Tickers in this Article: NBR, HP, BRNC, PTEN
Earnings season can be a busy time for investors and sometimes certain items go by unnoticed. In the energy sector, several rig companies reported higher revenues through early contract terminations, a one-time item that provides an immediate boost to earnings. These revenues can distort the analysis of such a company.

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Early Termination Payment
When a production operator signs a term contract for a rig, a clause is typically inserted that allows the customer to terminate the contract early. This termination involves the payment of a fee to the owner of a rig. Since the money is received immediately rather than over the term of the contract, it is usually booked as revenue in that quarter, although some companies stretch it out over several quarters. This has the inadvertent effect of boosting revenue and earnings.

Revenue Boosts and Effects
During its second fiscal quarter of 2009 (ending March 31), Helmerich and Payne (NYSE:HP) had 35 contracts terminated early by its customers. This increased earnings per share by $0.47 after tax. The company said the total early termination revenue booked in the quarter was $81 million. While this number is very high, it's important to note that some of this revenue would have been booked in the quarter anyway if the rigs had not been terminated early.

Nabors International (NYSE:NBR) also booked early termination revenue in its first quarter. The company said it received $26 million of income from "prepaid cancelled domestic rigs."

Patterson-UTI Energy (Nasdaq:PTEN) received $6.6 million in early termination revenue in the first quarter. Management did note that the number of termination requests had probably peaked in that quarter. Doug Wall, the President and CEO, said, "I would say it's still continuing, but I think the pace has abated somewhat." Wall indicated that he expects no early termination revenue in the second quarter. (These income statement red flags may not spell a company's downfall. Learn why in The One-Time Expense Warning.)

This early termination revenue can also have the effect of boosting margins in the quarter, and should probably be removed for a proper analysis. For example, Bronco Drilling Co., Inc (Nasdaq:BRNC), reported average daily cash margins of $9,087 in its land drilling fleet for the final quarter of 2008. However, during the conference call, Bronco said that $1,089 of that margin was due to early termination revenue.

The Bottom Line
Investors should understand that all the companies are adhering to accounting rules in recognizing this early termination revenue and there is nothing sinister going on. A case can even be made that this early termination revenue will assist the companies in getting through the downturn. Many rig companies saw an earnings boost from early termination revenues in the first quarter as customer cancelled rig contracts to manage cash flow during the downturn. Make sure you recognize that these revenues can alter margins and should be isolated when analyzing a company. (For more, see The Industry Handbook: The Oil Services Industry.)

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