Valaris Ltd quarterly report, Q3 FY2015

Business context and reporting period

This is Ensco plc’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2015—not a filing under the name Valaris Ltd. Ensco was an offshore contract driller with 69 rigs, including four under construction. KPMG conducted an interim review, not an audit.

Financial performance and liquidity

• Q3 revenue fell 16%; operating margin was approximately 39.8%, versus 44.7% a year earlier. Nine-month revenue fell 5%; operating margin was approximately 39.2%, versus 18.7%, with the prior-year comparison burdened by a $703.5M impairment charge.
• Q3 continuing-operations income was $317.1M, down from $423.7M. Q3 discontinued operations recorded a $23.3M loss. Nine-month discontinued-operations loss was $33.6M in 2015, compared with $811.2M in 2014.
• Nine-month cash from continuing operating activities was $1,274.6M, down 16%. Capital expenditures were $1,445.8M, implying a $171.2M shortfall of operating cash flow to capex before other cash flows.
• Cash and equivalents were $240.4M and short-term investments $850.0M at September 30. Working capital was $1,609.5M and the current ratio 3.0. Cash declined $424.4M from year-end 2014.
• Total debt was $5,903.3M; debt to total capital was 39.6%, down from 41.9% at year-end. No debt was drawn under the $2.25B revolver or commercial paper program. Management reported no debt maturities before 2019.
• Cash dividends were $0.15 per share in Q3 and $0.45 per share for the nine-month period, sharply below prior-year levels.

Material changes and unusual items

• Lower contracted rig days and lower floater rates drove revenue declines. Utilization fell to 62% in Q3 from 89%: floaters 59% versus 82%, and jackups 64% versus 92%. Average day rates were $232,008 versus $239,233.
• Contract termination revenue partly offset the downturn: $110.6M for ENSCO DS-4 and $58.6M related to ENSCO DS-9 were included in 2015 revenue. DS-4’s $110.6M lump-sum fee was collected in October. DS-9 was uncontracted after termination; the customer was obligated to pay monthly fees equivalent to two years at an approximately $550,000 operating day rate, subject to mitigation and re-contracting provisions.
• Ensco issued $1.1B of senior notes in Q1 and used proceeds to redeem 2016 notes and MARAD obligations. Debt-extinguishment losses totaled $33.5M for the nine months; interest expense also increased.
• Seven rigs were held for sale with an aggregate carrying value of $127.5M. 2015 impairment charges included $2.4M in continuing operations and $25.6M pre-tax on held-for-sale rigs in discontinued operations. Further asset impairments were possible if rig market values deteriorated.
• Newbuild and upgrade spending remained substantial. Nine-month capex was $1.446B, including $1.132B for new rig construction. Remaining fixed-price construction commitments were $1.217B, with most scheduled for 2016–2017; management estimated 2015 capex of approximately $1.65B.

Outlook, risks, and contingencies

Management described offshore contracting conditions as very challenging, with low oil prices, weaker customer spending, oversupply and intense bidding pressure. It expected limited contracting opportunities for the remainder of 2015 and 2016, with utilization and day rates under pressure through 2016. Customers sought concessions or terminated contracts; Ensco reported an October termination notice for jackup ENSCO 84 and reduced rates on certain other jackup contracts. Management cited $6.6B of contractual backlog and expected liquidity from cash, investments, operating cash flow and available borrowing capacity to fund capital needs and debt service.

• In October, Moody’s downgraded Ensco’s senior unsecured rating one notch to Baa2; the revolver pricing did not change, though another downgrade could increase borrowing and commitment costs. The revolver covenant ceiling for debt to capitalization had been raised from 50% to 60%.
• The company warned of possible future long-lived asset or goodwill impairment, including if its share price or operating outlook weakened. Its annual goodwill test was scheduled for December 31, 2015.
• An Audit Committee investigation into alleged irregularities concerning a legacy Petrobras contract was substantially complete and had found no evidence of Ensco or Pride wrongdoing, according to the filing. SEC and DOJ had been notified; potential government action and consequences remained uncertain.
• Other contingencies included asbestos claims with unquantifiable exposure, an approximately $3.0M Spanish environmental proceeding with uncertain outcome, and Brazilian spill assessments of approximately $150,000, for which a liability was recorded. The ENSCO 74 tanker litigation was closed after an appellate ruling affirming Ensco’s victory.
• The filing identifies risks from further contract cancellations or concessions, low demand and excess rig supply, newbuild delays, operational downtime, regulatory changes, foreign exchange exposure and climate-related rules or weather. No material changes to previously disclosed risk factors were reported.

Important facts for investors to verify

• Whether reported revenue and cash receipts from DS-4 and DS-9 termination arrangements were collected as expected and how termination fees are affected by mitigation or re-contracting.
• Current backlog, contract coverage, utilization, day rates and customer-concession exposure, particularly for 2016 and later.
• Actual newbuild delivery timing, remaining construction payments and capital spending compared with management’s estimates.
• Subsequent market values and sale proceeds for the seven held-for-sale rigs, and any additional asset or goodwill impairment charges.
• Liquidity, debt covenant headroom, credit-rating developments and the sustainability of the reduced dividend amid operating cash flow below capex.
• Developments in the Petrobras-related review and other legal or regulatory matters, including any estimate of exposure if the facts change.