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PER > SEC Filings for PER > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for SANDRIDGE PERMIAN TRUST

Form 10-Q for SANDRIDGE PERMIAN TRUST


13-Nov-2012

Quarterly Report


ITEM 2. Trustee's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

The following discussion and analysis is intended to help the reader understand the Trust's financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with the Trust's unaudited financial statements and the accompanying notes included in this Quarterly Report and the Trust's audited financial statements and the accompanying notes included in the 2011 Form 10-K.

Overview

The Trust is a statutory trust created on May 12, 2011 under the Delaware Statutory Trust Act. The business and affairs of the Trust are managed by the Trustee and, as necessary, the Delaware Trustee. The Trust's purpose is to hold the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and the derivatives agreement (described in Note 5 to the unaudited financial statements contained in Part I, Item 1 of this Quarterly Report) and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. Other than the foregoing activities, the Trust does not conduct any operations or activities. The Trustee has no involvement with, control or authority over, or responsibility for, any aspect of the operations on or relating to the properties in which the Trust has an interest. The Trust derives all or substantially all of its income and cash flow from the Royalty Interests and the derivatives agreement. The Trust is treated as a partnership for federal income tax purposes. The Trust's activities result in the Trust having nexus in Texas and, therefore, make it subject to Texas franchise tax. The Trust is required to pay Texas franchise tax each year at a maximum effective rate of 0.7% of its gross income apportioned to Texas in the prior year.

Properties. At September 30, 2012, the Trust's properties consisted of Royalty Interests in (a) the Initial Wells, (b) 400 additional wells (equivalent to approximately 415 Trust Development Wells under the development agreement as described below) that were drilled and perforated for completion between April 1, 2011 and September 30, 2012, and (c) the equivalent of approximately 473 Trust Development Wells to be drilled within an AMI consisting of approximately 17,400 gross acres (15,800 net acres) in Andrews County, Texas.

SandRidge is obligated to drill, or cause to be drilled, the Trust Development Wells on or before March 31, 2016. SandRidge is not permitted to drill and complete any well within the AMI for its own account, subject to certain exceptions, until it has satisfied the drilling obligation to the Trust. SandRidge has granted to the Trust a lien covering its interest in the AMI (except its interest in the Initial Wells) in order to secure the estimated amount of the drilling costs for the Trust's interests in the undeveloped Underlying Properties, the balance of which is reduced as SandRidge fulfills its drilling obligation under the development agreement. At September 30, 2012, the amount potentially recoverable under the lien was approximately $156.9 million.

The Trust is not responsible for any costs related to the drilling of the Trust Development Wells or any other operating or capital costs related to the Underlying Properties. The following table presents the number of Initial Wells, Trust Development Wells drilled and Trust Development Wells to be drilled as of December 31, 2011 and September 30, 2012.

                                                                      Trust                      Trust
                                                                   Development                Development
                                           Initial Wells         Wells Drilled(1)         Wells To Be Drilled          Total
December 31, 2011                                     517                    195                        693                 1,405
September 30, 2012                                    517                    415                        473                 1,405

(1) SandRidge is credited for having drilled one full Trust Development Well if a well is drilled and perforated for completion to the Grayburg/San Andres formation and SandRidge's net revenue interest in the well is equal to 69.3%. For wells in which SandRidge has a net revenue interest greater or less than 69.3%, SandRidge will receive proportionate credit for such well. In certain circumstances, SandRidge may also receive Trust Development Well credit for horizontal wells drilled to such formation.

Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust's administrative expenses and cash reserves withheld by the Trustee, property tax and Texas franchise tax, on or about 60 days following the completion of each quarter. The Trust's subordinated units are entitled to receive pro rata distributions from the Trust each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is at least equal to the Subordination Threshold. If there is not sufficient cash to fund such a distribution on all of the common units (including the common units SandRidge owns), the distribution to be made with respect to the subordinated units is reduced or eliminated for such quarter in order to make a distribution, to the extent possible, to all of the common units (including the common units held by


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SandRidge) up to the Subordination Threshold. However, there is no minimum distribution. If the cash available for distribution on all of the Trust units in any quarter exceeds the Incentive Threshold for the corresponding quarter, SandRidge, as holder of the Trust's subordinated units, is entitled to 50% of the amount by which the cash available for distribution exceeds the Incentive Threshold.

The following table sets forth the Subordination Threshold and Incentive Threshold for each remaining calendar quarter through the first quarter of 2017, as set out in the trust agreement.

                                  Subordination          Incentive
               Period(1)          Threshold(2)          Threshold(2)
               2012
               Third quarter    $           0.47      $          0.70
               Fourth quarter               0.49                 0.74

               2013
               First quarter                0.51                 0.77
               Second quarter               0.53                 0.80
               Third quarter                0.56                 0.84
               Fourth quarter               0.58                 0.87

               2014
               First quarter                0.61                 0.91
               Second quarter               0.63                 0.95
               Third quarter                0.65                 0.98
               Fourth quarter               0.66                 0.98

               2015
               First quarter                0.64                 0.96
               Second quarter               0.61                 0.92
               Third quarter                0.56                 0.85
               Fourth quarter               0.54                 0.81

               2016
               First quarter                0.53                 0.80
               Second quarter               0.52                 0.78
               Third quarter                0.51                 0.77
               Fourth quarter               0.50                 0.75

               2017
               First quarter                0.49                 0.74

(1) Due to the timing of the payment of production proceeds to the Trust, each distribution covers production from a three-month period consisting of the first two months of the most recently ended quarter and the final month of the quarter preceding it.

(2) Each of the Subordination Threshold (80% of quarterly target distribution) and Incentive Threshold (120% of quarterly target distribution) terminates after the fourth full calendar quarter following SandRidge's completion of its drilling obligation.

Pursuant to Internal Revenue Code Section 1446, withholding tax on income effectively connected to a United States trade or business allocated to foreign partners should be made at the highest marginal rate. Under Section 1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to foreign partners should be made at 30% of gross income unless the rate is reduced by treaty. This is intended to be a qualified notice to nominees and brokers as provided for under Treasury Regulation
Section 1.1446-4(b) by the Trust, and while specific relief is not specified for
Section 1441 income, this disclosure is intended to suffice. Nominees and brokers should withhold 35% of the distribution made to foreign partners.

Results of Trust Operations

The primary factors affecting the Trust's revenues and costs are the quantity of oil and natural gas production attributable to the Royalty Interests, the prices received for such production and amounts paid or received as net settlements under the derivatives agreement and the Trust's derivative contracts with unaffiliated third parties. Royalty income, post-production expenses, certain taxes and derivative settlements are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge and net derivative settlements are received from the Trust's derivative counterparty. Although the Trust was formed on May 12, 2011, the conveyance of the Royalty Interests did not occur until August 2011 and no proceeds from the sale of oil and natural gas production


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were received by the Trust until November 2011. As a result, the Trust did not recognize any income or make any distributions until November 2011. Information regarding the Trust's production, pricing and costs for the three and nine-month periods ended September 30, 2012 is presented below.

                                                   Three Months  Ended          Nine Months  Ended
                                                  September 30, 2012(1)        September 30, 2012(2)
Production Data
Oil (MBbls)(3)                                                       369                        1,058
Natural gas (MMcf)                                                   104                          280
Combined equivalent volumes (MBoe)                                   386                        1,105
Average daily combined equivalent volumes
(MBoe/d)                                                             4.2                          4.0

Average Prices
Oil (per Bbl)(3)                                 $                 89.44      $                 88.90
Natural gas (per Mcf)                            $                  1.73      $                  2.33
Combined equivalent (per Boe)                    $                 85.91      $                 85.74

Average Prices - including impact of
derivative settlements and post-production
expenses
Oil (per Bbl)(3)(4)                              $                 90.00      $                 91.68
Natural gas (per Mcf)                            $                  1.49      $                  2.01
Combined equivalent (per Boe)                    $                 86.37      $                 88.32

Expenses (per Boe)
Post-production                                  $                  0.06      $                  0.08
Production taxes                                 $                  4.07      $                  4.09

Total expenses                                   $                  4.13      $                  4.17

(1) Oil and natural gas volumes and related revenues and expenses for the three-month period ended September 30, 2012 (included in SandRidge's August 2012 net revenue distribution to the Trust) represent oil and natural gas production from March 1, 2012 to May 31, 2012.

(2) Oil and natural gas volumes and related revenues and expenses for the nine-month period ended September 30, 2012 (included in SandRidge's February 2012, May 2012 and August 2012 net revenue distributions to the Trust) represent oil and natural gas production from September 1, 2011 to May 31, 2012.

(3) Includes natural gas liquids.

(4) Includes impact of derivative settlements attributable to production from March 1, 2012 to May 31, 2012 for the three-month period ended September 30, 2012 and from September 1, 2011 to May 31, 2012 for the nine-month period ended September 30, 2012.

Trust Operations for the Three Months Ended September 30, 2012

Royalty Income. Royalty income received during the three-month period ended September 30, 2012 totaled $33.2 million. This was based upon production attributable to the Royalty Interests of 369 MBbls of oil and 104 MMcf of natural gas for the period from March 1, 2012 to May 31, 2012. Average prices received for oil and natural gas production, excluding the impact of derivative settlements and post-production expenses, during the three-month period ended September 30, 2012 were $89.44 per Bbl of oil and $1.73 per Mcf of natural gas.

Derivative Settlements. The Trust's derivatives agreement with SandRidge reduces the Trust's exposure to commodity price volatility attributable to a portion of production from the Royalty Interests through March 31, 2015 through the use of oil fixed price swaps. Net cash settlements received related to the Trust's derivatives during the three-month period ended September 30, 2012 were approximately $1.9 million, and included net settlements received of approximately $0.4 million related to production from March 1, 2012 to May 31, 2012 and net settlements received of approximately $1.5 million related to June 2012 production. Total net derivative settlements received by the Trust for production from March 1, 2012 to May 31, 2012, including $0.2 million paid in April 2012, were $0.2 million, which effectively increased the average price received for oil production for the related period by $0.56 per Bbl to $90.00 per Bbl.

Post-Production Expenses. The Trust bears post-production expenses attributable to production from the Royalty Interests. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil and natural gas produced. Post-production expenses for the three-month period ended September 30, 2012 totaled approximately $25,000.


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Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, excluding the effects of derivative settlements and net of any applicable tax credits. Production taxes for the three-month period ended September 30, 2012 totaled approximately $1.6 million, or $4.07 per Boe, and were approximately 4.7% of royalty income.

Distributable Income. Distributable income for the three-month period ended September 30, 2012 was $31.8 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $1.4 million (approximately $1.7 million withheld from the August 2012 cash distribution to unitholders less approximately $0.3 million used to pay Trust expenses during the period).

Trust Operations for the Nine Months Ended September 30, 2012

Royalty Income. Royalty income received during the nine-month period ended September 30, 2012 totaled $94.7 million. This was based upon production attributable to the Royalty Interests of 1,058 MBbls of oil and 280 MMcf of natural gas for the period from September 1, 2011 to May 31, 2012. Average prices received for oil and natural gas production, excluding the impact of derivative settlements and post-production expenses, during the nine-month period ended September 30, 2012 were $88.90 per Bbl of oil and $2.33 per Mcf of natural gas.

Derivative Settlements. Net cash settlements received related to the Trust's derivatives during the nine-month period ended September 30, 2012 were approximately $3.7 million and included net settlements received of approximately $2.2 million related to production from September 1, 2011 to May 31, 2012 and net settlements received of approximately $1.5 million related to June 2012 production. Total net derivative settlements received by the Trust for production from September 1, 2011 to May 31, 2012 were $2.9 million, including $0.7 million received in 2011, and effectively increased the average price received for oil production for the related period by $2.78 per Bbl to $91.68 per Bbl.

Post-Production Expenses. Post-production expenses for the nine-month period ended September 30, 2012 totaled approximately $90,000.

Production Taxes. Production taxes for the nine-month period ended September 30, 2012 totaled approximately $4.5 million, or $4.09 per Boe, and were approximately 4.8% of royalty income.

Property Taxes. The Trust paid its property tax for the period ended December 31, 2011 of approximately $0.2 million during the nine-month period ended September 30, 2012.

Texas Franchise Tax. The Trust paid its Texas franchise tax for the period ended December 31, 2011 of approximately $0.2 million during the nine-month period ended September 30, 2012.

Distributable Income. Distributable income for the nine-month period ended September 30, 2012 was $90.6 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $1.8 million (approximately $3.3 million withheld from the February 2012, May 2012 and August 2012 cash distributions to unitholders less approximately $1.5 million used to pay Trust expenses during the period).

Liquidity and Capital Resources

The Trust's principal sources of liquidity and capital are cash flow generated from the Royalty Interests, derivative contracts, and borrowings to fund administrative expenses, including any amounts borrowed under SandRidge's loan commitment described in Note 4 to the unaudited financial statements contained in Part I, Item I of this Quarterly Report. The Trust's primary uses of cash are distributions to Trust unitholders, including, if applicable, incentive distributions to SandRidge, payment of amounts owed under the Trust's derivative contracts, payment of Trust administrative expenses, including any reserves established by the Trustee for future liabilities, payment of applicable taxes and payment of expense reimbursements to SandRidge for out-of-pocket expenses incurred on behalf of the Trust. Under the conveyances granting the Royalty Interests, the Trust does not have any capital requirements related to drilling wells or any other operating and capital costs related to the wells.

Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee to SandRidge 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 sale of oil and natural gas production attributable to the Royalty Interests for the quarter, over the Trust's expenses for the quarter, subject in all cases to the subordination and incentive


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provisions previously described. If at any time the Trust's cash on hand (including available cash reserves) is not sufficient to pay the Trust's ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including SandRidge, to pay such expenses. If such funds are borrowed, no further distributions will be made to unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds have been repaid, except that if SandRidge loans such funds, SandRidge may permit the Trust to make distributions prior to SandRidge being repaid. There was no such loan outstanding at September 30, 2012 or December 31, 2011.

Under the derivatives agreement, SandRidge pays the Trust amounts it receives from its counterparty and the Trust pays SandRidge any amounts that SandRidge is required to pay such counterparty. Additionally, the Trust receives payment directly from its counterparty to the contracts novated to the Trust by SandRidge and is required to pay any amounts owed under those contracts directly to the counterparty. Significant payments by the Trust to SandRidge or the counterparty to the novated contracts could reduce or eliminate distributions paid to unitholders.

2012 Trust Distributions to Unitholders. During the nine-month period ended September 30, 2012, the Trust's distributions to unitholders were as follows:

                                   Covered  Production                                                              Total
                                          Period              Date Declared             Date Paid             Distribution Paid
                                                                                                                (in millions)
Calendar Quarter 2012
                                          September 1 -
First Quarter                         November 30, 2011       February 2, 2012       February 29, 2012                  $     29.1
                                     December 1, 2011 -
Second Quarter                        February 29, 2012         April 30, 2012            May 30, 2012                  $     30.5
                                        March 1, 2012 -
Third Quarter                              May 31, 2012          July 26, 2012         August 29, 2012                  $     30.1

Future Trust Distributions to Unitholders. On November 1, 2012, the Trust declared a cash distribution of $0.625203 per unit covering production for the period from June 1, 2012 to August 31, 2012 for record holders as of November 14, 2012. The distribution will be paid on or about November 29, 2012 and was calculated as follows (in thousands, except for unit and per unit amounts):

Revenues
 Royalty income                                                            $    31,731
 Derivative settlements, net                                                     4,093

Total revenues                                                                  35,824


Expenses
 Post-production expenses                                                           28
 Production taxes                                                                1,492
 Cash reserves withheld by Trustee(1)                                            1,481

Total expenses                                                                   3,001

Distributable income available to unitholders                              $    32,823

Distributable income per unit (52,500,000 units issued and outstanding)    $  0.625203

(1) Includes amounts withheld for payment of future Trust administrative expenses.

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