part of the business, we’re obviously very bullish on and we’re going to continue to invest in. On the International front, our growth has been slower than we would have liked this past year. And we’re – we’ve taken a step back and looked at our growth opportunities internationally and we feel they are still quite significant. We’re just showing up and making sure that we’re making the right investments in building our capabilities, both with – on the supply chain side. As we noted, the acquisition that we made in Eastern Europe and the plans that we have in China, these are going to improve – can help improve our customer service and improve our margins. But also just improving and investing in our brand development, too, is going to be key to that long-term growth in the International markets. But I think International will be in a good position as we enter 2020. And the expectations that we laid out in Investor Day are very – I think they’re achievable for that International part of the business. Coming back to Core North America then, this is the business that’s so critical for us to make sure that we stabilize that business. We’ve thought we’ve seen some good solid progress on the installer front with our value-added selling approach and how we bring that value to installers that helps keep our margin solid. A lot of opportunity to drive the non-lubricant side of the business, too. We’ve had some good success in improving our coolants sales and chemical sales on that installer and heavy-duty side of the business. So that’s a key part of our strategy. I’m feeling good about that. And then on the DIY side of the business, this is where we saw the most volatility in the past year with the growth of private label replacing that mid-tier brand. And as we’ve shared, that’s a price gap that we have to keep an eye on. And now is the critical time as we work with retailers on developing the plans for 2020. So we go through a pretty rigorous line review process with each of our retail partners. And as we get towards the end of our fiscal year and in preparation for November call, we’ll have a much better view as to what 2020 looks like. But again, I want to reiterate that, we feel we have a much better understanding of some of the dynamics that we’re dealing with. And we’re being aggressive in putting our plans in place, both with the retailer and those merchandising plans, but also on the consumer side to strengthen the brand of our consumer messaging. I feel very good about that progress. And with the cost-savings program that we’ve put in place, I feel like we’ve given ourselves the flexibility necessary to address the challenges and the – what I’d consider the unsettled market dynamics in DIY right now. So again, right now go back to – just to reiterate, go back to Investor Day and the guidelines that we laid out for our long-term expectations in each one of the business. That’s the best place to start and then we’ll provide more sharper guidance in the fall call. Thank you.

Perfect. Thank you very much. Very helpful.

Our next question comes from Jason English from Goldman Sachs. Please go ahead.

Hi. This is actually Cody on for Jason this morning. Thank you for taking our questions. Two quick questions for you, one on the Core North America front and one on the Quick Lubes. On core North America, North America lubricant volumes were weaker than we expected, but organic volumes came in better. You’d previously disclosed that you had 1 million gallons with the GCOC business. But based on your minus 3% organic sales growth this quarter, it implies that GCOC did about 630,000 gallons this quarter. What drove this step-up from the normalized 250,000 gallons a quarter?

Cody, in terms of the GCOC business that we transferred over to Quick Lubes as part of the sale, last year in the quarter, the volume related to GCOC was between 300,000 and 400,000 gallons. Now we’re lapping that in Q4, and so the Q4 year-over-year change will be substantially smaller than that. But the GCOC impact for Q3, in terms of that business that was transferred over to Quick Lubes, was in that 300,000 to 400,000 gallons range.

And that’s for this year you’re saying or for last year, you did 300,000 to 400,000 gallons?

That was – last year, Core North America – the volume last year for Core North America sold. And of course, when we acquired GCOC earlier this year – late last year, that volume is now all reported in the Quick Lubes segment.

So then you would have a gain of about 250,000 gallons in this quarter, like increased volume?

In Quick Lubes, I would – the way – the right way to think about it is if they – if we lost 300,000 to 400,000 gallons in Core North America, that 300,000 to 400,000 gallons shifted over to Quick Lubes for the quarter.

Okay. And then moving on to Quick Lubes quickly, your same-store sales growth continues to outperform our expectations, and quite frankly, your expectations as well. What is driving this? And also, what’s holding you back from making greater investment to accelerate store growth? And then can you remind us what you believe your long-term store growth opportunity is and update us on what your store growth per year is? Thank you.

Okay. That was a handful of questions and I’ll break that down. Just on the same-store sales growth performance, yes, we’ve been pretty excited about the results that we’ve seen because we are executing really well on both the transaction opportunity and the ticket opportunity. To reiterate on the transaction opportunity, some of the key things that have been driving our growth and our customer count has been stronger retention of our customers and also attracting new customers. We’ve laid it out on Investor Day where we’re not only attracting customers from a competitor of Quick Lubes, but also from the broader DIFM market. And our messaging around service you can see and experts you can trust is really playing well with the installer customer who continues to look for more and more convenience and also having their car serviced where they really trust the operator. They’re not going to be sold service that they don’t need or overcharged. They’re looking for that partner. And Valvoline and our vision for how we grow our business is to be more than just an oil change provider, but really that trusted partner for the car owner in helping them care for the vehicle. And that includes even referring our customers to our partners to have other services done, such as that car dealer referral program that we mentioned on our recall services. So that’s how we’re going to continue to grow, which is really well-positioned to deliver on the consumer expectations and that drive for convenience and trust. The ticket opportunities remain really strong for us and that’s because – not just because of the increase in synthetic oil changes, it’s also because we do have opportunities on the, what we call, the non-oil-change revenue side of the equation. And as customers better understand and better trust us to provide more and more of those services, we have real opportunities to improve our execution there and grow ticket on that front. So the combination of being able to grow both customer accounts and improve ticket led to a really powerful formula for driving that strong same-store sales performance. And so we – our expectation is, we’ll continue to be in a really good position for next year. With regard to the store investments that we’re making and accelerating our growth, if you go back to – first of all, the organic store growth and building stores, we went from really ground zero when we were at separation from Ashland to now building 25-plus stores a year and we’re investing in our capabilities. We brought those capabilities in-house, where we’re going to be doing much better than that in 2020, and really pushing the team towards growth in the 40 to 50 range for new store build. But we’re also making good progress with our franchisees on their store development plans with franchise – development agreements in place with our largest franchisees. That gives us much confidence in their plans for growth. And then our acquisition opportunities to drive our company store growth is still a big part of our plan, too. So in a short period of time, we have increased our store growth expectations and we’re going to always be looking for ways to continue to improve that, because we, in fact, feel that the opportunity for a much bigger footprint is significant for us. We shared then the target of adding 100 stores each year and we haven’t put a day on that as to when that would end. So while we haven’t laid out where – exactly what our expectation is and where we’ll be 10 years from now, we do feel it is a very long runway for us to have many more Valvoline Instant Oil Change stores, both in the U.S. and in Canada.

Great. Thank you very much.

You bet.

Our next question comes from the line of Mike Harrison with Seaport Global Securities. Please go ahead.

Hi. Good morning.

Good morning, Mike.

Just in terms of the – you mentioned the branded volume in Core North America was steady sequentially. Just wondering, I mean, we would typically expect to see a seasonal uptick in the June quarter. So is that the day that you guys lost share in, or are you adjusting for that seasonal impact?

Yes. There’s really – when you look at our volume and you can look over the last number of years, there’s not a big seasonal difference between Q3 and Q2. And even if Q2 starts in the winter months, you tend to have a – we tend to have a very strong March leading into the spring season, too. So the only quarter where we see a seasonal effect is really our first quarter, in the December quarter, where we tend to see little bit lower volume and then a strong pickup in Q2, and then Q3 and Q4 being pretty consistent. And that’s, in fact, what we’re seeing this year. That our Q2, Q3 and Q4 volumes are all going to be pretty close to one another, good solid stabilization there.

Okay. So you’re comfortable that that is a good number then, that is sequential volume? Okay

Yes.

And then the other question I have is, I was just wondering if you can provide a little bit more color on some of the issues that you’re addressing as you go through these line reviews with your key retail partners? You mentioned merchandising and promotional activity is something that might be changing. What is your focus going into this line review season?

Sure. To reiterate, the significant changes that took place in the last year were twofold. One was that, there has been a significant shift from our conventional lubricants to this synthetic segment. So conventional lubricants have been dropping at a double-digit rate really for the last couple of years and synthetics have been growing quite aggressively. The High Mileage segment has been kind of mid to upper single-digit growth rates, but the real significant news is the shift from conventional synthetic to synthetic. So what that involves is that, those shifts being reflected on the shelf. And so that’s one major change that retailers are making, and it’s been very profitable for retailers and it’s been good for our margins, too, as we sell more synthetics. That’s a key factor. The other factor has been this shift towards private label from the mid-tier brands. And so over the past year, year-and-a-half, mid-tier brands like the Mobil Super have lost distribution and that business is going to private label. Private label at most of our major accounts has grown significantly to take that volume and to expand even beyond that, and that’s where it had some negative share impact on Valvoline. It certainly had a negative impact on some of our competitors. And so that shift in dynamics is something that we’ve been adjusting to and making sure that our price points are right, our promotion tactics are right, that they keep our brands strong. So the retailers have a big role in this in terms of how they want to manage the category to optimize their traffic and their profitability. And so there has been probably sharper competition between the retailers on that private label pricing, whereas at the same time, they’re trying to make sure their category profits and their ability to move people up in the synthetics and higher-margin products that they’re capturing that margin. The motor oil category is very profitable for the retailer. So there are these dynamics that retailers are adjusting to. And the relationship that we have with our retail partners is really key for us navigating successfully through this. So that as we put our 2020 plan in place that it’s a plan that leads us to greater stabilization as we adjusted these factors of private label growth and the growth of the Synthetic segment.

All right. I appreciate the color there. Thanks, Sam.

Sure.

Our next question comes from the line of Chris Bottiglieri from Wolfe Research. Please go ahead.

Hi. Thanks for taking the question. Sorry if I missed this. I’m not sure if I heard it correctly. But I think you mentioned there is some one-time benefits in Q3 that you don’t anticipate in Q4? Did I hear that, or maybe you can just elaborate what those are and kind of how you think about it?

Yes. You heard that correctly, Chris. In our other income, we saw about a $3 million increase in Q3 versus last year, and it was driven by – we had a contract termination fee that benefited our Quick Lubes business and then we had a free trade zone incentive that benefited our International business. And we don’t expect those two things to recur in Q4. And in addition to that, we are expecting some modest integration costs associated with the business acquisition we did in Eastern Europe. And then we talked about some additional price cost lag in Q4. We think the combination of those things will see some modest deceleration from our performance in Q3.

Gotcha. Very help – that’s helpful. And then on North America, can you maybe just talk a little bit about the retail environment what you’re seeing? I know you mentioned you expect it to be very challenging. But it seems like even the aftermarket retailers are seeing pressure in that category. I’m not sure if there’s just price mix from substitution or from branded to private label and if that’s just a comp ad winner or not. But is there something else going on in the category now that you think the whole category is seeing, either – is there any data that you could track that maybe points to deferred maintenance? Is that an issue, or maybe any kind of macro thoughts that you’re seeing on DIY right now would be helpful?

I think the macroenvironment is showing signs of pretty good stability for the overall DIY environment. We’ve seen more stability in just category demand, where category demand for motor oil, for oil changes, has been closer to flat, down 1%, 1.5% over the past year. Whereas if you go back a couple of years ago, we are seeing sharper declines in DIY, so some encouraging signs there. I don’t think any of the retailers are dealing with issues of deferred maintenance. We’re seeing some pretty solid results come out of the retail channel and the results that they’re reporting with their comp sales. So it’s been – the issues that we’re dealing with on the motor oil side of the business are unique to motor oil with this shift towards synthetic and then, of course, the new dynamic with private label versus mid-tier brands, which we’ve explained. Now what’s different about where we are today versus where we were a year ago is that a year ago, some of these new dynamics were exactly that. They were new and we were adjusting to it. Today, we have much better understanding of the impact of the new dynamics and how best to respond to it. So I think we’re in a better place as we prepare for 2020 and beyond.

That’s helpful. Thank you.

Our next question comes from the line of Dmitry Silversteyn from Buckingham Research. Please go ahead.

Good morning. Thank you for taking my call. I’d like to explore a little bit what’s going on in your International business. First of all, Europe is not known to be a particularly strongly growing geography, so 9% growth there was pretty impressive. And I was wondering if you can provide some color in what you’re doing and how you’re doing it that you’re that successful? And then secondly, revisiting the last positive areas of China and Latin America. Can you talk about sort of what you’re seeing there in terms of market or company-specific headwinds? And how you’re dealing with them and when should we look for that business to start inflecting positively as well?

Okay. So taking a look at Europe first. We’ve really been focused on developing our distribution network in Europe and strengthening your partnership with our distributors and improving our customer service, reducing our lead times from order to getting the product into each of the different regions and countries into our distributor network. And so that’s been key for us in improving our performance. Our strengths tend to be in Northern Europe and then parts of Eastern Europe. And we see a really nice growth opportunity for us in Europe – in Eastern Europe, and that’s part of the rationale behind the plant and business that we purchased in the Serbia region. So we believe that’s going to help us really better access those markets. But in Northern Europe, we’ve seen some good progress with some upgrades and additions to our distributor network that are driving those improved results. So we feel good about Europe. The business in Latin America has been disappointing this year. We’ve had tremendous growth in Latin America over the last decade. It’s been really one of our shining stars of our International portfolio. And yet this past year, we’ve had a couple different effects. We’ve talked about moving our Brazilian business model to a licensee to reduce our risk in Brazil. That’s not one of our focus areas. But in other areas where we’ve had some significant growth, we just had a couple hiccups when it comes to some issues with a couple distributors and our growth plans in those regions. For example, Mexico was one where we had an underperforming distributor where we’re needing to make a change. But progress has been made there. I feel that Latin America will continue to be a strong growth region for us. And we expect to see some progress in Q4 and we expect to see a good year for Latin America in 2020. Then moving to China. China is a market that we feel has a very strong long-term growth potential for us. It’s a good, solid, profitable region for us where we have made good progress, both on the passenger car side and on the heavy-duty side. We have a good partnership with Cummins on the heavy-duty side of the business, and there again is where we’re investing both in developing our distribution network, but also beginning to increase our investment on the brand development side. And I would say this is a theme across our International business is that, we do expect to invest more in our marketing efforts as we go from, not just having distribution in the marketplace, but now driving more through a poll strategy with the consumer and the installer customers. So in China, certainly, we felt the impact of the slower economic conditions, particularly on the heavy-duty side of the business this past year. But longer-term, we still feel very pretty good about our prospects there. In our business, we’re all about market share growth internationally. It’s – we’re not totally dependent on what the overall market is doing, but how does Valvoline in the value proposition that we deliver by bringing strong service support and tools for our partners to improve the profitability beyond just our product sales. This is a key part of how we’ve grown our business in the U.S., and we’re building those capabilities into our international markets, too. So, again, going back to the big picture on our international business and what we shared on Investor Day is that, we’re expecting some solid mid single-digit growth performance in our International business in total. And that reflects a little bit more modest growth expectation, recognizing that we do need to make sure we’re investing and developing the brand in the different international markets. So that kind of gives you a good overview of where things stand internationally. I guess, the one other market region I’d like to address is that the Australia business, where we have a good strong mature business, has been a bit softer this past year, too. So, that’s been a bit of a drag on our performance in 2019. Long-term, again, we have a real strong business and strong share in Australia with a very good team. And I think we’re making the right adjustments as we get ready for 2020.

Okay, that’s helpful. If I may follow-up on the China opportunity. I think it was a couple of quarters ago that you guys bought a small, sort of do-it-for-me chain in that region to kind of see what you can learn and what you can do in that. Having had that for a couple of quarters, can you provide a little bit of an update on what your plans for China may be, or how they may have changed in terms of developing a VR or C-type model in the region?

Yes. To be more specific on what we put in place, it was a joint venture that was formed with one of our longer-term partners there to specifically pilot a Quick Lubes type model in China. We now have four stores that are up and running. It’s really too early to talk about results, because they are just a couple of months into operation. So we’re excited about the potential and to be piloting and begin learning around what that model might look like in China. But we do feel that with the consumer, we’re on that tremendous growth in car ownership in China and the type of choices that consumers have in China that are Quick Lubes type model could be a good solution for maintenance services in China. So we look forward to reporting on how the pilot stores are performing in future quarters. It’s just a little bit too early to share that other than we’re optimistic and excited to be in pilot mode right now.

I’m good. Thanks for the update.

Sure.

Our next question comes from the line of Olivia Tong from Bank of America Merrill Lynch. Please go ahead.

Thanks. Good morning. Most of my questions have been asked at this point. But I wanted to get a better sense on the DIY – the Quick Lubes business. That business has obviously been performing quite well. It seems that sales keep coming in well ahead of expectations. So I’d love to get a better understanding of a breakdown – a further breakdown in terms of how you’re thinking about traffic, the things you’re doing to drive traffic and things you’re doing to drive ticket? And as we go forward, is there going to be a change in terms of the contribution that comes from these two items? Thanks.

Yes. The good news is that, we expect to continue to see balanced contributions from both traffic and ticket. And the – on the traffic front, we feel there’s a couple of key contributors to that. One is the experience that we’re delivering consistently in our stores. Our teams are just doing a great job taking care of our customers. And when customers come in and our service is efficiently and done in a way that builds trust with our stores, in our brand, it really drives retention. I also think it drives word-of-mouth success in growing our cars, too. But it’s our key that make sure the operations are strong. And how we do that in the stores, the technology that we put in place to measure wait times, to measure how fast the service is to keep our teams focused on efficient oil changes and providing the services is really key. We know that when wait times increase, or the service times slow down, our customer satisfaction scores drop pretty quickly, too. And so that – just that focus and understanding of that dynamic is key to our success. And so we’re going to keep that strong and then you add in continued improvements in our marketing efforts. Those are key to driving our transactions. This new app is – I shared it on the call today, because I’m very excited about the impact that it can have on our business. And we know from the pilot stores is that our retention gets much stronger as consumers download the app and they begin to use it for understanding our wait times before they even come in. Obviously, there’s benefits to the consumer and how they manage their time, but it also has the extended benefit of moving that volume. And as we continue to grow volume, it moves it from the busiest times of day possibly to times where we’re less busy or to a store that’s not too far from the typical store they might visit, which might have less of a wait. So it drives – it actually drives efficiency in how we manage the continued growth in our cars. And then lastly, I just think the consumer trend and drive for convenience and the expectation that they can manage their car on their device, these are all things that we’re leaning heavily into. And so this just gives me confidence that we’ll continue to drive transactions and car kind of growth in our stores. Again, we shared it on Investor Day, when we break down the growth of new customers, we know it’s coming from a competitor of Quick Lubes, car dealerships, tire and repair. It’s really a balanced growth opportunity for us. And then lastly, we shared some interesting programs, what we call our referral program. We’re working more closely with our independent installer partners. There can be some real synergies here in terms of referring our Valvoline Instant Oil Change customers to our partners for service, whether it’s recall work, repair work, potentially a tire sale someday, too. We can refer those customers to our partners and at the same time benefit from that relationship, where they would like us to do the oil changes, because we’re a more efficient place to have those oil changes completed. So we feel like we’re opening up longer-term share growth in the Quick Lubes business as we get after the broader DIFM market and not just growth within the Quick Lubes business in terms of overall volume for oil changes themselves. And on the ticket front, so much of performing on ticket has to do with the strength of your teams in the stores and the process that you give them to explain our services to customers. And so as we continue to invest in our teams, in our stores and in those training programs and how we even measure their delivery of our services, it’s uncovered really nice opportunities for us to continue to get better there. And so we feel we still have a long runway for us to continue to make those improvements on the ticket side, again not by pushing sales onto customers, but by better explaining and consistently presenting those additional services that we offer. So these are some of the reasons why we’re excited about this business and why we talk about Valvoline becoming more a service-driven business is because of the growth in Quick Lubes and then that service mentality and how you build more service into other aspects of our business model.

Got it. Thanks, Sam. The details really helpful.

Good.

Our next question comes from the line of Laurence Alexander from Jefferies. Please go ahead.

Hi. This is Adam Bubes on for Laurence Alexander today. I was wondering if you could give us any indication regarding what percent of customers in Quick Lubes use the higher-priced synthetic oil? And where do you guys see that going over the next three to five years?

Adam, first of all, our overall mix in what we call our premium oil change is now at the low 60% of transactions.

65%.

65% now. So I’ll call it mid-60s. So we’re seeing the benefits of more cars requiring synthetic oil changes. And the expectation is that, it will continue to be a positive factor for us. The drain intervals tend to be a little bit longer on the synthetic oil changes. But the incremental profit opportunity more than makes up for that. So that growth towards synthetics is a real positive factor for us. But when you look out over the next few years, the majority of the new cars being produced today are requiring synthetic oil. I think it’s roughly about 70%. Is that right, Mary?

That’s right.

So as those new cars come into the car park population, that’s going to be a nice tailwind for us in driving synthetic growth within our Quick Lubes chain.

Perfect. That’s very helpful. And then one last question. I was wondering if you could touch on more on the opportunity possibly to expand Quick Lubes outside of North America? And how do those markets differ?

Yes. The closest in move out of the U.S. was first to Canada in terms of a new market for us. And while we’re still talking North America, it is still a new region for us. And so when we studied Canada and the opportunity there, we believe there’s an opportunity for – that Quick Lubes, in general, is underdeveloped in Canada. The acquisition opportunities that we looked at, good solid oil changes per day and good solid trends without really adding any of the tools that we have in our system. So as we bring our tools, our point of sales and marketing capabilities into the Canada business model, we’re excited about what we can do there in addition to building and developing more stores in Canada. So that one is easy and close in because of the consumer dynamics being very similar. I talked earlier about being encouraged, optimistic about the pilot in China. It’s too early to say what that looks like or how fast we’re going to go in China. But it’s great to be in pilot there, because based on some of the consumer dynamics that we see and the need for a high-quality offering between the expensive, less convenient car dealer and the local garage, we think there could be a nice play for Valvoline to participate in with a convenient high-quality alternative. So China is really interesting to us. In terms of other markets around the world, we’re not going – we’re not planning on being as aggressive right now and exploring those because of what we have on our plate closer in Canada and the pilot in China, and obviously just the growth opportunity that we have in the U.S. And part of that reflects the different dynamics in some of the mature markets like Australia and Europe where we just don’t see that Quick Lubes opportunity. The consumer dynamics are different and how cars are maintained. In other developing markets around the world, there could be opportunities for a Quick Lubes type model, but it’s just not in our priority list right now, given the opportunities that we have right here in North America.

Great. Thanks a lot.

Our next question comes from the line of Stephanie Benjamin from SunTrust. Please go ahead.

Hi. Good morning. Sam, I wanted to go back to the sort of commentary you made about the new Quick Lubes app. Is there anyway you could provide a little bit more color on how the app actually performs in the test markets? Did you see a spike in traffic that can be quantified compared to their total segment performance? That would just be very interesting. And then looking at Core North America, I know before it was kind of discussed that from a unit margin standpoint, close to that 360 for the full-year, are we expecting an improvement in 4Q, or how can we think about those full-year expectations? And then how does the promotional calendar look in 4Q? Meaning, how does it kind of compare to last year, so that we can look at that correctly? Thanks so much.

Okay. Yes, with regard to the app, it’s really going to be a driver of retention. So it’s not so much that it’s going to attract new customers, at least initially. I mean, hopefully, word-of-mouth that can help us in that regard. But what we have going on in our stores this summer is an effort when the consumer or car owner visits us to have them download the app while they’re in the store. So as you might recall, our consumers stay in their car. It gives us an opportunity to interact with them, so we have an incentive in place and effort by our teams to talk to the customer about, hey, let’s download this now, because it’s going to create some really nice benefits for you to use this in the future. So that you can manage your own wait times, you can come when it’s especially convenient. So the pilot market showed that our customer retention increased pretty substantially when the consumer downloaded the app and began to use that wait time benefit. I think that – and so that ultimately will help us obviously grow our car counts over time, but I can’t put a number on it at this point. But the other benefit that I mentioned in the presentation earlier is that, when we begin to communicate with consumers via the app and via texting, even e-mails, it’s just much more efficient than reminder cards in the mail. And it allows us to, I think, more graphically present some of the other services that they might be due for prior to even coming to the stores. So these are all great benefits for the consumer and an opportunity for us to improve our marketing efforts to the consumer as we communicate in a way that they want to be communicated with. So, obviously, we’re really excited about the program. It will take us time to roll it out across the whole system because of some of the investments that have to be made and the store-level technology at the franchise level. But on the company side, we’re locked and loaded in rolling out aggressively this year. So we’ll see a lot of good progress. And as we have more data to share, certainly, we’ll be willing to do that. Turning to the DIY business in the Core North America, margins and expectations for Q4, I think earlier in the call, we mentioned that, from a volume perspective, we’re feeling that we may be down slightly on the volume side of it on a year-over-year basis, but fairly consistent when it comes to the volume performance that we’ve seen over the last couple of quarters. From a margin perspective, again we expect, on an adjusted basis, when you factor out the ITC fire impact that we had on our margins in Q3, the Q3 to Q4 margin performance should be in a similar range. In other words, at the lower-end of the guidance that we had given between 360 and 370.

And the other thing I would add is that, in addressing your question on the promotional calendar, in the fourth quarter, our retail promotional calendar is just modestly softer. It’s quite similar with – I think there’s just one less event with one of our retail accounts. So it’s fairly comparable to last year for the fourth quarter.

Awesome. Well, thanks so much for the color.

Our next question comes from the line of Simeon Gutman from Morgan Stanley. Please go ahead. Simeon, your line is open. We would like to thank everyone for attending today. This concludes today – today’s event, and you may now disconnect.