NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. Organization of Trust
SandRidge Mississippian Trust I (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, Garfield, Grant and Woods counties in Oklahoma (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 2011. As consideration for conveyance of the Royalty Interests, the Trust remitted the proceeds of the offering, along with 3,750,000 Trust units and 7,000,000 subordinated units, which subsequently converted to common units in July 2014 as a result of SandRidge having met its drilling obligation to the Trust in April 2013, to certain wholly owned subsidiaries of SandRidge. At September 30, 2020, SandRidge owned 7,528,063 Trust units, or approximately 26.9% 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 any activity 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 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, 2030 (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 $1.0 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. See “Early Termination of the Trust” in Note 6 below.
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
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 a result, during the nine-month period ended September 30, 2020, the Trust recorded an impairment to the carrying value of the Investment in Royalty Interests of $3.3 million. The impairment resulted in a non-cash charge to trust corpus and did not affect the Trust’s distributable income. There was no impairment to the carrying value of the investment in royalty interests during the three- and nine-month periods ended September 30, 2019. Material write-downs in subsequent periods may occur if commodity prices decline or are sustained at current levels. 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, interest income 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 2019 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, 2019 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 2019 Form 10-K.
SANDRIDGE MISSISSIPPIAN TRUST I
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 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 November 2020. A summary of the Trust’s distributions to unitholders during the three- and nine-month periods ended September 30, 2020 and the year ended December 31, 2019 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Distribution
|
|
|
|
|
Covered
|
|
|
|
|
|
Distribution
|
|
Per Common
|
|
|
|
|
Production Period
|
|
Date Declared
|
|
Date Paid
|
|
Paid
|
|
Unit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Calendar Quarter 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September 1, 2019 — November 30, 2019
|
|
January 23, 2020
|
|
February 28, 2020
|
|
$
|
456,400
|
|
|
$
|
0.0163
|
|
|
|
Second Quarter
|
|
December 1, 2019 — February 29, 2020
|
|
April 23, 2020
|
|
May 29, 2020
|
|
$
|
358,400
|
|
|
$
|
0.0128
|
|
|
|
Third Quarter
|
|
March 1, 2020 — May 31, 2020
|
|
July 23, 2020
|
|
N/A
|
|
$
|
—
|
|
|
$
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
Distribution
|
|
|
|
|
Covered
|
|
|
|
|
|
Distribution
|
|
Per Common
|
|
|
|
|
Production Period
|
|
Date Declared
|
|
Date Paid
|
|
Paid
|
|
Unit
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Calendar Quarter 2019
|
|
|
|
|
|
|
|
|
|
|
|
|
First Quarter
|
|
September 1, 2018 — November 30, 2018
|
|
January 24, 2019
|
|
February 22, 2019
|
|
$
|
1,229,200
|
|
|
$
|
0.0439
|
|
|
|
Second Quarter
|
|
December 1, 2018 — February 28, 2019
|
|
April 25, 2019
|
|
May 24, 2019
|
|
$
|
1,027,600
|
|
|
$
|
0.0367
|
|
|
|
Third Quarter
|
|
March 1, 2019 — May 31, 2019
|
|
July 25, 2019
|
|
August 23, 2019
|
|
$
|
733,600
|
|
|
$
|
0.0262
|
|
|
|
Fourth Quarter
|
|
June 1, 2019 — August 31, 2019
|
|
October 24, 2019
|
|
November 22, 2019
|
|
$
|
380,800
|
|
|
$
|
0.0136
|
|
|
4. Related Party Transactions
Trustee Administrative Fee. Under the terms of the trust agreement, the Trust pays the Trustee an annual administrative fee, which for 2019 totaled $158,000. The annual fee can be adjusted for inflation by no more than 3% in any year. The Trustee’s administrative fees paid during the three-month period ended September 30, 2020 totaled approximately $41,000 compared to approximately $40,000 for the three-month period ended September 30, 2019. The Trustee’s administrative fees paid during the nine-month period ended September 30, 2020 totaled approximately $121,000 compared to approximately $118,000 for the three-month period ended September 30, 2019.
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 $200,000, 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
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
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 each of the three-month periods ended September 30, 2020 and 2019, totaled $50,000. Administrative fees paid to SandRidge for each of the nine-month periods ended September 30, 2020 and 2019, totaled $150,000.
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 September 30, 2020 or December 31, 2019.
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. The reduced demand for crude oil in the global market resulting from the economic effects of the global outbreak of the novel form of coronavirus known as COVID-19, and the oversupply in crude oil attributable to the dispute over production levels between Russia and the members of the Organization of Petroleum Exporting Countries (“OPEC”), have had, and are likely to continue to have, a negative impact on the Trustor’s financial condition. This negative impact could affect the Trustor’s ability to operate the wells and provide services to the Trust.
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, Lawrence 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 the Trust in or traceable to its initial public offering on or about April 7, 2011, and (b) purchasers of common units of SandRidge Mississippian Trust II (“SDR”) 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. 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”). In addition, because of the Court’s order, the only remaining defendants in the litigation are the Trust, 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 granting in part and denying in part the remaining defendants’ motions to dismiss the Exchange Act Claims and finding that the plaintiffs may pursue certain of the Exchange Act Claims against the
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
respective remaining defendants. In November 2017, the plaintiffs’ counsel informed counsel to the Trust that, notwithstanding the dismissal of all claims against SDR, the remaining claims in the litigation against the Trust are being asserted not only by purchasers of common units of the Trust, but also by purchasers of common units of SDR.
On January 19, 2018, the Trust filed a Motion for Partial Judgment on the Pleadings as to any claims against it brought by purchasers of common units of SDR, arguing that non-purchasers of common units in the Trust lack statutory standing to pursue claims against the Trust. On January 18, 2019, the Court granted the Trust's motion dismissing claims brought by purchasers of common units of SDR.
On July 2, 2018, defendants filed a motion for partial judgment on the pleadings, arguing that all claims asserted on behalf of the members of the putative class are barred by the statute of limitations. On March 26, 2019, the Court denied the motion without prejudice should discovery reveal a basis for again challenging the timeliness of plaintiffs' claims.
Discovery closed on June 19, 2019. Following a hearing on class certification on September 6, 2019, the motion for class certification remains pending.
On April 2, 2020, the Trust filed a Motion for Summary Judgment as to Plaintiffs’ remaining claims against the Trust, arguing that there is no evidence of requisite intent by the Trust, and further, that the alleged acts and omissions of other defendants are not properly attributable to the Trust. That motion remains pending.
On August 5, 2020, the Plaintiffs filed a motion for leave to file a second amended complaint against the Trust. That motion remains pending.
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. 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 October 23, 2020, the Trust announced that there would be no cash distribution in November 2020 with respect to production for the three-month period from June 1, 2020 to August 31, 2020. Distributable income for June 1, 2020 to August 31, 2020 was calculated as follows (in thousands, except for unit and per unit amounts):
|
|
|
|
|
|
|
|
Revenues
|
|
|
Royalty income
|
$
|
619
|
|
|
Total revenues
|
619
|
|
|
Expenses
|
|
|
Post-production expenses
|
144
|
|
|
Production taxes
|
35
|
|
|
Cash reserves withheld by Trustee (1)
|
385
|
|
|
Total expenses
|
564
|
|
|
Distributable income
|
55
|
|
|
Additional cash reserve (2)
|
55
|
|
|
Distributable income available to unitholders
|
$
|
—
|
|
|
Distributable income per unit (28,000,000 units issued and outstanding)
|
$
|
—
|
|
____________________
(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.
SANDRIDGE MISSISSIPPIAN TRUST I
NOTES TO FINANCIAL STATEMENTS - CONTINUED
(Unaudited)
COVID-19 and Oil Price Volatility. The amount of cash received or expected to be received by the Trust (and its ability to pay future distributions) has been and will be significantly and negatively impacted by prevailing low commodity prices, which have declined since the beginning of 2020 attributable primarily to the economic effects of the COVID-19 pandemic as well as the dispute over production levels between Russia and the members of OPEC, and could remain low for an extended period of time or decline further. Continued low oil, NGL and natural gas prices will reduce revenues to the Trust, which will reduce the amount of cash available for distribution to unitholders and in certain periods, such as the third and fourth quarters of 2020, could result in no distributions to unitholders, and could negatively affect the value of the Royalty Interests, which could reduce the amount of proceeds the Trust would receive from a sale of the Trust’s assets in connection with the early termination of the Trust as discussed below in “—Early Termination of the Trust.” Other important factors that could cause actual results to differ materially include expenses of the Trust and reserves for anticipated future expenses, and the effect, impact, potential duration or other implications of the COVID-19 pandemic.
Early Termination of the Trust. The trust agreement requires the Trust to dissolve and begin to liquidate on December 31, 2030 unless any of the following occurs: (a) the Trust sells all of the royalty interests previously conveyed to the Trust; (b) cash available for distribution for any four consecutive quarters, on a cumulative basis, is less than $1.0 million; (c) Trust unitholders approve an earlier dissolution of the Trust; or (d) the Trust is judicially dissolved. As cash available for distribution for the four consecutive quarters ended September 30, 2020, on a cumulative basis, totaled approximately $815,000, the Trust will be required to dissolve and commence winding up beginning as of the close of business on November 13, 2020 (the “dissolution trigger date”). Accordingly, the Trustee is required to 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, which is expected to include the establishment of cash reserves in such amounts as the Trustee in its discretion deems appropriate for the purpose of making reasonable provision for all claims and obligations of the Trust, including any contingent, conditional or unmatured claims and obligations, in accordance with the Delaware Statutory Trust Act. The sale process will involve costs that will reduce the amounts of any distributions to unitholders during the winding up period. As required by the trust agreement, within 30 days after the dissolution trigger date the Trustee plans to engage a third-party advisor to assist with the marketing and sale of the Trust’s assets. As provided in the trust agreement, SandRidge has a right of first refusal with respect to any sale of assets to a third party. The Trustee expects to complete the sale of the Trust’s assets and distribute the net proceeds of the sale to the Trust unitholders by the third quarter of 2021, and the Trust units are expected to be canceled shortly thereafter. Pending the sale of the Royalty Interests, and subject to the terms of such sale, the Trust anticipates that it will continue to receive income from the Royalty Interests and will continue to make quarterly distributions to unitholders to the extent there is available cash after payment of Trust expenses and additions to cash reserves. The Trust will remain in existence until the filing of a certificate of cancellation with the Secretary of State of the State of Delaware following the completion of the winding up process.
