PRT

Business Context and Reporting Period

Company: PermRock Royalty Trust (a Delaware statutory trust)

Reporting Period: Quarterly period ended September 30, 2018 (Form 10-Q)

Business Overview: The Trust holds an 80% Net Profits Interest in certain oil and natural gas properties (the "Underlying Properties") located in the Permian Basin, Texas. The Trust is passive; it has no control over operations, which are managed by Boaz Energy II, LLC. The Trust distributes monthly cash receipts to unitholders after deducting administrative expenses. As of November 14, 2018, there were 12,165,732 trust units outstanding.

Key Financial Metrics

Liquidity: The Trust relies on cash flow from the Net Profits Interest. As of September 30, 2018, no cash reserve for expenses had been established; instead, the Trust relies on a $1.0 million Letter of Credit provided by Boaz Energy to cover administrative expenses until May 31, 2019.

Material Changes and Operational Highlights

• Production Volumes (Three Months Ended Sep 30, 2018): Oil sales volumes were 145,881 Bbls and Gas sales volumes were 181,920 Mcf. These figures generally represent production from May through July 2018 due to the timing of cash receipts.
• Revenue Composition: Total revenues for the three-month period were $9,554,122, comprised primarily of oil revenue ($8,757,104) and gas revenue ($769,429).
• Costs: Total costs deducted to calculate net proceeds were $3,931,653 for the quarter, including production expenses ($1,638,674) and development costs ($1,166,347).
• Capital Expenditures: Boaz Energy revised its 2018 capital budget for the Underlying Properties to $1.2 million (up from $0.6 million) due to increased development costs for non-operated wells in Glasscock, Ward, and Crane Counties.

Outlook, Risks, and Management Commentary

• Hedging Strategy: Boaz Energy has entered into derivative put option contracts covering approximately 100% of expected oil production for the remainder of 2018 (strike price $60/Bbl) and 76% of 2019 production (strike price $50/Bbl). No hedging is in place for production after December 31, 2019, exposing the Trust to full price volatility thereafter.
• Subsequent Events: On October 19, 2018, the Trust declared a distribution of $0.115880 per unit based on August 2018 production. This distribution reflects an average oil price of $55.76/Bbl and gas price of $4.71/Mcf.
• Key Risks:
  • Commodity Price Volatility: Distributions are highly sensitive to oil and natural gas prices. The Trust bears 80% of all operating and development costs.
  • Depleting Assets: The Underlying Properties are depleting assets. Production is projected to increase through 2022 and decline thereafter. The Trust cannot acquire new properties to replace depleting reserves.
  • Operator Risk: The Trust has no control over Boaz Energy's operations. Boaz Energy may curtail production, abandon wells, or sell properties without unitholder consent under certain conditions.
  • Internal Controls: Boaz Energy has identified a material weakness in its internal control over financial reporting, though this did not impact the Trust's financial statements directly.

Investor Verification Checklist

• Production Timing: Verify that reported income reflects production from two months prior due to the lag in cash receipts.
• Hedge Expiration: Confirm the lack of hedging protection for oil production after December 31, 2019, and assess exposure to price declines.
• Capital Expenditure Impact: Monitor Boaz Energy's revised capital budget ($1.2M for 2018) and its impact on net profits available for distribution.
• Operator Financial Health: Review Boaz Energy's financial status, given the Trust's reliance on the operator for accurate reporting and the existence of a material weakness in Boaz Energy's internal controls.
• De Minimis Sales: Note that Boaz Energy has identified a property for a potential "Qualified De Minimis Sale," which could release a portion of the Net Profits Interest.