VOC Energy Trust: Form 10-Q for the period ended Mar 31, 2022

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 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. All information regarding operations has been provided to the Trustee by VOC Brazos.

Results of Operations

Results of Operations for the Quarters Ended March 31, 2022 and 2021

The following is a summary of income from net profits interest received by the Trust for the three months ended March 31, 2022 and 2021 consisting of the January distribution for each respective year:

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The cash received by the Trust from VOC Brazos during the quarter ended March 31, 2022 substantially represents the production by VOC Brazos from September 2021 through November 2021. The cash received by the Trust from VOC Brazos during the quarter ended March 31, 2021 substantially represents the production by VOC Brazos from September 2020 through November 2020. The revenues from oil production are typically received by VOC Brazos one month after production.

Gross proceeds. Oil and natural gas sales were $10,507,066 for the three months ended March 31, 2022, an increase of $5,355,245 or 103.9% from $5,151,821 for the three months ended March 31, 2021. Revenues are a function of oil and natural gas sales prices and volumes sold. The increase in gross proceeds was due to increases in market prices for oil and natural gas, partially offset by decreases in oil and natural gas sales volumes during the first quarter of 2022. During the three months ended March 31, 2022, the average price for oil increased 103.5% to $73.79 per Bbl and the average price for natural gas increased 179.2% to $5.78 per Mcf. During the three months ended March 31, 2022, oil sales volumes were 135,762 Bbls for the three months ended March 31, 2022, a decrease of 821 Bbls or 0.6% from 136,583 Bbls for the three months ended March 31, 2021, while natural gas sales volumes were 84,632 Mcf, a decrease of 11,354 Mcf or 11.8% from 95,986 Mcf for the same period in 2021.

Costs. Lease operating expenses were $3,458,894 for the three months ended March 31, 2022, an increase of $767,407 or 28.5% from $2,691,487 for the three months ended March 31, 2021. Production and property taxes were $665,791 for the three months ended March 31, 2022, a decrease of $85,766 or 11.4% from $751,557 for the same period in 2021. Such decrease is primarily due to a $157,275 or 110.1% increase in production taxes due to higher sales prices offset by a decrease in property taxes of $243,041 or 39.9%. Development expenses were $492,148 for the three months ended March 31, 2022, a decrease of $522,013 or 51.5% from $1,014,161 for the same period in 2021. Such decrease was primarily due to decreased development expenses during the three months ended March 31, 2022, compared to the three months ended March 31, 2021.

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 $5,890,233 for the three months ended March 31, 2022, an increase of $5,195,617 or 748.0% from $694,616 for the three months ended March 31, 2021. The Trust’s 80% net profits interest of these totals were $4,712,186 and $555,693, respectively. During the three months ended March 31, 2022 and 2021, VOC Brazos did not withhold or release any dollar amounts due to the Trust from the previously established cash reserve for future development, maintenance or operating expenditures, which resulted in income from the net profits interest of $4,712,186 and $555,693 for such periods, respectively. These amounts were reduced by a Trust holdback for current estimated expenses of $279,269 and $45,693 for the three months ended March 31, 2022 and 2021, respectively, and a Trust holdback for future estimated expenses of $182,917 for the three months ended March 31, 2022. The Trustee paid general and administrative expenses of $373,765 for the three months ended March 31, 2022, a decrease of $22,634 from $396,399 for the three months ended March 31, 2021. This decrease was primarily due to the differences in timing of receipt and payment of recurring general and administrative expenses. These factors resulted in distributable income for the three months ended March 31, 2022 of $4,250,000, an increase of $3,740,000 from $510,000 for the three months ended March 31, 2021.

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 reserve for future development, maintenance or operating expenses. As of March 31, 2022, $375,625 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 months ended March 31, 2022 and 2021, there were no such borrowings. VOC Brazos has provided a letter of credit in the amount of $1.7 million to the Trustee to protect the Trust against the risk that it does not have sufficient cash to pay future expenses.

In November 2021, the Trustee notified VOC Brazos that the Trustee intends to build a reserve for the payment of future known, anticipated or contingent expenses or liabilities, commencing with the distribution payable in the first quarter of 2022. The Trustee intends to withhold a portion of the proceeds otherwise available for distribution each quarter to gradually build a cash reserve to approximately $1.175 million. This amount is in addition to the $1.7 million letter of credit described above. The Trustee may increase or decrease the targeted amount at any time, and may increase or decrease the rate at which it is withholding funds to build the cash reserve at any time, without advance notice to the unitholders. Cash held in reserve will be invested as required by the Trust Agreement. Any cash reserved in excess of the amount necessary to pay or provide for the payment of future known, anticipated or contingent expenses or liabilities eventually will be distributed to unitholders, together with interest earned on the funds. The Trustee elected to withhold $182,917 from the proceeds otherwise available for distribution through March 31, 2022 towards the building of the cash reserve described above.

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. The cash reserve balance was $1,000,000 at March 31, 2022 and 2021, respectively.

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 (the “Exchange Act”). 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 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 the Trust’s Annual Report on Form 10-K for the year ended December 31, 2021 (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.

The Trust is a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and is not required to provide the information under this Item.

Evaluation of Disclosure Controls and Procedures. The Trustee maintains disclosure controls and procedures designed to ensure that information required to be disclosed by the Trust in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and regulations promulgated by the SEC. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Trust is accumulated and communicated by VOC Brazos to the Trustee, as trustee of the Trust, and its employees who participate in the preparation of the Trust’s periodic reports as appropriate to allow timely decisions regarding required disclosure.

As of the end of the period covered by this report, the Trustee carried out an evaluation of the Trust’s disclosure controls and procedures. A Trust Officer of the Trustee has concluded that the disclosure controls and procedures of the Trust are effective.

Due to the contractual arrangements of (i) the Trust Agreement and (ii) the conveyance of the net profits interest, the Trustee relies on (A) information provided by VOC Brazos, including historical operating data, plans for future operating and capital expenditures, reserve information and information relating to projected production and (B) conclusions and reports regarding reserves by the Trust’s independent reserve engineers. See “Risk Factors—Neither the trust nor the trust’s unitholders have the ability to influence VOC Brazos or control the operations or development of the underlying properties” in the Form 10-K.

Changes in Internal Control over Financial Reporting. During the quarter ended March 31, 2022, there was no change in the Trust’s internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, the Trust’s internal control over financial reporting. The Trustee notes for purposes of clarification that it has no authority over, and makes no statement concerning, the internal control over financial reporting of VOC Brazos.

There have not been any material changes from the risk factors previously disclosed in the Trust’s response to Item 1A to Part I of the Form 10-K.