VOC Energy Trust: Form 10-Q for the period ended Sep 30, 2023

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 September 30, 2023 and 2022

The following is a summary of income from net profits interest received by the Trust for the three months ended September 30, 2023 and 2022 consisting of the July distribution for each respective year:

The cash received by the Trust from VOC Brazos during the quarter ended September 30, 2023 substantially represents the production by VOC Brazos from March 2023 through May 2023. The cash received by the Trust from VOC Brazos during the quarter ended September 30, 2022 substantially represents the production by VOC Brazos from March 2022 through May 2022. The revenues from oil production are typically received by VOC Brazos one month after production.

Gross proceeds. Oil and natural gas sales were $9,240,585 for the three months ended September 30, 2023, a decrease of $4,962,665 or 34.9% from $14,203,250 for the three months ended September 30, 2022. Revenues are a function of oil and natural gas volumes sold and prices received. The decrease in gross proceeds was due to decreases in oil and natural gas sales volumes and in market prices for oil and natural gas sales during the third quarter of 2023. During the three months ended September 30, 2023, the average price for oil decreased 31.7% to $71.49 per Bbl and the average price for natural gas decreased 56.2% to $2.91 per Mcf. Oil sales volumes were 126,373 Bbls for the three months ended September 30, 2023, a decrease of 4,645 Bbls or 3.5% from 131,018 Bbls for the three months ended September 30, 2022, while natural gas sales volumes were 70,964 Mcf, a decrease of 3,235 Mcf or 4.4% from 74,199 Mcf for the same period in 2022.

Costs. Lease operating expenses were $3,553,191 for the three months ended September 30, 2023, a decrease of $298,404 or 7.7% from $3,851,595 for the three months ended September 30, 2022. Production and property taxes were $657,484 for the three months ended September 30, 2023, an increase of $11,916 or 1.8% from $645,568 for the same period in 2022. Such increase is the result of an increase of $152,694 or 59.7% in property taxes, partially offset by a decrease of $140,778 or 36.1% in production taxes due primarily to lower sales volumes and sales prices for oil and natural gas. Development expenses were $295,971 for the three months ended September 30, 2023, a decrease of $788,601 or 72.7% from $1,084,572 for the same period in 2022. Such decrease was primarily due to a decrease in drilling activity and development expenses, during the three months ended September 30, 2023, compared to the three months ended September 30, 2022, a period that included drilling costs associated with two horizontal wells in Texas.

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 $4,733,939 for the three months ended September 30, 2023, a decrease of $3,887,576 or 45.1% from $8,621,515 for the three months ended September 30, 2022. The Trust’s 80% net profits interest of these totals was $3,787,151 and $6,897,212, respectively. During the three months ended September 30, 2023 and 2022, 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 $3,787,151 and $6,897,212 for such periods, respectively. These amounts were reduced by a Trustee holdback for current estimated Trust expenses of $217,151 and $215,546 for the three months ended September 30, 2023 and 2022, respectively, and a Trustee holdback for future estimated Trust expenses of $221,666 for the three months ended September 30, 2022. The Trustee paid general and administrative expenses of $257,220 for the three months ended September 30, 2023, an increase of $95,896 from $161,324 for the three months ended September 30, 2022. This increase was primarily due to the differences in the timing of receipt and payment of recurring general and administrative expenses. These factors resulted in distributable income for the three months ended September 30, 2023 of $3,570,000, a decrease of $2,890,000 from $6,460,000 for the three months ended September 30, 2022.

Results of Operations for the Nine Months Ended September 30, 2023 and 2022

The following is a summary of income from net profits interest received by the Trust for the nine months ended September 30, 2023 and 2022 consisting of the January, April and July distributions for each respective year:

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The cash received by the Trust from VOC Brazos during the nine months ended September 30, 2023 substantially represents the production by VOC Brazos from September 2022 through May 2023. The cash received by the Trust from VOC Brazos during the nine months ended September 30, 2022 substantially represents the production by VOC Brazos from September 2021 through May 2022. The revenues from oil production are typically received by VOC Brazos one month after production.

Gross proceeds. Oil and natural gas sales were $29,793,178 for the nine months ended September 30, 2023, a decrease of $5,291,697 or 15.1% from $35,084,875 for the nine months ended September 30, 2022. Revenues are a function of oil and natural gas volumes sold and prices received. The decrease in gross proceeds was due to decreases in oil and natural gas sales volumes and in market prices for oil and natural gas sales during the nine months ended September 30, 2023. During the nine months ended September 30, 2023, the average price for oil decreased 11.1% to $76.18 per Bbl and the average price for natural gas decreased 13.2% to $5.44 per Mcf. Oil sales volumes were 374,744 Bbls for the nine months ended September 30, 2023, a decrease of 16,975 Bbls or 4.3% from 391,719 Bbls for the nine months ended September 30, 2022, while natural gas sales volumes were 229,109 Mcf, a decrease of 10,145 Mcf or 4.2% from 239,254 Mcf for the same period in 2022.

Costs. Lease operating expenses were $11,213,378 for the nine months ended September 30, 2023, an increase of $656,360 or 6.2% from $10,557,018 for the nine months ended September 30, 2022. Production and property taxes were $1,830,926 for the nine months ended September 30, 2023, an increase of $201,148 or 12.3% from $1,629,778 for the nine months ended September 30, 2022. Such increase is the result of an increase of $357,641 or 56.3% in property taxes, partially offset by a decrease of $156,493 or 15.7% in production taxes due primarily to lower sales volumes and sales prices for oil and natural gas. Development expenses were $1,326,443 for the nine months ended September 30, 2023, a decrease of $580,912 or 30.5% from $1,907,355 for the same period in 2022. Such decrease was primarily due to a decrease in drilling activity and development expenses, during the nine months ended September 30, 2023, compared to the nine months ended September 30, 2022, a period that included drilling costs associated with two horizontal wells in Texas.

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 $15,422,431 for the nine months ended September 30, 2023, a decrease of $5,568,293 or 26.5% from $20,990,724 for the nine months ended September 30, 2022. The Trust’s 80% net profits interest of these totals was $12,337,945 and $16,792,579, respectively. During the nine months ended September 30, 2023 and 2022, 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 $12,337,945 and $16,792,579 for such periods, respectively. These amounts were reduced by a Trustee holdback for current estimated Trust expenses of $716,915 and $735,079 for the nine months ended September 30, 2023 and 2022, respectively, and a Trustee holdback for future estimated Trust expenses of $231,030 and $587,500 for the nine months ended September 30, 2023 and 2022, respectively. The Trustee paid general and administrative expenses of $868,648 for the nine months ended September 30, 2023, an increase of $96,360 from $772,288 for the nine months ended September 30, 2022. This increase was primarily due to the differences in timing of receipt and payment of recurring general and administrative expenses. These factors resulted in distributable income of $11,390,000 for the nine months ended September 30, 2023 and $15,470,000 for the nine months ended September 30, 2022.

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 September 30, 2023, $1,328,174 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 nine months ended September 30, 2023 and 2022, 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.

Beginning in the first quarter of 2022, the Trustee withheld a portion of the proceeds otherwise available for distribution each quarter to gradually build a $1.175 million cash reserve for the payment of future known, anticipated, or contingent expenses or liabilities of the Trust. This amount is in addition to the $1.7 million letter of credit described above. The targeted $1.175 million cash reserve was fully funded as of January 30, 2023. The Trustee may increase or decrease the targeted amount at any time and may increase or decrease the rate at which it withholds 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.

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 $1.0 million at September 30, 2023 and 2022.

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 this Form 10-Q and in the Trust’s Annual Report on Form 10-K for the year ended December 31, 2022 (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 September 30, 2023, 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.