NOTES TO FINANCIAL STATEMENTS
(unaudited)
1.
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ORGANIZATION OF THE TRUST
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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:
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the Trust, upon approval of the holders of at least 75% of the outstanding Trust Units, sells the Net Profits Interest;
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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;
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the holders of at least 75% of the outstanding Trust Units vote in favor of dissolution; or
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the Trust is judicially dissolved.
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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 June 30, 2014 the Trust had $125,164 of cash and cash
equivalents, an increase of $39,812 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:
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Interest-bearing obligations of the United States government;
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Money market funds that invest only in United States government securities;
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Repurchase agreements secured by interest-bearing obligations of the United States government; or
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Bank certificates of deposit.
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Alternatively, cash held for distribution at the next
distribution date may be held in a noninterest-bearing account. At June 30, 2014 and December 31, 2013, the Trust did not have any cash on hand related to future distributions.
5
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
(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 June 30, 2014 and December 31, 2013, Enduro owned 8,600,000 Trust Units, or 26% of
the issued and outstanding Trust Units.
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 June 30, 2014 and for the three and six months ended June 30, 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.
6
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
(unaudited)
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.
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
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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.
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NET PROFITS INTEREST IN OIL AND NATURAL GAS PROPERTIES
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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 June 30, 2014 and December 31, 2013 was $177,030,243 and $154,688,885, respectively.
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 unhedged.
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.
7
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
(unaudited)
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.
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.
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DISTRIBUTIONS TO UNITHOLDERS
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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.
8
ENDURO ROYALTY TRUST
NOTES TO FINANCIAL STATEMENTS
(unaudited)
The following table provides information regarding the Trusts distributions paid during
the six months ended June 30, 2014 and 2013:
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Declaration Date
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Record Date
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Payment Date
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Distribution per Unit
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Six Months Ended June 30, 2014:
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December 20, 2013
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December 31, 2013
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January 15, 2014
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$
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0.134090
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January 21, 2014
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January 31, 2014
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February 14, 2014
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$
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0.117935
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February 18, 2014
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February 28, 2014
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March 14, 2014
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$
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0.100655
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March 21, 2014
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March 31, 2014
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April 14, 2014
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$
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0.070692
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April 17, 2014
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April 30, 2014
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May 14, 2014
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$
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0.032496
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May 20, 2014
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May 30, 2014
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June 13, 2014
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$
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0.082366
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Year to Date 2014
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$
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0.538234
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Six Months Ended June 30, 2013:
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December 20, 2012
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December 31, 2012
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January 15, 2013
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$
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0.139439
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January 18, 2013
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January 31, 2013
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February 14, 2013
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$
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0.125276
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February 15, 2013
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February 28, 2013
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March 14, 2013
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$
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0.070519
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March 18, 2013
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March 28, 2013
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April 12, 2013
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$
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0.056553
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April 19, 2013
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April 30, 2013
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May 14, 2013
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$
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0.124518
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May 20, 2013
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May 31, 2013
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June 14, 2013
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$
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0.096825
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Year to Date 2013
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$
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0.613130
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7.
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RELATED PARTY TRANSACTIONS
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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 and six months ended June 30, 2014, the Trust paid $50,100 and $100,100, respectively, to the Trustee pursuant to the terms of the Trust
Agreement. During the three and six months ended June 30, 2013, the Trust paid $50,000 and $100,451 respectively, to the Trustee pursuant to the terms of the Trust Agreement. The Trust did not pay any fees to the Delaware Trustee for the six
months ended June 30, 2014 and 2013, respectively.
On July 15, 2014, the distribution of $0.075786 per Trust Unit,
which was declared on June 20, 2014, was paid to Trust unitholders owning Trust Units as of June 30, 2014. The distribution consisted of net profits allocable to the Trust of $2,560,940, less cash reserves withheld for future Trust
expenses of approximately $60,000.
On July 21, 2014, the Trust declared a distribution of $0.103852 per unit to unitholders of
record as of July 31, 2014. The distribution is expected to be paid to unitholders on August 14, 2014.
9