Valaris Ltd quarterly report, Q1 FY2011

Business context and reporting period

Ensco plc’s Form 10-Q covers the three months ended March 31, 2011, with comparison to Q1 2010. The filing describes an offshore contract-drilling business operating through Deepwater, Asia Pacific, Europe and Africa, and North and South America segments. The filing is by Ensco plc, not a company named Valaris.

Key financial metrics

Cash increased primarily because Ensco issued $2.5 billion principal amount of senior notes in March. The notes were classified as short-term because of mandatory redemption provisions tied to the proposed Pride merger. The company reported $240.1 million of long-term debt apart from these notes and current maturities.

Material changes versus the prior comparable period

• Revenue fell $87.1 million, or 19%, and operating income fell $113.6 million, or 59%. The filing attributes the declines mainly to lower Asia Pacific jackup day rates, lower Europe and Africa utilization, and downtime on the ENSCO 7500 during an enhancement project.
• Total rig utilization declined to 72% from 80%; average day rates declined to $118,447 from $138,684. Deepwater utilization was 77% versus 99%, and Europe and Africa utilization was 54% versus 68%.
• Contract drilling expense rose to $191.6 million from $182.4 million; depreciation rose to $59.5 million from $51.7 million; and G&A rose to $30.1 million from $20.6 million. Higher G&A primarily reflected merger-related professional fees, share-based compensation and London headquarters costs.
• Q1 2010 included $29.2 million of net gain on disposal of discontinued operations from rig sales; Q1 2011 had no discontinued-operations income. This materially affects the year-over-year net income and EPS comparison.
• Operating cash flow declined $34.5 million, or 22%, while capital spending was lower year over year. Q1 2011 investing outflows were $130.5 million; financing inflows were $2,386.6 million, principally note proceeds.

Outlook, management commentary, risks and unusual items

• Pride merger: Announced February 6, 2011, the proposed transaction contemplated approximately $2.8 billion cash plus about 86 million Ensco ADSs for Pride shareholders; estimated total consideration was approximately $7.9 billion. Closing was expected in Q2 2011, subject to shareholder, regulatory and other conditions. Antitrust waiting-period early termination had been received; shareholder litigation remained pending.
• Liquidity and financing: Management expected to fund the merger cash component using cash, note proceeds and additional short-term financing. Ensco also disclosed approximately $83 million in anticipated combined advisory and professional fees, $70 million of ADS issuance costs and $44 million of Pride change-in-control severance payments. If the merger did not close within specified deadlines or was terminated, the notes could require redemption at 101% or 102% of principal, plus accrued interest.
• Capital spending outlook: Excluding the proposed merger, management projected 2011 capex of approximately $220 million for ENSCO 8500 Series construction, $95 million for two new jackups, $190 million for rig enhancements and $100 million for minor upgrades and improvements. Two new jackups were uncontracted and scheduled for delivery in 2013; two of three ENSCO 8500 Series rigs under construction were also uncontracted.
• Market outlook: Management cited improving tender activity in several regions and expected near-term demand improvement for deepwater and certain jackup segments. It cautioned that U.S. Gulf of Mexico permitting remained protracted, standard-duty jackups faced oversupply risk, and 2011 revenue, operating income and cash flow might not match 2010 levels.
• Gulf of Mexico and Macondo: Regulatory changes and delayed permits affected utilization and day rates. U.S. Gulf of Mexico operations generated $132.1 million, or 37% of Q1 revenue, of which 63% came from deepwater operations. Prolonged delays or added requirements could materially harm results.
• Contingencies: The filing disclosed unresolved Pride merger shareholder suits; a pending U.S. Department of Justice determination in an FCPA investigation (the SEC had said it did not intend to recommend enforcement); ENSCO 74 wreckage and third-party claims; ENSCO 69 insurance recovery litigation/arbitration; ENSCO 29 wreck-removal insurance litigation; asbestos claims; and a U.K. Working Time Directive appeal. Outcomes or exposures were not fully determinable. A $21 million ENSCO 74 removal liability and matching receivable were recorded, with estimated removal costs of $21–$35 million.
• Other items: Q1 2011 tax expense included $4.7 million attributable to prior years, including $3.2 million for unrecognized tax benefits. The reported effective tax rate was 20.6%; excluding those prior-year items it was 14.9%. KPMG performed an interim review, not an audit, and expressed no audit opinion.

Important facts for investors to verify

1. Whether and when the Pride merger closed, its final consideration, financing, integration costs and resulting debt and share dilution.
2. Whether Gulf of Mexico permitting and regulatory conditions improved, and the resulting effect on rig utilization, day rates and backlog.
3. Whether projected 2011 capital expenditures and rig delivery dates were achieved, particularly for uncontracted newbuilds.
4. Debt classification, cash available after merger-related payments, mandatory redemption terms and liquidity following any transaction.
5. Resolution and financial consequences of the disclosed litigation, FCPA matter, insurance claims and wreck-removal exposures.