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Equity Method Investment In ARO Equity Method Investment In ARO | 9 Months Ended
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Sep. 30, 2020
Equity Method Investments and Joint Ventures [Abstract] |
Equity Method Investment In ARO | Equity Method Investment in ARO Background ARO, a company that owns and operates offshore drilling rigs in Saudi Arabia, was formed and commenced operations in 2017 pursuant to the terms of an agreement entered into by Rowan and Saudi Aramco to create a 50/50 joint venture ("Shareholder Agreement"). Pursuant to the Rowan Transaction, Valaris acquired Rowan's interest in ARO making Valaris a 50% partner. ARO owns seven jackup rigs and leases nine rigs from us through bareboat charter arrangements (the "Lease Agreements") whereby substantially all operating costs are incurred by ARO. As of September 30, 2020, all nine of the leased rigs were operating under three-year drilling contracts with Saudi Aramco. The seven rigs owned by ARO, previously purchased from Rowan and Saudi Aramco, are currently operating under contracts with Saudi Aramco for an aggregate 15 years, renewed and re-priced every three years, provided that the rigs meet the technical and operational requirements of Saudi Aramco. Valaris and Saudi Aramco have agreed to take all steps necessary to ensure that ARO purchases at least 20 newbuild jackup rigs ratably over an approximate 10-year period. In January 2020, ARO ordered the first two newbuild jackups, each with a shipyard price of $176 million, for delivery scheduled in 2022. The partners intend for the newbuild jackup rigs to be financed out of available cash from ARO's operations and/or funds available from third-party debt financing. In the event ARO has insufficient cash from operations or is unable to obtain third-party financing, each partner may periodically be required to make additional capital contributions to ARO, up to a maximum aggregate contribution of $1.25 billion from each partner to fund the newbuild program. The Company's capital contributions to ARO pursuant to this requirement may require approval of the Bankruptcy Court during the Chapter 11 Cases. Each partner's commitment shall be reduced by the actual cost of each newbuild rig, on a proportionate basis. The partners agreed that Saudi Aramco, as a customer, will provide drilling contracts to ARO in connection with the acquisition of the newbuild rigs. The initial contracts provided by Saudi Aramco for each of the newbuild rigs will be for an eight-year term. The day rate for the initial contracts for each newbuild rig will be determined using a pricing mechanism that targets a six-year payback period for construction costs on an EBITDA basis. The initial eight-year contracts will be followed by a minimum of another eight years of term, re-priced in three-year intervals based on a market pricing mechanism. Upon establishment of ARO, Rowan entered into (1) an agreement to provide certain back-office services for a period of time until ARO develops its own infrastructure (the "Transition Services Agreement") and (2) an agreement to provide certain Rowan employees through secondment arrangements to assist with various onshore and offshore services for the benefit of ARO (the "Secondment Agreement"). These agreements remained in place subsequent to the Rowan Transaction. Pursuant to these agreements, we or our seconded employees provide various services to ARO, and in return, ARO provides remuneration for those services. From time to time, we may also sell equipment or supplies to ARO. During the quarter ended June 30, 2020, almost all remaining employees seconded to ARO became employees of ARO. Summarized Financial Information The operating revenues of ARO presented below reflect revenues earned under drilling contracts with Saudi Aramco for the seven ARO-owned jackup rigs as well as the rigs leased from us. Contract drilling expense is inclusive of the bareboat charter fees for the rigs leased from us. Cost incurred under the Secondment Agreement are included in contract drilling expense and general and administrative, depending on the function to which the seconded employee's service related. Substantially all costs incurred under the Transition Services Agreement are included in general and administrative. See additional discussion below regarding these related-party transactions. Summarized financial information for ARO is as follows (in millions):
|  | Three Months Ended September 30, |  | Nine Months Ended September 30, |  | April 11 - September 30,
|  | 2020 |  | 2019 |  | 2020 |  | 2019
Revenues |  | $ | 145.6 |  |  | $ | 138.4 |  |  | $ | 431.9 |  |  | $ | 262.2 |
Operating expenses |  |  |  |  |  |  |  |
Contract drilling (exclusive of depreciation) |  | 99.0 |  |  | 92.7 |  |  | 319.8 |  |  | 171.7 |
Depreciation |  | 14.8 |  |  | 14.6 |  |  | 41.1 |  |  | 26.9 |
General and administrative |  | 5.8 |  |  | 8.8 |  |  | 21.2 |  |  | 13.9 |
Operating income |  | 26.0 |  |  | 22.3 |  |  | 49.8 |  |  | 49.7 |
Other expense, net |  | 6.7 |  |  | 9.9 |  |  | 20.0 |  |  | 18.8 |
Provision (Benefit) for income taxes |  | (6.1) |  |  | 2.2 |  |  | (5.4) |  |  | 3.8 |
Net income |  | $ | 25.4 |  |  | $ | 10.2 |  |  | $ | 35.2 |  |  | $ | 27.1 |
| September 30, 2020 |  | December 31, 2019
Current assets | $ | 391.9 |  |  | $ | 407.2 |
Non-current assets | 898.2 |  |  | 874.8 |
Total assets | $ | 1,290.1 |  |  | $ | 1,282.0 |
Current liabilities | $ | 230.8 |  |  | $ | 183.2 |
Non-current liabilities | 940.8 |  |  | 1,015.5 |
Total liabilities | $ | 1,171.6 |  |  | $ | 1,198.7 |
Equity in Earnings of ARO We account for our interest in ARO using the equity method of accounting and only recognize our portion of ARO's net income, adjusted for basis differences as discussed below, which is included in equity in earnings of ARO in our condensed consolidated statements of operations. ARO is a variable interest entity; however, we are not the primary beneficiary and therefore do not consolidate ARO. Judgments regarding our level of influence over ARO included considering key factors such as each partner's ownership interest, representation on the board of managers of ARO and ability to direct activities that most significantly impact ARO's economic performance, including the ability to influence policy-making decisions. As a result of the Rowan Transaction, we recorded our equity method investment in ARO at its estimated fair value on the Transaction Date. Additionally, we computed the difference between the fair value of ARO's net assets and the carrying value of those net assets in ARO's GAAP financial statements ("basis differences"). The basis differences primarily relate to ARO's long-lived assets and the recognition of intangible assets associated with certain of ARO's drilling contracts that were determined to have favorable terms as of the Transaction Date. The basis differences are amortized over the remaining life of the assets or liabilities to which they relate and are recognized as an adjustment to the equity in earnings of ARO in our condensed consolidated statements of operations. The amortization of those basis differences are combined with our 50% interest in ARO's net income. A reconciliation of those components is presented below (in millions):
|  | Three Months Ended September 30, |  | Nine Months Ended September 30, |  | April 11 - September 30,
|  | 2020 |  | 2019 |  | 2020 |  | 2019
50% interest in ARO net income |  | $ | 12.7 |  |  | $ | 5.1 |  |  | $ | 17.6 |  |  | 13.6 |
Amortization of basis differences |  | (8.8) |  |  | (8.8) |  |  | (25.2) |  |  | (16.7) |
Equity in earnings (losses) of ARO |  | $ | 3.9 |  |  | $ | (3.7) |  |  | $ | (7.6) |  |  | $ | (3.1) |
Related-Party Transactions Revenues recognized by us related to the Lease Agreements, Transition Services Agreement and Secondment Agreement are as follows (in millions):
|  | Three Months Ended September 30, |  | Nine Months Ended September 30, |  | April 11 - September 30,
|  | 2020 |  | 2019 |  | 2020 |  | 2019
Lease revenue |  | $ | 21.0 |  |  | $ | 19.9 |  |  | $ | 62.4 |  |  | $ | 37.0 |
Secondment revenue |  | .8 |  |  | 17.9 |  |  | 20.8 |  |  | 33.5 |
Transition Services revenue |  | .2 |  |  | 5.0 |  |  | 2.2 |  |  | 10.2 |
Total revenue from ARO (1) |  | $ | 22.0 |  |  | $ | 42.8 |  |  | $ | 85.4 |  |  | $ | 80.7 |
(1) All of the revenues presented above are included in our Other segment in our segment disclosures. See "Note 1 5 - Segment Information" for additional information. Amounts receivable from ARO related to the items above totaled $13.7 million and $21.8 million as of September 30, 2020 and December 31, 2019, respectively, and are included in accounts receivable, net, on our condensed consolidated balance sheets. Additionally, as of December 31, 2019, we had a receivable from ARO of $14.2 million related to an agreement between us and ARO, pursuant to which ARO would reimburse us for certain capital expenditures related to the shipyard upgrade projects for the VALARIS JU-147 and VALARIS JU-148. Such amount was received in the first quarter of 2020. We had no amounts payable to ARO as of September 30, 2020 and $0.7 million as of December 31, 2019. During 2017 and 2018, Rowan contributed cash to ARO in exchange for 10-year shareholder notes receivable at a stated interest rate of LIBOR plus two percent. As of September 30, 2020 and December 31, 2019, the carrying amount of the long-term notes receivable from ARO was $442.7 million and $452.9 million, respectively. The Shareholders’ Agreement prohibits the sale or transfer of the shareholder note to a third party, except in certain limited circumstances. The notes receivable may be reduced by future Company obligations to the joint venture. During the nine months ended September 30, 2020, we recorded $10.2 million of employee benefit obligations against our long-term notes receivable from ARO. Interest is recognized as interest income in our condensed consolidated statement of operations and totaled $4.5 million and $13.7 million for the three and nine months ended September 30, 2020, respectively, $5.8 million and $10.9 million for the three months ended September 30, 2019 and for the period from April 11 through September 30, 2019, respectively. As of September 30, 2020, our interest receivable from ARO was $13.7 million, which is included in Accounts receivables, net on our condensed consolidated balance sheet. There was no interest receivable from ARO as of December 31, 2019. Maximum Exposure to Loss The following summarizes the total assets and liabilities as reflected in our condensed consolidated balance sheet as well as our maximum exposure to loss related to ARO (in millions). Our maximum exposure to loss is limited to (1) our equity investment in ARO, (2) the outstanding balance on our shareholder notes receivable, and (3) other receivables and contract assets related to services provided to ARO, partially offset by payables for services received.
|  | September 30, 2020 |  | December 31, 2019
Total assets |  | $ | 597.8 |  |  | $ | 623.5 |
Less: total liabilities |  | — |  |  | .7 |
Maximum exposure to loss |  | $ | 597.8 |  |  | $ | 622.8 |

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- Definition The entire disclosure for equity method investments and joint ventures. Equity method investments are investments that give the investor the ability to exercise significant influence over the operating and financial policies of an investee. Joint ventures are entities owned and operated by a small group of businesses as a separate and specific business or project for the mutual benefit of the members of the group. + References Reference 1: http://www.xbrl.org/2003/role/disclosureRef -Publisher FASB -Name Accounting Standards Codification -Topic 323 -URI http://asc.fasb.org/topic&trid=2196965 + Details
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