Leasing

6 Months Ended

Mar. 31, 2020

Leases [Abstract]

Leasing

LEASING

As described in Note 1, Valvoline adopted new lease accounting guidance effective October 1, 2019 and changed its policy for lease accounting prospectively for lease agreements entered into or reassessed from the date of adoption as described herein.

Lessee arrangements

Certain of the properties Valvoline utilizes, including quick-lube service center stores, offices, blending and warehouse facilities, in addition to certain equipment, are leased. Valvoline determines if an arrangement contains a lease at inception primarily based on whether or not the Company has the right to control the asset during the contract period. For all agreements where it is determined that a lease exists, including those with an initial term of 12 months or less, the related lease assets and liabilities are recognized on the Condensed Consolidated Balance Sheet as either operating or finance leases at the commencement date. The lease liability is measured at the present value of future lease payments over the lease term, and the right-of-use asset is measured at the lease liability amount, adjusted for prepaid lease payments, lease incentives and the lessee’s initial direct costs (e.g., commissions). The lease term includes options to extend or terminate the lease when it is reasonably certain that the option will be exercised.

Fixed payments, including variable payments based on a rate or index, are included in the determination of the lease liability, while other variable payments are recognized in the Condensed Consolidated Statements of Comprehensive Income in the period in which the obligation for those payments is incurred. Many leases contain lease components requiring rental payments and other components that require payment for taxes, insurance, operating expenses and maintenance. In instances where these other components are fixed, they are included in the measurement of the lease liability due to Valvoline's election to combine lease and non-lease components. Otherwise, these other components are expensed as incurred and comprise the majority of Valvoline's variable lease costs.

As most leases do not provide the rate implicit in the lease, the Company estimates its incremental borrowing rate to best approximate the rate of interest that Valvoline would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Valvoline applies the incremental borrowing rate to groups of leases with similar lease terms in determining the present value of future payments. In determining the incremental borrowing rate, the Company considers information available at commencement date, including lease term, interest rate yields for specific interest rate environments and the Company's credit spread.

The following table presents the Company's lease balances:

(In millions)	Location in Condensed Consolidated Balance Sheet	March 31, 2020
Assets
Operating lease assets	Operating lease assets	$	254
Finance lease assets	Property, plant and equipment, net	47
Amortization of finance lease assets	Property, plant and equipment, net	(8)
Total leased assets		$	293
Liabilities
Current:
Operating lease liabilities	Accrued expenses and other liabilities	$	30
Finance lease liabilities	Accrued expenses and other liabilities	2
Noncurrent:
Operating lease liabilities	Operating lease liabilities	226
Finance lease liabilities	Other noncurrent liabilities	41
Total lease liabilities		$	299

The following table presents the components of total lease costs:

(In millions)	Location in Condensed Consolidated Statements of Comprehensive Income	Three months ended March 31, 2020		Six months ended March 31, 2020
Operating lease cost	Cost of sales and Selling, general and administrative expenses (a)	$	11	$	22
Finance lease costs
Amortization of lease assets	Cost of sales (a)	1		1
Interest on lease liabilities	Net interest and other financing expenses	1		2
Variable lease cost	Cost of sales and Selling, general and administrative expenses (a)	1		2
Sublease income	Equity and other income, net	(2)		(3)
Total lease cost		$	12	$	24

(a) Supply chain and retail-related amounts are included in Cost of sales.

Other information related to the Company's leases follows:

(In millions)	Three months ended March 31, 2020		Six months ended March 31, 2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases (a)	$	11	$	21
Operating cash flows from finance leases	$	1	$	2
Financing cash flow from finance leases	$	—	$	—
Lease assets obtained in exchange for lease obligations:
Operating leases	$	13	$	28
Finance leases	$	18	$	18

(a) Included within the change in Other assets and liabilities within the Condensed Consolidated Statement of Cash Flows offset by noncash operating lease asset amortization and liability accretion.

The following table reconciles the undiscounted cash flows for the next five fiscal years ended September 30 and thereafter to the operating and finance lease liabilities recorded on the Condensed Consolidated Balance Sheet as of March 31, 2020:

(In millions)	Operating leases		Finance leases
Remainder of 2020	$	21	$	3
2021	39		6
2022	36		5
2023	33		5
2024	30		6
Thereafter	157		45
Total future lease payments	316		70
Imputed interest	60		27
Present value of lease liabilities	$	256	$	43

As of March 31, 2020, Valvoline has additional leases primarily related to its quick lube service center stores that have not yet commenced with approximately $44 million in undiscounted future lease payments that are not included in the table above. These leases are expected to commence over the next twelve months and generally have lease terms of 15 years.

In accordance with the previous lease accounting guidance, Valvoline's lease arrangements were previously classified as either capital, operating, or financing obligations. Previously classified capital leases are now considered finance leases under the new lease accounting guidance, while previous financing obligations have been derecognized and reclassified as operating leases. The classification of operating leases remains substantially unchanged under the new lease accounting guidance.

The future minimum lease payments by fiscal year as determined prior to the adoption of the new lease accounting guidance under the previously designated capital, financing and operating leases as of the fiscal year ended September 30, 2019, were as follows:

(In millions)	Operating leases		Capital leases and financing obligations
2020	$	36	$	6
2021	32		7
2022	29		7
2023	27		7
2024	23		7
Thereafter	120		50
Total future lease payments (a)	$	267	84
Imputed interest			29
Present value of lease liabilities			$	55

(a) Future lease payments do not include fixed payments for executory costs, such as taxes, insurance, maintenance and operating expenses.

The following table presents the weighted average remaining lease term and interest rate as of March 31, 2020:

Weighted average remaining lease term (in years):
Operating leases	9.8
Finance leases	12.6
Weighted average discount rate:
Operating leases	4.14	%
Finance leases	9.03	%

Leasing

LEASING

As described in Note 1, Valvoline adopted new lease accounting guidance effective October 1, 2019 and changed its policy for lease accounting prospectively for lease agreements entered into or reassessed from the date of adoption as described herein.

Lessee arrangements

Certain of the properties Valvoline utilizes, including quick-lube service center stores, offices, blending and warehouse facilities, in addition to certain equipment, are leased. Valvoline determines if an arrangement contains a lease at inception primarily based on whether or not the Company has the right to control the asset during the contract period. For all agreements where it is determined that a lease exists, including those with an initial term of 12 months or less, the related lease assets and liabilities are recognized on the Condensed Consolidated Balance Sheet as either operating or finance leases at the commencement date. The lease liability is measured at the present value of future lease payments over the lease term, and the right-of-use asset is measured at the lease liability amount, adjusted for prepaid lease payments, lease incentives and the lessee’s initial direct costs (e.g., commissions). The lease term includes options to extend or terminate the lease when it is reasonably certain that the option will be exercised.

Fixed payments, including variable payments based on a rate or index, are included in the determination of the lease liability, while other variable payments are recognized in the Condensed Consolidated Statements of Comprehensive Income in the period in which the obligation for those payments is incurred. Many leases contain lease components requiring rental payments and other components that require payment for taxes, insurance, operating expenses and maintenance. In instances where these other components are fixed, they are included in the measurement of the lease liability due to Valvoline's election to combine lease and non-lease components. Otherwise, these other components are expensed as incurred and comprise the majority of Valvoline's variable lease costs.

As most leases do not provide the rate implicit in the lease, the Company estimates its incremental borrowing rate to best approximate the rate of interest that Valvoline would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Valvoline applies the incremental borrowing rate to groups of leases with similar lease terms in determining the present value of future payments. In determining the incremental borrowing rate, the Company considers information available at commencement date, including lease term, interest rate yields for specific interest rate environments and the Company's credit spread.

The following table presents the Company's lease balances:

(In millions)	Location in Condensed Consolidated Balance Sheet	March 31, 2020
Assets
Operating lease assets	Operating lease assets	$	254
Finance lease assets	Property, plant and equipment, net	47
Amortization of finance lease assets	Property, plant and equipment, net	(8)
Total leased assets		$	293
Liabilities
Current:
Operating lease liabilities	Accrued expenses and other liabilities	$	30
Finance lease liabilities	Accrued expenses and other liabilities	2
Noncurrent:
Operating lease liabilities	Operating lease liabilities	226
Finance lease liabilities	Other noncurrent liabilities	41
Total lease liabilities		$	299

The following table presents the components of total lease costs:

(In millions)	Location in Condensed Consolidated Statements of Comprehensive Income	Three months ended March 31, 2020		Six months ended March 31, 2020
Operating lease cost	Cost of sales and Selling, general and administrative expenses (a)	$	11	$	22
Finance lease costs
Amortization of lease assets	Cost of sales (a)	1		1
Interest on lease liabilities	Net interest and other financing expenses	1		2
Variable lease cost	Cost of sales and Selling, general and administrative expenses (a)	1		2
Sublease income	Equity and other income, net	(2)		(3)
Total lease cost		$	12	$	24

(a) Supply chain and retail-related amounts are included in Cost of sales.

Other information related to the Company's leases follows:

(In millions)	Three months ended March 31, 2020		Six months ended March 31, 2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases (a)	$	11	$	21
Operating cash flows from finance leases	$	1	$	2
Financing cash flow from finance leases	$	—	$	—
Lease assets obtained in exchange for lease obligations:
Operating leases	$	13	$	28
Finance leases	$	18	$	18

(a) Included within the change in Other assets and liabilities within the Condensed Consolidated Statement of Cash Flows offset by noncash operating lease asset amortization and liability accretion.

The following table reconciles the undiscounted cash flows for the next five fiscal years ended September 30 and thereafter to the operating and finance lease liabilities recorded on the Condensed Consolidated Balance Sheet as of March 31, 2020:

(In millions)	Operating leases		Finance leases
Remainder of 2020	$	21	$	3
2021	39		6
2022	36		5
2023	33		5
2024	30		6
Thereafter	157		45
Total future lease payments	316		70
Imputed interest	60		27
Present value of lease liabilities	$	256	$	43

As of March 31, 2020, Valvoline has additional leases primarily related to its quick lube service center stores that have not yet commenced with approximately $44 million in undiscounted future lease payments that are not included in the table above. These leases are expected to commence over the next twelve months and generally have lease terms of 15 years.

In accordance with the previous lease accounting guidance, Valvoline's lease arrangements were previously classified as either capital, operating, or financing obligations. Previously classified capital leases are now considered finance leases under the new lease accounting guidance, while previous financing obligations have been derecognized and reclassified as operating leases. The classification of operating leases remains substantially unchanged under the new lease accounting guidance.

The future minimum lease payments by fiscal year as determined prior to the adoption of the new lease accounting guidance under the previously designated capital, financing and operating leases as of the fiscal year ended September 30, 2019, were as follows:

(In millions)	Operating leases		Capital leases and financing obligations
2020	$	36	$	6
2021	32		7
2022	29		7
2023	27		7
2024	23		7
Thereafter	120		50
Total future lease payments (a)	$	267	84
Imputed interest			29
Present value of lease liabilities			$	55

(a) Future lease payments do not include fixed payments for executory costs, such as taxes, insurance, maintenance and operating expenses.

The following table presents the weighted average remaining lease term and interest rate as of March 31, 2020:

Weighted average remaining lease term (in years):
Operating leases	9.8
Finance leases	12.6
Weighted average discount rate:
Operating leases	4.14	%
Finance leases	9.03	%