VALVOLINE INC, 10-K filed on 11/17/2017
Annual Report
Document Entity Information (USD $)
In Millions, except Share data, unless otherwise specified
12 Months Ended
Sep. 30, 2017
Nov. 10, 2017
Mar. 31, 2017
Document and Entity Information [Abstract]
 
 
 
Entity Registrant Name
VALVOLINE INC 
 
 
Entity Central Index Key
0001674910 
 
 
Document Type
10-K 
 
 
Document Period End Date
Sep. 30, 2017 
 
 
Amendment Flag
false 
 
 
Current Fiscal Year End Date
--09-30 
 
 
Entity Filer Category
Large Accelerated Filer 
 
 
Entity Common Stock, Shares Outstanding
 
202,527,634 
 
Document Fiscal Year Focus
2017 
 
 
Document Fiscal Period Focus
FY 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Voluntary Filers
No 
 
 
Entity Well Known Seasoned Issuer
Yes 
 
 
Public Float
 
 
$ 850 
Consolidated Statements of Comprehensive Income (USD $)
In Millions, except Per Share data, unless otherwise specified
3 Months Ended 12 Months Ended
Sep. 30, 2017
Jun. 30, 2017
Mar. 31, 2017
Dec. 31, 2016
Sep. 30, 2016
Jun. 30, 2016
Mar. 31, 2016
Dec. 31, 2015
Sep. 30, 2017
Sep. 30, 2016
Sep. 30, 2015
Net Income (Loss) Attributable to Parent [Abstract]
 
 
 
 
 
 
 
 
 
 
 
Sales
$ 547 
$ 534 
$ 514 
$ 489 
$ 494 
$ 499 
$ 480 
$ 456 
$ 2,084 
$ 1,929 
$ 1,967 
Cost of sales
349 
337 
316 
304 
300 
300 
288 
280 
1,306 
1,168 
1,282 
Gross profit
 
 
 
 
 
 
 
 
778 
761 
685 
Selling, general and administrative expense
 
 
 
 
 
 
 
 
375 
365 
348 
Pension and other postretirement plan non-service income and remeasurement adjustments, net
 
 
 
 
 
 
 
 
(136)
(22)
22 
Separation costs
 
 
 
 
 
 
 
 
32 
Equity and other income
 
 
 
 
 
 
 
 
(25)
(19)
(8)
Operating income
191 
104 
117 
120 
118 
113 
104 
96 
532 
431 
323 
Net interest and other financing expense
 
 
 
 
 
 
 
 
42 
Net loss on acquisition and divestiture
 
 
 
 
 
 
 
 
26 
Income before income taxes
 
 
 
 
 
 
 
 
490 
421 
297 
Income tax expense
 
 
 
 
 
 
 
 
186 
148 
101 
Net income
105 
56 
71 
72 
65 
75 
68 
65 
304 
273 
196 
NET INCOME PER SHARE
 
 
 
 
 
 
 
 
 
 
 
Net income per share, basic (usd per share)
$ 0.52 
$ 0.27 
$ 0.35 
$ 0.35 
$ 0.38 
$ 0.44 
$ 0.40 
$ 0.38 
$ 1.49 1
$ 1.60 1
$ 1.15 1
Net income per share, diluted (usd per share)
$ 0.52 
$ 0.27 
$ 0.35 
$ 0.35 
$ 0.38 
$ 0.44 
$ 0.40 
$ 0.38 
$ 1.49 1
$ 1.60 1
$ 1.15 1
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares outstanding, basic (in shares)
 
 
 
 
 
 
 
 
204 1
170 1
170 1
Weighted average common shares outstanding, diluted (in shares)
 
 
 
 
 
 
 
 
204 1
170 1
170 1
Dividends paid per common share (usd per share)
$ 0.05 
$ 0.05 
$ 0.05 
$ 0.05 
$ 0.00 
$ 0.00 
$ 0.00 
$ 0.00 
$ 0.20 
$ 0.00 
$ 0.00 
COMPREHENSIVE INCOME
 
 
 
 
 
 
 
 
 
 
 
Net income
105 
56 
71 
72 
65 
75 
68 
65 
304 
273 
196 
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
 
 
 
 
Unrealized translation gain (loss)
 
 
 
 
 
 
 
 
(34)
Pension and other postretirement obligation adjustment
 
 
 
 
 
 
 
 
(8)
(1)
Other comprehensive (loss) income
 
 
 
 
 
 
 
 
(1)
(34)
Comprehensive income
 
 
 
 
 
 
 
 
$ 303 
$ 280 
$ 162 
Consolidated Balance Sheets (USD $)
In Millions, unless otherwise specified
Sep. 30, 2017
Sep. 30, 2016
Current assets
 
 
Cash and cash equivalents
$ 201 
$ 172 
Accounts receivable, net
385 
363 
Inventories, net
175 
139 
Other current assets
29 
56 
Total current assets
790 
730 
Noncurrent assets
 
 
Net property, plant and equipment
391 
324 
Goodwill and intangibles
335 
267 
Equity method investments
30 
26 
Deferred income taxes
281 
389 
Other noncurrent assets
88 
89 
Total noncurrent assets
1,125 
1,095 
Total assets
1,915 
1,825 
Current liabilities
 
 
Short-term debt
75 
Current portion of long-term debt
15 
19 
Trade and other payables
192 
177 
Accrued expenses and other liabilities
196 
204 
Total current liabilities
478 
400 
Noncurrent liabilities
 
 
Long-term debt
1,034 
724 
Employee benefit obligations
342 
886 
Deferred income taxes
Other noncurrent liabilities
178 
143 
Total noncurrent liabilities
1,554 
1,755 
Commitments and contingencies
   
   
Stockholders’ deficit
 
 
Preferred stock, no par value, 40 shares authorized; no shares issued and outstanding
Common stock, par value $0.01 per share, 400 shares authorized, 203 and 205 shares issued and outstanding at September 30, 2017 and 2016, respectively
Paid-in capital
710 
Retained deficit
(167)
Ashland's net investment
(1,039)
Accumulated other comprehensive income (loss)
43 
(3)
Total stockholders’ deficit
(117)
(330)
Total liabilities and stockholders’ deficit
$ 1,915 
$ 1,825 
Consolidated Balance Sheets (Parenthetical) (USD $)
Sep. 30, 2017
Sep. 30, 2016
Statement of Financial Position [Abstract]
 
 
Preferred stock authorized (in shares)
40,000,000 
40,000,000 
Preferred stock issued (in shares)
Preferred stock outstanding (in shares)
Common stock, par value (usd per share)
$ 0.01 
$ 0.01 
Common stock authorized (in shares)
400,000,000 
400,000,000 
Common stock issued (in shares)
203,000,000 
205,000,000 
Common stock outstanding (in shares)
203,000,000 
205,000,000 
Consolidated Statements of Stockholders' Deficit (USD $)
In Millions, except Share data, unless otherwise specified
Total
Common stock
Paid-in capital
Retained deficit
Accumulated other comprehensive (loss) income
Ashland's net investment
Stockholders' equity (deficit), beginning balance at Sep. 30, 2014
$ 724 
 
 
 
$ (27)
$ 751 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Net income
196 
 
 
 
 
196 
Currency translation adjustments
(34)
 
 
 
(34)
 
Net transfers to Ashland
(269)
 
 
 
 
(269)
Amortization of pension and other postretirement prior service credits in income
 
 
 
 
 
Stockholders' equity (deficit), ending balance at Sep. 30, 2015
617 
 
 
 
(61)
678 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Net income
273 
 
 
 
 
273 
Currency translation adjustments
 
 
 
 
Net transfers to Ashland
(1,500)
 
 
 
 
(1,500)
Contribution of net liabilities from Ashland
(439)
 
 
 
51 
(490)
Issuance of common stock to Ashland and in connection with initial public offering, net of offering costs (in shares)
 
205,000,000 
 
 
 
 
Issuance of common stock to Ashland and in connection with initial public offering, net of offering costs
712 
710 
 
 
 
Amortization of pension and other postretirement prior service credits in income
(1)
 
 
 
(1)
 
Stockholders' equity (deficit), ending balance at Sep. 30, 2016
(330)
710 
(3)
(1,039)
Common stock outstanding, ending balance (in shares) at Sep. 30, 2016
205,000,000 
205,000,000 
 
 
 
 
Increase (Decrease) in Stockholders' Equity [Roll Forward]
 
 
 
 
 
 
Net income
304 
 
 
304 
 
 
Currency translation adjustments
 
 
 
 
Contribution of net liabilities from Ashland
(10)
 
 
(55)
47 
(2)
Amortization of pension and other postretirement prior service credits in income
(8)
 
 
 
(8)
 
Net transfers from Ashland
 
 
 
 
Distribution of Ashland's net investment
 
(710)
(326)
 
1,036 
Stock-based compensation
 
 
 
 
Repurchase of common stock (in shares)
 
(2,000,000)
 
 
 
 
Repurchase of common stock
(50)
 
 
(50)
 
 
Dividends paid, $0.049 per common share
(40)
 
 
(40)
 
 
Stockholders' equity (deficit), ending balance at Sep. 30, 2017
$ (117)
$ 2 
$ 5 
$ (167)
$ 43 
$ 0 
Common stock outstanding, ending balance (in shares) at Sep. 30, 2017
203,000,000 
203,000,000 
 
 
 
 
Consolidated Statements of Stockholders' Deficit (Parenthetical)
3 Months Ended 12 Months Ended
Sep. 30, 2017
Jun. 30, 2017
Mar. 31, 2017
Dec. 31, 2016
Sep. 30, 2016
Jun. 30, 2016
Mar. 31, 2016
Dec. 31, 2015
Sep. 30, 2017
Sep. 30, 2016
Sep. 30, 2015
Statement of Stockholders' Equity [Abstract]
 
 
 
 
 
 
 
 
 
 
 
Dividends paid per common share (usd per share)
$ 0.05 
$ 0.05 
$ 0.05 
$ 0.05 
$ 0.00 
$ 0.00 
$ 0.00 
$ 0.00 
$ 0.20 
$ 0.00 
$ 0.00 
Consolidated Statements of Cash Flows (USD $)
In Millions, unless otherwise specified
12 Months Ended
Sep. 30, 2017
Sep. 30, 2016
Sep. 30, 2015
Cash flows from operating activities
 
 
 
Net income
$ 304 
$ 273 
$ 196 
Adjustments to reconcile to cash flows from operations
 
 
 
Depreciation and amortization
42 
38 
38 
Debt issuance cost amortization
Deferred income taxes
117 
13 
(9)
Equity income from affiliates
(12)
(12)
(12)
Distributions from equity affiliates
16 
18 
Net loss on acquisition and divestiture
26 
Impairment of equity investment
14 
Pension contributions
(412)
(2)
(Gain) loss on Valvoline pension and other postretirement plan remeasurements
(68)
(42)
Stock-based compensation expense
Change in assets and liabilities
 
 
 
Accounts receivable
(22)1
(17)1
53 1
Inventories
(35)1
(4)1
(6)1
Payables and accrued liabilities
1
1
1
Other assets and liabilities
(64)1
38 1
1
Total cash (used in) provided by operating activities
(130)
311 
330 
Cash flows from investing activities
 
 
 
Additions to property, plant and equipment
(68)
(66)
(45)
Proceeds from disposal of property, plant and equipment
Acquisitions, net of cash required
(68)
(83)
(5)
Proceeds from sale of operations
23 
Total cash used in investing activities
(135)
(148)
(26)
Cash flows from financing activities
 
 
 
Net transfers from (to) Ashland
(1,504)
(304)
Cash contributions from Ashland
60 
Proceeds from initial public offering, net of offering costs of $40
719 
Proceeds from borrowings, net of issuance costs of $5 in 2017 and $15 in 2016
470 
1,372 
Repayments on borrowings
(90)
(637)
Repurchase of common stock
(50)
Cash dividends paid
(40)
Total cash provided by (used in) financing activities
295 
10 
(304)
Effect of currency exchange rate changes on cash and cash equivalents
(1)
(1)
Increase in cash and cash equivalents
29 
172 
Cash and cash equivalents - beginning of year
172 
Cash and cash equivalents - end of year
201 
172 
Supplemental disclosures
 
 
 
Interest paid
35 
Income taxes paid
$ 26 
$ 17 
$ 0 
Consolidated Statements of Cash Flows (Parenthetical) (USD $)
In Millions, unless otherwise specified
12 Months Ended
Sep. 30, 2017
Sep. 30, 2016
Statement of Cash Flows [Abstract]
 
 
Offering costs incurred in initial public offering
 
$ 40 
Debt issuance costs
$ 5 
$ 15 
Description of Business and Basis of Presentation
Description of Business and Basis of Presentation
DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

Valvoline Inc. (“Valvoline” or the “Company”) is a worldwide producer, marketer, and supplier of engine and automotive maintenance products and services. Valvoline is one of the most recognized and respected premium consumer brands in the global automotive lubricant industry, known for its high quality products and superior levels of service. Established in 1866, Valvoline’s heritage spans over 150 years, during which it has developed powerful name recognition across multiple product and service channels.

Valvoline was incorporated in May 2016 as a subsidiary of Ashland Global Holdings Inc. (which together with its predecessors and consolidated subsidiaries is referred to as “Ashland”). Prior to this time, Valvoline operated as an unincorporated commercial unit of Ashland. Following a series of restructuring steps prior to the initial public offering (“IPO”) of Valvoline common stock, the Valvoline business was transferred from Ashland to Valvoline such that the Valvoline business included substantially all of the historical Valvoline business reported by Ashland, as well as certain other legacy Ashland assets and liabilities transferred to Valvoline from Ashland (the “Contribution”). In connection with the IPO on September 28, 2016, 34.5 million shares of Valvoline common stock were sold to investors and Ashland retained 170 million shares for 83% of the total outstanding shares of Valvoline common stock.

On May 12, 2017, Ashland distributed all of its remaining interest in Valvoline to Ashland stockholders (the “Distribution”) through a pro rata dividend on shares of Ashland common stock outstanding at the close of business on the record date of May 5, 2017, marking the completion of Valvoline's separation from Ashland. Effective upon Distribution, Ashland no longer owns any shares of Valvoline common stock, and Valvoline is no longer a controlled and consolidated subsidiary of Ashland.

Basis of presentation and consolidation

The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and U.S. Securities and Exchange Commission (“SEC”) regulations. The financial statements are presented on a consolidated basis for all periods presented and include the accounts of the Company and its majority-owned subsidiaries. All intercompany transactions and balances within Valvoline have been eliminated in consolidation. Certain prior period amounts have been reclassified in the accompanying consolidated financial statements and notes thereto to conform to the current period presentation. Refer to Note 17 for information regarding a revision to correct an immaterial error in the net earnings per share (“EPS”) calculations previously reported in the consolidated financial statements for the periods prior to and including September 30, 2016.

The Contribution of the Valvoline business by Ashland to Valvoline was treated as a reorganization of entities under common Ashland control. As a result, Valvoline has retrospectively presented the consolidated financial statements of Valvoline and its subsidiaries for periods presented prior to the completion of the Contribution, which have been prepared on a stand-alone basis and derived from Ashland’s consolidated financial statements and accounting records using the historical results of operations, and assets and liabilities attributed to Valvoline’s operations, as well as allocations of expenses from Ashland. The consolidated financial statements for periods presented subsequent to the completion of the Contribution reflect the transfer of various assets and liabilities from Ashland on a carryover basis (historical cost) and the consolidated operations of Valvoline and its majority-owned subsidiaries as a separate, stand-alone entity.

All transactions and balances between Valvoline and Ashland have been reported in the consolidated financial statements. For periods prior to the IPO, these transactions were considered to be effectively settled for cash at the time the transactions were recorded. These transactions and net cash transfers to and from Ashland’s centralized cash management system are reflected as a component of Ashland's net investment on the Consolidated Balance Sheets and as a financing activity within the accompanying Consolidated Statements of Cash Flows. In the Consolidated Statements of Stockholders’ Deficit, Ashland's net investment on the Consolidated Balance Sheets represents the cumulative net investment by Ashland in Valvoline through the IPO, including net income through the completion of the IPO and net cash transfers to and from Ashland through Distribution. Valvoline's retained earnings from the IPO through September 30, 2017 were not material and accordingly, were not separately presented in the Consolidated Balance Sheets or Consolidated Statements of Stockholders’ Deficit. Concurrent with the Distribution, Ashland's net investment in Valvoline was reduced to zero with a corresponding adjustment to Paid-in capital and Retained deficit.

Prior to the completion of the IPO, Valvoline utilized centralized functions of Ashland to support its operations, and in return, Ashland allocated certain of its expenses to Valvoline. Such expenses represent costs related, but not limited to, treasury, legal, accounting, insurance, information technology, payroll administration, human resources, stock incentive plans and other services. These costs, together with an allocation of Ashland overhead costs, are included within the Selling, general and administrative expense in the Consolidated Statements of Comprehensive Income and are disclosed in more detail in Note 19. Where it was possible to specifically attribute such expenses to activities of Valvoline, these amounts were charged or credited directly to Valvoline without allocation or apportionment. Allocation of all other such expenses was based on a reasonable reflection of the utilization of service provided or benefits received by Valvoline during the periods presented on a consistent basis, such as headcount, square footage, tangible assets or sales. However, the allocations of these shared expenses may not represent the amounts that would have been incurred had Valvoline operated autonomously or independently from Ashland in those periods. Actual costs that would have been incurred if Valvoline had been a stand-alone company would depend on multiple factors, including organizational structure and strategic decisions in various areas, including information technology and infrastructure. Upon completion of the IPO, Valvoline assumed responsibility for the costs of these functions.
Significant Accounting Principles
Significant Accounting Principles
SIGNIFICANT ACCOUNTING POLICIES

Valvoline’s significant accounting policies, which conform to U.S. GAAP and are applied on a consistent basis in all years presented, except as indicated, are described below.

Use of estimates, risks and uncertainties

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosures of contingent assets and liabilities. Significant items that are subject to such estimates and assumptions include, but are not limited to, long-lived assets (including goodwill), sales deductions, employee benefit obligations and income taxes. Although management bases its estimates on historical experience and various other assumptions that are believed to be reasonable under the circumstances, actual results could differ significantly from the estimates under different assumptions or conditions.

Cash and cash equivalents

All short-term, highly liquid investments having original maturities of three months or less are considered to be cash equivalents.

Accounts receivable and allowance for doubtful accounts

Valvoline records an allowance for doubtful accounts as a best estimate of the amount of probable credit losses for accounts receivable. Valvoline estimates the allowance for doubtful accounts based on a variety of factors, including the length of time receivables are past due, the financial health of its customers, macroeconomic conditions, past transaction history with the customer and changes in customer payment terms. If the financial condition of its customers deteriorates or other circumstances occur that result in an impairment of customers’ ability to make payments, the Company records additional allowances as needed. The Company writes off uncollectible trade accounts receivable against the allowance for doubtful accounts when collections efforts have been exhausted and/or any legal action taken by the Company has concluded.

Inventories

Inventories are carried at the lower of cost or market value. Inventories are primarily stated at cost using the weighted-average cost method. Cost includes materials, labor and manufacturing overhead related to the purchase and production of inventories. In addition, certain lubricants are valued at cost using the last-in, first-out (“LIFO”) method. The Company regularly reviews inventory quantities on hand and the estimated utility of inventory. Excess and obsolete reserves are established based on forecasted usage, product demand and life cycle, as well as utility.

Property, plant and equipment

The cost of property, plant and equipment is depreciated by the straight-line method over the estimated useful lives of the assets. Buildings are depreciated principally over 5 to 35 years and machinery and equipment principally over 5 to 15 years. Property, plant and equipment is relieved of the cost and related accumulated depreciation when assets are disposed of or otherwise retired. Gains or losses on the dispositions of property, plant and equipment are included in the Consolidated Statements of Comprehensive Income. Property, plant and equipment carrying values are evaluated for recoverability when impairment indicators are present and are conducted at the lowest identifiable level of cash flows. Such indicators could include, among other factors, operating losses, unused capacity, market value declines and technological obsolescence. Recorded values of asset groups of property, plant and equipment that are not expected to be recovered through undiscounted future net cash flows are written down to current fair value, which generally is determined from estimated discounted future net cash flows (assets held for use) or net realizable value (assets held for sale).


Business combinations
 
The financial results of the businesses that Valvoline has acquired are included in the Company’s consolidated financial results based on the respective dates of the acquisitions. The Company allocates the purchase consideration to the identifiable assets acquired and liabilities assumed in the business combination based on their acquisition-date fair values. The excess of the purchase consideration over the amounts assigned to the identifiable assets and liabilities is recognized as goodwill. Factors giving rise to goodwill generally include synergies that are anticipated as a result of the business combination, including access to new customers and markets. The fair values of identifiable intangible assets acquired in business combinations are generally determined using an income approach, requiring financial forecasts and estimates as well as market participant assumptions.

Goodwill and other intangible assets

Valvoline tests goodwill for impairment annually as of July 1 or when events and circumstances indicate an impairment may have occurred. This annual assessment consists of Valvoline determining each reporting unit’s current fair value compared to its current carrying value. Valvoline’s reporting units are Core North America, Quick Lubes, and International.
In evaluating goodwill for impairment, Valvoline has the option to first perform a qualitative assessment to determine whether further impairment testing is necessary or to perform a quantitative assessment by comparing the fair value of a reporting unit to its carrying amount, including goodwill. Under the qualitative assessment, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. Qualitative factors include macroeconomic conditions, industry and market conditions, cost factors, overall financial performance, among others.
If under the quantitative assessment, the fair value of a reporting unit is less than its carrying amount, then the amount of the impairment loss, if any, must be measured under step two of the impairment analysis. In step two of the analysis, an impairment loss will be recorded equal to the excess of the carrying value of the reporting unit’s goodwill over its implied fair value. Fair values of the reporting units are estimated using a weighted methodology considering the output from both the income and market approaches. The income approach incorporates the use of a discounted cash flow (“DCF”) analysis. A number of significant assumptions and estimates are involved in the application of the DCF model to forecast operating cash flows, including markets and market shares, sales volumes and prices, costs to produce, tax rates, capital spending, discount rate, weighted average cost of capital, terminal values and working capital changes. Several of these assumptions vary among reporting units. The cash flow forecasts are generally based on approved strategic operating plans. The market approach is performed using the Guideline Public Companies method which is based on earnings multiple data. The Company also performs a reconciliation between market capitalization and the estimate of the aggregate fair value of the reporting units, including consideration of a control premium.
Valvoline elected to perform a qualitative assessment during the fiscal 2017 and determined that it is not more likely than not that the fair values of Valvoline's reporting units are less than carrying amounts. In fiscal 2016, a quantitative assessment indicated that each reporting unit had a fair value that exceeded book value by 300% and more.

Acquired finite-lived intangible assets principally consist of certain trademarks and trade names, intellectual property, and customer relationships. Intangible assets acquired in an asset acquisition are carried at cost, less accumulated amortization. For intangible assets acquired in a business combination, the estimated fair values of the assets acquired are used to establish the carrying value, which is determined using common techniques, and the Company employs assumptions developed using the perspective of a market participant. These intangible assets are amortized on a straight-line basis over their estimated useful lives. Valvoline reviews finite-lived intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable and any not expected to be recovered through undiscounted future net cash flows and assets are written down to current fair value.

Equity method investments

Investments in companies, including joint ventures, where Valvoline has the ability to exert significant influence, but not control, over operating and financial policies of the investee are accounted for under the equity method of accounting. As of September 30, 2017 and 2016, Valvoline’s investments in these unconsolidated affiliates were $30 million and $26 million, respectively. Judgment regarding the level of influence over each investment includes considering key factors such as the Company’s ownership interest, representation on the board of directors, and participation in policy-making decisions. The Company’s proportionate share of the net income or loss of these companies is included in the Consolidated Statements of Comprehensive Income.

The Company evaluates equity method investments for impairment whenever events or changes in circumstances indicate that the carrying amount of the investment might not be recoverable. Factors considered by the Company when reviewing an equity method investment for impairment include the length of time and extent to which the fair value of the equity method investment has been less than cost, the investee’s financial condition and near-term prospects, and the intent and ability to hold the investment for a period of time sufficient to allow for anticipated recovery. An impairment that is other-than-temporary is recognized in the period identified.

Pension and other postretirement benefit plans
Prior to the Contribution in fiscal 2016, Valvoline employees were eligible to participate in pension and other postretirement benefit plans sponsored by Ashland in many of the countries where the Company does business. Prior to the Contribution, the Company accounted for its participation in Ashland-sponsored pension and other postretirement benefit plans as a participation in a multiemployer plan, and recognized its allocated portion of net periodic benefit cost based on Valvoline-specific plan participants. In conjunction with the Contribution, certain of Ashland's pension and other postretirement benefit obligations and plan assets were transferred to and assumed by the Company, for which Valvoline accounts for as single-employer plans prospectively from the Contribution in late fiscal 2016. As single-employer plans, Valvoline recognizes the net liabilities and the full amount of any costs or gains. Valvoline also had certain international single-employer pension plans prior to the Contribution for which the net liabilities and associated costs have been recognized in the historical periods.

The majority of U.S. pension plans have been closed to new participants since January 1, 2011 and effective September 30, 2016, the accrual of pension benefits for participants were frozen. In addition, most foreign pension plans are closed to new participants while those that remain open relate to areas where local laws require plans to operate within the applicable country. In addition, Valvoline sponsors healthcare and life insurance plans for certain qualifying retired or disabled employees. During March 2016, these other postretirement benefit plans were amended to reduce retiree life and medical benefits effective October 1, 2016 and January 1, 2017, respectively.

The funded status of Valvoline’s pension and other postretirement benefit plans is recognized in the Consolidated Balance Sheets. The funded status is measured as the difference between the fair value of plan assets and the benefit obligation at September 30, the measurement date, and whenever a remeasurement is triggered. The fair value of plan assets represents the current market value of assets held by irrevocable trust funds for the sole benefit of participants. For defined benefit pension plans, the benefit obligation is the projected benefit obligation (“PBO”) and for other postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation (“APBO”). The PBO represents the actuarial present value of benefits expected to be paid upon retirement based on estimated future compensation levels. The APBO represents the actuarial present value of other postretirement benefits attributed to employee services already rendered. The measurement of the benefit obligations is based on estimates and actuarial valuations. These valuations reflect the terms of the plans and use participant-specific information such as compensation, age and years of service, as well as certain key assumptions that require significant judgment, including, but not limited to, estimates of discount rates, expected return on plan assets, rate of compensation increases, interest rates and mortality rates.

Valvoline recognizes the change in the fair value of plan assets and net actuarial gains and losses annually in the fourth quarter of each fiscal year and whenever a plan is determined to qualify for a remeasurement. Such gains and losses may be related to actual results that differ from assumptions as well as changes in assumptions, which may occur each year. The remaining components of pension and other postretirement benefits expense are recorded ratably on a quarterly basis. The service cost component of pension and other postretirement benefits costs is allocated to each reportable segment on a ratable basis, while the remaining non-service and remeasurement components of pension and other postretirement benefits costs are excluded from segment results and included in Unallocated and other as those items are not included in the evaluation of segment performance.

Commitments and contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Legal costs such as outside counsel fees and expenses are charged to expense in the period incurred and are recorded in Selling, general and administrative expense in the Consolidated Statements of Comprehensive Income. 
Valvoline partially insures its workers’ compensation claims and other general business insurance needs. Prior to the IPO, Ashland charged Valvoline for the applicable portion of costs. As part of the Contribution, Valvoline was transferred certain active and legacy Ashland insurance reserves. Valvoline records accrued liabilities related to these costs based upon specific claims filed and loss development factors, which contemplate a number of factors including claims history and expected trends. These loss development factors are developed in consultation with external actuaries.
Revenue recognition

Sales generally are recognized when persuasive evidence of an arrangement exists, products are delivered or services are provided to customers, the sales price is fixed or determinable and collectability is reasonably assured. Valvoline reports all sales net of tax assessed by qualifying governmental authorities. Certain shipping and handling costs paid by the customer are recorded in sales, while those costs paid by Valvoline are recorded in cost of sales.

Sales rebates and discounts, consisting primarily of promotional rebates and customer pricing discounts, are offered through various programs to customers. Sales are recorded net of these rebates and discounts totaling $360 million, $388 million and $345 million in the Consolidated Statements of Comprehensive Income for the years ended September 30, 2017, 2016 and 2015, respectively. Sales rebates and discounts are recognized as incurred, generally at the time of the sale, or over the term of the sales contract. Valvoline bases its estimates on historical rates of customer discounts and rebates as well as the specific identification of discounts and rebates expected to be realized.

Franchise revenue is also included within sales and was $28 million, $25 million, and $22 million during 2017, 2016, and 2015, respectively. Franchise revenue generally consists of initial franchise fees and royalties. Initial franchise fees are recognized when all material obligations have been substantially performed and the store has opened for business. Franchise royalties are based upon a percentage of monthly sales of the franchisees and are recognized in the month such sales occur.

Expense recognition

Cost of sales include material and production costs, as well as the costs of inbound and outbound freight, purchasing and receiving, inspection, warehousing, internal transfers and all other distribution network costs. Selling, general and administrative expenses are expensed as incurred and include sales and marketing costs, advertising, customer support, environmental remediation, and administrative costs, including allocated corporate charges from Ashland for periods prior to the IPO. Advertising costs ($61 million in 2017, $58 million in 2016 and $56 million in 2015) and research and development costs ($13 million in each 2017 and 2016, and $11 million in 2015) are expensed as incurred.

Stock-based compensation

For the periods prior to the Distribution, share-based awards for key Valvoline employees and directors were principally settled in Ashland common stock and expense was allocated to Valvoline based on the awards and terms previously granted. In connection with the Distribution, outstanding Ashland share-based awards held by Valvoline employees were converted to equivalent share-based awards of Valvoline. Stock-based compensation expense is generally recognized based on the grant date fair value of new or modified awards over the requisite vesting period. The Company’s outstanding stock-based compensation awards are primarily classified as equity, with certain liability-classified awards based on award terms and conditions. Valvoline accounts for forfeitures when they occur and recognizes stock-based compensation expense within the Selling, general and administrative expense caption of the Consolidated Statements of Comprehensive Income.

Income taxes

For the periods prior to Distribution, Valvoline’s operating results are included in Ashland’s consolidated U.S., state, and certain Ashland international subsidiaries' income tax returns. For these periods, the income tax provision in these Consolidated Statements of Comprehensive Income has been calculated as if Valvoline was operating on a stand-alone basis and filed separate tax returns in the jurisdictions in which it operates.

Income tax expense is provided based on income before income taxes. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for tax purposes. These deferred taxes are determined based on the enacted tax rates expected to apply in the periods in which the deferred assets or liabilities are expected to be settled or realized. Valvoline records valuation allowances related to its deferred income tax assets when it is more likely than not that some portion or all of the deferred income tax assets will not be realized.

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being sustained upon examination by authorities. Interest and penalties related to uncertain tax positions are recognized as part of the provision for income taxes and are accrued beginning in the period that such interest and penalties would be applicable under relevant tax law and until such time that the related tax benefits are recognized.

Derivatives
Valvoline's derivative instruments consist of foreign currency exchange contracts, which are accounted for as either assets or liabilities in the Consolidated Balance Sheets at fair value and the resulting gains or losses are recognized as adjustments to earnings. Valvoline does not currently have any derivative instruments that are designated and qualify as hedging instruments.



Fair value measurements

Fair value is defined as an exit price, representing an amount that would be received to sell an asset or the amount paid to transfer a liability in an orderly transaction between market participants at the measurement date. As such, fair value is a market-based measurement determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the guidance prioritizes the inputs used to measure fair value into the three-tier fair value hierarchy. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). An instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement.

Except for pension plan assets, which are reviewed on annual basis, the Company reviews the fair value hierarchy classification on a quarterly basis. Changes to the observability of valuation inputs may result in a reclassification of levels for certain securities within the fair value hierarchy. Valvoline measures its financial assets and financial liabilities at fair value based on one or more of the following three valuation techniques:

Market approach: Prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Cost approach: Amount that would be required to replace the service capacity of an asset (replacement cost).
Income approach: Techniques to convert future amounts to a single present amount based upon market expectations (including present value techniques, option pricing and excess earnings models).

The Company generally uses a market approach, when practicable, in valuing financial instruments. In certain instances, when observable market data is lacking, the Company uses valuation techniques consistent with the income approach whereby future cash flows are converted to a single discounted amount. The Company uses multiple sources of pricing as well as trading and other market data in its process of reporting fair values. The fair values of cash and cash equivalents, trade receivables and accounts payable approximate their carrying values due to the relatively short-term nature of the instruments.

Foreign currency translation

Operations outside the United States are measured primarily using the local currency as the functional currency.  Upon consolidation, the results of operations of the subsidiaries and affiliates whose functional currency is other than the U.S. dollar are translated into U.S. dollars at the average exchange rates for the year while assets and liabilities are translated at year-end exchange rates. Adjustments to translate assets and liabilities into U.S. dollars are recorded in the stockholders’ equity section of the Consolidated Balance Sheets as a component of accumulated other comprehensive loss and are included in net earnings only upon sale or substantial liquidation of the underlying foreign subsidiary or affiliated company.

Earnings per share

Basic EPS is calculated by dividing net income by the weighted-average number of shares outstanding during the reported period. The calculation of diluted EPS is similar to basic EPS, except that the weighted-average number of shares outstanding includes the additional dilution from potential common stock such as stock-based compensation awards. Refer to Note 17 for information regarding a revision to correct an immaterial error in the net EPS calculations previously reported in the consolidated and condensed consolidated financial statements for the periods prior to and including September 30, 2016. While there were no shares of common stock outstanding prior to Valvoline’s IPO, the weighted average number of shares outstanding in these historical periods are based on the 170 million shares of common stock issued to Ashland.

New accounting pronouncements

Accounting Standards Updates Recently Adopted

In April 2015, the Financial Accounting Standards Board (the “FASB”) issued accounting guidance to help entities evaluate the accounting for fees paid by a customer in a cloud computing arrangement. Cloud computing arrangements represent the delivery of hosted services over the internet which includes software, platforms, infrastructure and other hosting arrangements. Under the guidance, customers that gain access to software in a cloud computing arrangement account for the software as internal-use software only if the arrangement includes a software license. Valvoline adopted this standard on a prospective basis on October 1, 2016, and as a result, certain costs related to these arrangements will be expensed when incurred. The adoption of this guidance did not have a material impact on the Company's financial condition, results of operations or cash flows.

In May 2015, the FASB issued accounting guidance which removed the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. Valvoline adopted this standard on October 1, 2016. Accordingly, certain investments that were measured using the net asset value per share practical expedient have not been categorized within the fair value hierarchy tables and have been separately disclosed. This guidance does not impact the valuation or recognition of these investments, and relevant disclosure amendments have been retrospectively applied to all periods presented in the Notes to Consolidated Financial Statements. Refer to Note 14 for additional information.

In March 2016, the FASB issued new accounting guidance for certain aspects of share-based payments to employees, which includes multiple provisions intended to simplify various aspects of the accounting for share-based payments. In particular, the tax effects of all stock-based compensation awards will be included in income, windfall tax benefits and deficiencies will be reported as discrete items in the interim period when they arise, all tax-related cash flows from share-based payments will be reported as operating activities in the statement of cash flows, the classification of awards as liabilities or equity due to tax withholdings may change, and accounting for forfeitures may change. This guidance is effective for the Company beginning October 1, 2017; however, Valvoline elected to early adopt this guidance in the quarter ended June 30, 2017, with all relevant adjustments applied as of the beginning of the fiscal year. This guidance also allows entities to make an accounting policy election to either estimate the number of awards that are expected to vest or account for forfeitures when they occur. The Company has elected to recognize forfeitures as they occur rather than estimate a forfeiture rate. The impact on Valvoline's consolidated financial statements as a result of adopting this new guidance was not material.

Accounting Standards Updates Issued But Not Yet Effective

In May 2014, the FASB issued accounting guidance outlining a single comprehensive five step model for entities to use in accounting
for revenue arising from contracts with customers (ASC 606, Revenue from Contracts with Customers). The new guidance supersedes
most current revenue recognition guidance, in an effort to converge the revenue recognition principles within U.S. GAAP. This new
guidance also requires entities to disclose certain quantitative and qualitative information regarding the nature, amount, timing and
uncertainty of qualifying revenue and cash flows arising from contracts with customers. Entities have the option of using a full
retrospective or a modified retrospective approach to adopt the new guidance. This guidance becomes effective for Valvoline on
October 1, 2018. Valvoline is in the process of evaluating its revenue streams, as well as the available implementation options, and cannot currently estimate the financial statement impact of adoption, though certain reclassifications are expected to be required in presentation of the Consolidated Statements of Comprehensive Income. The Company expects to complete its implementation assessment in early 2018 and will provide updated disclosures of the anticipated impact of adoption in future filings.

In July 2015, the FASB issued accounting guidance to simplify the subsequent measurement of certain inventories by replacing the
current lower of cost or market test with a lower of cost and net realizable value test. The guidance applies only to inventories for
which cost is determined by methods other than LIFO and the retail inventory method. This guidance became effective
prospectively for Valvoline on October 1, 2017. Valvoline utilizes LIFO to value approximately 72% of its gross inventory and does not expect there to be material differences in the Company's current valuation methodology for its remaining inventory using lower of cost or market to net realizable value.

In February 2016, the FASB issued new accounting guidance related to lease transactions. The primary objective of this guidance is to
increase transparency and comparability among organizations by requiring lessees to recognize assets and liabilities on the balance
sheet for the rights and obligations created by leases and to disclose key information about leasing arrangements. The presentation of
the Consolidated Statements of Comprehensive Income and the Consolidated Statements of Cash Flows is largely unchanged under
this guidance. This guidance retains a distinction between finance leases and operating leases, and the classification criteria for
distinguishing between finance leases and operating leases are substantially similar to the classification criteria for distinguishing
between capital leases and operating leases in the current accounting literature. The guidance will become effective for Valvoline on
October 1, 2019. Valvoline is currently evaluating the impact this guidance will have on Valvoline’s consolidated financial statements and developing specific assessment and implementation plans. The Company currently expects that most of its operating lease commitments will be subject to the new standard and recognized as operating lease liabilities and right-of-use assets upon adoption. Thus, the Company expects adoption will result in a material increase to the assets and liabilities on the Consolidated Balance Sheets.

In January 2017, the FASB issued accounting guidance which simplifies the subsequent measurement of goodwill by eliminating the second step of the two-step impairment test under which the implied fair value of goodwill is determined as if the reporting unit were being acquired in a business combination. The guidance instead requires entities to compare the fair value of a reporting unit with its carrying amount and recognize an impairment charge for any amount by which the carrying amount exceeds the reporting unit’s fair value. This guidance must be applied prospectively and will become effective for Valvoline on October 1, 2020, with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Valvoline's annual evaluation of goodwill for impairment is performed as of July 1. As this guidance simplifies the process for measuring impairment, management does not expect there will be an impact on the consolidated financial statements given the Company's historical excess fair value of its reporting units.

In March 2017, the FASB issued accounting guidance that will change how employers who sponsor defined benefit pension and/or postretirement benefit plans present the net periodic benefit cost in the Consolidated Statements of Comprehensive Income. This guidance requires employers to present the service cost component of net periodic benefit cost in the same caption within the Consolidated Statements of Comprehensive Income as other employee compensation costs from services rendered during the period. All other components of the net periodic benefit cost will be presented separately outside of the operating income caption. This guidance must be applied retrospectively and will become effective for Valvoline on October 1, 2018, with early adoption being optional. Valvoline adopted this guidance on October 1, 2017, which will have a significant impact on the presentation of the Consolidated Statements of Comprehensive Income as it will result in a reclassification of current and historical Pension and other postretirement plan non-service income and remeasurement adjustments, net from within operating income to non-operating income beginning with the Quarterly Report on Form 10-Q that will be filed for the first fiscal quarter of 2018.

The FASB issued other accounting guidance during the period that is not currently applicable or expected to have a material impact on Valvoline's financial statements, and therefore, is not described above.
Fair Value Measurements
Fair Value Measurements
FAIR VALUE MEASUREMENTS

Valvoline uses applicable guidance for defining fair value, the initial recording and periodic remeasurement of certain assets and liabilities measured at fair value, and related disclosures for instruments measured at fair value. Fair value accounting guidance establishes a fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. An instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the instrument’s fair value measurement. Valvoline measures assets and liabilities using inputs from the following three levels of fair value hierarchy:

Level 1 - Observable inputs such as unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3 - Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect Valvoline’s own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which may include Valvoline’s own financial data such as internally developed pricing models, DCF methodologies, as well as instruments for which the fair value determination requires significant management judgment.

For assets that are measured using quoted prices in active markets (Level 1), the total fair value is the published market price per unit multiplied by the number of units held without consideration of transaction costs. Assets and liabilities that are measured using significant other observable inputs (Level 2) are primarily valued by reference to quoted prices of similar assets or liabilities in active markets, adjusted for any terms specific to that asset or liability. For all other assets and liabilities for which unobservable inputs are used (Level 3), fair value is derived by using fair value models, such as a DCF model or other standard pricing models that Valvoline considers reasonable.

The following table sets forth, by level within the fair value hierarchy, the Company's financial assets and liabilities that were accounted for at fair value on a recurring basis.
 
September 30, 2017
 
September 30, 2016
 
 
 
Quoted prices in active markets for identical assets
 
 
 
Quoted prices in active markets for identical assets
(In millions)
Fair Value
 
Level 1
 
Fair Value
 
Level 1
Assets
 
 
 
 
 
 
 
Cash equivalents
$
46

 
$
46

 
$
12

 
$
12

Foreign currency derivatives
1

 
1

 

 

Non-qualified trust
30

 
30

 
34

 
$
34

Total assets at fair value
$
77

 
$
77

 
$
46

 
$
46

 
 
 
 
 
 
 
 
Liabilities
 

 
 

 
 

 
 

Foreign currency derivatives
$
1

 
$
1

 
$

 
$

Total liabilities at fair value
$
1

 
$
1

 
$

 
$



There were no Level 2 or 3 financial assets or liabilities that were accounted for at fair value on a recurring basis in fiscal 2017 or 2016. Furthermore, there were no transfers between levels of the fair value hierarchy during fiscal 2017 or 2016.
Cash equivalents
Cash equivalents are included in Cash and cash equivalents on the Consolidated Balance Sheets. The Company's policy is to consider all highly liquid investments with an original maturity of three months or less at the Company's date of purchase to be cash equivalents. The carrying value of cash equivalents approximates fair value because of the short-term maturity of these instruments.
Derivatives

Until the IPO, Valvoline participated in Ashland’s centralized derivative programs that engage in certain hedging activities, which
Ashland used to manage its exposure to fluctuations in foreign currencies. Gains and losses related to a hedge were either recognized in Ashland’s income immediately to offset the gain or loss on the hedged item, or deferred and recorded in the equity section of
Ashland’s balance sheet as a component of accumulated other comprehensive loss and subsequently recognized in Ashland’s income
when the underlying hedged item was recognized in earnings. Gains or losses on hedges during the year ended September 30, 2016 were not material and are reflected in Valvoline’s Consolidated Statements of Comprehensive Income through allocation from Ashland in Selling, general and administrative expense.

Valvoline began its own derivative program in September 2016 to manage exposure to fluctuations in foreign currency as a result of its global operating activities. The Company uses derivatives not designated as hedging instruments consisting primarily of forward contracts to hedge foreign currency denominated balance sheet exposures and exchange one foreign currency for another for a fixed rate at a future date of twelve months or less. For these derivatives, changes in the fair value are recognized in Selling, general and administrative expense in the Consolidated Statements of Comprehensive Income to offset the gain or loss on the hedged item in the same period as the remeasurement losses and gains of the related foreign currency-denominated exposures. Gains and losses recognized during the years ended September 30, 2017 and 2016 related to changes in fair value of these instruments were not material. The Company utilizes derivative instruments that are purchased exclusively from highly rated financial institutions. The Company had outstanding contracts with notional values of $47 million and $10 million as of September 30, 2017 and 2016, respectively. The fair value of these outstanding contracts were recorded on the Consolidated Balance Sheets as assets or liabilities in Other current assets or Accrued expense and other liabilities, respectively, as shown above at fair market value based upon market price quotations.
Non-qualified trust funds
The Company maintains a non-qualified trust to fund benefit payments for certain of its U.S. non-qualified pension plans, which primarily consists of highly liquid fixed income U.S. government bonds and are classified as Other noncurrent assets in the Consolidated Balance Sheets. Gains and losses related to these investments are immediately recognized within the Consolidated Statements of Comprehensive Income. Fair value measurements for these investments are based on quoted market prices in active markets and are categorized as Level 1.
Long-term debt
The Company's outstanding senior notes consist of $375 million of fixed rate senior unsecured notes issued in July 2016 (the “2024 Notes”) and $400 million of fixed rate senior unsecured notes issued in August 2017 (the “2025 Notes”).
The fair values shown in the table below are based on the prices at which the bonds have recently traded in the market as well as the overall market conditions on the date of valuation, stated coupon rates, the number of coupon payments each year and the maturity dates. The fair value of the debt is included in the Consolidated Balance Sheets at carrying value, rather than fair value, and is therefore excluded from the fair value table above. The fair value of the 2024 Notes and the 2025 Notes is based on quoted market prices, which are Level 1 inputs within the fair value hierarchy. Carrying values shown in the following table are net of unamortized discounts and issuance costs.
 
September 30, 2017
 
September 30, 2016
(In millions)
Fair value
 
Carrying value
 
Unamortized discount and issuance costs
 
Fair value
 
Carrying value
 
Unamortized discount and issuance costs
2024 Notes
$
401

 
$
370

 
$
5

 
$
394

 
$
369

 
$
6

2025 Notes
408

 
394

 
6

 

 

 

Total
$
809

 
$
764

 
$
11

 
$
394

 
$
369

 
$
6



Refer to Note 11 for details of other debt instruments that have variable interest rates, and accordingly, their carrying amounts approximate fair value.
Pension plan assets
Pension plan assets must be measured at least annually in accordance with accounting guidance on employers' accounting for pensions. The fair value measurement guidance requires that the valuation of plan assets comply with its definition of fair value, which is based on the notion of an exit price and the maximization of observable inputs. The fair value measurement guidance does not apply to the calculation of pension and other postretirement obligations since the liabilities are not measured at fair value. Refer to Note 14 for disclosures regarding the fair value of plan assets, including fair value and classification within the fair value hierarchy.
Acquisitions and Divestitures
Acquisitions and Divestitures
ACQUISITIONS AND DIVESTITURES

2017 Acquisitions

During fiscal 2017, Valvoline completed several acquisitions in the Quick Lubes reportable segment, including the acquisition of several stores from Time-It Lube LLC and Time-It Lube of Texas, LP (collectively, “Time-It Lube”) on January 31, 2017. In total, Valvoline acquired 43 locations for an aggregate purchase price of $72 million, of which $4 million was paid in fiscal 2016. Of the $72 million, approximately $66 million was allocated to goodwill and the remainder was allocated to working capital, customer relationships and trade names.
Goodwill is calculated as the excess of the consideration transferred over the net assets acquired and represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. The factors contributing to the recognition of goodwill were based on strategic benefits that are expected to be realized from these acquisitions. All of the goodwill is expected to be deductible for income tax purposes.
2016 Acquisitions

During fiscal 2016, Valvoline completed several acquisitions in the Quick Lubes reportable segment, including the acquisition of OCH International, Inc. (“Oil Can Henry’s”) on February 1, 2016. In total, Valvoline acquired 104 locations, 42 of which were franchise locations. The aggregate purchase price, net of cash acquired for all acquisitions in fiscal 2016 was $79 million. Of the $79 million, $94 million was allocated to goodwill, $16 million to other assets, including working capital; property, plant and equipment; intangible assets; and other noncurrent assets. Valvoline also assumed $11 million of debt, $11 million of current liabilities and $9 million of other noncurrent liabilities.
The factors contributing to the recognition of goodwill were based on strategic benefits that are expected to be realized from these acquisitions. Approximately $83 million of the goodwill recognized in 2016 was not deductible for income tax purposes.

From the date of acquisition through September 30, 2016, the total revenue for Oil Can Henry’s company-owned and franchise locations totaled $34 million with operating income of $2 million.

Car Care Products Divestiture

During 2015, Ashland entered into a definitive sale agreement to sell Valvoline’s car care product assets within the Core North America reportable segment for $24 million, which included Car Brite™ and Eagle One™ automotive appearance products. Prior to the sale, Valvoline recognized a pre-tax loss of $26 million in 2015 to recognize the assets at fair value less cost to sell, using Level 2 nonrecurring fair value measurements. The loss is reported within the Net loss on acquisition and divestiture caption within the Consolidated Statements of Comprehensive Income. The transaction closed on June 30, 2015 and Valvoline received net proceeds of $19 million after adjusting for certain customary closing costs and final working capital amounts.

The sale of Valvoline’s car care product assets did not qualify for discontinued operations treatment since it did not represent a strategic shift that had or will have a major effect on Valvoline’s operations and financial results.

Venezuela Equity Method Investment Divestiture

During 2015, Valvoline sold the equity method investment in Venezuela within the International reportable segment. Prior to the sale, Valvoline recognized a $14 million impairment in 2015, for which there was no tax effect, using Level 2 nonrecurring fair value measurements within the Equity and other income caption of the Consolidated Statements of Comprehensive Income.

Valvoline’s decision to sell the equity investment and the resulting impairment charge recorded during 2015 was reflective of the continued devaluation of the Venezuelan currency (Bolivar) based on changes to the Venezuelan currency exchange rate mechanisms during the fiscal year. In addition, the continued lack of exchangeability between the Venezuelan bolivar and U.S. dollar had restricted the equity method investee’s ability to pay dividends and obligations denominated in U.S. dollars. These exchange regulations and cash flow limitations, combined with other recent Venezuelan regulations and the impact of declining oil prices on the Venezuelan economy, had significantly restricted Valvoline’s ability to conduct normal business operations through the joint venture arrangement. Valvoline determined this divestiture did not represent a strategic shift that had or will have a major effect on Valvoline’s operations and financial results, and thus, it did not qualify for discontinued operations treatment.
Equity Method Investments
Equity Method Investments
EQUITY METHOD INVESTMENTS

Summarized financial information for companies accounted for on the equity method is presented in the following table, along with a summary of the amounts recorded in the consolidated financial statements. The results of operations and amounts recorded by Valvoline as of and for the years ended September 30, 2017, 2016 and 2015 include results for the Valvoline equity method investment within Venezuela prior to its divestiture in 2015. Refer to Note 4 for further information on this divestiture in 2015. Valvoline has a strategic relationship with Cummins Inc. (“Cummins”), a leading heavy duty engine manufacturer for co-branding products in the heavy duty business and has a 50% interest in joint ventures in India and China and smaller joint ventures in select countries in South America and Asia.

At September 30, 2017 and 2016, Valvoline’s stockholders’ deficit included $28 million and $26 million, respectively, of undistributed earnings from affiliates accounted for on the equity method. The summarized financial information for all companies accounted for on the equity method by Valvoline is as of and for the years ended September 30, 2017, 2016 and 2015 as follows:

(In millions)
2017
 
2016
 
2015
Financial position
 
 
 
 
 
Current assets
$
105

 
$
86

 
 
Current liabilities
(69
)
 
(55
)
 
 
Working capital
36

 
31

 
 
Noncurrent assets
25

 
24

 
 
Noncurrent liabilities
(1
)
 
(2
)
 
 
Stockholders’ equity
$
60

 
$
53

 
 
Results of operations
 
 
 
 
 
Sales
$
289

 
$
255

 
$
275

Income from operations
53

 
46

 
48

Net income
25

 
23

 
24

Amounts recorded by Valvoline
 
 
 
 
 
Investments and advances
$
30

 
$
26

 
$
29

Equity income (loss) (a)
12

 
12

 
(2
)
Distributions received
8

 
16

 
18

 
 
 
 
 
 
(a) 2015 includes a $14 million impairment of the equity method investment in Venezuela as further discussed in Note 4
Accounts Receivable
Accounts Receivable
ACCOUNTS RECEIVABLE

The following summarizes Valvoline’s accounts receivable as of the Consolidated Balance Sheet dates:

(In millions)
September 30, 2017
 
September 30, 2016
Trade and other accounts receivable
$
390

 
$
368

Less: Allowance for doubtful accounts
(5
)
 
(5
)
 
$
385

 
$
363



Prior to the Distribution in May 2017, Ashland was party to an agreement to sell certain Valvoline customer accounts receivable in the form of drafts or bills of exchange to a financial institution. Each draft constituted an order to pay for obligations of the customer to Ashland arising from the sale of goods to the customer. The intention of the arrangement was to decrease the time accounts receivable is outstanding and increase cash flows as Ashland in turn remitted payment to Valvoline. During fiscal 2017 and prior to the Distribution, there was $40 million of accounts receivable sold, and during the year ended September 30, 2016, there was $126 million of accounts receivable sold to the financial institution under this agreement.

Following the Distribution, Valvoline became party to the arrangement to sell certain customer accounts receivable in the form of draft or bills of exchange to the financial institution. Following Distribution through the remainder of the year ended September 30, 2017, Valvoline sold $50 million of accounts receivable to the financial institution.
Inventories
Inventories
INVENTORIES

Inventories are carried at the lower of cost or market value. Inventories are primarily stated at cost using the weighted-average cost method. In addition, certain lubricants with a replacement cost of $83 million at September 30, 2017 and $68 million at September 30, 2016 are valued at cost using the LIFO method.

The following summarizes Valvoline’s inventories in the Consolidated Balance Sheets as of September 30:

(In millions)
2017
 
2016
Finished products
$
180

 
$
149

Raw materials, supplies and work in process
31

 
21

LIFO reserves
(33
)
 
(29
)
Excess and obsolete inventory reserves
(3
)
 
(2
)
 
$
175

 
$
139

Property, Plant and Equipment
Property, Plant and Equipment
PROPERTY, PLANT AND EQUIPMENT

The following table summarizes the various components of property, plant and equipment within the Consolidated Balance Sheets as of September 30:

(In millions)
2017
 
2016
Land
$
51

 
$
50

Buildings (a)
286

 
216

Machinery and equipment
442

 
382

Construction in progress
44

 
79

Total property, plant and equipment
823

 
727

Accumulated depreciation (b)
(432
)
 
(403
)
Net property, plant and equipment
$
391

 
$
324

 
 
 
 
(a)
Includes $28 million and $7 million of assets under capitalized leases as of September 30, 2017 and September 30, 2016 respectively.
(b)
Includes $4 million and $2 million for assets under capitalized leases as of September 30, 2017 and September 30, 2016, respectively.

Non-cash accruals included in total property, plant and equipment totaled $39 million and $25 million for the years ended September 30, 2017 and 2016, respectively. There were no non-cash accruals included in total property, plant and equipment in 2015.

The following summarizes property, plant and equipment charges included within the Consolidated Statements of Comprehensive Income.

(In millions)
2017
 
2016
 
2015
Depreciation (includes capital leases)
$
42

 
$
38

 
38

Goodwill and Other Intangibles
Goodwill and Other Intangibles
GOODWILL AND OTHER INTANGIBLES

Goodwill
The following summarizes the changes in the carrying amount of goodwill for each reportable segment and in total during 2017 and 2016:

(In millions)
Core North America
 
Quick Lubes
 
International
 
Total
Balance at September 30, 2015
$
89

 
$
41

 
$
40

 
$
170

Acquisitions (a)

 
94

 

 
94

Balance at September 30, 2016
89

 
135

 
40

 
264

Acquisitions (b)

 
66

 

 
66

Balance at September 30, 2017
$
89

 
$
201

 
$
40

 
$
330

 
 
 
 
 
 
 
 
(a)
Relates to the acquisition of Oil Can Henry's in 2016, as well as other smaller Quick Lubes acquisitions in 2016.
(b)
Relates to the acquisition of the business assets of Time-It Lube of $44 million and $22 million for the acquisition of 15 additional locations within the Quick Lubes reportable segment during 2017.

Other intangible assets

Valvoline's purchased intangible assets were specifically identified when acquired and have finite lives. These assets are reported in Goodwill and intangibles in the Consolidated Balance Sheets. The following summarizes the gross carrying amounts and accumulated amortization of the Company's intangible assets as of September 30:

(In millions)
2017
 
2016
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
 
Gross carrying amount
 
Accumulated amortization
 
Net carrying amount
Definite-lived intangible assets
 
 
 
 
 
 
 
 
 
 
 
Trademarks and trade names
$
2

 
(1
)
 
$
1

 
$
1

 
$

 
$
1

Customer relationships
5

 
(2
)
 
3

 
3

 
$
(2
)
 
1

Other intangible assets
1

 

 
1

 
1

 
$

 
1

Total definite-lived intangible assets
$
8

 
$
(3
)
 
$
5

 
$
5

 
$
(2
)
 
$
3

 
 
 
 
 
 
 
 
 
 
 
 


Amortization expense recognized on intangible assets during the years ended September 30, 2017 and 2016, as well as the expected amortization expense for the next five years is immaterial in each period and in the aggregate.
Other Noncurrent Assets and Current and Noncurrent Liabilities
Other Noncurrent Assets and Current and Noncurrent Liabilities
OTHER NONCURRENT ASSETS AND CURRENT AND NONCURRENT LIABILITIES

The following table provides the components of Other noncurrent assets in the Consolidated Balance Sheets as of September 30:

(In millions)
2017
 
2016
Non-qualified trust investments
$
30

 
$
34

Notes receivable from customers
35

 
26

Customer incentive programs
11

 
16

Other
12

 
13

 
$
88

 
$
89

 
 
 
 


The following table provides the components of Accrued expenses and other liabilities in the Consolidated Balance Sheets as of September 30:

(In millions)
2017
 
2016
Sales deductions and rebates
$
54

 
$
67

Accrued pension and other postretirement plans
20

 
24

Incentive compensation
23

 
21

Accrued vacation
20

 
18

Accrued taxes (excluding income taxes)
6

 
14

Accrued payroll
10

 
9

Accrued interest
7

 
4

Other current taxes payable
1

 
5

Other
55

 
42

 
$
196

 
$
204

 
 
 
 


The following table provides the components of Other noncurrent liabilities in the Consolidated Balance Sheets as of September 30:

(In millions)
2017
 
2016
Obligations to Ashland (a)
$
74

 
$
71

Self-insurance reserves
17

 
25

Deferred compensation
14

 
8

Unfavorable leasehold interest
6

 
7

Capitalized lease obligations
25

 
6

Financing obligations
33

 
19

Other
9

 
7

 
$
178

 
$
143

 
 
 
 
(a) Principally includes amounts due to Ashland under the terms of the Tax Matters Agreement further described in Note 13. Under the Tax Matters Agreement, amounts due to Ashland include the value of certain tax attributes as well as amounts payable to Ashland for various uncertain tax positions and tax-related indemnification obligations.
Debt
Debt
DEBT

The following table summarizes Valvoline’s short-term borrowings and long-term debt at September 30:
(In millions)
2017
 
2016
2025 Notes
$
400

 
$

2024 Notes
375

 
$
375

Term Loans
285

 
375

2017 Accounts Receivable Securitization
75

 

Revolver

 

Other (a)
(11
)
 
(7
)
Total debt
$
1,124

 
$
743

Short-term debt
75

 

Current portion of long-term debt
15

 
19

Long-term debt
$
1,034

 
$
724

 
 
 
 
(a) At September 30, 2017, Other includes $13 million of debt issuance costs and discounts and $2 million of debt acquired through acquisitions. At September 30, 2016, Other included $9 million of debt issuance costs cost discounts and $2 million of debt acquired through acquisitions.
Senior Notes Due 2025
During August 2017, Valvoline completed the issuance of 4.375% senior unsecured notes due 2025 with an aggregate principal amount of $400 million. The 2025 Notes are guaranteed by each of Valvoline's subsidiaries that guarantee obligations under the existing senior secured credit facility. The net proceeds of the offering of $394 million (after deducting initial purchasers' discounts and debt issuance costs) were used to make a voluntary contribution to the Company's qualified U.S. pension plan.
The 2025 Notes contain customary events of default for similar debt securities, which if triggered may accelerate payment of principal, premium, if any, and accrued but unpaid interest on the 2025 Notes. Such events of default include non-payment of principal and interest, non-performance of covenants and obligations, default on other material debt, and bankruptcy or insolvency. If a change of control repurchase event occurs, Valvoline may be required to offer to purchase the 2025 Notes from the holders thereof. The 2025 Notes are not otherwise required to be repaid prior to maturity, although they may be redeemed at the option of Valvoline at any time prior to their maturity in the manner specified in the indentures governing the 2025 Notes.
Senior Notes Due 2024
During July 2016, Valvoline completed the issuance of 5.500% senior unsecured notes due 2024 with an aggregate principal amount of $375 million. The 2024 Notes are guaranteed by each of Valvoline's subsidiaries that guarantee obligations under the existing senior secured credit facility. The net proceeds of the offering of $370 million (after deducting initial purchasers’ discounts and debt issuance costs) were transferred to Ashland.

The 2024 Notes contain customary events of default for similar debt securities, which if triggered may accelerate payment of principal, premium, if any, and accrued but unpaid interest on the 2024 Notes. Such events of default include non-payment of principal and interest, non-performance of covenants and obligations, default on other material debt, and bankruptcy or insolvency. If a change of control repurchase event occurs, Valvoline may be required to offer to purchase the 2024 Notes from the holders thereof. The 2024 Notes are not otherwise required to be repaid prior to maturity, although they may be redeemed at the option of Valvoline at any time prior to their maturity in the manner specified in the indentures governing the 2024 Notes.

Senior Credit Agreement

The 2016 Senior Credit Agreement provides for an aggregate principal amount of $1,325 million in senior secured credit facilities (“2016 Credit Facilities”), comprised of (i) a five-year $875 million term loan A facility (“Term Loans”) and (ii) a five-year $450 million revolving credit facility (including a $100 million letter of credit sublimit) (“Revolver”).
On September 26, 2016, Valvoline borrowed the full $875 million available under the Term Loans, resulting in approximately $865 million of net proceeds (after deducting fees and expenses). On September 27, 2016, Valvoline borrowed $137 million under the Revolver. The net proceeds of these borrowings under the Term Loans and Revolver were transferred to Ashland. On September 28, 2016, Valvoline used $637 million of the net proceeds received from the IPO to repay $500 million of the $875 million outstanding under the Term Loans and the full $137 million balance outstanding under the Revolver. The 2016 Credit Facilities are guaranteed by Valvoline’s existing and future subsidiaries (other than certain immaterial subsidiaries, joint ventures, special purpose financing subsidiaries, regulated subsidiaries, foreign subsidiaries and certain other subsidiaries), and are secured by a first-priority security interest in substantially all the personal property assets, and certain real property assets, of Valvoline and the guarantors, including all or a portion of the equity interests of certain of Valvoline’s domestic subsidiaries and first-tier foreign subsidiaries. The 2016 Credit Facilities may be prepaid at any time without premium.
At Valvoline’s option, the loans issued under the 2016 Senior Credit Agreement bear interest at either LIBOR or an alternate base rate, in each case plus the applicable interest rate margin. The interest rate fluctuates between LIBOR plus 1.500% per annum and LIBOR plus 2.500% per annum (or between the alternate base rate plus 0.500% per annum and the alternate base rate plus 1.500% annum), based upon Valvoline’s corporate credit ratings or the consolidated first lien net leverage ratio (as defined in the 2016 Senior Credit Agreement).
The 2016 Senior Credit Agreement contains usual and customary representations and warranties, and usual and customary affirmative and negative covenants, including limitations on liens, additional indebtedness, investments, restricted payments, asset sales, mergers, affiliate transactions and other customary limitations, as well as financial covenants (including maintenance of a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio). As of the end of any fiscal quarter, the maximum consolidated leverage ratio and minimum consolidated interest coverage ratio permitted under the 2016 Senior Credit Agreement are 4.5 and 3.0, respectively.
As of September 30, 2017, Valvoline is in compliance with all covenants under the 2016 Senior Credit Agreement. As of September 30, 2017 and 2016, there were no amounts outstanding on the Revolver. Total borrowing capacity remaining under the 2016 Senior Credit Agreement was $436 million under the Revolver, due to a reduction of $14 million for letters of credit at September 30, 2017.

Accounts Receivable Securitization

In November 2016, Valvoline entered into a $125 million accounts receivable securitization facility (the “2017 Accounts Receivable Securitization”) with various financial institutions. The Company may from time to time, obtain up to $125 million (in the form of cash or letters of credit) through the sale of an undivided interest in its accounts receivable. The agreement has a term of one year but is extendable at the discretion of the Company and the financial institutions. The Company accounts for the 2017 Accounts Receivable Securitization as secured borrowings, which are classified as Short-term debt, and the receivables sold remain in Accounts receivable in the Consolidated Balance Sheets.

During the first quarter of 2017, Valvoline borrowed $75 million under the 2017 Accounts Receivable Securitization and used the net proceeds to repay an equal amount of the Term Loans. As a result, the Company recognized an immaterial charge related to the accelerated amortization of previously capitalized debt issuance costs, which is included in Net interest and other financing expense in the Consolidated Statements of Comprehensive Income for the year ended September 30, 2017. At September 30, 2017, $75 million was outstanding and the total borrowing capacity remaining under the 2017 Accounts Receivable Securitization was up to $50 million. The weighted average interest rate for this instrument was 1.8% for the year ended September 30, 2017.

Deferred Debt Issuance Costs and Discounts

As of September 30, 2017 and 2016, Valvoline had approximately $16 million and $13 million, respectively, in deferred debt issuance costs and discounts, comprised of $3 million in both periods in Other noncurrent assets related to the Revolver as there was no balance outstanding and the remainder recorded in Long-term debt as a direct reduction to the related debt obligations on the Consolidated Balance Sheets. During fiscal 2017, Valvoline recorded an additional $6 million in deferred debt issuance costs and discounts related to the 2025 Notes and $3 million in amortization expense in Net interest and other financing expense in the Consolidated Statements of Comprehensive Income, which included $1 million of accelerated amortization due to the repayment on the Term Loans in connection with the 2017 Accounts Receivable Securitization borrowing. During fiscal 2016, Valvoline deferred debt issuance costs and discounts of $17 million, of which approximately $4 million of amortization was accelerated as a result of the repayment on the Term Loans. Debt issuance costs and discounts that are incurred by the Company in connection with the issuance of debt are deferred and generally amortized to interest expense using the effective interest method over the contractual term of the underlying indebtedness.




Long-term Debt Maturities
The future estimated maturities of long-term debt, excluding debt issuance costs and discounts, are as follows:

(In millions)
 
 
Year ending September 30
  
 
2018
  
$
90

2019
  
30

2020
  
30

2021
  
211

2022
  

Thereafter
  
776

Total
  
$
1,137

Lease Commitments
Lease Commitments
LEASE COMMITMENTS

Valvoline and its subsidiaries are lessees of office buildings, Quick Lubes stores, transportation equipment, warehouses and storage facilities, other equipment, and other facilities and properties under leasing agreements that expire at various dates. Capitalized lease obligations are primarily included in Other noncurrent liabilities while capital lease assets are included in Net property, plant and equipment.

As of September 30, 2017, future minimum rental payments for operating leases, capital leases and other financing obligations are as follows:
(In millions)
 
Operating leases (a)
 
Capital leases and financing obligations
2018
 
$
21

 
$
6

2019
 
19

 
6

2020
 
14

 
7

2021
 
11

 
6

2022
 
10

 
6

Thereafter
 
38

 
52

Total future minimum lease payments
 
$
113

 
$
83

 
 
 
 
 
(a) Minimum payments have not been reduced by minimum sublease rentals of $5 million due in the future under noncancelable subleases.

Rental expense under operating leases for operations was as follows for the years ended September 30:

(In millions)
2017
 
2016
 
2015
Minimum rentals (including rentals under short-term leases)
$
18

 
$
15

 
$
12

Contingent rentals
2

 
2

 
2

Sublease rental income
(1
)
 
(1
)
 
(1
)
 
$
19

 
$
16

 
$
13

Income Taxes
Income Taxes
INCOME TAXES

For the years ended September 30, income tax expense consisted of the following:
(In millions)
2017
 
2016
 
2015
Current
 
 
 
 
 
Federal
$
47

 
$
99

 
$
81

State
8

 
24

 
16

Foreign
14

 
12

 
13

 
69

 
135

 
110

Deferred
 
 
 
 
 
Federal (a)
106

 
14

 
(5
)
State (b)
12

 
2

 
(1
)
Foreign
(1
)
 
(3
)
 
(3
)
 
117

 
13

 
(9
)
Income tax expense
$
186

 
$
148

 
$
101

 
 
 
 
 
 
(a) Federal deferred income taxes of $106 million net of $96 million operating loss generated in the current year.
(b) State deferred income taxes of $12 million net of $10 million operating loss generated in the current year and a $4 million valuation allowance release.

Deferred income taxes are provided for income and expense items recognized in different years for tax and financial reporting purposes. As of September 30, 2017, management intends to indefinitely reinvest approximately $47 million of foreign earnings. Because these earnings are considered indefinitely reinvested, no U.S. tax provision has been accrued related to the repatriation of these earnings, and it is not practicable to estimate the amount of U.S. tax that might be payable if these earnings were ever to be remitted.
Temporary differences that give rise to significant deferred tax assets and liabilities are presented in the following table as of September 30:
(In millions)
2017
 
2016
Deferred tax assets
 
 
 
Federal net operating loss carryforwards (a)
$
96

 
$

Foreign net operating loss carryforwards (b)
1

 
1

State net operating loss carryforwards (c)
28

 
18

Employee benefit obligations
132

 
351

Compensation accruals
29

 
17

Environmental, self-insurance and litigation reserves (net of receivables)
6

 
10

Credit carryforwards (d)
13

 
20

Other items
7

 
5

Valuation allowances (e)
(8
)
 
(12
)
Total deferred tax assets
304

 
410

Deferred tax liabilities
 
 
 
Goodwill and other intangibles (f)
3

 

Property, plant and equipment
17

 
21

Unremitted earnings
3

 
2

Total deferred tax liabilities
23

 
23

Net deferred tax asset
$
281

 
$
387

 
 
 
 
(a)
Gross federal net operating loss carryforwards of $273 million will expire in 2037.
(b)
Gross foreign net operating loss carryforwards of $5 million will expire in the years 2020 to 2037.
(c)
Apportioned net operating loss carryforwards of $620 million will expire in future years as follows: $8 million in 2019, and the remaining balance in the years 2020 to 2037.
(d)
Credit carryforwards consist primarily of foreign tax credits of $5 million expiring in 2027, research and development credits of $7 million expiring in the years 2034 to 2037 and alternative minimum tax credits of $1 million with no expiration date.
(e)
Valuation allowances primarily relate to certain state and foreign net operating loss carryforwards, and certain other deferred tax assets.
(f)
The total gross amount of goodwill as of September 30, 2017 expected to be deductible for tax purposes is $79 million.

As of September 30, 2017 and 2016, valuation allowances of $8 million and $12 million, respectively, were recorded on the Consolidated Balance Sheets related to deferred tax assets that are not expected to be realized or realizable.
The U.S. and foreign components of income before income taxes and a reconciliation of the statutory federal income tax with the provision for income taxes follow.
(In millions)
2017
 
2016
 
2015
Income before income taxes
 
 
 
 
 
United States (a)
$
433

 
$
382

 
$
245

Foreign
57

 
39

 
52

Total income before income taxes
$
490

 
$
421

 
$
297

 
 
 
 
 
 
Income taxes computed at U.S. statutory rate (35%)
$
171

 
$
147

 
$
104

Increase (decrease) in amount computed resulting from
 
 
 
 
 
Uncertain tax positions
2

 
3

 
1

State taxes
17

 
16

 
9

International rate differential
(7
)
 
(5
)
 
(8
)
Permanent items (b)
(8
)
 
(11
)
 
(5
)
Tax Matters Agreement activity
10

 

 

Other items
1

 
(2
)
 

Income tax expense
$
186

 
$
148

 
$
101

 
 
 
 
 
 
(a)
A significant component of the fluctuations within this caption relates to the remeasurements of the U.S. pension and other postretirement plans.
(b)
Permanent items in each year relate primarily to the domestic manufacturing deduction and income from equity affiliates. Further, 2017 includes adjustments related to certain non-deductible separation costs of $2 million, and 2015 includes adjustments related to the sale of the Venezuela joint venture of $6 million.

Income tax expense for the year ended September 30, 2017 was $186 million or an effective tax rate of 38.0% compared to an expense of $148 million or an effective tax rate of 35.2% for the year ended September 30, 2016 and expense of $101 million or an effective tax rate of 34.0% for the year ended September 30, 2015. The increase in the 2017 and 2016 effective tax rates is partially due to the increase in income from pension and other postretirement benefits that generated significant income amounts in higher tax rate jurisdictions. Additionally, in fiscal 2017, the effective tax rate was impacted by income tax expense resulting from the Tax Matters Agreement activity with Ashland, certain non-deductible separation costs, and the partial loss of certain tax deductions from the $394 million voluntary contribution to the U.S. qualified pension plan, partially offset by a benefit from a state valuation allowance release. For fiscal years 2017 through 2015, the effective tax rate was impacted favorably by the lower tax rate on foreign earnings and net favorable permanent items. These favorable items are offset by the unfavorable impact of state taxes, and these adjustments net to an immaterial overall impact to the effective tax rate for each year.

Unrecognized tax benefits

U.S. GAAP prescribes a recognition threshold and measurement attribute for the accounting and financial statement disclosure of tax positions taken or expected to be taken in a tax return. The evaluation of a tax position is a two-step process.  The first step requires Valvoline to determine whether it is more likely than not that a tax position will be sustained upon examination based on the technical merits of the position. The second step requires Valvoline to recognize in the financial statements each tax position that meets the more likely than not criteria, measured at the amount of benefit that has a greater than 50% likelihood of being realized. Valvoline had $10 million and $8 million of unrecognized tax benefits at September 30, 2017 and 2016, respectively.  As of September 30, 2017, the total amount of unrecognized tax benefits that, if recognized, would affect the tax rate was $10 million. The remaining unrecognized tax benefits relate to tax positions for which ultimate deductibility is highly certain but for which there is uncertainty as to the timing of such deductibility. Recognition of these tax benefits would not have an impact on the effective tax rate.
Valvoline recognizes interest and penalties related to uncertain tax positions as a component of income tax expense in the Consolidated Statements of Comprehensive Income. Such interest and penalties were immaterial in each of the years ended September 30, 2017, 2016 and 2015.  Valvoline had $1 million in interest and penalties related to unrecognized tax benefits accrued as of September 30, 2017 and 2016.

The table below is a rollforward of the changes in gross unrecognized tax benefits for the past three fiscal years:

(In millions)
 
Balance at September 30, 2014
$
4

Increases related to positions taken on items from prior years
1

Balance at September 30, 2015
5

Increases related to positions taken on items from prior years
2

Increases related to positions taken in the current year
1

Balance at September 30, 2016
8

Increases related to positions taken in the current year
2

Balance at September 30, 2017
$
10



From a combination of statute expirations and audit settlements in the next twelve months, Valvoline expects no significant decrease in the amount of accrual for uncertain tax positions. For the remaining balance as of September 30, 2017, it is reasonably possible that there could be changes to the amount of uncertain tax positions due to activities of the taxing authorities, settlement of audit issues, reassessment of existing uncertain tax positions, or the expiration of applicable statute of limitations; however, Valvoline is not able to estimate the impact of these items at this time.
Valvoline or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions, or it is included in a consolidated return in these jurisdictions.  Foreign taxing jurisdictions significant to Valvoline include Australia, Canada, Mexico, China, Singapore, India and the Netherlands. Valvoline is subject to U.S. federal income tax examinations, either directly or as part of a consolidated return, by tax authorities for periods after September 30, 2011 and U.S. state income tax examinations by tax authorities for periods after September 30, 2006. With respect to countries outside of the United States, with certain exceptions, Valvoline’s foreign subsidiaries are subject to income tax audits for years after 2006.

Tax Matters Agreement

For the periods prior to the separation from Ashland and Distribution, Valvoline is included in Ashland’s consolidated U.S. and state income tax returns and in tax returns of certain Ashland international subsidiaries (collectively, the “Ashland Group Returns”). Under the Tax Matters Agreement between Valvoline and Ashland that was entered into on September 22, 2016, Ashland will generally make all necessary tax payments to the relevant tax authorities with respect to Ashland Group Returns, and Valvoline will make tax sharing payments to Ashland, inclusive of tax attributes utilized. The amount of the tax sharing payments will generally be determined as if Valvoline and each of its relevant subsidiaries included in the Ashland Group Returns filed their own consolidated, combined or separate tax returns for the period from the IPO to Distribution that include only Valvoline and/or its relevant subsidiaries, as the case may be. During fiscal 2017, Valvoline made $48 million in net tax-sharing payments to Ashland for the period prior to Distribution. In addition, Valvoline recognized a $16 million benefit in Selling, general and administrative expense for a reduction in amounts due to Ashland under the Tax Matters Agreement as a result of Ashland’s estimated utilization of Valvoline tax attributes in the Ashland Group Returns. This benefit was offset by additional income tax expense of $16 million.
For taxable periods that begin on or after the day after the date of Distribution, Valvoline is not included in any Ashland Group Returns and will file tax returns that include only Valvoline and/or its subsidiaries, as appropriate. Valvoline will not be required to make tax sharing payments to Ashland for those taxable periods. Nevertheless, Valvoline has (and will continue to have following Distribution) joint and several liability with Ashland to the U.S. Internal Revenue Service (“IRS”) for the consolidated U.S. federal income taxes of the Ashland consolidated group for the taxable periods in which Valvoline was part of the Ashland consolidated group.

The Tax Matters Agreement also generally provides that Valvoline has indemnified Ashland for the following items:

Taxes of Valvoline for all taxable periods that begin on or after the day after the date of the Distribution;
Taxes of Valvoline for the period between the IPO and full separation from Ashland and Distribution that are not attributable to Ashland Group Returns;
Taxes for the pre-IPO period that arise on audit or examination and are directly attributable to the Valvoline business;
Certain U.S. federal, state or local taxes for the pre-IPO period of Ashland and/or its subsidiaries for that period that arise on audit or examination and are directly attributable to neither the Valvoline business nor the Ashland chemicals business;
Certain tax attributes inherited from Ashland as the result of the Contribution from Ashland; and
Transaction Taxes (as defined below) that are allocated to Valvoline under the Tax Matters Agreement.

Total liabilities related to these and other obligations owed to Ashland under the Tax Matters Agreement are $62 million and $66 million at September 30, 2017 and 2016, respectively. The net liability at September 30, 2017 consisted of $1 million recorded in Accrued expenses and other liabilities and $61 million recorded in Other noncurrent liabilities in the Consolidated Balance Sheets. As of September 30, 2016, the net liability consisted of $5 million of receivables recorded in Other current assets and $71 million recorded in Other noncurrent liabilities in the Consolidated Balance Sheets.
The Tax Matters Agreement also provides that Valvoline indemnify Ashland for any taxes (and reasonable expenses) resulting from the failure of the Distribution to qualify for non-recognition of gain and loss or certain reorganization transactions related to the Contribution or the Distribution to qualify for their intended tax treatment (“Transaction Taxes”), where the taxes result from (1) breaches of covenants (including covenants containing the restrictions described below that are designed to preserve the tax-free nature of the Stock Distribution), (2) the application of certain provisions of U.S. federal income tax law to the Distribution with respect to acquisitions of Valvoline’s common stock or (3) any other actions that Valvoline knows or reasonably should expect would give rise to such taxes. The Tax Matters Agreement also requires Valvoline to indemnify Ashland for a portion of certain other Transaction Taxes allocated to Valvoline based on Valvoline’s market capitalization relative to the market capitalization of Ashland.

Valvoline will have either sole control, or joint control with Ashland, over any audit or examination related to taxes for which Valvoline is required to indemnify Ashland.

The Tax Matters Agreement imposes certain restrictions on Valvoline and its subsidiaries (including restrictions on share issuances or repurchases, business combinations, sales of assets and similar transactions) that are designed to preserve the tax-free nature of the Distribution. These restrictions will apply for the two-year period after the Distribution. However, Valvoline will be able to engage in an otherwise restricted action if Valvoline obtains an appropriate opinion from counsel or ruling from the IRS.
Employee Benefit Plans
Employee Benefit Plans
EMPLOYEE BENEFIT PLANS

Pension and other postretirement plans

Prior to the Contribution in fiscal 2016, Valvoline employees were eligible to participate in pension and other postretirement benefit plans sponsored by Ashland in many of the countries where the Company does business. Prior to the Contribution, the Company accounted for its participation in Ashland-sponsored pension and other postretirement benefit plans as a participation in a multiemployer plan, and recognized its allocated portion of net periodic benefit cost based on Valvoline-specific plan participants. In conjunction with the Contribution, certain of Ashland's pension and other postretirement benefit obligations and plan assets were transferred to and assumed by the Company, for which Valvoline accounts for as single-employer plans prospectively from the Contribution in late fiscal 2016. As single-employer plans, Valvoline recognizes the net liabilities and the full amount of any costs or gains. Valvoline also had certain international single-employer pension plans prior to the Contribution for which the net liabilities and associated costs have been recognized in the historical periods.

Valvoline recognizes the funded status of each applicable plan on the Consolidated Balance Sheets whereby each underfunded plan is recognized as a liability. Changes in the fair value of plan assets and net actuarial gains or losses are recognized upon remeasurement, which is at least annually in the fourth quarter of each year. 

The majority of U.S. pension plans have been closed to new participants since January 1, 2011 and effective September 30, 2016, the accrual of pension benefits for participants were frozen. In addition, most foreign pension plans are closed to new participants while those that remain open relate to areas where local laws require plans to operate within the applicable country.

In addition, Valvoline sponsors healthcare and life insurance plans for certain qualifying retired or disabled employees. During March 2016, these other postretirement benefit plans were amended to reduce retiree life and medical benefits effective October 1, 2016 and January 1, 2017, respectively. The effect of these plan amendments resulted in a remeasurement gain of $8 million within Pension and other postretirement plan non-service income and remeasurement adjustments, net in the Consolidated Statements of Comprehensive Income during the first fiscal quarter of 2017. These plans have limited the annual per capita costs to an amount equivalent to base year per capita costs, plus annual increases of up to 1.5% per year for costs incurred. As a result, health care cost trend rates do not have a significant impact on the Company's future obligations for these plans. The assumed pre-65 health care cost trend rate as of September 30, 2017 was 7.9% and continues to be reduced to 4.5% in 2037 and thereafter.
Pension annuity programs
On August 29, 2017, Valvoline used pension assets to purchase a non-participating annuity contract from an insurer that will pay and administer future pension benefits for approximately 6,000 participants within the qualified U.S. pension plan. Valvoline transferred approximately $585 million of the outstanding pension benefit obligation in exchange for pension trust assets whose value approximated the liability value.
On September 15, 2016, Valvoline used pension assets to purchase a non-participating annuity contract from an insurer that will pay and administer future pension benefits for 14,800 participants within the qualified U.S. pension plan. Valvoline transferred approximately $378 million of the outstanding pension benefit obligation in exchange for pension trust assets whose value approximated the liability value.
The annuity purchase transactions did not generate a material settlement adjustment during 2017 or 2016. The insurers have unconditionally and irrevocably guaranteed the full payment of benefits to plan participants associated with the annuity purchase and benefit payments will be in the same form that was in effect under the plan. The insurers have also assumed all investment risk associated with the pension assets that were delivered as annuity contract premiums.
Components of net periodic benefit costs (income)

For segment reporting purposes, service cost is allocated to each reportable segment, while all other net periodic benefit costs are recorded within Unallocated and other. The following table summarizes the components of pension and other postretirement plans net periodic benefit costs (income) and the assumptions used in this determination for the years ended September 30:
(In millions)
Pension benefits
 
Other postretirement benefits
2017
 
2016
 
2015
 
2017
 
2016
 
2015
Net periodic benefit (income) costs
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
2

 
$
3

 
$
1

 
$

 
$

 
$

Interest cost
86

 
11

 
3

 
1

 

 

Expected return on plan assets
(145
)
 
(17
)
 
(3
)
 

 

 

Amortization of prior service credit (a)

 

 

 
(12
)
 
(1
)
 

Actuarial (gain) loss
(63
)
 
(42
)
 
2

 
(5
)
 

 

Pre-separation allocation from Ashland (b)

 
21

 
43

 

 

 

 
$
(120
)
 
$
(24
)
 
$
46

 
$
(16
)
 
$
(1
)
 
$

Weighted-average plan assumptions (c)
 
 
 
 
 
 
 
 
 
 
 
Discount rate for service cost (d)
2.15
%
 
4.10
%
 
4.08
%
 
2.95
%
 
4.25
%
 

Discount rate for interest cost (d)
2.84
%
 
3.23
%
 
4.08
%
 
2.64
%
 
2.92
%
 

Rate of compensation increase
2.99
%
 
3.23
%
 
3.15
%
 

 

 

Expected long-term rate of return on plan assets
6.56
%
 
6.77
%
 
5.34
%
 

 

 

 
 
 
 
 
 
 
 
 
 
 
 

(a) Other postretirement plan changes announced in March 2016 resulted in negative plan amendments that are being amortized within this caption during 2017 and 2016.
(b)
The pre-Contribution allocation from Ashland are costs in fiscal 2015 and 2016 until the transfer of plans to Valvoline at September 1, 2016. The allocation during 2016 and 2015 is comprised of service cost of $7 million and $8 million, respectively; non-service income of $10 million and $9 million, respectively; and actuarial losses of $24 million and $44 million, respectively.
(c ) The plan assumptions are a blended weighted-average rate for Valvoline’s U.S. and non-U.S. plans. The assumptions for 2015 only reflect Valvoline stand-alone plans. The 2016 assumptions reflect a combination of a full year of Valvoline stand-alone plans and one month for the plans transferred to Valvoline on September 1, 2016. The U.S. pension plans represented approximately 97% of the total pension benefits projected benefit obligation at September 30, 2017. Other postretirement benefit plans consist of U.S. and Canada, with the U.S. plan representing approximately 76% of the total other postretirement projected benefit obligation at September 30, 2017. Non-U.S. plans use assumptions generally consistent with those of U.S. plans.        
(d) Weighted-average discount rates reflect the adoption of the full yield curve approach in 2016.                    

The following table shows the amortization of prior service cost (credit) recognized in accumulated other comprehensive loss.

 
Pension benefits
 
Other postretirement benefits
(In millions)
2017
 
2016
 
2017
 
2016
Transfer in of unrecognized prior service cost (credit)
$

 
$
1

 
$

 
$
(81
)
Amortization of prior service credit

 

 
12

 
1

Total amount recognized in accumulated other comprehensive income

 
1

 
12

 
(80
)
Net periodic benefit income
(120
)
 
(24
)
 
(16
)
 
(1
)
Total amount recognized in net periodic benefit income and accumulated other comprehensive income
$
(120
)
 
$
(23
)
 
$
(4
)
 
$
(81
)
 
 
 
 
 
 
 
 


Amounts to be Recognized

The following table shows the amount of prior service credit in accumulated other comprehensive loss at September 30, 2017 that is expected to be recognized as a component of net periodic benefit cost (income) during the fiscal 2018:
(In millions)
Pension benefits
 
Other postretirement benefits
Prior service credit
$

 
$
(12
)


Obligations and funded status

Summaries of the change in benefit obligations, plan assets, funded status of the plans, amounts recognized in the balance sheet, and assumptions used to determine the benefit obligations for 2017 and 2016 follow for the Valvoline-sponsored pension and other postretirement benefit plans included within the Consolidated Balance Sheets.
(In millions)
Pension benefits
 
Other postretirement benefits
2017
 
2016
 
2017
 
2016
Change in benefit obligations
 
 
 
 
 
 
 
Benefit obligations at October 1
$
3,138

 
$
59

 
$
73

 
$

Transfer from Ashland

 
3,523

 

 
75

Service cost
2

 
3

 

 

Interest cost
86

 
11

 
1

 

Participant contributions

 

 
3

 
1

Benefits paid
(210
)
 
(20
)
 
(16
)
 
(3
)
Actuarial (gain)
(60
)
 
(66
)
 
(5
)
 

Foreign currency exchange rate changes
4

 
1

 
1

 

Transfers in
6

 

 

 

Curtailment/Settlement
(585
)
 
(373
)
 

 

Benefit obligations at September 30
$
2,381

 
$
3,138

 
$
57

 
$
73

Change in plan assets
 
 
 
 
 
 
 
Value of plan assets at October 1
$
2,307

 
$
46

 
$

 
$

Transfer from Ashland

 
2,653

 

 

Actual return on plan assets
148

 
(7
)
 

 

Employer contributions
412

 
6

 
13

 
2

Participant contributions

 

 
3

 
1

Benefits paid
(210
)
 
(20
)
 
(16
)
 
(3
)
Foreign currency exchange rate changes
3

 
2