As described in Note 1, Valvoline adopted new revenue recognition accounting guidance effective October 1, 2018, and accordingly, changed its accounting policy for revenue recognition prospectively from the date of adoption as described herein.
Impacts on financial statements
The adoption of the new revenue accounting guidance did not have a significant impact on the Company’s condensed consolidated financial statements. As a result of the Company’s adoption using the modified retrospective adoption approach, the Company recorded an adjustment to its Condensed Consolidated Balance Sheet as of October 1, 2018 related to the timing of certain sales to distributors.
The following table reconciles the Condensed Consolidated Balance Sheet line items impacted by the cumulative effect of adoption of the new revenue recognition accounting guidance on October 1, 2018:
|(In millions)||September 30, 2018 as reported||Adjustments ||Balances at October 1, 2018|
|Accounts receivable, net||$||409 ||$||(33)||$||376 |
|Inventories, net||$||176 ||$||14 ||$||190 |
|Deferred income taxes||$||138 ||$||6 ||$||144 |
|Retained deficit||$||399 ||$||13 ||$||412 |
Most revenue transactions and activities recorded under the new revenue recognition accounting guidance are substantially consistent with the treatment under prior guidance. The following tables summarize the impact of the new revenue accounting guidance on Valvoline’s Condensed Consolidated Balance Sheet and Condensed Consolidated Statement of Comprehensive Income as of and for the three months ended December 31, 2018:
|December 31, 2018|
|Impact of Changes to Condensed Consolidated Balance Sheet||As reported |
|Under prior guidance |
|Accounts receivable, net||$||331 ||$||29 ||$||360 |
|Inventories, net||$||200 ||$||(12)||$||188 |
|Deferred income taxes||$||134 ||$||(6)||$||128 |
|Accrued expenses and other liabilities||$||198 ||$||1 ||$||199 |
|Retained deficit||$||379 ||$||(12)||$||367 |
(a) Adjustments include the opening retained deficit adjustments as detailed in the table above.
|Three months ended December 31, 2018 |
|Impact of Changes to Condensed Consolidated Statement of Comprehensive Income||As reported ||Adjustments ||Under prior guidance |
|Sales||$||557 ||$||(15)||$||542 |
|Cost of sales||374 ||(15)||359 |
|Gross profit||$||183 ||$||— ||$||183 |
|Selling, general and administrative expenses||$||105 ||$||2 ||$||107 |
|Operating income||$||87 ||$||(2)||$||85 |
|Income before income taxes||$||72 ||$||(2)||$||70 |
|Income tax expense||$||19 ||$||(1)||$||18 |
|Net income||$||53 ||$||(1)||$||52 |
|Basic earnings per share||$||0.28 ||$||(0.01)||$||0.27 |
|Diluted earnings per share||$||0.28 ||$||(0.01)||$||0.27 |
Disaggregation of revenue
The following summarizes sales by primary customer channel for the Company’s reportable segments for the three months ended December 31, 2018:
|(In millions) |
|Quick Lubes |
|Company-owned operations ||$||124 |
|Non-company owned operations ||65 |
|Total Quick Lubes ||189 |
|Core North America |
|Retail ||116 |
|Installer and other ||116 |
|Total Core North America ||232 |
|International ||136 |
|Consolidated sales ||$||557 |
Sales by reportable segment disaggregated by geographic market follows for the three months ended December 31, 2018:
|(In millions) ||Quick Lubes ||Core North America ||International ||Totals |
|Primary geographic markets |
North America (a)
|$||189 ||$||232 ||$||— ||$||421 |
|Europe, Middle East and Africa (EMEA) ||— ||— ||44 ||44 |
|Asia Pacific ||— ||— ||67 ||67 |
Latin America (a)
|— ||— ||25 ||25 |
|Totals ||$||189 ||$||232 ||$||136 ||$||557 |
(a) Valvoline includes the United States and Canada in its North America region. Mexico is included within the Latin America region.
The following disaggregates the Company’s sales by timing of revenue recognized for the three months ended December 31, 2018:
|(In millions) |
|Timing of revenue recognized |
|Sales at a point in time ||$||547 |
|Franchised revenues transferred over time ||10 |
|Consolidated sales ||$||557 |
Nature of goods and services
Valvoline generates all operating revenues from contracts with customers, primarily as a result of the sale and service delivery of engine and automotive maintenance products to customers. Valvoline derives its sales from its broad line of products and complementary services through three principal activities managed across its three reportable segments: (i) engine and automotive maintenance products, (ii) company-owned quick-lube operations,
and (iii) franchised quick-lube operations. Valvoline’s sales are generally to retail, installer, industrial, distributor, franchise and end consumers to facilitate vehicle and equipment service and maintenance. Approximately 98% of Valvoline’s net sales are products and services sold at a point in time through either ship-and-bill performance obligations or company-owned quick lube operations. The remaining 2% of Valvoline’s net sales generally relate to franchise fees.
Revenue is recognized for the amount that reflects the consideration the Company is expected to be entitled to based on when control of the promised good or service is transferred to the customer. Revenue recognition is evaluated through the following five steps: (i) identification of the contract(s) with a customer; (ii) identification of the performance obligations in the contract; (iii) determination of the transaction price; (iv) allocation of the transaction price to the performance obligations in the contract; and (v) recognition of revenue when or as a performance obligation is satisfied. Below is a summary of the key considerations for Valvoline’s material revenue-generating activities:
Engine and automotive maintenance products
Engine and automotive maintenance products primarily include lubricants, antifreeze, chemicals, filters, and other complementary products for use across a wide array of vehicles and engines. The Company’s customers typically enter into a sales agreement which outlines a framework of terms and conditions that apply to all current and future purchase orders for the customer submitted under the supply agreement. In these situations, the Company’s contract with the customer is the sales agreement combined with the customer purchase order as specific products and quantities are not indicated until a purchase order is submitted. As the Company’s contract with the customer is typically for a single purchase order under the supply agreement to be delivered at a point in time, the duration of the contract is almost always one year or less. The Company’s products are distinct and separately identifiable on customer purchase orders, with each product sale representing a separate performance obligation that is generally delivered simultaneously. Valvoline is the principal to these contracts as the Company has control of the products prior to transfer to the customer. Accordingly, revenue is recognized on a gross basis.
The Company determines the point in time at which control is transferred and the performance obligation is satisfied by considering when the customer has the ability to direct the use of and obtain substantially all of the remaining benefits of the product, which generally coincides with the transfer of title and risk of loss to the customer and is typically determined based on delivery terms within the underlying contract.
While payment terms with customers vary by region and customer and are generally 30 to 60 days after delivery, Valvoline does not provide extended payment terms of a year or more.
Company-owned quick-lube operations
Performance obligations related to company-owned quick-lube operations primarily include the sale of engine and automotive maintenance products and related services. These performance obligations are distinct and are delivered simultaneously at a point in time. Accordingly, revenue from company-owned quick-lube operations is recognized when payment is tendered at the point of sale, which coincides with the completion of product and service delivery and the transfer of control and benefits from the performance obligations to the customer.
Franchised quick-lube operations
The primary performance obligations related to franchised quick-lube operations include product sales as described above and the license of intellectual property, which provides access to the Valvoline brand and proprietary information to operate service center stores over the term of a franchise agreement. Other franchise performance obligations do not result in material revenue. Each performance obligation is distinct, and franchisees generally receive and consume the benefits provided by the Company’s performance over the course of the franchise agreement, which typically ranges from 10 to 15 years. Billings and payments occur monthly.
In exchange for the license of Valvoline intellectual property, franchisees generally remit initial fees upon opening a service center store and royalties at a contractual rate of the applicable service center store sales over the term of the franchise agreement. The license provides access to the intellectual property over the term of the franchise
agreement and is considered a right-to-access license of symbolic intellectual property as substantially all its utility is derived from association with the Company’s past and ongoing activities. The license granted to operate each franchised service center store is the predominant item to which the royalties relate and represent a distinct performance obligation which is recognized over time as the underlying sales occur as this is the most appropriate measure of progress toward complete satisfaction of the performance obligation.
The Company only offers an assurance-type warranty with regard to the intended functionality of products sold, which therefore, does not represent a distinct performance obligation within the context of the contract. Product returns and refunds are generally not material and are not accepted unless the item is defective as manufactured. Estimated product returns are recorded as a reduction in reported revenues at the time of sale based upon historical product return experience and is adjusted for known trends to arrive at the amount of consideration to which Valvoline expects to receive.
The nature of Valvoline’s contracts with customers often give rise to variable consideration consisting primarily of promotional rebates and customer pricing discounts based on achieving certain levels of sales activity that generally decrease the transaction price. The Company determines the transaction price as the amount of consideration it expects to be entitled to in exchange for fulfilling the performance obligations, including the effects of any variable consideration, or amounts payable to the customer when there is a basis to reasonably estimate the amount and it is probable there will not be a significant reversal. Variable consideration is recorded as a reduction of the transaction price at the time of sale and is primarily estimated utilizing the most likely amount method that is expected to be earned as the Company is able to estimate the anticipated discounts within a sufficiently narrow range of possible outcomes based on its extensive historical experience with certain customers, similar programs and management’s judgment with respect to estimating customer participation and performance levels. Variable consideration is reassessed at each reporting date and adjustments are made, when necessary.
Allocation of transaction price
In each contract with multiple performance obligations, Valvoline allocates the transaction price, including variable consideration, to each performance obligation on a relative standalone selling price basis, which is generally determined based on the directly observable data of the Company’s standalone sales of the performance obligations in similar circumstances to similar customers. In the absence of directly observable standalone prices, the Company may utilize prices charged by competitors selling similar products or use an expected cost-plus margin approach. The amount allocated to each performance obligation is recognized as revenue as control is transferred to the customer.
Valvoline invoices customers once or as performance obligations are satisfied, at which point payment becomes unconditional. As the majority of the Company’s performance obligations are satisfied at a point in time and customers typically do not make material payments in advance, nor does Valvoline have a right to consideration in advance of control transfer, the Company had no contract assets or contract liabilities recorded within its Condensed Consolidated Balance Sheet at adoption or as of December 31, 2018. The Company recognizes a receivable on its Condensed Consolidated Balance Sheet when the Company performs a service or transfers a product in advance of receiving consideration, and the Company’s right to consideration is unconditional and only the passage of time is required before payment of that consideration is due.
Practical expedients and accounting policies
Valvoline elected the following practical expedients and policy elections in accordance with the new revenue recognition accounting guidance adopted beginning in fiscal 2019:
•Significant financing component – The promised amount of consideration has not been adjusted as the Company does not have significant financing arrangements with its customers. The Company expects that the period between when the Company transfers a promised good or service to the customer and when the customer pays for that good or service will be one year or less.
•Incremental costs of obtaining a contract - The Company expenses incremental direct costs of obtaining a contract, primarily sales commissions, when incurred due to the short-term nature of individual contracts, which would result in amortization periods of one year or less. These costs are not material and are recorded in Selling, general and administrative expenses within the Condensed Consolidated Statements of Comprehensive Income.
•Shipping and handling costs - Valvoline elected to account for shipping and handling activities that occur after the customer has obtained control as fulfillment activities (i.e., an expense) rather than as a performance obligation. Accordingly, amounts billed for shipping and handling are a component of the transaction price included in net sales, while costs incurred are included in cost of sales.
•Sales and use-based taxes - Valvoline excludes from its revenue any amounts collected from customers for sales (and similar) taxes. These amounts are, however, reflected in accrued expenses until remitted to the appropriate governmental authority.
•Disclosure of remaining performance obligations - The Company elected to apply the practical expedient to omit disclosures of remaining performance obligations for contracts which have an initial expected term of one year or less. In addition, the Company has elected to not disclose remaining performance obligations for its franchise agreements with variable consideration based on service center store sales.