NOTES TO FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION OF THE TRUST
Formation of the Trust and Provisions for Liabilities and Expenses
Enduro Royalty Trust (the Trust) is a Delaware statutory trust formed in May 2011 pursuant to a trust agreement (the
Trust Agreement) among Enduro Resource Partners LLC (Enduro), as trustor, The Bank of New York Mellon Trust Company, N.A. (the Trustee), as trustee, and Wilmington Trust Company (the Delaware Trustee),
as Delaware Trustee.
The Trust was created to acquire and hold for the benefit of the Trust unitholders a net profits interest
representing the right to receive 80% of the net profits from the sale of oil and natural gas production from certain properties in the states of Texas, Louisiana and New Mexico held by Enduro as of the date of the conveyance of the net profits
interest to the Trust (the Net Profits Interest). The properties in which the Trust holds the Net Profits Interest are referred to as the Underlying Properties. Enduro is a Delaware limited liability company engaged in the
production and development of oil and natural gas from properties located in the Rockies, the Permian Basin of west Texas and southeastern New Mexico, and the Arklatex region of Texas and Louisiana.
The Net Profits Interest is passive in nature and neither the Trust nor the Trustee has any management control over or responsibility for
costs relating to the operation of the Underlying Properties. The Trust is not subject to any pre-set termination provisions based on a maximum volume of oil or natural gas to be produced or the passage of time. The Trust will dissolve upon the
earliest to occur of the following:
|
|
|
the Trust, upon approval of the holders of at least 75% of the outstanding Trust Units, sells the Net Profits Interest;
|
|
|
|
the annual cash proceeds received by the Trust attributable to the Net Profits Interest are less than $2 million for each of any two consecutive years;
|
|
|
|
the holders of at least 75% of the outstanding Trust Units vote in favor of dissolution; or
|
|
|
|
the Trust is judicially dissolved.
|
The Trustee may create a cash reserve to pay for future
liabilities of the Trust and may authorize the Trust to borrow money to pay administrative or incidental expenses of the Trust that exceed its cash on hand and available reserves. At March 31, 2014 the Trust had $121,995 of cash and cash
equivalents, an increase of $36,643 from the December 31, 2013 cash and cash equivalents balance of $85,352. The Trustee may authorize the Trust to borrow from any person, including the Trustee, the Delaware Trustee or an affiliate thereof,
although none of the Trustee, the Delaware Trustee or any affiliate of either of them intends to lend funds to the Trust. The Trustee may also cause the Trust to mortgage its assets to secure payment of the indebtedness. The terms of such
indebtedness and security interest, if funds were loaned by the entity serving as Trustee or Delaware Trustee or an affiliate thereof, would be similar to the terms which such entity would grant to a similarly situated commercial customer with whom
it did not have a fiduciary relationship. Under the terms of the Trust Agreement, Enduro provided the Trust with a $1.0 million letter of credit to be used by the Trust in the event that its cash on hand (including available cash reserves) is not
sufficient to pay ordinary course administrative expenses. If the Trust requires more than the $1.0 million under the letter of credit to pay administrative expenses, Enduro has agreed to loan funds to the Trust necessary to pay such expenses. If
the Trust borrows funds, draws on the letter of credit or Enduro loans funds to the Trust, no further distributions will be made to Trust unitholders until such amounts borrowed or drawn are repaid. Since its formation, the Trust has not borrowed
any funds and no amounts have been drawn on the letter of credit.
Each month, the Trustee pays Trust obligations and expenses and
distributes to Trust unitholders the remaining proceeds received from the Net Profits Interest. The cash held by the Trustee as a reserve against future liabilities or for distribution at the next distribution date must be invested in:
|
|
|
Interest-bearing obligations of the United States government;
|
|
|
|
Money market funds that invest only in United States government securities;
|
|
|
|
Repurchase agreements secured by interest-bearing obligations of the United States government; or
|
|
|
|
Bank certificates of deposit.
|
Alternatively, cash held for distribution at the next
distribution date may be held in a noninterest-bearing account. At March 31, 2014 and December 31, 2013, the Trust did not have any cash on hand related to future distributions.
6
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS - Continued
(unaudited)
Net Profits Interest Conveyance, Initial Public Offering and Secondary Offering
On November 8, 2011, Enduro conveyed to the Trust, through the merger of a wholly owned subsidiary of Enduro with the Trust, the Net
Profits Interest in exchange for 33,000,000 units of beneficial interest in the Trust (the Trust Units). Immediately following the conveyance, Enduro completed an initial public offering of 13,200,000 Trust Units at $22.00 per unit.
After the completion of the initial public offering and as of December 31, 2012 and 2011, Enduro owned 19,800,000 Trust Units, or 60% of the issued and outstanding Trust Units.
On October 2, 2013, Enduro completed a secondary offering of 11,200,000 Trust Units at a price of $13.85 per unit to the public. The
Trust did not sell any units in the offering and did not receive any proceeds from the offering. After the completion of the secondary offering, and as of March 31, 2014 and December 31, 2013, Enduro owned 8,600,000 Trust Units, or 26% of
the issued and outstanding Trust Units.
7
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS - Continued
(unaudited)
2. BASIS OF PRESENTATION
The accompanying Statement of Assets, Liabilities and Trust Corpus as of December 31, 2013, which has been derived from audited financial
statements, and the unaudited interim financial statements as of March 31, 2014 and for the three months ended March 31, 2014 and 2013 have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.
Accordingly, certain information and disclosures normally included in annual financial statements have been condensed or omitted pursuant to those rules and regulations. Therefore, these financial statements should be read in conjunction with the
financial statements and notes thereto included in the Trusts 2013 Annual Report on Form 10-K.
In the opinion of the Trustee, the
accompanying unaudited financial statements reflect all adjustments that are necessary for a fair presentation of the interim periods presented and include all the disclosures necessary to make the information presented not misleading.
The preparation of financial statements requires the Trustee to make estimates and assumptions that affect reported amounts of assets and
liabilities and the reported amounts of revenues and expenses during the reporting period. Although the Trustee believes that these estimates are reasonable, actual results could differ from those estimates.
The Trust uses the modified cash basis of accounting to report Trust receipts of income from 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 of the Underlying
Properties plus any payments made or net payments received in connection with the settlement of certain hedge contracts, multiplied by 80%. Cash distributions of the Trust are made based on the amount of cash received by the Trust pursuant to terms
of the conveyance creating the Net Profits Interest.
Under the terms of the conveyance, the monthly Net Profits Interest calculation
includes oil and natural gas revenues received as well as cash settlements for applicable hedge contracts received by Enduro during the relevant month. Monthly operating expenses and capital expenditures represent incurred expenses, and as a result,
represent accrued expenses as well as expenses paid during the period.
The financial statements of the Trust are prepared on the
following basis:
(a) Income from 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 includes the Trustees 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 future
expenditures that would not be recorded as contingent liabilities under accounting principles generally accepted in the United States of America (GAAP);
(e) Amortization of the Net Profits Interest in oil and natural gas properties is calculated on a unit-of-production basis and is charged
directly to the Trust corpus; and
(f) The Net Profits Interest in oil and natural gas properties is periodically assessed whenever events
or circumstances indicate that the aggregate value may have been impaired below its total capitalized cost based on the Underlying Properties. If an impairment loss is indicated by the carrying amount of the assets exceeding the sum of the
undiscounted expected future net cash flows of the Net Profits Interest, then an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds its estimated fair value determined using discounted cash flows.
The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in
the month of production; cash reserves may be established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; expenses are recorded when paid instead of when incurred; and amortization of the net
profits interest calculated on a unit-of-production basis is charged directly to trust corpus instead of as an expense. While these statements differ from financial statements prepared in accordance with GAAP, the modified cash basis of reporting
revenues, expenses, and distributions is considered to be the most meaningful because monthly distributions to the Trust unitholders are based on net cash receipts.
8
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS - Continued
(unaudited)
This comprehensive basis of accounting other than GAAP corresponds to the accounting
permitted for royalty trusts by the U.S. Securities and Exchange Commission as specified by Staff Accounting Bulletin Topic 12:E,
Financial Statements of Royalty Trusts
.
New Accounting Pronouncements
As
the Trusts financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trusts financial statements. No new accounting pronouncements have been adopted or issued that would impact
the financial statements of the Trust.
3. NET PROFITS INTEREST IN OIL AND NATURAL GAS PROPERTIES
The Net Profits Interest in oil and natural gas properties was recorded at its fair value on the date of conveyance. Amortization of the Net
Profits Interest in oil and natural gas properties is calculated on a unit-of-production basis based on the Underlying Properties production and reserves. Accumulated amortization as of March 31, 2014 and December 31, 2013 was
$166,022,731 and $154,688,885, respectively.
4. COMMODITY HEDGES
The Trust is exposed to fluctuations in energy prices in the normal course of business due to the Net Profits Interest in the Underlying
Properties. 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 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 Enduro and its third party operators can economically produce. To mitigate the negative effects of a possible decline in oil and natural gas prices on
distributable income to the Trust and to achieve more predictable cash flows, Enduro entered into hedge contracts with respect to approximately 51% of expected oil and natural gas production for 2013. Enduro did not enter into any hedge contracts
relating to oil and natural gas volumes expected to be produced after 2013 and the terms of the Net Profits Interest prohibit Enduro from entering into new hedging arrangements burdening the Trust. As of December 31, 2013, all hedge contracts
had matured. Consequently, all production attributable to the Trust in 2014 and thereafter is expected to be unhedged.
5. INCOME TAXES
Federal Income Taxes
For federal
income tax purposes, the Trust is a grantor trust and therefore is not subject to tax at the trust level. Trust unitholders are treated as owning a direct interest in the assets of the Trust, and each Trust unitholder is taxed directly on his pro
rata share of the income and gain attributable to the assets of the Trust and entitled to claim his pro rata share of the deductions and expenses attributable to the assets of the Trust. The income of the Trust is deemed to have been received or
accrued by each unitholder at the time such income is received or accrued by the Trust rather than when distributed by the Trust.
The
deductions of the Trust consist of severance taxes and administrative expenses. In addition, each unitholder is entitled to depletion deductions because the Net Profits Interest constitutes economic interests in oil and gas properties
for federal income tax purposes. Each unitholder is entitled to amortize the cost of the Trust Units through cost depletion over the life of the Net Profits Interest or, if greater, through percentage depletion. Unlike cost depletion, percentage
depletion is not limited to a unitholders depletable tax basis in the Trust Units. Rather, a unitholder is entitled to percentage depletion as long as the applicable Underlying Properties generate gross income.
Some Trust Units are held by a middleman, as such term is broadly defined in U.S. Treasury Regulations (and includes custodians, nominees,
certain joint owners, and brokers holding an interest for a custodian in street name). Therefore, the Trustee considers the Trust to be a non-mortgage widely held fixed investment trust (WHFIT) for U.S. federal income tax purposes. The
Bank of New York Mellon Trust Company, N.A., 919 Congress Avenue, Austin, Texas 78701, telephone number (512) 236-6545, is the representative of the Trust that will provide tax information in accordance with applicable U.S. Treasury Regulations
governing the information reporting requirements of the Trust as a WHFIT. Tax information is also posted by the trustee at
www.enduroroyaltytrust.com
. Notwithstanding the foregoing, the middlemen holding units on behalf of unitholders, and
not the Trustee of the Trust, are solely responsible for complying with the information reporting requirements under the U.S. Treasury Regulations with respect to such units, including the issuance of IRS Forms 1099 and certain written tax
statements. Unitholders whose units are held by middlemen should consult with such middlemen regarding the information that will be reported to them by the middlemen with respect to the Trust Units.
9
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS - Continued
(unaudited)
The tax consequences to a unitholder of ownership of Trust Units will depend in part on the
unitholders tax circumstances. Unitholders should consult their tax advisors about the federal tax consequences relating to owning the Trust Units.
State Taxes
The Trusts
revenues are from sources in the states of Louisiana, New Mexico and Texas. Because it distributes all of its net income to unitholders, the Trust should not be taxed at the trust level in Louisiana or New Mexico. While the Trust should not owe
tax, the Trustee is required to file a return with Louisiana reflecting the income and deductions of the Trust attributable to properties located in that state. Texas does not impose a state income tax, so the Trusts income will not be subject
to income tax at the trust level in Texas. Louisiana and New Mexico presently have income taxes which tax income of nonresidents from real property located within that state. Louisiana and New Mexico tax nonresidents on royalty income from the
royalties located in that state. Louisiana and New Mexico also impose a corporate income tax which may apply to unitholders organized as corporations.
Texas imposes a franchise tax at a rate of 1% on gross revenues less certain deductions, as specifically set forth in the Texas franchise tax
statutes. Entities subject to tax generally include trusts unless otherwise exempt. Trusts that receive at least 90% of their federal gross income from designated passive sources, including royalties from mineral properties and other income from
other non-operating mineral interests, and do not receive more than 10% of their income from operating an active trade or business, generally are exempt from the Texas franchise tax as passive entities. While the Trust is intended to be
exempt from Texas franchise tax at the Trust level as a passive entity, each unitholder that is considered a taxable entity under the Texas franchise tax would generally be required to include its portion of Trust net income in its own Texas
franchise tax computation.
Each unitholder should consult his or her own tax advisor regarding state tax requirements, if any, applicable
to such persons ownership of Trust Units.
6. DISTRIBUTIONS TO UNITHOLDERS
Each month, the Trustee determines the amount of funds available for distribution to the Trust unitholders. 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) that month, over the Trusts liabilities for that month, subject to adjustments for changes
made by the Trustee during the month in any cash reserves established for future liabilities of the Trust. Distributions are made to the holders of Trust Units as of the applicable record date (generally the last business day of each calendar month)
and are payable on or before the 10th business day after the record date.
The following table provides information regarding the
Trusts distributions paid during the three months ended March 31, 2014 and 2013:
|
|
|
|
|
|
|
|
|
Declaration Date
|
|
Record Date
|
|
Payment Date
|
|
Distribution per Unit
|
|
Three Months Ended March 31, 2014:
|
|
|
|
|
|
|
|
|
December 20, 2013
|
|
December 31, 2013
|
|
January 15, 2014
|
|
$
|
0.134090
|
|
January 21, 2014
|
|
January 31, 2014
|
|
February 14, 2014
|
|
$
|
0.117935
|
|
February 18, 2014
|
|
February 28, 2014
|
|
March 14, 2014
|
|
$
|
0.100655
|
|
|
|
|
|
Three Months Ended March 31, 2013:
|
|
|
|
|
|
|
|
|
December 20, 2012
|
|
December 31, 2012
|
|
January 15, 2013
|
|
$
|
0.139439
|
|
January 18, 2013
|
|
January 31, 2013
|
|
February 14, 2013
|
|
$
|
0.125276
|
|
February 15, 2013
|
|
February 28, 2013
|
|
March 14, 2013
|
|
$
|
0.070519
|
|
7. RELATED PARTY TRANSACTIONS
Under the terms of the Trust Agreement, the Trust pays an annual administrative fee of $200,000 to the Trustee and $2,000 to the Delaware
Trustee. During the three months ended March 31, 2014 and 2013, the Trust paid $50,000 and $50,451, respectively, to the Trustee pursuant to the terms of the Trust Agreement. No amounts were paid to the Delaware Trustee.
10
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS - Continued
(unaudited)
8. SUBSEQUENT EVENTS
On April 14, 2014, the distribution of $0.070692 per Trust Unit, which was declared on March 21, 2014, was paid to Trust unitholders
owning Trust Units as of March 31, 2014. The distribution consisted of net profits allocable to the Trust of $2,407,842, less cash reserves withheld for future Trust expenses of approximately $75,000.
On April 17, 2014, the Trust declared a distribution of $0.032496 per unit to unitholders of record as of April 30, 2014. The
distribution is expected to be paid to unitholders on May 14, 2014.
11