Valaris Ltd annual report, FY2016

Filing identity and reporting period

Important mismatch: The supplied filing is Ensco plc’s Form 10-K for the fiscal year ended December 31, 2016, filed February 28, 2017. It is not a filing by Valaris Ltd. The summary below reflects the filing text provided.

Ensco was an offshore contract drilling company operating globally, with floater and jackup segments. Its revenue was earned primarily under day-rate drilling contracts.

Financial performance and position

Revenue declined about 32% year over year. Average rig utilization fell to 58% from 72%, and average day rate fell to $192,427 from $233,325. The filing reports 2016 operating margin of approximately 33%; this result should be read in light of termination-related revenue and debt-extinguishment gains described below. The filing does not provide a clearly stated adjusted or normalized profit margin.

Fourth-quarter 2016 revenue was $504.6 million, operating income was $80.7 million, continuing-operations income was $30.6 million, and net income attributable to Ensco was $39.0 million. In fourth-quarter 2015, revenue was $828.3 million and Ensco recorded a $2.472 billion net loss, including substantial impairment charges.

Year-end working capital was $2.425 billion, with a current ratio of 3.8. Cash, cash equivalents and short-term investments totaled approximately $2.602 billion. The company had a $2.25 billion revolving credit facility, with no borrowings outstanding at year-end, and reported compliance with its covenants. Debt was 39.0% of total capitalization.

Changes versus prior period and unusual items

• Revenue fell $1.287 billion, reflecting fewer contracted rig days, lower day rates, contract terminations and asset sales. Contract drilling expenses also declined, by $568.6 million, through stacking and cost reductions.
• Utilization and average day rates decreased in both segments: floater utilization was 54% versus 69%, and jackup utilization was 60% versus 73%.
• 2015 included $2.746 billion of impairment charges; no impairment charge was recorded in 2016. Ensco had written off all goodwill by the end of 2015.
• 2016 revenue included $205 million of lump-sum settlements related to ENSCO DS-9 and ENSCO 8503. Other income included $287.8 million of gains on debt extinguishments, contributing materially to reported 2016 earnings.
• Operating cash flow decreased 37% year over year, to $1.077 billion. Capital expenditures fell to $322.2 million from $1.620 billion.
• Ensco issued 65.55 million shares in April 2016 for net proceeds of $585.5 million, and repurchased $1.131 billion principal amount of debt for $863.9 million. It also issued $849.5 million principal amount of 3.00% exchangeable notes in December.
• The dividend was cut from $0.15 per share per quarter in 2015 to $0.01 per quarter in 2016. A $0.01 first-quarter 2017 dividend was declared; future dividends remained discretionary.

Outlook, risks and contingencies

Management expected 2017 to remain challenging, with expiring contracts likely to renew at lower rates and no meaningful near-term recovery in offshore drilling demand. It expected jackup demand to recover before floater demand if markets improved. The company forecast approximately $425 million of 2017 capital expenditures: $335 million for newbuilds, $30 million for enhancements and $60 million for minor upgrades.

Backlog declined by $2.136 billion year over year and may not be fully realized: customer termination rights, renegotiations, downtime and contract expirations could further reduce revenue and cash flow. Recent contract awards were short-term and highly competitive, with day rates sometimes near or below direct operating costs. Two newbuilds were uncontracted; ENSCO DS-10 delivery was deferred to 2019 and ENSCO 123 to 2018.

• Liquidity and refinancing: Credit ratings were below investment grade, limiting market access and potentially raising financing costs. The credit facility required debt-to-capitalization of no more than 60%. Management stated it expected to meet obligations but warned that further deterioration in drilling demand could materially impair liquidity.
• Brazil/Petrobras: Petrobras declared the ENSCO DS-5 contract void and alleged improper payments involving a former marketing consultant. Ensco disputed the allegations; its internal investigation found no evidence of company or employee involvement. Ensco and Petrobras pursued arbitration, including Petrobras’s counterclaim. The company could not estimate potential exposure.
• Other litigation and regulatory matters: A customer lawsuit alleged approximately $45 million in damages; Ensco said it could not reasonably estimate potential liability. Brazilian environmental assessments included a recorded $190,000 liability; a separate Spanish matter involved a claimed $3 million, with customer guarantees and an expected contractual indemnity. The filing also describes unresolved anti-corruption inquiries related to prior Pride matters.
• Uninsured operational exposure: Ensco retained U.S. Gulf of Mexico hurricane windstorm risk for eight jackups and six floaters, citing the cost and limited coverage available. Insurance was scheduled for renewal in May 2017.
• Other principal risks include continued oil-price weakness, rig oversupply and newbuild deliveries, contract cancellations, further asset impairments, environmental and safety regulation, geopolitical and foreign-exchange risks, and customer concentration. The five largest customers generated 50% of 2016 revenue.

Investor verification priorities

• Confirm the issuer and filing: this source is Ensco plc’s 2016 10-K, not a Valaris Ltd filing.
• Assess earnings quality by separating recurring drilling economics from the $205 million termination settlements and $287.8 million debt-extinguishment gains.
• Verify the status and collectability of backlog, particularly contracts subject to termination or renegotiation and the Petrobras dispute.
• Review debt maturities, post-year-end 2017 exchange offers, facility covenant headroom and the effect of below-investment-grade ratings on refinancing access.
• Track utilization, day rates, stacking, newbuild commitments and actual 2017 capital spending against management’s outlook.
• Monitor the Petrobras investigation/arbitrations, the approximately $45 million customer claim, insurance renewal and retained Gulf hurricane exposure.