ITEM 1.
Financial Statements
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF ASSETS AND TRUST CORPUS
(In thousands, except unit data)
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June 30, 2019
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December 31, 2018
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ASSETS
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(Unaudited)
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Cash and cash equivalents
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$
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2,300
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$
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2,266
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Investment in royalty interests
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467,146
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467,146
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Less: accumulated amortization and impairment
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(440,793)
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(427,265)
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Net investment in royalty interests
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26,353
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39,881
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Total assets
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$
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28,653
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$
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42,147
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TRUST CORPUS
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Trust corpus, 49,725,000 units issued and outstanding at June 30, 2019 and December 31, 2018
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$
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28,653
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$
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42,147
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF DISTRIBUTABLE INCOME (Unaudited)
(In thousands, except per unit data)
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Three Months Ended June 30,
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Six Months Ended June 30,
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2019
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2018
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2019
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2018
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Revenues
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Royalty income
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$
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2,797
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$
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3,852
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$
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5,985
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$
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7,858
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Total revenues
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2,797
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3,852
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5,985
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7,858
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Expenses
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Post-production expenses
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418
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452
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817
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933
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Production taxes
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173
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241
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368
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478
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Trust administrative expenses
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528
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145
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937
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679
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Cash reserves (used) withheld for current Trust expenses, net of amounts withheld (used)
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(58)
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265
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6
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128
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Total expenses
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1,061
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1,103
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2,128
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2,218
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Distributable income available to unitholders
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$
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1,736
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$
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2,749
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$
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3,857
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$
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5,640
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Distributable income per unit (49,725,000 units)
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$
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0.035
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$
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0.055
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$
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0.078
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$
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0.113
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
STATEMENTS OF CHANGES IN TRUST CORPUS (Unaudited)
(In thousands, except per unit data)
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Three Months Ended June 30,
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Six Months Ended June 30,
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2019
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2018
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2019
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2018
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Trust corpus, beginning of period
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$
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40,728
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$
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45,547
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$
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42,147
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$
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46,830
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Amortization of investment in royalty interests
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(1,571)
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(1,177)
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(3,087)
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(2,330)
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Impairment of investment in royalty interests
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(10,441)
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—
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(10,441)
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—
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Net cash reserves (used) withheld
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(58)
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265
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6
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128
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Distributable income
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1,736
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2,749
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3,857
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5,640
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Distributions paid to unitholders
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(1,741)
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(2,735)
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(3,829)
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(5,619)
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Trust corpus, end of period
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$
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28,653
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$
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44,649
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$
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28,653
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$
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44,649
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Distributions per unit (49,725,000 units)
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$
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0.035
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$
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0.055
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$
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0.077
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$
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0.113
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The accompanying notes are an integral part of these financial statements.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Organization of Trust
SandRidge Mississippian Trust II (the “Trust”) is a statutory trust formed under the Delaware Statutory Trust Act pursuant to a trust agreement, as amended and restated, by and among SandRidge Energy, Inc. (“SandRidge”), as Trustor, The Bank of New York Mellon Trust Company, N.A., as Trustee (the “Trustee”), and The Corporation Trust Company, as Delaware Trustee (the “Delaware Trustee”).
The Trust holds Royalty Interests in specified oil and natural gas properties located in the Mississippian formation in Alfalfa, Grant, Kay, Noble and Woods counties in northern Oklahoma and Barber, Comanche, Harper and Sumner counties in southern Kansas (the “Underlying Properties”). The Royalty Interests were conveyed by SandRidge to the Trust concurrent with the initial public offering of the Trust’s common units (“Trust units”) in April 2012. As consideration for conveyance of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 7,393,750 Trust units and 12,431,250 subordinated units, which subsequently converted to common units as a result of SandRidge having met its drilling obligation to the Trust in March 2015, to certain wholly owned subsidiaries of SandRidge. At June 30, 2019, SandRidge owned 18,675,000 Trust units, or approximately 37.6% of all Trust units.
The Trust is passive in nature and neither the Trust nor the Trustee has any control over, or responsibility for, any operating or capital costs related to the Underlying Properties. The business and affairs of the Trust are administered by the Trustee. The trust agreement generally limits the Trust’s business activities to owning the Royalty Interests and activities reasonably related thereto, including activities required or permitted by the terms of the conveyances related to the Royalty Interests.
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Due to the timing of the payment of production proceeds to the Trust, each distribution covers production from a three-month period consisting of the first two months of the most recently ended quarter and the final month of the quarter preceding it.
The Trust will dissolve and begin to liquidate on December 31, 2031 (the “Termination Date”), unless sooner terminated in accordance with the provisions of the trust agreement, and will soon thereafter wind up its affairs and terminate. At the Termination Date, 50% of the Royalty Interests will revert automatically to SandRidge. The remaining 50% of the Royalty Interests will be sold at that time, with the net proceeds of the sale, as well as any remaining Trust cash reserves, distributed to the unitholders on a pro rata basis. SandRidge has a right of first refusal to purchase the Royalty Interests retained by the Trust at the Termination Date. The Trust will not dissolve until the Termination Date unless any of the following occurs: (a) the Trust sells all of the Royalty Interests; (b) cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $5.0 million; (c) Trust unitholders approve an earlier dissolution of the Trust; or (d) the Trust is judicially dissolved. In the case of any of the foregoing, the Trustee would then sell all of the Trust’s assets, either by private sale or public auction, and distribute the net proceeds of the sale to the Trust unitholders after payment, or reasonable provision for payment, of all Trust liabilities.
Potential Early Termination of the Trust.
Based
on its estimates for the next twelve months regarding projected production from the Underlying Properties and estimated pricing based on futures prices as of June 30, 2019 readily available in the public market adjusted for differentials, SandRidge believes that cash available for distribution for the four consecutive quarters ending March 31, 2020, on a cumulative basis, may fall below $5.0 million, which would require the Trust to commence termination shortly after the quarterly cash distribution is made in May 2020. If that occurs, the Trustee would be required to sell all of the Trust’s remaining assets and liquidate the Trust.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
2. Basis of Presentation and Summary of Significant Accounting Policies
Basis of Accounting.
The financial statements of the Trust differ from financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) as the Trust records revenues when cash is received (rather than when earned) and expenses when paid (rather than when incurred) and may also establish cash reserves for contingencies, which would not be accrued in financial statements prepared in accordance with GAAP. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the Securities and Exchange Commission (“SEC”) as specified by Staff Accounting Bulletin Topic 12:E,
Financial Statements of Royalty Trusts
. Amortization of investment in royalty interests, calculated on a unit-of-production basis, and any impairments are charged directly to trust corpus. Distributions to unitholders are recorded when declared.
Significant Accounting Policies.
Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, which may require such entities to accrue or defer revenues and expenses in a period other than when such revenues are received or expenses are paid. Because the Trust’s financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trust’s financial statements.
The Trust is treated for federal and applicable state income tax purposes as a partnership. For U.S. federal income tax purposes, a partnership is not a taxable entity and incurs no U.S. federal income tax liability. With respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal income tax purposes.
Impairment of Investment in Royalty Interests.
On a quarterly basis, the Trust evaluates the carrying value of the investment in royalty interests by comparing the undiscounted cash flows expected to be realized from the Royalty Interests to the carrying value. If the expected future undiscounted cash flows are less than the carrying value, the Trust recognizes an impairment loss for the difference between the carrying value and the estimated fair value of the Royalty Interests, which is determined using future cash flows of the net oil, natural gas and natural gas liquids (“NGL”) reserves attributable to the Royalty Interests, discounted at a rate based upon the weighted average cost of capital of publicly traded royalty trusts. The weighted average cost of capital is based upon inputs that are readily available in the public market. The future cash flows of the net oil, natural gas and NGL reserves attributable to the Royalty Interests utilizes the oil and natural gas futures prices readily available in the public market adjusted for differentials and estimated quantities of oil, natural gas and NGL reserves that geological and engineering data demonstrate, with reasonable certainty, to be recoverable in future years from known reservoirs under existing economic and operating conditions. As there are numerous uncertainties inherent in estimating quantities of proved reserves, these quantities are a significant unobservable input resulting in the fair value measurement being considered a level 3 measurement within the fair value hierarchy. As discussed in "
Potential Early Termination of the Trust"
in Note 1 above
, it was determined at June 30, 2019 that it is more likely than not that the Trust's remaining assets will be sold and the Trust will be liquidated significantly before the end of its previously estimated useful life. As a result, during the three- and six-month periods ended June 30, 2019, the Trust recorded a $10.4 million impairment in the carry
ing value of the Investment in Royalty Interests.
The impairment resulted in a non-cash charge to trust corpus and did not affect the Trust’s distributable income. There were no impairments in the carrying value of the investment in royalty interests during the three- and six-month periods ended June 30, 2018. Material write-downs in subsequent periods may occur if commodity prices decline or a change in circumstances causes a decline in expected future undiscounted cash flows relative to the carrying value of the investment in royalty interests. See “Risks and Uncertainties” in Note 5 below for further discussion.
Distributable Income Per Unit.
Distributable income per unit amounts as calculated for the periods presented in the accompanying unaudited statements of distributable income may differ from declared distribution amounts per unit due to rounding and the timing of the Trust’s payment of Trust administrative expenses.
Interim Financial Statements.
The accompanying unaudited interim financial statements have been prepared in accordance with the accounting policies stated in the audited financial statements contained in the 2018 Form 10-K 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 accompanying statement of assets and trust corpus as of December 31, 2018 has been derived from audited financial statements. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the 2018 Form 10-K.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
3. Distributions to Unitholders
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Distributions cover a three-month production period. See Note 6 for discussion of the Trust’s quarterly distribution to be paid in August 2019. A summary of the Trust’s distributions to unitholders during the three- and six-month periods ended June 30, 2019 and the year ended December 31, 2018 is as follows:
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Total
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Distribution
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Covered
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Distribution
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Per Common
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Production Period
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Date Declared
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Date Paid
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Paid
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Unit
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Calendar Quarter 2019
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First Quarter
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September 1, 2018 — November 30, 2018
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January 24, 2019
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February 22, 2019
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$
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2,088,450
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$
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0.042
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Second Quarter
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December 1, 2018 — February 28, 2019
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April 25, 2019
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May 24, 2019
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$
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1,740,375
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$
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0.035
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Calendar Quarter 2018
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First Quarter
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September 1, 2017 — November 30, 2017
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January 25, 2018
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February 23, 2018
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$
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2,884,050
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$
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0.058
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Second Quarter
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December 1, 2017 — February 28, 2018
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April 26, 2018
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May 25, 2018
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$
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2,734,875
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$
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0.055
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Third Quarter
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March 1, 2018 — May 31, 2018
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July 26, 2018
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August 24, 2018
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$
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2,237,625
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$
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0.045
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Fourth Quarter
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June 1, 2018 — August 31, 2018
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October 25, 2018
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November 23, 2018
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$
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2,436,525
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$
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0.049
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4. Related Party Transactions
Trustee Administrative Fee.
Under the terms of the trust agreement, the Trust pays the Trustee an annual administrative fee, which prior to 2017 was $150,000. The annual fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s administrative fees paid during each of the three-month periods ended June 30, 2019 and 2018 totaled approximately $38,000. The Trustee’s administrative fees paid for the six-month periods ended June 30, 2019 and 2018 totaled approximately $77,000 and $76,000, respectively.
Registration Rights Agreement.
The Trust is party to a registration rights agreement pursuant to which the Trust has agreed to register the offering of the Trust units held by SandRidge and certain of its affiliates and permitted transferees upon request by SandRidge. The holders have the right to require the Trust to file no more than five registration statements in aggregate, one of which has been filed to date. The Trust does not bear any expenses associated with such transactions.
Administrative Services Agreement.
The Trust is party to an administrative services agreement with SandRidge that obligates the Trust to pay SandRidge an annual administrative services fee for accounting, tax preparation, bookkeeping and informational services performed by SandRidge on behalf of the Trust. For its services under the administrative services agreement, SandRidge receives an annual fee of $300,000, which is payable in equal quarterly installments and will remain fixed for the life of the Trust. SandRidge is also entitled to receive reimbursement for its out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the administrative services agreement. The administrative services agreement will terminate on the earliest to occur of: (i) the date the Trust shall have dissolved and commenced winding up in accordance with the trust agreement, (ii) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (iii) pertaining to services to be provided with respect to any Underlying Properties transferred by SandRidge, the date that either SandRidge or the Trustee may designate by delivering 90-days’ prior written notice, provided that the transferee of such Underlying Properties assumes responsibility to perform the services in place of SandRidge and (iv) a date mutually agreed to by SandRidge and the Trustee. Administrative fees paid to SandRidge for the three-month period ended June 30, 2019 totaled $75,000. There were no amounts paid to SandRidge during the three-month period ended June 30, 2018, as the related quarterly administrative fee was paid during a prior period. During each of the six-month periods ended June 30, 2019 and 2018, the Trust paid administrative fees to SandRidge equal to $150,000.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
5. Commitments and Contingencies
Loan Commitment.
Pursuant to the trust agreement, if at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, SandRidge will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses. Any funds loaned by SandRidge pursuant to this commitment will be limited to the payment of current accounts payable or other obligations to trade creditors in connection with obtaining goods or services or the payment of other current liabilities arising in the ordinary course of the Trust’s business, and may not be used to satisfy Trust indebtedness, or to make distributions. If SandRidge loans funds pursuant to this commitment, no further distributions will be made to unitholders (except in respect of any previously determined quarterly cash distribution amount) until such loan is repaid. Any such loan will be on an unsecured basis, and the terms of such loan will be substantially the same as that which would be obtained in an arm’s length transaction between SandRidge and an unaffiliated third party. No such loan from SandRidge was outstanding at June 30, 2019 or December 31, 2018.
Risks and Uncertainties.
The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as overall oil, natural gas and NGL production and inventories in relevant markets, economic conditions, the global political environment, regulatory developments and competition from other energy sources. Oil, natural gas and NGL prices historically have been volatile and may be subject to significant fluctuations in the future. Low levels of future production, continued low commodity prices and the absence of any derivative arrangements would continue to reduce the Trust’s revenues and distributable income available to unitholders.
The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust. The ability to operate the properties depends on the Trustor’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. On May 16, 2016, the Trustor and certain of its direct and indirect subsidiaries (collectively, the “Debtors”) filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”) under the caption In re: SandRidge Energy Inc., et al. On September 20, 2016, the Bankruptcy Court entered an amended order confirming the Amended Joint Chapter 11 Plan of Reorganization dated September 19, 2016 (the “Plan”), as modified by the Confirmation Order (the “Amended Confirmation Order”), and on October 4, 2016, the Plan became effective in accordance with its terms and the Debtors emerged from the Chapter 11 Cases. On September 23, 2016, an informal group of former SandRidge shareholders appealed the Amended Confirmation Order. On February 22, 2017, the district court before which the appeal was pending entered an order approving a stipulation to voluntarily dismiss the appeal with prejudice.
Legal Proceedings.
On June 9, 2015, the Duane & Virginia Lanier Trust, on behalf of itself and all other similarly situated unitholders of the Trust, filed a putative class action complaint in the U.S. District Court for the Western District of Oklahoma against the Trust, SandRidge and certain current and former executive officers of SandRidge, among other defendants (the “Securities Litigation”). The complaint, which was amended on November 11, 2016 (adding Ivan Nibur, Lawerence Ross, Jase Luna, and Mathew Willenbuncher as lead plaintiffs) and supplemented on May 1, 2017, asserts a variety of federal securities claims on behalf of a putative class of (a) purchasers of common units of SandRidge Mississippian Trust I ("SDT") in or traceable to its initial public offering on or about April 7, 2011, and (b) purchasers of common units of the Trust in or traceable to its initial public offering on or about April 17, 2012. The claims are based on allegations that SandRidge and certain of its current and former officers and directors, among other defendants, including the Trust, are responsible for making false and misleading statements, and omitting material information, concerning a variety of subjects, including oil and gas reserves. The plaintiffs seek class certification, an order rescinding the Trust’s initial public offering and an unspecified amount of damages, plus interest, attorneys’ fees and costs. As a result of its reorganization in bankruptcy in 2016, SandRidge is a nominal defendant only.
On August 30, 2017, the Court entered an order dismissing the plaintiffs’ claims under Sections 11, 12(a)(2), and 15 of the Securities Act of 1933. A partial judgment dismissing the claims was entered in accordance with the order on December 5, 2017, and the time to appeal that judgment has now expired. As a result of the Court’s order, the only claims remaining in the litigation are the plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder (the “Exchange Act Claims”). The only remaining defendants in the litigation are SDT, James D. Bennett, Matthew K. Grubb, Tom L. Ward, and SandRidge as a nominal defendant only.
On September 11, 2017, the Court entered a subsequent order regarding the remaining defendants' motions to dismiss the Exchange Act Claims, granting the motion in part and denying the motion in part.
SANDRIDGE MISSISSIPPIAN TRUST II
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
On January 19, 2018, SDT filed a Motion for Partial Judgment on the Pleadings as to any claims against it brought by purchasers of common units of the Trust, arguing that such purchasers lack standing to assert claims against SDT because they did not purchase units in SDT. On January 18, 2019, the Court granted SDT's motion dismissing claims brought by purchasers of the Trust.
Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trust’s administrative expenses significantly. However, the Trust is entitled to contractual indemnification covering reasonable costs of investigation and attorney’s fees and expenses that the Trust believes will be applicable. The Trust will estimate and, if the Trustee deems it appropriate, begin reserving funds for potential losses that may arise out of litigation to the extent that such losses are probable and can be reasonably estimated. Significant judgment will be required in making any such estimates and any final liabilities of the Trust may ultimately be materially different than any estimates. The Trust is currently unable to assess the probability of loss or estimate a range of any potential loss the Trust may incur in connection with the Securities Litigation, and has not established any reserves relating to the Securities Litigation. The Trust may withhold estimated amounts from future distributions to cover future costs associated with the litigation if determined necessary. The Trust has not yet fully analyzed any rights it may have to indemnities that may be applicable or any claims it may make in connection with the Securities Litigation.
6. Subsequent Events
Distribution to Unitholders.
On July 25, 2019, the Trust declared a cash distribution of $0.028 per unit covering production for the three-month period from March 1, 2019 to May 31, 2019. The distribution will be paid on or about August 23, 2019 to record holders as of August 9, 2019. Distributable income for March 1, 2019 to May 31, 2019 was calculated as follows (in thousands, except for unit and per unit amounts):
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Revenues
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Royalty income
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$
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2,393
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Total revenues
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2,393
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Expenses
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Post-production expenses
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418
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Production taxes
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142
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Cash reserves withheld by Trustee (1)
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408
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Total expenses
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968
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Distributable income
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$
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1,425
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Additional cash reserve (2)
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50
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Distributable income available to unitholders
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$
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1,375
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Distributable income per unit (49,725,000 units issued and outstanding)
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$
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0.028
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____________________
(1) Includes amounts withheld for payment of future Trust administrative expenses.
(2) Cash reserve increase for the payment of future known, anticipated or contingent expenses or liabilities.
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 financial condition, results of operations, liquidity and capital resources of SandRidge Mississippian Trust II (the “Trust”). This discussion and analysis should be read in conjunction with the Trust’s unaudited interim financial statements and the accompanying notes included in this Quarterly Report and the Trust’s audited financial statements and the accompanying notes included in the 2018 Form 10-K. All information regarding operations has been provided to the Trustee by SandRidge.
Overview
The Trust is a statutory trust created under the Delaware Statutory Trust Act. The business and affairs of the Trust are administered by the Trustee and, as necessary, the Delaware Trustee. The Trust’s purpose is to hold the Royalty Interests, to distribute to the Trust unitholders cash that the Trust receives in respect of the Royalty Interests and to perform certain administrative functions in respect of the Royalty Interests and the Trust units. Other than the foregoing activities, the Trust does not conduct any operations or activities. The Trustee has no involvement with, control or authority over, or responsibility for, any aspect of the operations on or relating to the properties in which the Trust has an interest. The Trust derives all or substantially all of its income and cash flow from the Royalty Interests. The Trust is treated as a partnership for federal income tax purposes.
Commodity Price Volatility.
The Trust’s quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and NGL. The markets for these commodities are volatile, as demonstrated by significant price swings experienced during 2018 and the three months ended March 31, 2019. As a result, there can be no assurance that prices for oil, natural gas and NGL, and therefore the Trust’s quarterly cash distributions, will be maintained for any significant period of time.
Impairment of Investment in Royalty Interests.
During the three- and six-month periods ended June 30, 2019, the Trust recorded a $10.4 million impairment in the carrying value of the Investment in Royalty Interests. The impairment resulted in a non-cash charge to trust corpus and did not affect the Trust’s distributable income. There were no impairments in the carrying value of the Investment in Royalty Interests during 2018. Material write-downs in subsequent periods may occur if commodity prices decline or a change in circumstances causes a decline in expected future undiscounted cash flows relative to the carrying value of the investment in royalty interests. See “Impairment of Investment in Royalty Interests” in Note 2 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for further discussion of the impairments.
Properties.
As of June 30, 2019, the Trust’s properties consisted of Royalty Interests in oil and natural gas wells located in northern Oklahoma and southern Kansas.
Distributions.
The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter.
Pursuant to Internal Revenue Code (“IRC”) Section 1446, withholding tax on income effectively connected to a United States trade or business allocated to foreign partners should be made at the highest marginal rate. Under IRC Section 1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to foreign partners should be made at 30% of gross income unless the rate is reduced by treaty. This is intended to be a qualified notice to nominees and brokers as provided for under Treasury Regulation Section 1.1446-4(b) by the Trust, and while specific relief is not specified for IRC Section 1441 income, this disclosure is intended to suffice. Nominees and brokers should withhold at the highest marginal rate on the distribution made to foreign partners.
Litigation.
As described in more detail in Item 1 of Part II,
Legal Proceedings
, claims were brought against the Trust, SandRidge and others in a putative class action during 2015. Regardless of the outcome of the litigation, the Trust may incur expenses in defending the litigation, and any such expenses may increase the Trust’s administrative expenses significantly. Further, any costs incurred by the Trust in connection with any settlement of or judgment in the litigation could increase the Trust’s administrative expenses significantly.
NYSE Listing Status.
As previously disclosed, on May 10, 2019, the Trust received written notification from The New York Stock Exchange (“NYSE”) that the Trust no longer satisfied the continued listing compliance standards set forth under Rule 802.01C of the NYSE Listed Company Manual because the average closing price of the Trust units fell below $1.00 over a 30 consecutive
trading-day period that ended May 8, 2019. If the Trust were unable to regain compliance with the applicable standards within a six-month cure period, the NYSE would commence suspension and delisting procedures.
Potential Early Termination of the Trust.
The Trust Agreement provides that the Trust will terminate if cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $5.0 million. If this occurs, the Trust Agreement will require the Trustee to sell the Royalty Interests, either by private sale or public auction, subject to SandRidge’s right of first refusal to purchase the Royalty Interests. After the sale of all of the Royalty Interests, payment of all Trust liabilities and establishment of reasonable provisions for the payment of additional anticipated or contingent Trust expenses or liabilities, the Trustee will distribute the net proceeds of the sale to the Trust unitholders.
Based on its estimates for the next twelve months regarding projected production from the Underlying Properties and estimated pricing based on futures prices as of June 30, 2019 readily available in the public market adjusted for differentials, SandRidge believes that cash available for distribution for the four consecutive quarters ending March 31, 2020, on a cumulative basis, may fall below $5.0 million, which would require the Trust to commence termination shortly after the quarterly cash distribution is made in May 2020. If that occurs, the Trustee would be required to sell all of the Trust’s remaining assets and liquidate the Trust.
As previously announced, the Trustee has begun withholding the greater of $50,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase existing cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of $625,000.
In light of the potential early termination of the Trust, the Trustee may increase the rate at which it withholds funds in order to increase the reserves.
Results of Trust Operations
The primary factors affecting the Trust’s revenues and costs are the quantity of oil, natural gas and NGL production attributable to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge. Information regarding the Trust’s production, pricing and costs for the three- and six-month periods ended June 30, 2019 and 2018 is presented below.
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Three Months Ended June 30,
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Six Months Ended June 30,
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2019(1)
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2018(2)
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2019(3)
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2018(4)
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Production Data
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Oil (MBbls)
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11
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20
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23
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45
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NGL (MBbls)
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48
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45
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92
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93
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Natural gas (MMcf)
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458
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584
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971
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1,211
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Combined equivalent volumes (MBoe)
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136
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162
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277
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339
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Average daily combined equivalent volumes (MBoe/d)
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1.5
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1.8
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1.5
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1.9
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Well Data
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Initial and Trust Development Wells producing - average
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121
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151
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125
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155
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Revenues (in thousands)
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Royalty income
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$
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2,797
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$
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3,852
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$
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5,985
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$
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7,858
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Total revenue
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2,797
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3,852
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5,985
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7,858
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Expenses (in thousands)
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Post-production expenses
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418
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452
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817
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933
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Production taxes
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173
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241
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368
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478
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Trust administrative expenses
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528
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145
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937
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679
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Cash reserves (used) withheld for current Trust expenses, net of amounts withheld (used)
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(58)
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265
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6
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128
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Total expenses
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1,061
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1,103
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2,128
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2,218
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Distributable income available to unitholders
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$
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1,736
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$
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2,749
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$
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3,857
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$
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5,640
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Average Prices
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Oil (per Bbl)
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$
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49.46
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$
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59.76
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$
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57.44
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$
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55.33
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NGL (per Bbl)
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$
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17.59
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$
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28.38
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$
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23.16
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$
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27.66
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Combined oil and NGL (per Bbl)
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$
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23.66
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$
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37.92
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$
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29.33
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$
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36.67
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Natural gas (per Mcf)
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$
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3.02
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$
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2.39
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$
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2.60
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$
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2.32
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Combined equivalent (per Boe)
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$
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20.54
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$
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23.74
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$
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21.54
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$
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23.14
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Average Prices – including impact of post-production expenses
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Natural gas (per Mcf)
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$
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2.11
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$
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1.62
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$
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1.75
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$
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1.55
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Combined equivalent (per Boe)
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$
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17.45
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$
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20.94
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$
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18.59
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$
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20.38
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Expenses (per Boe)
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Post-production
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$
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3.09
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$
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2.79
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$
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2.95
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$
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2.75
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Production taxes
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$
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1.27
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$
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1.49
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$
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1.33
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$
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1.41
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____________________
1.
Production volumes and related revenues and expenses for the three-month period ended June 30, 2019 (included in SandRidge’s May 2019 net revenue distribution to the Trust) represent production from December 1, 2018 to February 28, 2019.
2.
Production volumes and related revenues and expenses for the three-month period ended June 30, 2018 (included in SandRidge’s May 2018 net revenue distribution to the Trust) represent production from December 1, 2017 to February 28, 2018.
3.
Production volumes and related revenues and expenses for the six-month period ended June 30, 2019 (included in SandRidge’s February 2019 and May 2019 net revenue distributions to the Trust) represent production from September 1, 2018 to February 28, 2019.
4.
Production volumes and related revenues and expenses for the six-month period ended June 30, 2018 (included in SandRidge’s February 2018 and May 2018 net revenue distributions to the Trust) represent production from September 1, 2017 to February 28, 2018.
Three Months Ended June 30, 2019 Compared to the Three Months Ended June 30, 2018
Revenues
Royalty Income.
Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the three-month period ended June 30, 2019 totaled $2.8 million compared to $3.9 million received during the three-month period ended June 30, 2018. The approximate $1.1 million decrease in royalty income consisted of approximately $0.7 million attributable to a decrease in total volumes produced and approximately $0.4 million attributable to a decrease in prices received. The average number of producing wells in the three-month period ended June 30, 2019 decreased by 30 from 151 in the three-month period ended June 30, 2018, because wells that could not economically produce due to continued declining production were shut-in.
Expenses
Production Taxes.
Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the three-month period ended June 30, 2019 totaled approximately $0.2 million, or $1.27 per Boe, and were approximately 6.2% of royalty income. Production taxes for the three-month period ended June 30, 2018 totaled approximately $0.2 million, or $1.49 per Boe, and were approximately 6.3% of royalty income.
Trust Administrative Expenses
. Trust administrative expenses generally consist of fees paid to the Trustee and the Delaware Trustee, administrative services fees paid to SandRidge, tax return and related form preparation fees, legal and accounting fees, and other expenses incurred as a result of being a publicly traded entity. Trust administrative expenses for the three-month period ended June 30, 2019 totaled approximately $0.5 million compared to approximately $0.1 million for the three-month period ended June 30, 2018. The increase during the 2019 period partially relates to the timing of administrative expense payments.
Distributable Income
Distributable income for the three-month period ended June 30, 2019 was $1.7 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $58,000, reflecting approximately $528,000 used to pay Trust expenses during the period partially offset by approximately $470,000 withheld from the May 2019 cash distribution to unitholders. Distributable income for the three-month period ended June 30, 2018 was $2.7 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $265,000, reflecting approximately $410,000 withheld from the May 2018 cash distribution to unitholders partially offset by approximately $145,000 used to pay Trust expenses during the period.
Six Months Ended June 30, 2019 Compared to the Six Months Ended June 30, 2018
Revenues
Royalty Income.
Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the six-month period ended June 30, 2019 totaled $6.0 million compared to $7.9 million received during the six-month period ended June 30, 2018. The approximate $1.9 million decrease in royalty income consisted of approximately $1.8 million attributable to a decrease in total volumes produced, and by approximately $0.1 million attributable to a decrease in prices received. The average number of producing wells in the six-month period ended June 30, 2019 decreased by 30 from 155 in the six-month period ended June 30, 2018, because wells that could not economically produce due to continued declining production were shut-in.
Expenses
Production Taxes.
Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the six-month period ended June 30, 2019 totaled approximately $0.4 million, or $1.33 per Boe, and were approximately 6.2% of royalty income. Production taxes for the six-month period ended June 30, 2018 totaled approximately $0.5 million, or $1.41 per Boe, and were approximately 6.1% of royalty income. Production tax rates increased in the 2018 period due to Trust wells reaching the expiration point of a previously reduced tax rate. The average effective production tax rate for the Trust will continue to increase, up to a maximum rate of 7%, as more Trust wells reach this expiration point.
Trust Administrative Expenses
. Trust administrative expenses for the six-month period ended June 30, 2019 totaled approximately $0.9 million compared to approximately $0.7 million for the six-month period ended June 30, 2018. The increase during the 2019 period partially relates to the timing of administrative expense payments.
Distributable Income
Distributable income for the six-month period ended June 30, 2019 was $3.9 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $6,000, reflecting approximately $943,000 withheld in aggregate from the February 2019 and May 2019 cash distribution to unitholders partially offset by approximately $937,000 used to pay Trust expenses during the period. Distributable income for the six-month period ended June 30, 2018 was $5.6 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $128,000, reflecting approximately $807,000 withheld in aggregate from the February 2018 and May 2018 cash distributions to unitholders partially offset by approximately $679,000 used to pay Trust expenses during the period.
Liquidity and Capital Resources
The Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings to fund administrative expenses, including any amounts borrowed under SandRidge’s loan commitment described in Note 5 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report. The Trust’s primary uses of cash are distributions to Trust unitholders, including, if applicable, payment of Trust administrative expenses, including any reserves established by the Trustee for future liabilities, payment of applicable taxes and payment of expense reimbursements to SandRidge for out-of-pocket expenses incurred on behalf of the Trust. The Trust does not have any capital requirements related to drilling wells or any other operating or capital costs related to the wells.
Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of $75,000 to SandRidge pursuant to an administrative services agreement. Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the sale of production attributable to the Royalty Interests that quarter over the Trust’s expenses for the quarter. If at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including SandRidge, to pay such expenses. The Trustee does not intend to lend funds to the Trust. If such funds are borrowed, no further distributions will be made to unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds have been repaid. No such loan was outstanding at June 30, 2019 or December 31, 2018.
Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee has withheld, and in the future intends to withhold, the greater of $50,000 or 3.5% of the funds otherwise available for distribution each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of $625,000. In February and May 2019, the Trustee withheld an aggregate of approximately $139,000 from the funds otherwise available for distribution. The withholding for the distribution to Trust unitholders expected to occur on or before August 23, 2019 is $50,000.
The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including the operation of the Trust wells, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses. The ability to operate the properties depends on the Trustor’s future financial condition and economic performance, access to capital, and other factors, many of which are out of the control of the Trustor. On May 16, 2016, the Trustor and certain of its direct and indirect subsidiaries (collectively, the “Debtors”) filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of Texas (the “Bankruptcy Court”) under the caption In re: SandRidge Energy Inc., et al. On September 20, 2016, the Bankruptcy Court entered an amended order confirming the Amended Joint Chapter 11 Plan of Reorganization dated September 19, 2016 (the “Plan”), as modified by the Confirmation Order (the “Amended Confirmation Order”), and on October 4, 2016, the Plan became effective in accordance with its terms and the Debtors emerged from the Chapter 11 Cases. On September 23, 2016, an informal group of former SandRidge shareholders appealed the Amended Confirmation Order. On February 22, 2017, the district court before which the appeal was pending entered an order approving a stipulation to voluntarily dismiss the appeal with prejudice.
2019 Trust Distributions to Unitholder
s. During the six-month period ended June 30, 2019, the Trust’s distributions to unitholders were as follows:
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Total
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Covered
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Distribution
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Production Period
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Date Declared
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Date Paid
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Paid
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Calendar Quarter 2019
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First Quarter
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September 1, 2018 — November 30, 2018
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January 24, 2019
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February 22, 2019
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$
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2,088,450
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Second Quarter
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December 1, 2018 — February 28, 2019
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April 25, 2019
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May 24, 2019
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$
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1,740,375
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Future Trust Distributions to Unitholders.
During the three-month production period from March 1, 2019 to May 31, 2019, combined sales volumes were slightly higher compared to the three-month period ended February 28, 2019. The increase, however, was offset by lower natural gas and NGL average prices compared to the previous period. On July 25, 2019, the Trust declared a cash distribution of $0.028 per unit covering production for the period. The distribution will be paid on or about August 23, 2019 to record unitholders as of August 9, 2019 and was calculated as follows (in thousands, except for unit and per unit amounts):
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Revenues
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Royalty income
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$
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2,393
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Total revenues
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2,393
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Expenses
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Post-production expenses
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418
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Production taxes
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142
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Cash reserves withheld by Trustee (1)
|
408
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Total expenses
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968
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Distributable income
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$
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1,425
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Additional cash reserve (2)
|
50
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Distributable income available to unitholders
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$
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1,375
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Distributable income per unit (49,725,000 units issued and outstanding)
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$
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0.028
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____________________
(1) Includes amounts withheld for payment of future Trust administrative expenses.
(2) Cash reserve increase for the payment of future known, anticipated or contingent expenses or liabilities.
As the Trust cannot acquire or cause additional wells to be drilled on its behalf, the Trust’s production is expected to decline each quarter during the remainder of its life.