Valaris Ltd quarterly report, Q2 FY2016

Business context and reporting period

The supplied filing is Ensco plc’s unaudited Form 10-Q for the quarter ended June 30, 2016—not a filing under the name Valaris Ltd. Ensco provided offshore contract drilling services through Floater and Jackup segments; it reported 57 operating rigs and four rigs under construction. KPMG performed an interim review, not an audit.

Financial performance and liquidity

Second-quarter operating margin was approximately 46.1% (operating income divided by revenue); this includes termination-payment revenue and should not be read as a normalized run rate. First-half cash flow from continuing operations less capital expenditures was approximately $590.8 million.

At June 30, cash and cash equivalents were $790.3 million, short-term investments $1.01 billion, and total debt $4.91 billion. Working capital was $1.94 billion and the current ratio 4.2. Debt to total capital was 38.4%, down from 47.4% at year-end 2015. The $2.25 billion revolving credit facility was undrawn; Ensco reported compliance with its covenants.

Material changes versus comparable periods

• Second-quarter revenue fell 14% year over year; first-half revenue fell 22%. Excluding $205 million of lump-sum termination settlements, management said revenue declined 33% in the quarter and 32% in the first half.
• Utilization and average day rates weakened: second-quarter floater utilization was 57% versus 76% and Jackup utilization 63% versus 77%. Average day rates were $359,575 for Floaters versus $417,463 and $111,791 for Jackups versus $139,797.
• First-half operating cash flow was $800.2 million versus $891.0 million. Excluding the termination settlements, management reported a 33% decline in cash flow from continuing operations.
• Net income rose, but included a $260.8 million pretax gain on debt extinguishment. The company repurchased $940.2 million principal amount of debt for $684.8 million and issued shares for net proceeds of $585.5 million; weighted-average shares increased.
• The quarterly dividend was reduced to $0.01 per share from $0.15 a year earlier. First-half dividends were $0.02 per share versus $0.30.

Outlook, risks, contingencies, and unusual items

• Management described offshore drilling conditions as very challenging, citing weak demand, oversupply, reduced customer spending, low day rates, contract cancellations and requests for concessions. It expected no meaningful near-term demand recovery and anticipated further backlog declines, lower revenue and operating cash flow for the remainder of 2016, and declining results through 2016–2017 as contracts expired or renewed at lower rates.
• Backlog fell to $4.1 billion from $5.8 billion at December 31, 2015. The company forecast 2016 capital expenditures of approximately $400 million: $250 million for newbuilds, $25 million for enhancements and $125 million for minor upgrades and improvements. Remaining fixed-price shipyard commitments for four rigs totaled $1.23 billion, with payments scheduled through 2018.
• Petrobras declared the ENSCO DS-5 drilling services agreement void, while Ensco disputed the allegations and treated the contract as terminated. Ensco recorded no revenue for amounts due from late 2015 through termination and fully reserved earlier related receivables. Arbitration proceedings against Petrobras and Samsung Heavy Industries were underway; potential exposure was not reasonably estimable.
• A Brazil-related internal investigation into alleged bribery was substantially complete; the Audit Committee reported finding no evidence that Ensco, Pride or their employees knew of or participated in wrongdoing. SEC and DOJ inquiries and possible penalties remained risks.
• Credit ratings were under pressure: Moody’s had downgraded Ensco to below investment grade; S&P downgraded it in July to BBB-. Ensco reported limited or no access to commercial paper markets and warned further downgrades could constrain financing or increase borrowing costs.
• Other matters included asbestos claims with unestimable potential exposure, Brazilian environmental assessments, and a Spanish environmental proceeding. Letters of credit and surety bonds totaled $72.3 million. The board retained discretion to reduce or suspend dividends.

Important facts for investors to verify

• Confirm the issuer and corporate lineage: this source is an Ensco plc filing, despite the request identifying Valaris Ltd.
• Assess earnings quality by separating the $260.8 million debt-extinguishment gain and $205 million of contract termination settlements from recurring operating performance.
• Track rig utilization, day rates, contract terminations, backlog changes and customer concessions, especially Saudi Aramco jackup rate reductions.
• Review liquidity and refinancing capacity against the $4.91 billion debt balance, credit-rating pressure, covenant requirements and $1.23 billion remaining newbuild commitments.
• Monitor the Petrobras dispute and related investigations, including collectability of receivables, arbitration outcomes and any regulatory or customer consequences.