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VOC ENERGY TRUST - 10-Q - Trustee's Discussion and Analysis of Financial Condition and Results of Operations.

August 7, 2014

The following discussion of the Trust's financial condition and results of operations should be read in conjunction with the financial statements and notes thereto. The Trust's purpose is, in general, to hold the net profits interest, to distribute to the Trust unitholders cash that the Trust receives in respect of the net profits interest and the assigned interest in the hedge contracts and to perform certain administrative functions in respect of the net profits interest and the Trust units. The Trust derives substantially all of its income and cash flows from the net profits interest and the hedge contracts.

Results of Operations for the Quarters Ended June 30, 2014 and 2013

The following is a summary of income from net profits interest received by the Trust for the three months ended June 30, 2014 and 2013 consisting of the January distribution for each respective year:

Three months ended June 30, 2014 2013 Sales volumes: Oil (Bbl) 177,684 185,017 Natural gas (Mcf) 132,349 143,626 Total (BOE) 199,742 208,955 Average sales prices: Oil (per Bbl) $ 92.68$ 90.16 Natural gas (per Mcf) $ 4.79$ 3.98 Gross proceeds: Oil sales $ 16,467,520$ 16,680,248 Natural gas sales 633,518 571,403 Total gross proceeds 17,101,038 17,251,651 Costs: Production and development costs: Lease operating expenses 3,541,521 3,235,599 Production and property taxes 505,141 539,708 Development expenses 1,734,265 2,376,111 Total 5,780,927 6,151,418 Settlement of hedge contracts - payments received (152,207 ) (719,386 ) Total costs 5,628,720 5,432,032



Excess of revenues over direct operating expenses and lease equipment and development costs

11,472,318 11,819,619 Times net profits interest over the term of the Trust 80 % 80 % Income from net profits interest before reserve adjustments 9,177,854 9,455,695 Cash reserve 0 (1,000,000 ) Income from net profits interest $ 9,177,854$ 8,455,695 6



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The cash received by the Trust from VOC Brazos during the quarter ended June 30, 2014 substantially represents the production and settlement of hedge contracts by VOC Brazos from December 2013 through February 2014. The cash received by the Trust from VOC Brazos during the quarter ended June 30, 2013 substantially represents the production by VOC Brazos from December 2012 through February 2013. The revenues from oil production are typically received by VOC Brazos one month after production.

Gross proceeds. Oil and natural gas sales were $17,101,038 for the three months ended June 30, 2014, a decrease of $150,613 or 0.9% from $17,251,651for the three months ended June 30, 2013. Revenues are a function of oil and natural gas sales prices and volumes sold. The decrease in gross proceeds was due to decreases in oil and natural gas sales volumes during the second quarter of 2014. These decreases were slightly offset by increases in market prices for oil and natural gas during the second quarter of 2014. During the three months ended June 30, 2014, the average price for oil increased 2.8% to $92.68 per Bbl and the average price for natural gas increased 20.4% to $4.79 per Mcf. Oil sales volumes were 177,684 Bbls for the three months ended June 30, 2014, a decrease of 7,333 Bbls or 4.0% from 185,017 Bbls, while natural gas sales volumes were 132,349 Mcf, a decrease of 11,277 Mcf or 7.9%.

Costs. Lease operating expenses were $3,541,521 for the three months ended June 30, 2014, an increase of $305,922 or 9.5% from $3,235,599 for the three months ended June 30, 2013. The increase was primarily due to increases in the costs of oilfield goods and services. Production and property taxes were $505,141 for the three months ended June 30, 2014, a decrease of $34,567 or 6.4% from $539,708 for the same period in 2013. Such decrease is primarily due to a reduction in production taxes as a result of a decrease in production volumes for the period. Development expenses were $1,734,265 for the three months ended June 30, 2014, a decrease of $641,846 or 27.0% from $2,376,111 for the same period in 2013. The decrease was primarily due to incurring a limited portion of drilling costs of one horizontal well and completion costs of two horizontal wells in 2014 as compared to incurring a portion of drilling costs of one horizontal well, completion costs of one horizontal well and drilling and completion costs of one horizontal well in 2013, offset by increases in well completion costs and the costs of oilfield goods and services.

Settlement of hedge contracts. Cash settlements relating to hedge contracts resulted in gains of $152,207 for the three months ended June 30, 2014, a decrease of $567,179 from gains of $719,386 for the three months ended June 30, 2013. The decrease was due primarily to lower hedge volumes, offset by higher market prices for oil and higher hedge strike prices.

Excess of revenues over direct operating expenses and lease equipment and development costs. The excess of revenues over direct operating expenses and lease equipment and development costs from the underlying properties was $11,472,318 for the three months ended June 30, 2014, a decrease of $347,301 or 2.9% from $11,819,619 for the three months ended June 30, 2013. The Trust's 80% net profits interest of these totals were $9,177,854 and $9,455,695, respectively. During the three months ended June 30, 2014 and 2013, VOC Brazos increased its cash reserve by $0 and $1,000,000, respectively, for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of $9,177,854 and $8,455,695 for such periods, respectively. These amounts were further reduced by a Trust holdback for future expenses of $337,854 and $295,695 for the three months ended June 30, 2014 and 2013, respectively. The Trustee paid general and administrative expenses of $171,439 for the three months ended June 30, 2014, a decrease of $60,621 from $232,060 for the three months ended June 30, 2013. These factors resulted in distributable income for the three months ended June 30, 2014 of $8,840,000, an increase of $680,000 from $8,160,000 for the three months ended June 30, 2013.

Results of Operations for the Six Months Ended June 30, 2014 and 2013

The following is a summary of income from net profits interest received by the Trust for the six months ended June 30, 2014 and 2013 consisting of the January and April distributions for each respective year:

Six months ended June 30, 2014 2013 Sales volumes: Oil (Bbl) 371,698 377,190 Natural gas (Mcf) 280,422 292,314 Total (BOE) 418,435 425,909 Average sales prices: Oil (per Bbl) $ 94.40$ 88.63 Natural gas (per Mcf) $ 4.65$ 3.83 Gross proceeds: Oil sales $ 35,088,953$ 33,431,331 Natural gas sales 1,303,369 1,119,305 Total gross proceeds 36,392,322 34,550,636 Costs: Production and development costs: Lease operating expenses 7,227,232 6,939,372 Production and property taxes 2,840,537 3,091,158 Development expenses 2,530,398 9,309,156 Total 12,598,167 19,339,686 Settlement of hedge contracts - payments received (28,577 ) (1,855,395 ) Total costs 12,569,590 17,484,291



Excess of revenues over direct operating expenses and lease equipment and development costs

23,822,732 17,066,345 Times net profits interest over the term of the Trust 80 % 80 % Income from net profits interest before reserve adjustments 19,058,186 13,653,076 Cash reserve 0 (750,000 ) Income from net profits interest $ 19,058,186$ 12,903,076 7



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The cash received by the Trust from VOC Brazos during the six months ended June 30, 2014 substantially represents the production and settlement of hedge contracts by VOC Brazos from September 2013 through February 2014. The cash received by the Trust from VOC Brazos during the six months ended June 30, 2013 substantially represents the production by VOC Brazos from September 2012 through February 2013. The revenues from oil production are typically received by VOC Brazos one month after production.

Gross proceeds. Oil and natural gas sales were $36,392,322 for the six months ended June 30, 2014, an increase of $1,841,686 or 5.3% from $34,550,636 for the six months ended June 30, 2013. Revenues are a function of oil and natural gas sales prices and volumes sold. The increase in gross proceeds was due to higher market prices for oil and gas sales during the first six months of 2014, which was partially offset by a decrease in oil sales volumes and gas sales volumes during the first six months of 2014. During the six months ended June 30, 2014, the average price for oil increased 6.5% to $94.40 per Bbl and the average price for natural gas increased 21.4% to $4.65 per Mcf. Oil sales volumes were 371,698 Bbls for the six months ended June 30, 2014, a decrease of 5,492 Bbls or 1.5% from 377,190 Bbls, while natural gas sales volumes were 280,422 Mcf, a decrease of 11,892 Mcf or 4.1% from 292,314 Mcf.

Costs. Lease operating expenses were $7,227,232 for the six months ended June 30, 2014, an increase of $287,860 or 4.1% from $6,939,372 for the six months ended June 30, 2013. The increase was primarily due to increases in the costs of oilfield goods and services. Production and property taxes were $2,840,537 for the six months ended June 30, 2014, a decrease of $250,621 or 8.1% from $3,091,158 for the same period in 2013. Such decrease is primarily due to decreases in ad valorem taxes of $276,538 partially offset by increases in production taxes due to higher prices for oil and gas. Development expenses were $2,530,398 for the six months ended June 30, 2014, a decrease of $6,778,758 or 72.8% from $9,309,156 for the same period in 2013. The decrease was primarily due to incurring a limited portion of drilling costs of one horizontal well and completion costs of two horizontal wells in 2014 as compared to incurring a portion of drilling costs of one horizontal well, completion costs of one horizontal well, drilling and completion costs of one horizontal well, and the costs associated with a horizontal well that was abandoned due to mechanical issues with the wellbore in 2013, offset by increases in well completion costs and the costs of oilfield goods and services.

Settlement of hedge contracts. Cash settlements relating to hedge contracts resulted in gains of $28,577 for the six months ended June 30, 2014, a decrease of $1,826,818 from $1,855,395 for the six months ended June 30, 2013. The decrease was due primarily to lower hedge volumes and slightly lower hedge strike prices, offset by higher market prices for oil.

Excess of revenues over direct operating expenses and lease equipment and development costs. The excess of revenues over direct operating expenses and lease equipment and development costs from the underlying properties was $23,822,732 for the six months ended June 30, 2014, an increase of $6,756,387 or 39.6% from $17,066,345 for the six months ended June 30, 2013. The Trust's 80% net profits interest of these totals were $19,058,186 and $13,653,076, respectively. During the six months ended June 30, 2014 and 2013, VOC Brazos increased its cash reserve by $0 and $750,000, respectively, for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of $19,058,186 and $12,903,076 for such periods, respectively. These amounts were further reduced by a Trust holdback for future expenses of $528,185 and $323,076 for the six months ended June 30, 2014 and 2013, respectively. The Trustee paid general and administrative expenses of $547,099 for the six months ended June 30, 2014, an increase of $56,255 from $490,844 for the six months ended June 30, 2013. These factors resulted in distributable income for the six months ended June 30, 2014 of $18,530,000, an increase of $5,950,000 from $12,580,000 for the six months ended June 30, 2013.

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Liquidity and Capital Resources

Other than Trust administrative expenses, including any reserves established by the Trustee for future liabilities, the Trust's only use of cash is for distributions to Trust unitholders. Administrative expenses include payments to the Trustee as well as a quarterly administrative fee to VOC Brazos pursuant to an administrative services agreement. Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the net profits interest and other sources (such as interest earned on any amounts reserved by the Trustee) in that quarter, over the Trust's expenses paid for that quarter. Available funds are reduced by any cash that the Trustee decides to hold as a reserve against future expenses. As of June 30, 2014, $432,357 was held by the Trustee as such a reserve.

The Trustee may cause the Trust to borrow funds required to pay expenses if the Trustee determines that the cash on hand and the cash to be received are insufficient to cover the Trust's expenses. If the Trust borrows funds, the Trust unitholders will not receive distributions until the borrowed funds are repaid. During the three and six months ended June 30, 2014 and 2013, there were no such borrowings. VOC Brazos has provided a letter of credit in the amount of $1 million to the Trustee to protect the Trust against the risk that it does not have sufficient cash to pay future expenses.

Income to the Trust from the net profits interest is based on the calculation and definitions of "gross proceeds" and "net proceeds" contained in the conveyance.

As substantially all of the underlying properties are located in mature fields, VOC Brazos does not expect future costs for the underlying properties to change significantly compared to recent historical costs other than changes due to fluctuations in the general cost of oilfield services. VOC Brazos may establish a cash reserve of up to $1.0 million in the aggregate at any given time from the dollar amount otherwise distributable to the Trust to reduce the impact on distributions of uneven capital expenditure timing. VOC Brazos released $250,000 in January 2013 and withheld $1 million in April 2013 in accordance with this cash reserve. No amounts were released or withheld in 2014 as of June 30, 2014. The reserve balance was $1,000,000 at June 30, 2014 and 2013.

The amounts received by VOC Brazos from the hedge contract counterparty upon settlement of the hedge contracts will reduce the operating expenses related to the underlying properties in calculating the net proceeds. However, if the hedge payments received by VOC Brazos under the hedge contracts and other non-production revenue exceed operating expenses during a quarterly period, the ability to use such excess amounts to offset operating expenses will be deferred, with interest accruing on such amounts at the prevailing prime rate, until the next quarterly period where the hedge payments and the other non-production revenue are less than such expenses. In addition, the aggregate amounts paid by VOC Brazos on settlement of the hedge contracts will reduce the amount of net proceeds paid to the Trust.

The Trust does not have any transactions, arrangements or other relationships with unconsolidated entities or persons that could materially affect the Trust's liquidity or the availability of capital resources.

Hedge Contracts



The revenues derived from the underlying properties depend substantially on prevailing crude oil prices and, to a lesser extent, natural gas prices. As a result, commodity prices also affect the amount of cash flow available for distribution to the Trust unitholders. Lower prices may also reduce the amount of oil and natural gas that VOC Brazos can economically produce. VOC Brazos sells the oil and natural gas production from the underlying properties under floating market price contracts each month. VOC Brazos had entered into hedge contracts which expired on June 30, 2014, to reduce the exposure of the revenues from oil production from the underlying properties to fluctuations in crude oil prices and to achieve more predictable cash flow. VOC Brazos has not entered into any hedge contracts relating to oil volumes to be produced after June 30, 2014, and the terms of the conveyance of the net profits interest prohibit VOC Brazos from entering into new hedging arrangements for the benefit of the Trust.

Note Regarding Forward-Looking Statements

This Form 10-Q includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact included in this Form 10-Q, including without limitation the statements under "Trustee's Discussion and Analysis of Financial Condition and Results of Operations" are forward-looking statements. Although VOC Brazos advised the Trust that it believes that the

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expectations reflected in the forward-looking statements contained herein are reasonable, no assurance can be given that such expectations will prove to have been correct. Important factors that could cause actual results to differ materially from expectations ("Cautionary Statements") are disclosed in this Form 10-Q and in the Trust's Annual Report on Form 10-K for the year ended December 31, 2013 (the "Form 10-K"), including under the section "Item 1A. Risk Factors". All subsequent written and oral forward-looking statements attributable to the Trust or persons acting on its behalf are expressly qualified in their entirety by the Cautionary Statements.


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Source: Edgar Glimpses


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