SBR

SABINE ROYALTY TRUST - 10-Q Summary (Period Ended June 30, 2014)

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2014, for Sabine Royalty Trust (the "Trust"). The Trust holds royalty and mineral interests in producing oil and gas properties located in Florida, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas. It is a passive entity that distributes cash received from royalties and interest to unit holders. Southwest Bank became the Trustee effective May 30, 2014, succeeding Bank of America, N.A. There were 14,579,345 units of beneficial interest outstanding as of August 8, 2014.

Key Financial Metrics

Material Changes vs. Prior Period

• Quarter-over-Quarter (Q2 2014 vs. Q2 2013): Royalty income increased by approximately $2.68 million (19%). This was driven by higher oil and natural gas prices ($2.7 million) and increased oil production ($1.7 million). These gains were partially offset by a decrease in natural gas production ($1.3 million) and a delay in receiving state income tax refunds ($0.4 million).
• Year-over-Year (Six Months 2014 vs. Six Months 2013): Royalty income increased by $955,000 (3%). Increases in oil and gas prices ($3.8 million) and oil production ($2.0 million) were offset by a significant decrease in natural gas production ($4.5 million) and higher state income taxes withheld ($0.6 million).
• Expenses: General and administrative expenses increased by approximately $91,500 for the quarter and $205,100 for the six-month period compared to the prior year, primarily due to higher revenue processing fees, printing costs, and legal fees.
• Production Volumes: Oil production increased to 122,226 barrels in Q2 2014 from 103,589 barrels in Q2 2013. Natural gas production decreased to 1,388,575 Mcfs in Q2 2014 from 1,642,953 Mcfs in Q2 2013.

Outlook, Risks, and Commentary

• Trustee Change: Southwest Bank assumed the role of Trustee on May 30, 2014, following a vote by unit holders.
• Accounting Basis: Financial statements are prepared on a modified cash basis, not GAAP. Royalty income is recognized when received, not when produced. Amortization of royalty interests reduces Trust Corpus rather than operating income.
• Market Risk: The Trust has no long-term debt or derivative instruments. It is subject to commodity price risk; however, the Trustee believes interest rate risk is immaterial due to the short-term nature of investments.
• Contingencies: The Trustee is not aware of any contingencies related to royalty properties as of June 30, 2014. Unfavorable resolutions would reduce future income and distributions.
• Tax Considerations: The Trust is a grantor trust for federal tax purposes. Unit holders are responsible for taxes on income. New Mexico and Oklahoma withhold taxes on payments, which the Trust seeks to recover and distribute.
• Subsequent Events: Distributions of $0.25364 and $0.38632 per unit were declared for July and August 2014, respectively.

Investor Verification Checklist

• Verify the impact of declining natural gas production volumes on future distributable income.
• Confirm the status of state tax refunds (New Mexico and Oklahoma) and their timing relative to distribution cycles.
• Review the Trust Agreement regarding the new Trustee (Southwest Bank) and any changes in fee structures or administrative processes.
• Monitor commodity price trends (Henry Hub gas and NYMEX oil) as they directly correlate to royalty receipts with a lag.
• Check for any updates on the "other payables" ($377,142) which represent suspended royalty receipts pending title verification.