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MSB > SEC Filings for MSB > Form 10-Q on 5-Jun-2013All Recent SEC Filings

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Form 10-Q for MESABI TRUST


5-Jun-2013

Quarterly Report


Item 2. Trustees' Discussion and Analysis of Financial Condition and Results
of Operations.

Forward-Looking Statements

Certain information included in this Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934. All such forward-looking statements, including those statements regarding estimation of iron ore pellet production, shipments or pricing, are based on information from the lessee/operator (and its parent corporation) of the mine located on the lands owned and held in trust for the benefit of the holders of units of beneficial interest of Mesabi Trust. These statements may be identified by the use of forward-looking words, such as "may," "will," "could," "project," "predict, " "intend," "believe," "anticipate," "expect," "estimate," "continue," "potential," "plan," "should," "assume," "forecast" and other similar words. Such forward-looking statements are inherently subject to known and unknown risks and uncertainties. Actual results and future developments could differ materially from the results or developments expressed in or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, volatility of iron ore and steel prices, market supply and demand, competition, environmental hazards, health and safety conditions, regulation or government action, litigation and uncertainties about estimates of reserves. Further, substantial portions of royalties earned by Mesabi Trust are based on estimated prices that are subject to interim and final adjustments which can be positive or negative and are dependent in part on multiple price and inflation index factors under agreements to which Mesabi Trust is not a party and that are not known until after the end of a contract year. It is possible that future negative price adjustments could partially or even completely offset royalties or royalty income that would otherwise be payable to the Trust in any particular quarter, or at year end, thereby potentially reducing cash available for distribution to the Trust's Unitholders in future quarters. For a discussion of the factors, including without limitation, those that could materially and adversely affect Mesabi Trust's actual results and performance, see "Risk Factors" set forth on pages 3 through 8 of Mesabi Trust's Annual Report on Form 10-K for the year-ended January 31, 2013. Mesabi Trust undertakes no obligation, other than that imposed by law, to make any revisions to the forward-looking statements contained in this filing or to update them to reflect circumstances occurring after the date of this filing.


This discussion should be read in conjunction with the condensed financial statements and notes presented in this Quarterly Report on Form 10-Q and the financial statements and notes in the last filed Annual Report on Form 10-K filed for the period ended January 31, 2013 for a full understanding of Mesabi Trust's financial position and results of operations for the three month period ended April 30, 2013.

Background

Mesabi Trust ("Mesabi Trust" or the "Trust"), formed pursuant to an Agreement of Trust dated July 18, 1961 (the "Agreement of Trust"), is a trust organized under the laws of the State of New York. Mesabi Trust holds all of the interests formerly owned by Mesabi Iron Company ("MIC"), including all right, title and interest in the Amendment of Assignment, Assumption and Further Assignment of Peters Lease (the "Amended Assignment of Peters Lease"), the Amendment of Assignment, Assumption and Further Assignment of Cloquet Lease (the "Amended Assignment of Cloquet Lease" and together with the Amended Assignment of Peters Lease, the "Amended Assignment Agreements"), the beneficial interest in a trust organized under the laws of the State of Minnesota to administer the Mesabi Fee Lands (as defined below) as the trust corpus in compliance with the laws of the State of Minnesota on July 18, 1961 (the "Mesabi Land Trust") and all other assets and property identified in the Agreement of Trust. The Amended Assignment of Peters Lease relates to an Indenture made as of April 30, 1915 among East Mesaba Iron Company ("East Mesaba"), Dunka River Iron Company ("Dunka River") and Claude W. Peters (the "Peters Lease") and the Amended Assignment of Cloquet Lease relates to an Indenture made May 1, 1916 between Cloquet Lumber Company and Claude W. Peters (the "Cloquet Lease").

The Agreement of Trust specifically prohibits the Trustees from entering into or engaging in any business. This prohibition applies even to business activities the Trustees may deem necessary or proper for the preservation and protection of the Trust Estate. Accordingly, the Trustees' activities in connection with the administration of Trust assets are limited to collecting income, paying expenses and liabilities, distributing net income to the holders of Certificates of Beneficial Interest in Mesabi Trust ("Unitholders") after the payment of, or provision for, such expenses and liabilities, and protecting and conserving the assets held.

The Trustees do not intend to expand their responsibilities beyond those permitted or required by the Agreement of Trust, the Amendment to the Agreement of Trust dated October 25, 1982 (the "Amendment"), and those required under applicable law. Mesabi Trust has no employees, but it engages independent consultants to assist the Trustees in, among other things, monitoring the volume and sales prices of iron ore products shipped from Silver Bay, Minnesota, based on information supplied to the Trustees by Northshore, the lessee/operator of the lands leased under the Peters Lease and Cloquet Lease (the "Peters Lease Lands" and "Cloquet Lease Lands," respectively) and the 20% fee interest of certain lands that are particularly described in, and subject to a mining lease under, the Peters Lease (the "Mesabi Fee Lands," and together with the Peters Lease Lands and Cloquet Lease Lands, the "Mesabi Trust lands"), and its parent company Cliffs Natural Resources Inc. ("Cliffs"). References to Northshore in this quarterly report, unless the context requires otherwise, are applicable to Cliffs as well.

Leasehold royalty income constitutes the principal source of the Trust's revenue. The income of the Trust is highly dependent upon the activities and operations of Northshore. Royalty rates and the resulting royalty payments received by the Trust are determined in accordance with the terms of the Trust's leases and assignments of leases.

Three types of royalties, as well as royalty bonuses, comprise the Trust's leasehold royalty income:

Base overriding royalties. Base overriding royalties have historically constituted the majority of the Trust's royalty income. Base overriding royalties are determined by both the volume and selling price of iron ore products shipped. Northshore is obligated to pay


the Trust base overriding royalties in varying amounts, based on the volume of iron ore products shipped. Base overriding royalties are calculated as a percentage of the gross proceeds of iron ore products produced at the Trust lands (and to a limited extent other lands) and shipped from Silver Bay, Minnesota. The percentage ranges from 2-1/2% of the gross proceeds for the first one million tons of iron ore products so shipped annually to 6% of the gross proceeds for all iron ore products in excess of 4 million tons so shipped annually. Base overriding royalties are impacted by, among other things, price adjustments under the Cliffs Pellet Agreements and, as described elsewhere in this report, such adjustments may be positive or negative.

Royalty bonuses. The Trust earns royalty bonuses when iron ore products shipped from Silver Bay are sold at prices above a threshold price per ton. The royalty bonus is based on a percentage of the gross proceeds of product shipped from Silver Bay and sold at prices above a threshold price. The threshold price is adjusted (but not below $30.00 per ton) on an annual basis for inflation and deflation (the "Adjusted Threshold Price"). The Adjusted Threshold Price was $50.65 per ton for calendar year 2012 and is $51.55 per ton for calendar year 2013. The royalty bonus percentage ranges from 1/2 of 1% of the gross proceeds (on all tonnage shipped for sale at prices between the Adjusted Threshold Price and $2.00 above the Adjusted Threshold Price) to 3% of the gross proceeds (on all tonnage shipped for sale at prices $10.00 or more above the Adjusted Threshold Price). Royalty bonuses are subject to price adjustments under the Cliffs Pellet Agreements and, as described elsewhere in this report, such adjustments may be positive or negative.

Fee royalties. Fee royalties have historically constituted a smaller component of the Trust's total royalty income. Fee royalties are payable to the Mesabi Land Trust, a Minnesota land trust, which holds a 20% interest as fee owner in the Amended Assignment of Peters Lease. Mesabi Trust holds the entire beneficial interest in the Mesabi Land Trust for which U.S. Bank N.A. acts as the corporate trustee. Mesabi Trust receives the net income of the Mesabi Land Trust, which is generated from royalties on the amount of crude ore mined after the payment of expenses to U.S. Bank N.A. for its services as corporate trustee. Crude ore is the source of iron oxides used to make iron ore pellets and other products. The fee royalty on crude ore is based on an agreed price per ton, subject to certain indexing.

Minimum advance royalties. Northshore's obligation to pay base overriding royalties and royalty bonuses with respect to the sale of iron ore products generally accrues upon the shipment of those products from Silver Bay. However, regardless of whether any shipment has occurred, under the terms of the Amended Assignment Agreements, Northshore is obligated to pay to the Trust a minimum advance royalty. Each year, the amount of the minimum advance royalty is adjusted (but not below $500,000 per annum) for inflation and deflation in accordance with the Amended Assignment Agreements. The minimum advance royalty was $844,452 for calendar year 2012 and is $859,429 for calendar year 2013. Until overriding royalties (and royalty bonuses, if any) for a particular year equal or exceed the minimum advance royalty for the year, Northshore must make quarterly payments of up to 25% of the minimum advance royalty for the year. Because minimum advance royalties are essentially prepayments of base overriding royalties and royalty bonuses earned each year, any minimum advance royalties paid in a fiscal quarter are recouped by credits against base overriding royalties and royalty bonuses earned in later fiscal quarters during the year.

Under the relevant documents, Northshore may mine and ship iron ore products from lands other than Mesabi Trust lands. Northshore is obligated to make quarterly royalty payments to the Trust in January, April, July and October of each year based on shipments of iron ore products from Silver Bay, Minnesota during each calendar quarter. In the case of base overriding royalties and royalty bonuses, these quarterly royalty payments are to be made whether or not the related proceeds of sale have been


received by Northshore by the time such payments become due. Northshore alone determines whether to mine off Trust and/or such other lands, based on its current mining and engineering plan. The Trustees do not exert any influence over mining operational decisions. To encourage the mining of iron ore products from Mesabi Trust lands, Mesabi Trust receives royalties, in part, based on the greater of the following two methods of calculating royalty payments (i) the aggregate quantity of iron ore products shipped that were produced using iron ore mined from Mesabi Trust lands, and (ii) a portion of the aggregate quantity of all iron ore products shipped from Silver Bay that were mined from any lands, such portion being 90% of the first four million tons shipped from Silver Bay during the calendar year, 85% of the next two million tons shipped during the calendar year, and 25% of all tonnage shipped from Silver Bay during such year in excess of six million tons. The royalty percentage paid to the Trust increases as the aggregate tonnage of iron ore products shipped, attributable to the Trust, in any calendar year increases past each of the first four one-million ton volume thresholds. Assuming a consistent sales price per ton throughout a calendar year, shipments of iron ore product attributable to the Trust later in the year generate a higher royalty to the Trust, as total shipments for the year exceed increasing levels of royalty percentages and pass each of the first four one-million ton volume thresholds.

During the course of its fiscal year some portion of royalties expected to be paid to Mesabi Trust is based in part on estimated prices for iron ore products sold under term contracts between Northshore, Cliffs and certain of their customers (the "Cliffs Pellet Agreements"). The Cliffs Pellet Agreements use estimated prices which are subject to interim and final pricing adjustments, which can be positive or negative, and which adjustments are dependent in part on multiple price and inflation index factors that are not known until after the end of a contract year. Even though Mesabi Trust is not a party to the Cliffs Pellet Agreements, these adjustments can result in significant variations in royalties received by Mesabi Trust (and in turn the resulting amount available for distribution to Unitholders by the Trust) from quarter to quarter and on a comparative historical basis, and these variations, which can be positive or negative, cannot be predicted by Mesabi Trust. In either case, these price adjustments will impact future royalties received by the Trust that become available for distribution to Unitholders.

Deutsche Bank Trust Company Americas, the Corporate Trustee, performs certain administrative functions for Mesabi Trust. The Trust maintains a website at www.mesabi-trust.com. The Trust makes available (free of charge) its annual, quarterly and current reports (and any amendments thereto) filed with the Securities and Exchange Commission (the "SEC") through its website as soon as reasonably practicable after electronically filing or furnishing such material with or to the SEC.

Results of Operations

Comparison of Iron Ore Pellet Production and Shipments for the Three Months Ended April 30, 2013 and April 30, 2012

As shown in the table below, production of iron ore pellets at Northshore from Mesabi Trust lands during the fiscal quarter ended April 30, 2013 totaled 933,437 tons, and actual shipments over the same period totaled 568,548 tons. By comparison, actual pellet production and actual shipments for the comparable prior period were 1,399,462 tons and 689,443 tons, respectively. The decreases in production and shipments at Northshore, as compared to the prior comparable period, is the result of decreases in anticipated demand and actual orders from Cliffs' customers.

                       Pellets Produced from   Pellets Shipped from
Fiscal Quarter Ended    Trust Lands (tons)      Trust Lands (tons)
   April 30, 2013                    933,437                568,548
   April 30, 2012                  1,399,462                689,443


Comparison of Royalty Income for the Three Months Ended April 30, 2013 and April 30, 2012

Total royalty income for the current quarter decreased $1,164,704 to $2,528,417, as compared to the three months ended April 30, 2012. The decrease in total royalty income is due to lower average sales prices per ton of iron ore pellets sold and a decrease in the total volume of iron ore pellets shipped during the three months ended April 30, 2013, each as compared to the three months ended April 30, 2012.

The table below shows that the base overriding royalties, the bonus royalties, and the fee royalties decreased $529,106, $571,122, and $64,476 respectively, for the three months ended April 30, 2013, as compared to the three months ended April 30, 2012. The decreases in the base overriding royalties and the bonus royalties are both attributable to lower sales prices per ton of iron ore pellets and the decrease in the volume of tons shipped during the three months ended April 30, 2013, each as compared to the three months ended April 30, 2012. The decrease in the fee royalty amount is due to a decrease in the amount of ore mined under the Peters Lease.

The table below summarizes the components of Mesabi Trust's royalty income for the three months ended April 30, 2013 and April 30, 2012, respectively:

                                             Three Months Ended April 30,
                                               2013               2012
Base overriding royalties                 $     1,061,633    $     1,590,739
Bonus royalties                                 1,312,360          1,883,482
Minimum advance royalty paid (recouped)                 -                  -
Fee royalties                                     154,424            218,900
Total royalty income                      $     2,528,417    $     3,693,121

Comparison of Income, Expenses and Distributions for the Three Months Ended April 30, 2013 and April 30, 2012

Net income for the three months ended April 30, 2013 was $2,202,389, a decrease of $1,167,503 compared to the three months ended April 30, 2012. As with the decrease in total royalty income, the decrease in net income for the quarter ended April 30, 2013 is the result of lower average sales prices per ton of iron ore pellets sold and a decrease in the total volume of iron ore pellets shipped during the three months ended April 30, 2013, each as compared to the three months ended April 30, 2012. The Trust's expenses for the three months ended April 30, 2013 were $326,418, an increase of $2,864 compared to the Trust's expenses for the three month period ended April 30, 2012. The table below summarizes the Trust's income and expenses for the three months ended April 30, 2013 and April 30, 2012, respectively.

                          Three Months Ended April 30,
                            2013               2012
Total Royalty Income   $     2,528,417    $     3,693,121
Interest Income                    390                325
Gross Income                 2,528,807          3,693,446
Expenses                       326,418            323,554
Net income             $     2,202,389    $     3,369,892

As presented on the Trust's Condensed Statements of Income on page 2 of this quarterly report, the Trust's net income per unit decreased $0.089 to $0.1679 for the three months ended April 30, 2013, as compared to the three months ended April 30, 2012. Distributions declared per unit increased $0.015 from $0.065 for the three months ended April 30, 2012 to $0.08 for the three months ended April 30,


2013. The $0.015 per unit increase over the same period last year is primarily attributable to a reduction in the amount of negative price adjustments to royalties previously received by the Trust.

Distributions are declared after receiving notification from Northshore as to the amount of royalty income that is expected to be paid to the Trust based on shipments through the end of each calendar quarter, and such royalty payments may include pricing adjustments with respect to shipments during prior periods. The Trust accounts for and reports accrued income receivable based on shipments during the last month of the Trust's fiscal quarter (April, July, October and January) and price adjustments under the Cliffs Pellet Agreements (which can be positive or negative and can result in significant variations in royalties received by Mesabi Trust and cash available for distribution to Unitholders). The Trust accounts for these amounts by using estimated prices and reports such amounts even though accrued income receivable is not available for distribution to Unitholders until it is received by the Trust. Accordingly, distributions declared by the Trust are not equivalent to the Trust's Net Income during the periods reported in this quarterly report on Form 10-Q.

Comparison of Unallocated Reserve as of April 30, 2013, April 30, 2012 and January 31, 2013

As set forth in the table below, Unallocated Reserve, which is comprised of accrued income receivable, unallocated cash and U.S. Government securities for potential fixed or contingent future liabilities, and prepaid expenses and accrued expenses, decreased from $3,548,599 as of April 30, 2012 to $2,335,010 as of April 30, 2013. The decrease in the Unallocated Reserve as of April 30, 2013, as compared to April 30, 2012, is primarily the result of a decrease in the Trust's accrued income receivable. The accrued income receivable portion of the Unallocated Reserve decreased from $2,915,527 as of April 30, 2012 to $1,599,406 as of April 30, 2013. The decrease in the accrued income receivable portion of the Unallocated Reserve is the result of a reduction in shipments and lower average sales prices per ton on pellets shipped in the month of April 2013, as compared to April 2012. The increase in the unallocated cash and U.S. Government securities for potential fixed or contingent future liabilities is due to the Trustees' decision to add additional reserves to the Trust's unallocated cash and U.S. Government securities for unexpected losses.

                                                     Three Months Ended April 30,
                                                       2013               2012
Accrued Income Receivable                         $     1,599,406    $     2,915,527
Unallocated Cash and U.S. Government Securities           818,866            700,155
Prepaid Expenses and Accrued Expenses (net)               (83,262 )          (67,083 )
Unallocated Reserve                               $     2,335,010    $     3,548,599

The Trust does not currently have any deferred royalty revenue liability. It is possible that future negative price adjustments could offset, or even eliminate, future royalties or royalty income that would otherwise be payable to the Trust in any particular quarter, or at year end, thereby potentially reducing cash available for distribution to the Trust's Unitholders in future quarters. See the discussion under the heading "Risk Factors" beginning on page 3 of the Trust's Annual Report on Form 10-K for the fiscal year ended January 31, 2013.

The Trust's Unallocated Reserve as of April 30, 2013 increased $1,152,788, as compared to the fiscal year ended January 31, 2013. The increase in the Unallocated Reserve is due primarily to an increase in the accrued income receivable. At January 31, 2013, the Unallocated Reserve consisted of $944,526 in unallocated cash and U.S. Government securities and $218,053 of accrued income receivable, as compared to $818,866 of unallocated cash and U.S. Government securities and $1,599,406 of accrued income receivable as of April 30, 2013.


The Trustees have determined that the unallocated cash and U.S. Government securities portion of the Unallocated Reserve should be maintained at a prudent level, usually within the range of $500,000 to $1,000,000, to meet present or future liabilities of the Trust. Although the actual amount of the Unallocated Reserve will fluctuate from time to time and may increase or decrease from its current level, it is currently intended that future distributions will be highly dependent upon royalty income as it is received and the level of Trust expenses. The amount of future royalty income available for distribution will be subject to the volume of iron ore product shipments and the dollar level of sales by Northshore. Shipping activity is greatly reduced during the winter months. Economic conditions, particularly those affecting the steel industry, may adversely affect the amount and timing of such future shipments and sales. The Trustees will continue to monitor the economic circumstances of the Trust to strike a responsible balance between distributions to Unitholders and the need to maintain adequate reserves at a prudent level, given the unpredictable nature of the iron ore industry, the Trust's dependence on the actions of the lessee/operator, and the fact that the Trust essentially has no other liquid assets.

Recent Developments

On April 25, 2013, Cliffs announced that it was ready to produce a new kind of iron ore pellet in Minnesota that could potentially open new markets. In its press release, Cliffs stated that it successfully completed a two-week, full-scale production test of direct reduced iron-grade pellets at its Silver Bay plant in March. According to the press release, the new kind of pellets are low in silica, which makes them suitable for feed for a DRI plant. Then the reduced pellets can be used for making steel in smaller electric arc furnaces, known as mini-mills. Standard taconite pellets from the taconite mines in northeastern Minnesota have historically fed big traditional blast furnaces around the Great Lakes. The Trustees are not able to predict when production of such new pellets might commence nor whether such production would be located at Northshore's Silver Bay facility, and Cliffs did not provide any such forecasts.

As previously reported, two of the four production lines at Northshore were idled beginning January 5, 2013 through the end of the Trust's first fiscal quarter ended April 30, 2013. The Trustees have not been informed of, and are not able to predict, when these production lines will resume operation.

Important Factors Affecting Mesabi Trust

The Agreement of Trust specifically prohibits the Trustees from entering into or engaging in any business. This prohibition seemingly applies even to business activities the Trustees deem necessary or proper for the preservation and protection of the Trust's assets. Accordingly, the Trustees' activities in connection with the administration of Trust assets are limited to collecting income, paying expenses and liabilities, distributing net income to Mesabi Trust's Unitholders after the payment of, or provision for, such expenses and liabilities, and protecting and conserving the assets held.

Neither Mesabi Trust nor the Trustees have any control over the operations and activities of Northshore, except within the framework of the Amended Assignment Agreements. Cliffs alone controls (i) historical operating data, including iron ore production volumes, marketing of iron ore products, operating and capital expenditures as they relate to Northshore, environmental and other liabilities and the effects of regulatory changes; (ii) plans for Northshore's future operating and capital expenditures; (iii) geological data relating to ore reserves; (iv) projected production of iron ore products; (v) contracts between Cliffs and Northshore with their customers; and (vi) the decision to mine off Mesabi Trust and/or state lands based on Cliffs' current mining and engineering plan. The Trustees do not exert any influence over mining operational decisions at Northshore, nor do the Trustees provide any input regarding the ore reserve estimated at Northshore as reported by Cliffs. While the Trustees request . . .

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