PermRock Royalty Trust - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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þ  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2020

Or

¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from: _____________ to _____________

Commission File Number: 001-38472

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PERMROCK ROYALTY TRUST

(Exact name of registrant as specified in the

Amended and Restated Trust Agreement of PermRock Royalty Trust)

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Simmons Bank, Trustee

P.O. Box 470727

Fort Worth, Texas 76147

 (Address of Principal Executive Offices) (Zip Code)

(855) 588-7839

(Registrant’s telephone number, including area code)

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Securities registered pursuant to Section 12(b) of the Act:  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes   ¨ No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  ¨ Yes  ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨ Yes  þ No

As of November 16, 2020, 12,165,732 trust units representing beneficial interests in PermRock Royalty Trust were outstanding.

TABLE OF CONTENTS

i

Glossary of Terms

ii

PART I. – FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

The condensed financial statements included herein are presented without audit, pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted pursuant to such rules and regulations, and Simmons Bank, as Trustee (the “Trustee”), believes that the disclosures are adequate to make the information presented not misleading.  These condensed interim financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto included in the Trust’s 2019 Annual Report on Form 10-K (“2019 Annual Report”).  In the opinion of the Trustee, all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the assets, liabilities and Trust corpus of PermRock Royalty Trust at September 30, 2020 and December 31, 2019, and the distributable income and changes in Trust corpus for the three- and nine-month periods ended September 30, 2020 and September 30, 2019 have been included.  Distributable income for such interim periods is not necessarily indicative of distributable income for the full year.

1

PERMROCK ROYALTY TRUST

CONDENSED STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS

The accompanying notes to condensed financial statements are an integral part of these financial statements.

2

PERMROCK ROYALTY TRUST

CONDENSED STATEMENTS OF DISTRIBUTABLE INCOME (UNAUDITED)

The accompanying notes to condensed financial statements are an integral part of these financial statements.

3

PERMROCK ROYALTY TRUST

CONDENSED STATEMENTS OF CHANGES IN TRUST CORPUS (UNAUDITED)

The accompanying notes to condensed financial statements are an integral part of these financial statements.

4

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

PermRock Royalty Trust (the “Trust”) is a Delaware statutory trust formed on November 22, 2017 under the Delaware Statutory Trust Act pursuant to a trust agreement dated November 22, 2017, as amended and restated on May 4, 2018, by and among Boaz Energy II, LLC (“Boaz Energy”), as trustor, Simmons Bank, as Trustee (the “Trustee”), and Wilmington Trust, National Association, as Delaware Trustee (the “Delaware Trustee”) (such amended and restated trust agreement, as amended to date, the “Trust Agreement”).

The Trust was created to acquire and hold the Net Profits Interest for the benefit of the Trust unitholders.  In connection with the closing of the initial public offering of Trust units, on May 4, 2018, Boaz Energy conveyed the Net Profits Interest to the Trust in exchange for Trust units pursuant to a conveyance agreement between Boaz Energy, the Trustee and the Delaware Trustee (the “Conveyance”).  The Net Profits Interest represents an interest in the Underlying Properties.

The Net Profits Interest entitles the Trust to receive 80% of the net profits from the sale of oil and natural gas production from the Underlying Properties.  The Net Profits Interest is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, costs relating to the operation of the Underlying Properties.  The Trust has and will continue to make monthly cash distributions of the balance, if any, of all of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and any cash reserves, to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date.  Distributions generally relate to sales from a one-month period.

The Trustee may deposit funds awaiting distribution in an account with an FDIC-insured or national bank, including the Trustee, if the interest paid to the Trust at least equals amounts paid by the Trustee on similar deposits, and make other short-term investments with the funds distributed to the Trust.

In May 2018, Boaz Energy completed an initial public offering of 6,250,000 of its Trust units.  

The Trust uses the modified cash basis of accounting to report Trust receipts of the Net Profits Interest and payments of expenses incurred.  The Net Profits Interest represents the right to receive revenues (primarily oil and natural gas sales), less direct operating expenses, lease operating expenses, severance and ad valorem taxes and development expenses of the Underlying Properties, multiplied by 80%, less any payments made or plus any payments received in connection with the settlement of certain hedge contracts.  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.

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

5

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

The financial statements of the Trust are prepared on a modified cash basis of accounting, which is considered to be the most meaningful basis of preparation for a royalty trust because monthly distributions to the Trust unitholders are based on net cash receipts.  Although this basis of accounting is permitted for royalty trusts by the SEC, the financial statements of the Trust differ from financial statements prepared in accordance with GAAP because net profits income is not accrued in the month of production, expenses are not recognized when incurred and cash reserves may be established for certain contingencies that would not be recorded in GAAP financial statements.  This comprehensive basis of accounting other than 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 accompanying unaudited financial statements have been prepared by the Trust in accordance with the accounting policies stated in the audited financial statements and notes of the Trust thereto included in the Trust’s 2019 Annual Report and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements.

The preparation of financial statements requires the Trust to make estimates and assumptions that affect the reported amounts of assets and liabilities and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates. Estimated future cash flows used to determine amortization and potential impairment of the investment in the Net Profits Interest are subject to change.

The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil and natural gas, each of which depends on numerous factors beyond the Trust’s control such as economic conditions, the global political environment, regulatory developments and competition from other energy sources.  Oil and natural gas prices historically have been volatile and may be subject to significant fluctuations in the future.

Revenue received by the Trust (and its ability to pay distributions) has been and will continue to be directly affected by the volatility in commodity prices, which declined sharply during the first and second quarters of 2020 and remained depressed in the third quarter of 2020 in response to the economic effects of the COVID-19 pandemic.  The decline in commodity prices has resulted in an oversupply of crude oil, further exacerbating the decline in crude oil prices, which could remain depressed for an extended period of time.

Contingencies related to the Underlying Properties that are unfavorably resolved would generally be expected to result in reductions to cash receipts to the Trust in respect of the Net Profits Interest with corresponding reductions to cash distributions to Trust unitholders.  Please see the discussion of litigation in Note 9 to condensed financial statements.

Tax counsel advised the Trust at the time of formation that for U.S. federal income tax purposes, the Trust is treated as a grantor trust and will not be subject to federal income tax at the trust level.  Trust unitholders will be treated for such purposes as owning a direct interest in the assets of the Trust, and each Trust unitholder is taxed directly on its pro rata share of the income and any gain, if sold, attributable to the assets of the Trust and is entitled to claim its pro rata share of deductions and expenses attributable to the assets of the Trust.  Each Trust unitholder should consult his or her own tax advisor regarding income tax requirements, if any, applicable to such unitholder’s ownership of Trust units.

6

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Pursuant to the Trust Agreement, as of May 31, 2019, the Trustee began retaining cash from the distributions the Trust receives 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 as they become due.  The Trustee is authorized to retain cash reserves (i) in an amount not to exceed $1.0 million at any one time and (ii) in such amounts as the Trustee in its discretion deems appropriate to pay for future liabilities of the Trust, but not less than $25,000 per month or more than $100,000 per month.  Cash reserves held by the Trustee for administrative expenses totaled $1,000,000 as of September 30, 2020.

Boaz Energy is entitled under the Conveyance to reserve up to $3 million from the net profits for certain future taxes and development or operating expenses.  In July 2020, Boaz Energy applied $192,721 net to the Trust of funds previously reserved toward taxes and development expenses, plus an advancement from Boaz Energy to the Trust in the amount of $140,606.  Then, in August 2020, Boaz Energy reserved $320,960 net to the Trust,  which was applied in part to recoupment of the $140,606 net to the Trust balance of previously advanced funds, and the remaining $180,354 net to the Trust was reserved for certain future taxes and development expenses. In September 2020, Boaz Energy reserved an additional $117,802 net to the Trust for certain future taxes and development expenses.  As of September 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $298,156.

The Trust makes monthly cash distributions of the net amount, if any, of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and cash reserves to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date.

Based on 12,165,732 Trust units outstanding at each date listed below, the per unit distributions during the quarter ended September 30, 2020 were as follows:

Trustee Administrative Fee.  Under the terms of the Trust Agreement, the Trust pays an annual administrative fee to the Trustee and the Delaware Trustee.  The Delaware Trustee’s annual fee is $4,000.  For 2020, the Trustee’s annual administrative fee is $189,072, which is divided into twelve equal monthly payments throughout the year.  The Trustee’s annual administrative fee will increase at a rate of 3% per year for the first three years of the Trust’s existence, increase at a rate of 2% per year for the following two years, then increase at a rate of 1% per year until the 20th anniversary of the Trust’s formation and then remain flat thereafter.  These costs of the Trust, which are included in administration expenses, are deducted by the Trust before distributions are made to Trust unitholders.

Agreements with Boaz Energy.  On May 4, 2018, the Trust entered into a registration rights agreement for the benefit of Boaz Energy and certain of its affiliates and transferees, pursuant to which the Trust agreed to register the offering of the Trust units held by Boaz Energy and certain of its affiliates and permitted transferees upon request by Boaz Energy.  As of September 30, 2020, Boaz Energy owned 5,878,332 Trust units of the 12,165,732 Trust units issued and outstanding.

7

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

Income from the Net Profits Interest is exposed to fluctuations in energy prices in the normal scope of business.  To mitigate the negative effects of a possible decline in oil prices on distributable income to the Trust, Boaz Energy entered into derivative put option contracts with respect to approximately 100% of expected oil production attributable to the Net Profits Interest during 2018 and 76% of such production during 2019.  These derivative contracts consisted of put option contracts with strike prices of $60 per barrel in 2018 and $50 per barrel in 2019.  Boaz Energy believed that these put option contracts provided downside protection to the Trust in the event spot prices for crude oil declined below the applicable strike price, while still allowing the Trust to benefit from increasing crude oil prices.  If prices for crude oil as quoted on NYMEX declined below the applicable strike prices, Boaz Energy could exercise its put option and receive payment generally equal to the difference between the applicable strike price and the market price for crude oil at the time of exercise, multiplied by the notional quantity of crude oil hedged under the applicable put option contract being exercised.  These contracts expired as of December 31, 2019, and after December 31, 2019 none of the production attributable to the Underlying Properties is hedged.

Because the derivative contracts have expired, there were no cash proceeds from settlement of derivative contracts during the three or nine months ended September 30, 2020. There were no cash proceeds from settlement of derivative contracts during the three months ended September 30, 2019, but for the nine months ended September 30, 2019, there was $688,562 ($550,850 net to the Trust) in cash proceeds from the settlement of derivative contracts.  

Boaz Energy has advised the Trustee that the estimate for Boaz Energy’s 2020 capital budget has been increased from $2.5 million to $4.2 million, based principally upon capital projects being implemented by outside operators, of which $3.3 million has been expended as of September 30, 2020.  Based on current oil and gas prices, Boaz Energy has informed the Trustee that it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers principally in the Permian Platform area, the costs of which are included in the $4.2 million estimate.  The estimated 2020 capital budget is subject to change based on, among other things, changes in the price of oil and natural gas, the impact of the COVID-19 pandemic on prices and economic activity, Boaz Energy’s actual capital requirements, capital expenditure requirements of third-party operators, the pace of regulatory approvals and the mix of projects.

On October 1, 2018, a lawsuit styled Thaleia L. Marston, Trustee of the Marston Trust v. Blackbeard Operating, LLC, et.al, No. 18-10-24761 – CVW in the 143rd District Court in Ward County, Texas (the “2018 Litigation”) was filed, naming, among others, Boaz Energy and the Trust as defendants.  The plaintiff is a lessor under two leases operated by Blackbeard Operating, LLC.  The Underlying Properties include the interests of Boaz Energy in some of the minerals covered by those leases.  The litigation seeks surface use damages and alleges violations of the terms of the leases, among other things. While it is not yet possible to estimate any potential loss or range of loss, Boaz Energy has advised the Trustee that it does not anticipate the litigation will materially affect the Trust.  On January 3, 2020, Lawrence M. Marston joined the lawsuit as a plaintiff alleging surface damage claims against Blackbeard and Goodnight Midstream Permian, L.L.C., but not against the Trust.  On January 17, 2020, the Trust and the other defendants filed a motion for summary judgment, which would dispose of the claims against the Trust if granted.  After delays related to COVID-19, a hearing on the summary judgment motions filed by the Defendants and Goodnight was held on August 27, 2020.  As of September 30, 2020 the court had not yet ruled on the motion for summary judgment. A mediation was conducted on November 10, 2020, but no settlement was reached.

8

PERMROCK ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

On October 20, 2020, the Trust declared a cash distribution of 0.013487 per Trust unit based upon production during the month of August 2020 to record holders as of October 30, 2020. The distribution will be paid on November 16, 2020. The following table shows underlying oil and natural gas sales and average prices during the production month of August 2020 and attributable to the distribution declared on October 20, 2020:

In October 2020, Boaz Energy reserved $104,000 net to the Trust for certain future taxes and development expenses.

A mediation was conducted on November 10, 2020 with respect to the 2018 Litigation, but no settlement was reached.

9

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 condensed financial statements and the accompanying notes included in this Quarterly Report on Form 10-Q (“Quarterly Report”) and the Trust’s audited financial statements and the accompanying notes included in the Trust’s 2019 Annual Report.

Cautionary Statement Regarding Forward Looking Statements

Certain information included in this Quarterly Report contains, and other materials filed or to be filed by the Trust with the SEC (as well as information included in oral statements or other written statements made or to be made by the Trust) may contain or include, forward-looking statements within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended (the “Securities Act”).  Such forward-looking statements generally are accompanied by words such as “may,” “will,” “estimate,” “expect,” “predict,” “project,” “anticipate,” “goal,” “should,” “assume,” “believe,” “plan,” “intend,” or other words that convey the uncertainty of future events or outcomes.  All statements other than statements of historical fact included in this Quarterly Report are forward-looking statements, including without limitation statements under this “Trustee’s Discussion and Analysis of Financial Conditions and Results of Operations” and all statements regarding Boaz Energy and Simmons Bank’s (as Trustee of the Trust) expectations, beliefs and plans regarding the following: (i) Boaz Energy’s capital budget and projects, timing and estimated costs, and the resulting impact of those activities on the computation of the Net Profits Interest; (ii) outside operators’ capital projects and the resulting impact of those activities on the Net Profits Interest; (iii) implementation or continued use of waterflood projects and workovers and the location of waterflood projects and workovers; (iv)  Boaz Energy’s estimated capital expenditures; (v) the timing of capital expenditures and capital reserve amounts; (vi) the expected timing of litigation proceedings; (vii) the impact of current litigation matters on the Trust; (viii) Boaz Energy’s staffing levels or future reductions in staffing on the Underlying Properties; (ix) shut in of wells on the Underlying Properties; (x) the effects of COVID-19 and OPEC production levels; and (xi) distributions to Trust unitholders.  Such statements are based on certain assumptions of the Trustee, and certain assumptions of information provided to the Trust by Boaz Energy, the owner of the Underlying Properties; are based on an assessment of, and are subject to, a variety of factors deemed relevant by the Trustee and Boaz Energy; and involve risks and uncertainties.  Certain factors could affect the future results of the energy industry in general, and Boaz Energy and the Trust in particular, and could cause actual results to differ materially from those projected in such forward-looking statements.  Those factors include, without limitation, the following:

·

the effect of changes in commodity prices or alternative fuel prices;

·

uncertainties in estimating production and oil and natural gas reserves of the Underlying Properties;

·

risks associated with the drilling and operation of oil and natural gas wells;

·

the cost of developing the Underlying Properties;

·

the ability to maintain anticipated production levels;

·

the amount of future direct operating expenses, development expenses and other capital expenditures;

·

availability and terms of capital to fund capital expenditures;

·

risks associated with Boaz Energy and its ability to transfer operation of the Underlying Properties to third parties without the approval of Trust unitholders;

·

the effect of existing and future laws and regulatory actions;

·

risks associated with derivative instruments, such as lower than expected production volumes, default of counterparties, and increases in price differentials;

·

conditions in the capital markets;

·

competition from others in the energy industry;

·

uncertainty in whether development projects will be pursued;

·

severe or unseasonable weather that may adversely affect production;

·

costs to comply with current and future governmental regulation of the oil and natural gas industry, including environmental, health and safety laws and regulations, and regulations with respect to hydraulic fracturing and the disposal of produced water;

·

the effect of existing and future laws and regulatory actions, including real estate, bankruptcy and tax legislation and the ability to accurately interpret the impact of such laws;

·

general economic conditions affecting the areas where Boaz Energy operates;

10

·

actions by Boaz Energy, including such that result in conflicts of interest, that adversely affect the Trust;

·

the outcome of pending litigation matters;

·

the cost of inflation; and

·

the risk factors discussed in Item 1A of Part II of this Quarterly Report and in Part I of the Trust’s 2019 Annual Report.

You should not place undue reliance on any forward-looking statements.  All forward-looking statements speak as of the date of this Quarterly Report.  The Trust does not undertake any obligation to release publicly any revisions to the forward-looking statements to reflect events or circumstances after the date of this Quarterly Report or to reflect the occurrence of unanticipated events, unless required by applicable law.

Boaz Energy Information

As a holder of a net profits interest, the Trust relies on Boaz Energy for information regarding Boaz Energy and its affiliates; the Underlying Properties, including the operations, acreage, well and completion count, working interests, production volumes, sales revenues, capital expenditures, operating expenses, reserves, drilling plans, drilling results and leasehold terms related to the Underlying Properties; and factors and circumstances that have or may affect the foregoing.

Overview

PermRock Royalty Trust, a Delaware statutory trust formed in November 2017 by Boaz Energy, completed its initial public offering in May 2018.  The Trust’s main asset and source of income is the Net Profits Interest, which entitles the Trust to receive 80% of the net profits from oil and natural gas production from the Underlying Properties.  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.

Although the Trust was formed on November 22, 2017, the conveyance of the Net Profits Interest did not occur until May 4, 2018, with an effective date of January 1, 2018, and no proceeds were received by the Trust from Boaz Energy during the three-month period ended March 31, 2018.  As a result, the Trust did not recognize any income or make any distributions during the three-month period ended March 31, 2018.

The Trust is required to make monthly cash distributions of substantially all of its monthly cash receipts, after deduction of fees and expenses for the administration of the Trust and any cash reserves, to holders of its Trust units as of the applicable record date on or before the 10th business day after the record date.  The Net Profits Interest is entitled to a share of the profits from and after January 1, 2018 attributable to production occurring on or after such date.  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 amount of Trust revenues and cash distributions to Trust unitholders depends on, among other things:

·

volumes produced;

·

wellhead prices;

·

price differentials;

·

production and development costs;

·

potential reductions or suspensions of production; and

·

the amount and timing of Trust administrative expenses.

Boaz Energy typically receives payment for oil production 30 to 60 days after it is produced and for natural gas production 60 to 90 days after it is produced.

Properties.  The Underlying Properties consist of four operating areas in the Permian Basin in Texas, aggregating 35,390 gross (22,997 net) acres.  The Permian Clearfork area consists of 2,434 net acres on the Central Basin Platform of the Permian Basin in Hockley and Terry Counties, Texas.  The Permian Abo area consists of 1,667 net acres on the Central Basin Platform of the Permian Basin in Terry and Cochran Counties, Texas.  The Permian Shelf area consists of 14,727 net acres on the Eastern Shelf of the Permian Basin in Glasscock, Schleicher, Stonewall and Coke Counties, Texas.  The Permian Platform area consists of 4,169 net acres on the Central Basin Platform of the Permian Basin in Ward, Crane, Terry and Ector Counties, Texas.

11

Outlook

Boaz Energy has informed the Trustee that due to current oil and natural gas pricing it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers, principally in the Permian Platform area.  Boaz Energy has implemented reduced staffing measures on the Underlying Properties and anticipates reacting on a monthly basis to the need to shut in wells on the Underlying Property to reduce the risk of a realization of negative oil prices in a production month. Boaz Energy has indicated it currently intends to continue to build a reserve for capital costs and other expenses, as permitted under the Conveyance, which reserves will reduce distributions to the Trust.

RESULTS OF OPERATIONS

Distributable Income

Three Months Ended September 30, 2020

For the three months ended September 30, 2020, net profits income received by the Trust was $326,946 compared to $2,950,430 for the same period of the prior year. This decrease in net profits income was primarily due to decreased oil production and sales, as well as decreased oil prices and oversupply resulting from economic effects of the COVID-19 pandemic. See “Computation of Income from the Net Profits Interest Received by the Trust” below.

After considering interest income of $127 and general and administrative expenditures of $205,416, distributable income for the three months ended September 30, 2020 was $121,657, or $0.010000 per Trust unit. For the three months ended September 30, 2019, total distributable income was $2,556,326, or $0.210124 per unit.

Interest income was lower for the quarter ended September 30, 2020 as compared to the prior year, due to less investable cash received attributable to the Net Profits Interest and lower interest rates.  General and administrative expenditures decreased by $32,000 for the three months ended September 30, 2020 as compared to the prior year, primarily due to timing of payments.

Pursuant to the Trust Agreement, as of May 31, 2019, the Trustee was authorized to begin retaining cash reserves for administrative expenses.  The Trustee did not retain any cash reserves during the three months ended September 30, 2020.  During the three months ended September 30, 2019, $160,000 in cash reserves were retained. Total cash reserves were $1,000,000 as of September 30, 2020 compared to $300,000 as of September 30, 2019.

Based on 12,165,732 Trust units outstanding at each date listed below, the per unit distributions during the three months ended September 30, 2020 were as follows:

Nine Months Ended September 30, 2020

For the nine months ended September 30, 2020, net profits income received by the Trust was $2,458,193 compared to $8,414,422 for the same period of the prior year. This decrease in net profits income was primarily due to decreased oil production and sales, as well as decreased oil prices and oversupply resulting from economic effects of the COVID-19 pandemic and the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries. See “Computation of Income from the Net Profits Interest Received by the Trust” below.

After considering interest income of $4,446, general and administrative expenditures of $745,917, distributable income for the nine months ended September 30, 2020 was $1,316,722, or $0.108232 per Trust unit. For the nine months ended September 30, 2019, total distributable income was $7,272,839, or $0.597812 per unit.

Interest income decreased for the nine months ended September 30, 2020 as compared to the prior year, due to less investable cash received attributable to the Net Profits Interest in 2020 and lower interest rates. General and administrative expenditures decreased by $103,000 for the nine months ended September 30, 2020 as compared to the prior year, primarily due to timing of payments and lower legal fees.

12

The Trustee retained $400,000 in cash reserves during the nine months ended September 30, 2020 compared to $160,000 in cash reserves retained in the prior year period. Pursuant the terms of the Trust Agreement, the Trustee was authorized to begin retaining cash reserves for administrative expenses in May of 2019.  Total cash reserves were $1,000,000 as of September 30, 2020 compared to a total of $300,000 as of September 30, 2019.

Computation of Income from the Net Profits Interest Received by the Trust

The Net Profits Interest entitles the Trust to receive 80% of the net profits attributable to Boaz Energy’s interest from the sale of oil and natural gas production from the Underlying Properties.  The Trust’s income from the Net Profits Interest consists of monthly net profits attributable to income from the Underlying Properties.  Because of the interval between the time of production and receipt of net profits income by the Trust, the Trust recognizes production during the month in which the related net profits income is paid to the Trust.  Net profits income for the three months ended September 30, 2020, was based on production during the months of May 2020 through July 2020.  The table below outlines the computation of income from the Net Profits Interest received by the Trust for the three and nine months ended September 30, 2020 and September 30, 2019:

(1)

Quarterly sales volumes are typically reported for a three-month period, and therefore sales volumes for the three months ended September 30, 2020 reflect production volumes for May 2020 through July 2020.  Sales volumes for the nine months ended September 30, 2020 reflect production volumes for November 2019 through July 2020.

(2)

Sales volumes for natural gas include NGLs.

(3)

Reflects gross cash proceeds from settlement of derivative contracts relating to production as discussed in Note 7 to condensed financial statements and elsewhere in this Quarterly Report.

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(4)

Boaz Energy is entitled under the Conveyance to reserve up to $3 million from the net profits for certain future taxes and expenses. In July 2020, Boaz Energy applied $192,721 net to the Trust of funds previously reserved toward taxes and development expenses, plus an advancement from Boaz Energy to the Trust in the amount of $140,606.  Then, in August 2020, Boaz Energy reserved $320,960 net to the Trust,  which was applied in part to recoupment of the $140,606 net to the Trust balance of previously advanced funds, and the remaining $180,354 net to the Trust was reserved for certain future taxes and development expenses. In September 2020, Boaz Energy reserved an additional $117,802 net to the Trust for certain future taxes and development expenses.  As of September 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $298,156.

Important factors used in calculating the Trust’s net profits income include the volumes of oil and natural gas produced from the Underlying Properties and the realized prices received for the sale of those minerals, including oil and natural gas liquids, as well as direct operating expenses, lease operating expenses, severance and ad valorem taxes, development and other expenses and capital reserves.

Sales Volumes

Oil

Oil sales volumes decreased by 44,563 Bbls (32%) and 59,649 Bbls (14%), respectively, for the three and nine months ended September 30, 2020 as compared to the same periods in the prior year.  Boaz Energy reports this decrease was primarily due to decreased oil demand as a result of oversupply and economic effects of COVID-19, and also, as pertains to the nine-month decrease, Boaz Energy’s shut in of a material amount of production in May 2020 due to price uncertainties.

Natural Gas

Natural gas sales volumes decreased by 20,715 (14%) for the three months ended September 30, 2020 as compared to the prior year period. Boaz Energy reports this decrease was primarily because of decreased natural gas demand and sales as a result of oversupply and economic effects of COVID-19. Natural gas sales volumes decreased by 39,961 Mcf (9%) for the nine months ended September 30, 2020 as compared to the prior year period. Boaz Energy reports this decrease was primarily because of the effects of a shut in at a natural gas processing plant in Crane County during the first quarter of 2020 and Boaz Energy’s shut in of a material amount of production in May 2020 due to price uncertainties, but also due to the decrease in natural gas demand and sales as a result of oversupply and economic effects of COVID-19.

Sales Prices

Oil

The average realized oil price per Bbl decreased for the three months ended September 30, 2020 as compared to the prior year period primarily related to oversupply, decreased demand and economic effects of COVID-19. The average realized oil price per Bbl for the three months ended September 30, 2020 is primarily related to production from May 2020 through July 2020, when the average NYMEX price was $35.84 per Bbl.   The average realized oil price per Bbl also decreased for the nine months ended September 30, 2020 due to oversupply, decreased demand and economic effects of COVID-19. The average realized oil price per Bbl for the nine months ended September 30, 2020 is primarily related to production from November 2019 through July 2020, when the average NYMEX price was $42.19 per Bbl.

Natural Gas

The average realized natural gas price per Mcf decreased for the three and nine months ended September 30, 2020 as compared to the prior year period because of oversupply of ethane and other natural gas liquids, decreased demand, depressed pricing and costs to dispose of excess natural gas liquids.  The average realized natural gas price per Mcf for the three months ended September 30, 2020 is primarily related to production from May 2020 through July 2020 when the average NYMEX price was $1.72 per Mcf. The decrease in the average realized natural gas price per Mcf for the nine months ended September 30, 2020 is primarily related to production from November 2019 through July 2020, when the average NYMEX price was $1.94 per Mcf.  

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Costs

Direct Operating Expenses

Direct operating expenses decreased for the three and nine months ended September 30, 2020 as compared to the prior year periods primarily because of a slowdown in operations in light of current prices for oil and natural gas and economic conditions during the COVID-19 pandemic.

Lease Operating Expenses

Lease operating expenses decreased for the three and nine months ended September 30, 2020 as compared to the prior year periods as a result of less operating activity and a decrease in staffing.

Severance and ad Valorem Taxes

Severance and ad valorem taxes decreased for the three and nine months ended September 30, 2020 as a result of reduced volumes and prices of oil and natural gas and also because of a credit to the Trust in the first quarter of 2020 when actual ad valorem taxes were less than the accrual amounts.  

Development Expenses Related to the Underlying Properties

Development expenses related to the Underlying Properties decreased for the three and nine months ended September 30, 2020 as compared to the prior year period because of an overall slow-down in developmental activities in light of decreased oil and natural gas prices and economic uncertainty due to COVID-19.

Other Expenses

Other expenses increased by $22,319 for the three months ended September 30, 2020 as compared to the prior year period, primarily due to the drilling of additional wells by outside operators. Other expenses increased by $102,993 for the nine months ended September 30, 2020 as compared to the prior year period, primarily because of the drilling of additional wells as well as the annual adjustment to overhead made by Boaz Energy in January 2020.

Capital Reserve

In July 2020, Boaz Energy applied $192,721 net to the Trust of funds previously reserved toward taxes and development expenses, plus an advancement from Boaz Energy to the Trust in the amount of $140,606.  Then, in August 2020, Boaz Energy reserved $320,960 net to the Trust,  which was applied in part to recoupment of the $140,606 net to the Trust balance of previously advanced funds, and the remaining $180,354 net to the Trust was reserved for certain future taxes and development expenses. In September 2020, Boaz Energy reserved an additional $117,802 net to the Trust for certain future taxes and development expenses.  As of September 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $298,156.

Derivative Contracts

Income from the Net Profits Interest is exposed to fluctuations in energy prices in the normal scope of business.  To mitigate the negative effects of a possible decline in oil prices on distributable income to the Trust, Boaz Energy entered into derivative put option contracts with respect to approximately 100% of expected oil production attributable to the Net Profits Interest during 2018 and 76% of such production during 2019.  These derivative contracts consisted of put option contracts with strike prices of $60 per barrel in 2018 and $50 per barrel in 2019.  Boaz Energy believed that these put option contracts provided downside protection to the Trust in the event spot prices for crude oil decline below the applicable strike price, while still allowing the Trust to benefit from increasing crude oil prices.  If prices for crude oil as quoted on NYMEX declined below the applicable strike prices, Boaz Energy could exercise its put option and receive payment generally equal to the difference between the applicable strike price and the market price for crude oil at the time of exercise, multiplied by the notional quantity of crude oil hedged under the applicable put option contract being exercised.  These contracts expired as of December 31, 2019, and after December 31, 2019, none of the production attributable to the Underlying Properties is hedged.

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Because the derivative contracts have expired, there were no cash proceeds from settlement of derivative contracts during the three or nine months ended September 30, 2020. There were no cash proceeds from settlement of derivative contracts during the three months ended September 30, 2019, but for the nine months ended September 30, 2019, there was $688,562 ($550,850 net to the Trust) in cash proceeds from the settlement of derivative contracts.

LIQUIDITY AND CAPITAL RESOURCES

The Trust’s principal sources of liquidity and capital are cash flow generated from the Net Profits Interest, the amounts held by the Trustee as cash reserves to pay future liabilities, and borrowings, if any to fund administrative expenses.  The Trust’s primary uses of cash are distributions to Trust unitholders, payment of Trust administrative expenses, including, if applicable, any reserves established by the Trustee for future liabilities.

Administrative expenses include the Trustee and Delaware Trustee fees, accounting, engineering, legal, tax advisory and other professional fees, and tax reporting and distribution expenses.  The Trust is also responsible for paying other expenses incurred as a result of being a publicly traded entity, including costs associated with annual, quarterly and current reports to the SEC, New York Stock Exchange listing fees, independent auditor fees and registrar and transfer agent fees.  If the Trustee determines that cash on hand and cash to be received in respect of the Net Profits Interest are, or will be, insufficient to cover the Trust’s liabilities and expenses, the Trustee may cause the Trust to borrow funds to pay liabilities of the Trust.

As authorized under the Trust Agreement, beginning May 31, 2019, the Trustee began retaining cash from the distributions the Trust received (i) in an amount not to exceed $1.0 million at any one time 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 as they become due and (ii) in such amounts as the Trustee in its discretion deems appropriate to pay for future liabilities of the Trust, but not less than $25,000 or more than $100,000 per month.  Cash reserves held by the Trustee for administrative expenses totaled $1,000,000 as of September 30, 2020.

Boaz Energy Capital Expenditure Budget

Boaz Energy has advised the Trustee that the estimate for Boaz Energy’s 2020 capital budget has been increased from $2.5 million to $4.2 million, based principally upon capital projects being implemented by outside operators, of which $3.3 million has been expended as of September 30, 2020.  Based on current oil and gas prices, Boaz Energy has informed the Trustee that it is not planning any new Boaz Energy-operated wells or other significant capital projects for the remainder of 2020, other than waterflood projects and workovers principally in the Permian Platform area, the costs of which are included in the $4.2 million estimate.  The estimated 2020 capital budget is subject to change based on, among other things, changes in the price of oil and natural gas, the impact of the COVID-19 pandemic on prices and economic activity, Boaz Energy’s actual capital requirements, capital expenditure requirements of third-party operators, the pace of regulatory approvals and the mix of projects.

In July 2020, Boaz Energy applied $192,721 net to the Trust of funds previously reserved toward taxes and development expenses, plus an advancement from Boaz Energy to the Trust in the amount of $140,606.  Then, in August 2020, Boaz Energy reserved $320,960 net to the Trust,  which was applied in part to recoupment of the $140,606 net to the Trust balance of previously advanced funds, and the remaining $180,354 net to the Trust was reserved for certain future taxes and development expenses. In September 2020, Boaz Energy reserved an additional $117,802 net to the Trust for certain future taxes and development expenses.  As of September 30, 2020, the balance of funds reserved by Boaz Energy, net to the Trust, was $298,156.

Distributions Declared After Quarter End

On October 20, 2020, the Trust declared a cash distribution of 0.013487 per Trust unit based upon production during the month of August 2020 to record holders as of October 30, 2020. The distribution will be paid on November 16, 2020. The following table shows underlying oil and natural gas sales and average prices attributable to the distribution declared on October 20, 2020:

In October 2020, Boaz reserved $104,000 net to the Trust for certain future taxes and development expenses.

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Off-Balance Sheet Arrangements

As of September 30, 2020, the Trust had no off-balance sheet arrangements.

New Accounting Pronouncements

As the Trust’s financial statements are prepared on the modified cash basis, most accounting pronouncements are not applicable to the Trust’s financial statements.  No new accounting pronouncements have been adopted or issued that would impact the financial statements of the Trust.

Critical Accounting Policies and Estimates

Refer to Note 2 to the unaudited condensed financial statements contained in this Quarterly Report and the Trust’s 2019 Annual Report on Form 10-K, including the audited financial statements of the Trust and notes thereto included therein, for a description of the Trust’s accounting policies and use of estimates.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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 required under this Item.

ITEM 4.

CONTROLS AND PROCEDURES

The Trustee conducted an evaluation of the effectiveness of the Trust’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(a) and 15d-15(a) as of the end of the period covered by this Quarterly Report.  Based on this evaluation, the Trustee has concluded that the disclosure controls and procedures of the Trust are effective as of September 30, 2020, that the information required to be disclosed by the Trust in its reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC, and such information is accumulated and communicated, as appropriate to allow timely decisions regarding required disclosure.  In its evaluation of disclosure controls and procedures, the Trustee has relied, to the extent considered reasonable, on information provided by Boaz Energy.

Due to the nature of the Trust as a passive entity and in light of the contractual arrangements pursuant to which the Trust was created, including the provisions of the Trust Agreement and the Conveyance, the Trustee’s disclosure controls and procedures related to the Trust necessarily rely on (A) information provided by Boaz Energy, including information relating to results of operations, the costs and revenues attributable to the Trust’s interests under the Conveyance and other operating and historical data, plans for future operating and capital expenditures, reserve information, information relating to projected production, and other information relating to the status and results of operations of the Underlying Properties, and (B) conclusions and reports regarding reserves by the Trust’s independent reserve engineers.

During the quarter ended September 30, 2020 there were no changes in the Trust’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Trustee’s internal control over financial reporting.  The Trustee notes for purposes of clarification that it has no authority over, has not evaluated and makes no statement concerning, the internal control over financial reporting of Boaz Energy.

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PART II. – OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

On October 1, 2018, a lawsuit styled Thaleia L. Marston, Trustee of the Marston Trust v. Blackbeard Operating, LLC, et.al, No. 18-10-24761 – CVW in the 143rd District Court in Ward County, Texas (the “2018 Litigation”) was filed, naming, among others, Boaz Energy and the Trust as defendants.  The plaintiff is a lessor under two leases operated by Blackbeard Operating, LLC.  The Underlying Properties include the interests of Boaz Energy in some of the minerals covered by those leases.  The litigation seeks surface use damages and alleges violations of the terms of the leases, among other things. While it is not yet possible to estimate any potential loss or range of loss, Boaz Energy has advised the Trustee that it does not anticipate the litigation will materially affect the Trust.  On January 3, 2020, Lawrence M. Marston joined the lawsuit as a plaintiff alleging surface damage claims against Blackbeard and Goodnight Midstream Permian, L.L.C., but not against the Trust.  On January 17, 2020, the Trust and the other defendants filed a motion for summary judgment, which would dispose of the claims against the Trust if granted.  After delays related to COVID-19, a hearing on the summary judgment motions filed by the Defendants and Goodnight was held on August 27, 2020.  As of September 30, 2020 the court had not yet ruled on the motion for summary judgment. A mediation was conducted on November 10, 2020, but no settlement was reached.

ITEM 1A.

RISK FACTORS

Except as provided below, there have been no material changes to the risk factors contained in Item 1A of the Trust’s 2019 Annual Report on Form 10-K.

The COVID-19 pandemic and efforts to contain the virus could adversely affect the operators of the Underlying Properties, the Net Profits Interest and the cash available for distribution to unitholders.

The effect of the recent outbreak of COVID-19 and response efforts to contain the pandemic are unprecedented and continue to evolve.  A rapid and sharp decline in oil prices occurred in the first quarter of 2020.  Oil prices have ranged widely during the second and third quarters of 2020 and remain depressed.  The extent and duration of the decline and curtailed economic activity, including business and operational disruptions, closures, limitations and restrictions on travel, and supply chain and workforce disruptions, is unknown and continues to evolve and affect the operators of the Underlying Properties and production activity.  It is not possible to reliably estimate the impact these developments will have on future periods. The value of the Net Profits Interest and the Trust’s ultimate cash available for distribution is highly dependent on the financial condition of Boaz Energy and other third-party operators, oil and natural gas prices, supply and demand, and other factors, which are being negatively impacted by the COVID-19 pandemic.  Boaz Energy shut in production of certain wells during May 2020 and Boaz Energy or any third-party operator of the Underlying Properties could, in future periods, shut in or curtail production from wells on the Underlying Properties or plug and abandon marginal wells that otherwise may have been allowed to continue to produce for a longer period under conditions of higher prices, without the consent of the Trust or the Trust unitholders. Substantial and extended declines in economic activity and oil, natural gas and natural gas liquids prices have resulted and may continue to result in a reduction in the amount of oil and natural gas that is economic to produce from the Underlying Properties, reduced net proceeds to which the Trust is entitled, and elimination of cash available for distribution to Trust unitholders for an unknown period of time.

The ability or willingness of OPEC and other oil exporting nations to set and maintain production levels has a significant impact on oil and natural gas commodity prices, which could reduce the amount of cash available for distribution to Trust unitholders.

The Organization of Petroleum Exporting Countries (“OPEC”) is an intergovernmental organization that seeks to manage the price and supply of oil on the global energy market. Actions taken by OPEC members, including those taken alongside other oil exporting nations, have a significant impact on global oil supply and pricing. The extent and duration of production cuts by OPEC members and other oil exporting nations to support crude oil prices have fluctuated and may continue to do so.  There can be no assurance that OPEC members and other oil exporting nations will continue to agree to production cuts or other actions to support and stabilize oil prices, nor can there be any assurance that they will not further reduce oil prices or increase production. Uncertainty regarding future actions to be taken by OPEC members or other oil exporting countries could lead to increased volatility in the price of oil, which could adversely affect the financial condition and economic performance of the operators of the Underlying Properties and may reduce net profits income and significantly reduce or completely eliminate the amount of cash available for distribution to Trust unitholders for an unknown period of time.

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ITEM 6.

EXHIBITS

The exhibits marked with the asterisk symbol (*) are filed or furnished with this Quarterly Report on Form 10-Q.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 16, 2020

The registrant, PermRock Royalty Trust, has no principal executive officer, principal financial officer, board of directors or persons performing similar functions.  Accordingly, no additional signatures are available, and none have been provided.  In signing the report above, the Trustee does not imply that it has performed any such function or that any such function exists pursuant to the terms of the Trust Agreement under which it serves.

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