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VOC > SEC Filings for VOC > Form 10-K on 13-Mar-2014All Recent SEC Filings

Show all filings for VOC ENERGY TRUST

Form 10-K for VOC ENERGY TRUST


13-Mar-2014

Annual Report


Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations.

The following review of the trust's financial condition and results of operations should be read in conjunction with the financial statements and notes thereto. The trust was formed on November 3, 2010. The conveyance of the net profits interest, however, did not occur until May 10, 2011. As a result, the trust did not recognize any income or make any distributions during the year ended December 31, 2010. The trust's first quarterly distribution was paid on August 15, 2011. Such distribution was comprised of the net proceeds of production collected by VOC Brazos from January 1, 2011 through June 30, 2011, less a $1.0 million cash reserve established by VOC Brazos for future development, maintenance or operating expenditures, and less $0.5 million for future expenses of the trust. The trust's purpose is, in general, to hold the net profits interest and the assigned interest in the hedge contracts, 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.

Critical Accounting Policies

The trust uses the modified cash basis of accounting to report receipts by the trust of the net profits interest and payments of expenses incurred. The net profits interest represents the right to receive revenues (oil and natural gas sales), less direct operating expenses (lease operating expenses and production and property taxes) and development expenses (which are capitalized in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") of the underlying properties plus any payments made or net of payments received in connection with the settlement of certain hedge contracts, times 80%. Cash distributions of the trust will be made based on the amount of cash received by the trust pursuant to terms of the conveyance creating the net profits interest.

The financial statements of the trust, as prepared on a modified cash basis, reflect the trust's assets, trust corpus, earnings and distributions as follows:

(a)
Income from the net profits interest is recorded when distributions are received by the trust;

(b)
Distributions to trust unitholders are recorded when paid by the trust;

(c)
Trust general and administrative expenses (which include the trustee's fees as well as accounting, engineering, legal and other professional fees) are recorded when paid;

(d)
Cash reserves for trust expenses may be established by the trustee for certain expenditures that would not be recorded as contingent liabilities under U.S. GAAP;


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(e)
Amortization of the investment in net profits interest, calculated using the units-of-production method based upon total estimated proved reserves, is charged directly to trust corpus and does not affect distributable income; and

(f)
The trust evaluates its investment in the net profits interest periodically to determine whether its aggregate value has been impaired below its total capitalized cost based on the underlying properties. The trust will provide a write-down to its investment in the net profits interest if and when total capitalized costs, less accumulated amortization, exceed undiscounted future net cash flows attributable to the trust's interests in the proved oil and gas reserves of the underlying properties.

While these statements differ from financial statements prepared in accordance with U.S. GAAP, the modified cash basis of reporting revenues and distributions is considered most meaningful because quarterly distributions to the trust unitholders are based on net cash receipts received from VOC Brazos.

This comprehensive basis of accounting other than U.S. GAAP corresponds to the accounting permitted for royalty trusts by the SEC as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. The following is a summary of income from net profits interest received


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by the trust for the years ended December 31, 2011, 2012 and 2013, consisting of the February, May, August and November distributions for each respective year.

                                                   Year Ended December 31,
                                            2011             2012             2013
Sales volumes:
Oil (Bbl)                                    496,953 (1)      796,066 (2)      769,584 (3)
Natural gas (Mcf)                            340,164 (1)      554,524 (2)      576,433 (3)
Total (BOE)                                  553,647          888,487          865,656
Average sales prices:
Oil (per Bbl)                           $      90.35     $      91.61     $      92.36
Natural gas (per Mcf)                   $       4.96     $       3.92     $       3.95
Gross proceeds:
Oil sales                               $ 44,900,938 (1) $ 72,923,858 (2) $ 71,081,973 (3)
Natural gas sales                          1,686,384 (1)    2,173,822 (2)    2,279,338 (3)


Total gross proceeds                      46,587,322       75,097,680       73,361,311
Costs:
Production and development costs:
Lease operating expenses                   9,126,491       14,085,066       14,305,693
Production and property taxes              1,280,424        5,072,355        5,627,791
Development expenses                       4,216,239       11,834,253       18,008,251


Total                                     14,623,154       30,991,674       37,941,735
Settlement of hedge
contracts-payments received                 (351,629 )     (2,597,216 )     (2,111,069 )


Total costs                               14,271,525       28,394,458       35,830,666


Excess of revenues over direct
operating expenses and lease
equipment and development costs           32,315,797       46,703,222       37,530,645
Times net profits interests over the
term of the Trust                                 80 %             80 %             80 %


Income from net profits interest
before reserve adjustments                25,852,638       37,362,577       30,024,516
Cash reserve                              (1,000,000 )        750,000         (750,000 )


Income from net profits interest        $ 24,852,638     $ 38,112,577     $ 29,274,516


(1)
Oil and gas sales volumes and related revenues for the year ended December 31, 2011 (consisting of VOC Brazos' August and November 2011 net profits interest distributions to the trust) generally represent the production by VOC Brazos from January 2011 through August 2011.

(2)
Oil and gas sales volumes and related revenues for the year ended December 31, 2012 (consisting of VOC Brazos' February, May, August and November 2012 net profits interest distributions to the trust) generally represent the production by VOC Brazos from September 2011 through August 2012.

(3)
Oil and gas sales volumes and related revenues for the year ended December 31, 2013 (consisting of VOC Brazos' February, May, August and November 2013 net profits interest distributions to the trust) generally represent the production by VOC Brazos from September 2012 through August 2013.

Comparison of Results of the Trust for the Years Ended December 31, 2013 and 2012

Income from Net Profits Interest. Income from net profits interest is recorded on a modified cash basis when net profits interest proceeds are received by the Trust from VOC Brazos. Net profits


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interest proceeds that VOC Brazos remits to the Trust are based on the oil and gas production VOC Brazos has received payment for within one month following the end of the most recent fiscal quarter. VOC Brazos receives payment for its crude oil sales generally within 30 days following the month in which it is produced. Income from net profits interest is generally a function of oil and gas gross proceeds, lease operating expenses, production and property taxes, development expenses and cash settlements on hedge contracts as follows:

Gross proceeds. Oil and natural gas sales were $73,361,311 for the year ended December 31, 2013, a decrease of $1,736,369 or 2.3% from $75,097,680 for the year ended December 31, 2012. Revenues are a function of oil and natural gas sales prices and volumes sold. The decrease in gross proceeds was due to higher market prices for oil and a decrease in oil sales volumes during 2013, which was partially offset by an increase in natural gas sales volumes and a slight increase in the market price for natural gas. During the year ended December 31, 2013, the average price for oil increased 0.8% to $92.36 per Bbl and the average price for natural gas increased 0.8% to $3.95 per Mcf. Oil sales volumes were 769,584 Bbls for the year ended December 31, 2013, a decrease of 26,482 Bbls or 3.3% from 796,066 Bbls, while natural gas sales volumes were 576,433 Mcf, an increase of 21,909 Mcf or 4.0% from 554,524 Mcf.

Costs. Lease operating expenses were $14,305,693 for the year ended December 31, 2013, an increase of $220,627 or 1.6% from $14,085,066 for the year ended December 31, 2012. The increase was primarily due to increases in the costs of oilfield goods and services. Production and property taxes were $5,627,791 for the year ended December 31, 2013, an increase of $555,436 or 11.0% from $5,072,355 for 2012. Such increase is primarily due to increases in ad valorem taxes partially offset by decreases in production taxes due to decreases in volumes sold. Ad valorem taxes are paid and included in production and property taxes. Development expenses were $18,008,251 for the year ended December 31, 2013, an increase of $6,173,998 or 52.2% from $11,834,253 for 2012. The increase was primarily due to the timing of when the costs associated with drilling three operated horizontal wells, one non-operated horizontal well and one horizontal well that was abandoned due to mechanical issues with the wellbore in 2013 were incurred as compared to when the costs associated with drilling three operated horizontal wells in the previous period were incurred, as well as increases in completion costs and the costs of oilfield goods and services for 2013.

Settlement of hedge contracts. Cash settlements relating to hedge contracts resulted in gains of $2,111,069 for the year ended December 31, 2013, a decrease of $486,147 from $2,597,216 for 2012. The decrease was due primarily to higher market prices for oil, lower hedge volumes and slightly lower 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 $37,530,645 for the year ended December 31, 2013, a decrease of $9,172,577 or 19.6% from $46,703,222 for the year ended December 31, 2012. The Trust's 80% net profits interest of these totals were $30,024,516 and $37,362,577, respectively. During the year ended December 31, 2013, VOC Brazos increased its cash reserve for future development, maintenance or operating expenditures by a net amount of $750,000 and during the year ended December 31, 2012, VOC Brazos decreased its cash reserve by a net amount of $750,000, which resulted in income from the net profits interest of $29,274,516 and $38,112,577 for such years, respectively. These amounts were further reduced by a Trust holdback for future expenses of $714,516 and $882,577 for the years ended December 31, 2013 and 2012, respectively. The Trustee paid general and administrative expenses of $737,846 for the year ended December 31, 2013, an increase of $31,722 from $706,124 for the year ended December 31, 2012. These factors resulted in distributable income for the year ended December 31, 2013 of $28,560,000, a decrease of $8,670,000 from $37,230,000 for the year December 31, 2012.


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Comparison of Results of the Trust for the Years Ended December 31, 2012 and 2011

As noted above, VOC Brazos conveyed a net profits interest to the Trust as of May 10, 2011. In addition to the conveyance of the net profits interest, VOC Brazos also assigned to the Trust the right to receive a payment equal to the amount the Trust would have received had the net profits interest been in effect during the period from January 1, 2011 through the day prior to the closing of the initial public offering. The cash received by the Trust for the year ended December 31, 2012 (consisting of VOC Brazos' February, May, August and November 2012 net profits interest distributions to the Trust) generally represents the production by VOC Brazos from September 2011 through August 2012 (twelve months), while the cash received by the Trust for the year ended December 31, 2011 (consisting of VOC Brazos' August and November 2011 net profits interest distributions to the Trust) generally represents the production by VOC Brazos from January 2011 through August 2011 (eight months). The differences in the comparisons below are primarily attributable to the fact that the Trust received income from the net profits interest attributable to twelve months of production in 2012 versus eight months in 2011.

Income from Net Profits Interest. Income from net profits interest is recorded on a modified cash basis when net profits interest proceeds are received by the Trust from VOC Brazos. Net profits interest proceeds that VOC Brazos remits to the Trust are based on the oil and gas production VOC Brazos has received payment for within one month following the end of the most recent fiscal quarter. VOC Brazos receives payment for its crude oil sales generally within 30 days following the month in which it is produced. Income from net profits interest is generally a function of oil and gas gross proceeds, lease operating expenses, production and property taxes, development expenses and cash settlements on hedge contracts as follows:

Gross proceeds. Oil and natural gas sales were $75,097,680 for the year ended December 31, 2012, an increase of $28,510,358 or 61.2% from $46,587,322 for the year ended December 31, 2011. The increase in gross proceeds was due to higher market prices for oil and an increase in oil and natural gas sales volumes during 2012, which was partially offset by a decrease in the market price for natural gas. During the year ended December 31, 2012, the average price for oil increased 1.4% to $91.61 per Bbl and the average price for natural gas decreased 21.0% to $3.92 per Mcf. Oil sales volumes were 796,066 Bbls for the year ended December 31, 2012, an increase of 299,113 Bbls or 60.2% from 496,953 Bbls, while natural gas sales volumes were 554,524 Mcf, an increase of 214,360 Mcf or 63.0% from 340,164 Mcf.

Costs. Lease operating expenses were $14,085,066 for the year ended December 31, 2012, an increase of $4,958,575 or 54.3% from $9,126,491 for the year ended December 31, 2011. The increase was primarily due to increases in the costs of oilfield goods and services. Production and property taxes were $5,072,355 for the year ended December 31, 2012, an increase of $3,791,931 or 296.1% from $1,280,424 for 2011. Such increase is primarily due to increases in ad valorem taxes. Ad valorem taxes are paid and included in production and property taxes. Development expenses were $11,834,253 for the year ended December 31, 2012, an increase of $7,618,014 or 180.7% from $4,216,239 for 2011. The increase was primarily due to the timing of when the costs associated with drilling three operated horizontal wells in 2013 were incurred as compared to when the costs associated with drilling one operated horizontal well in the previous period were incurred, the costs associated with a horizontal well that was abandoned due to mechanical issues with the wellbore, as well as increases in completion costs and the costs of oilfield goods and services.

Settlement of hedge contracts. Cash settlements relating to hedge contracts resulted in gains of $2,597,216 for the year ended December 31, 2012, an increase of $2,245,587 from $351,629 for 2011. The decrease was due primarily to higher market prices for oil, lower hedge volumes and slightly lower hedge strike prices.


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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 $46,703,222 for the year ended December 31, 2012, an increase of $14,387,425 or 44.5% from $32,315,797 for the year ended December 31, 2011. The Trust's 80% net profits interest of these totals were $37,362,577 and $25,852,638, respectively. During the year ended December 31, 2012, VOC Brazos decreased its cash reserve for future development, maintenance or operating expenditures by a net amount of $750,000 and during the year ended December 31, 2011, VOC Brazos increased its cash reserve by $1,000,000, which resulted in income from the net profits interest of $38,112,577 and $24,852,638 for such years, respectively. These amounts were further reduced by a Trust holdback for future expenses of $882,577 and $712,638 for the years ended December 31, 2012 and 2011, respectively. The Trustee paid general and administrative expenses of $706,124 for the year ended December 31, 2012, an increase of $290,633 from $415,491 for the year ended December 31, 2011. These factors resulted in distributable income for the year ended December 31, 2012 of $37,230,000, an increase of $13,090,000 from $24,140,000 for the year December 31, 2011.

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. Available funds are the excess cash, if any, received by the trust from the net profits interest and payments from 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 the trustee decides to hold as a reserve against future expenses. The trust paid, out of the first cash payment received by the trust, the trustee's and Delaware trustee's legal expenses incurred in forming the trust, in connection with the initial public offering (that were not otherwise paid by VOC Brazos) and related matters, as well as the Delaware trustee's acceptance fee in the amount of $5,000.

The trustee can authorize the trust to borrow money to pay trust administrative or incidental expenses that exceed cash held by the trust. The trustee may authorize the trust to borrow from the trustee as lender provided the terms of the loan are fair to the trust unitholders. The trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the trust at least equals amounts paid by the trustee on similar deposits, and make no other short-term investments with the funds distributed to the trust. The trustee has no current plans to authorize the trust to borrow money. If the trust borrows funds, the trust unitholders will not receive distributions until the borrowed funds are repaid. During the year ended December 31, 2013, the trust made no borrowings.

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 as compared to recent historical costs other than changes due to fluctuations in the cost of oilfield services generally. However, see "Trustee's Discussion and Analysis of Financial Condition and Results of Operations-Planned Development and Workover Program" below. VOC Brazos has agreed to post a letter of credit in the amount of $1 million in favor of the trustee to protect the trustee against the risk that the trust does not have sufficient cash to pay its expenses.

The amounts received by VOC Brazos from the hedge contract counterparty upon settlement of the hedge contracts 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 are deferred, with interest accruing on such amounts at the prevailing prime rate, until the next quarterly period in which the hedge payments and the other non-production revenue are less than such expenses. In addition, the aggregate amounts paid


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by VOC Brazos on settlement of the hedge contracts reduce the amount of net proceeds paid to the trust.

The trust pays the trustee an administrative fee of $150,000 per year. The trust pays the Delaware trustee a fee of $2,500 per year. The trust also incurs, either directly or as a reimbursement to the trustee, legal, accounting, tax and engineering fees, printing costs and other expenses that are deducted by the trust before distributions are made to trust unitholders, including the $18,750 administrative services fee payable quarterly to VOC Brazos pursuant to an administrative services agreement. The trust is also responsible for paying other expenses incurred as a result of being a publicly traded entity, including costs associated with annual and quarterly reports to trust unitholders, tax return and Form 1099 preparation and distribution, NYSE listing fees, independent auditor fees and registrar and transfer agent fees.

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.

Planned Development and Workover Program

The primary goals of VOC Brazos' development and workover program have been to develop proved undeveloped reserves, manage workovers and minimize the natural decline in production in areas in which it operates. However, VOC Brazos is not obligated to undertake any development activities, so any drilling and completing activities will be subject to the reasonable discretion of VOC Brazos. No assurance can be given, however, that any development well will produce in commercially paying quantities or that the characteristics of any development well will match the characteristics of VOC Brazos' existing wells or VOC Brazos' historical drilling success rate. With respect to the underlying properties, VOC Brazos expects, but is not obligated, to implement the following development strategies specific to each of its primary operating areas:


Kansas. VOC Brazos' historical development and workover program for the Kansas Underlying Properties has included recompleting certain existing wells, drilling infill development wells, conducting 3-D seismic surveys, completing workovers and applying new production technologies. VOC Brazos intends to continue this program with respect to the Kansas Underlying Properties, and expects to incur total development expenditures for these properties through December 31, 2015 of approximately $1.6 million, of which VOC Brazos contemplates spending approximately $1.2 million to drill and complete six vertical wells. The remaining approximately $0.4 million is expected to be used for recompletions and workovers of nine wells.


Texas. VOC Brazos' historical development and workover program for the Texas Underlying Properties has included recompleting certain existing wells, drilling infill development wells, completing workovers and applying new production technologies. In 2009, after an extensive review of horizontal development drilling in the areas, VOC Brazos commenced drilling horizontal wells in the Kurten Woodbine Units in order to accelerate the development of proved undeveloped reserves. VOC Brazos has successfully completed twelve of its first thirteen horizontal wells to the Woodbine C sand in this area with average lateral lengths of approximately 3,000 feet. VOC Brazos intends to continue developing the Woodbine C sand underlying the Kurten Woodbine Units, utilizing horizontal wells completed with multiple fracture stimulations together with recompletions of existing vertical wellbores into additional pay intervals. VOC Brazos expects total development expenditures for the Texas Underlying Properties through December 31, 2016 to be approximately $21.6 million. Of this total, VOC Brazos contemplates spending approximately $20.5 million to drill and complete ten horizontal wells in the Woodbine C sand. The remaining approximately $1.1 million is expected to be used


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for recompletions and workovers of nine Woodbine vertical wells to additional Woodbine sands and seven existing wells in the Sand Flat Unit.

The trust is not directly obligated to pay any portion of the capital expenditures made with respect to the underlying properties; however, capital expenditures made by VOC Brazos with respect to the underlying properties will be deducted from the gross proceeds in calculating the net proceeds from which cash will be paid to the trust. As a result, the trust will indirectly bear an 80% (subject to certain limitations during the final three years of the trust, as described above under "Item 1. Business-Computation of Net Proceeds-Net Profits Interest") share of any capital expenditures made with respect to the underlying properties. Accordingly, higher or lower capital expenditures will, in general, directly decrease or increase, respectively, the cash received by the trust in respect of its net profits interest. As the cash received by the trust in respect of the net profits interest will be reduced by the trust's pro rata share of these capital expenditures, VOC Brazos expects that it will incur capital expenditures with respect to the underlying properties throughout the term of the trust on a basis that balances the impact of the capital expenditures on current cash distributions to the trust unitholders with the longer term benefits of increased oil and natural gas production expected to result from the capital expenditures. In addition, VOC Brazos may establish a capital reserve of up to $1.0 million in the aggregate at any given time to reduce the impact on distributions of uneven capital expenditure timing.

VOC Brazos, as the designated operator of the underlying properties, is entitled to make all determinations related to capital expenditures with respect to the underlying properties, and there are no limitations on the amount of capital expenditures that VOC Brazos may incur with respect to the underlying properties. VOC Brazos is required under the conveyance to use commercially reasonable efforts to cause the operators of the underlying properties to operate these properties as would a reasonably prudent operator acting with respect to its own properties (without regard to the existence of the net profits interest). As the trust unitholders would not be expected to fully realize the benefits of capital expenditures made with respect to the underlying properties towards the end of the term of the trust, during each twelve-month . . .

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