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SDR > SEC Filings for SDR > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for SANDRIDGE MISSISSIPPIAN TRUST II

Form 10-Q for SANDRIDGE MISSISSIPPIAN TRUST II


8-Aug-2014

Quarterly Report


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 Trust's financial condition, results of operations, liquidity and capital resources. This discussion and analysis should be read in conjunction with the Trust's unaudited 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 2013 Form 10-K.

Overview

The Trust is a statutory trust created on December 13, 2011 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 the Trust's derivative contracts (described in Note 4 to the unaudited financial statements contained in Part I, Item 1 of this Quarterly Report) 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 and the Trust's derivative contracts. The Trust is treated as a partnership for federal income tax purposes.

Properties. As of June 30, 2014, the Trust's properties consisted of Royalty Interests in (a) the Initial Wells, (b) 166 additional wells (equivalent to approximately 197 Trust Development Wells under the development agreement as described below) that were drilled and perforated for completion between December 31, 2011 and June 30, 2014, and (c) the equivalent of approximately 9 Trust Development Wells to be drilled within an AMI consisting of approximately 51,900 gross acres (40,800 net acres) in northern Oklahoma and southern Kansas.

SandRidge is obligated to drill, or cause to be drilled, the Trust Development Wells on or before December 31, 2016. SandRidge is not permitted to drill and complete any well within the AMI for its own account until it has satisfied the drilling obligation to the Trust. SandRidge has granted to the Trust a lien covering its interest in the AMI (except its interest in the Initial Wells) in order to secure the estimated amount of the drilling costs for the Trust's interests in the undeveloped Underlying Properties. Subsequent to the drilling of 103 Trust Development Wells, the total amount that may be recovered has been reduced proportionately as each of the remaining Trust Development Wells has been drilled. At June 30, 2014, the amount potentially recoverable under the lien was approximately $23.1 million.

The Trust is not responsible for any costs related to the drilling of the Trust Development Wells or any other operating or capital costs related to the Underlying Properties. The following table presents the number of Initial Wells, Trust Development Wells drilled and Trust Development Wells to be drilled as of June 30, 2014 and December 31, 2013.

                                                           Trust
                                          Trust          Development
                                       Development       Wells To Be
                    Initial Wells    Wells Drilled(1)      Drilled     Total
June 30, 2014                  67                 197              9     273
December 31, 2013              67                 184             22     273



(1) SandRidge is credited for having drilled one full Trust Development Well if a well is drilled and perforated for completion with a perforated length between 3,500 feet and 4,500 feet within the Mississippian formation and SandRidge's net revenue interest in the well is equal to 47.4%. For wells with a perforated length of less than 3,500 feet or greater than 4,500 feet and for wells in which SandRidge has a net revenue interest greater or less than 47.4%, SandRidge receives proportionate credit for such well.

Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust's administrative expenses, property taxes and cash reserves withheld by the Trustee, on or about 60 days following the completion of each quarter. The Trust's subordinated units are entitled to receive pro rata distributions from the Trust each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is at least equal to the Subordination Threshold. If there is not sufficient cash to fund such a distribution on all of the common units (including the common units SandRidge owns), the distribution to be made with respect to the subordinated units is reduced or eliminated for such quarter in order to make a distribution, to the extent possible, to all of the common units (including the common units held by SandRidge) up to the Subordination Threshold. However, there is no minimum distribution. If the cash available for distribution on all of the Trust units in


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any quarter exceeds the Incentive Threshold for the corresponding quarter, SandRidge, as holder of the Trust's subordinated units, is entitled to 50% of the amount by which the cash available for distribution exceeds the Incentive Threshold.

The following table sets forth the approximate Subordination Threshold and Incentive Threshold for each remaining calendar quarter through the fourth quarter of 2017, as set out in the trust agreement.

                      Subordination       Incentive
Period(1)              Threshold(2)      Threshold(2)

2014
Second quarter (3)   $          0.60   $          0.89
Third quarter                   0.60              0.90
Fourth quarter                  0.58              0.87

2015
First quarter                   0.63              0.95
Second quarter                  0.64              0.97
Third quarter                   0.64              0.96
Fourth quarter                  0.64              0.96

2016
First quarter                   0.67              1.00
Second quarter                  0.64              0.96
Third quarter                   0.58              0.87
Fourth quarter                  0.54              0.81
2017
First quarter                   0.51              0.77
Second quarter                  0.48              0.73
Third quarter                   0.46              0.69
Fourth quarter                  0.44              0.66



(1) 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.

(2) The subordination period will terminate and the subordinated units will automatically convert into common units on a one-for-one basis after the fourth full calendar quarter following SandRidge's completion of its drilling obligation, at which point the units will no longer be subject to the Subordination Threshold or have the benefit of the Incentive Threshold. Amounts have been rounded to two decimal places and are presented as set forth in the trust agreement. Actual distributions are declared and paid based upon a calculation carried out to three decimal places.

(3) A distribution of $0.486 per common unit was declared on July 31, 2014 and is expected to be paid on or about August 29, 2014. Because income available for distribution on the Trust common units was $0.486 per unit, which was below the Subordination Threshold of $0.592 for the period, no distribution will be paid to the subordinated units for the period. See Note 6 to the financial statements contained in Item 1 of this report for further discussion.

Litigation. As described in more detail in Item 1 of Part II, Legal Proceedings, the Trust has been named as an additional defendant in a putative class action against SandRidge and others. 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.

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, currently 39.6% for individuals, on the distribution made to foreign partners.


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Results of Trust Operations

The primary factors affecting the Trust's revenues and costs are the quantity of oil and natural gas production attributable to the Royalty Interests, the prices received for such production and amounts paid or received as net settlements under the derivatives agreement. Royalty income, post-production expenses, certain taxes and derivative settlements are recorded on a cash basis when net revenue distributions are received by the Trust from SandRidge and net derivative settlements are received from the Trust's derivative counterparties. Information regarding the Trust's production, pricing and costs for the three and six-month periods ended June 30, 2014 and 2013 is presented below.

                                       Three Months Ended            Six Months Ended
                                             June 30,                     June 30,
                                      2014(1)       2013(2)        2014(3)       2013(4)
Production Data
Oil (MBbls)(5)                              174           235            386           462
Natural gas (MMcf)                        1,500         1,702          3,165         3,460
Combined equivalent volumes
(MBoe)                                      424           518            913         1,039
Average daily combined
equivalent volumes (MBoe/d)                 4.7           5.8            5.0           5.7

Well Data
Initial and Trust Development
Wells producing - average                   231           176            230           163

Revenues (in thousands)
Royalty income                      $    21,691    $   26,692    $    46,596    $   51,535
Derivative settlements                      454         2,430          1,752         6,584
Total revenue                       $    22,145    $   29,122    $    48,348    $   58,119

Expenses (in thousands)
Post-production expenses            $       725    $      929    $     1,568    $    1,918
Property taxes                              369             -            369           250
Production taxes                            236           391            634           776
Trust administrative expenses               460           182            908           786
Cash reserves (used) withheld
for current Trust expenses, net
of amounts withheld (used)                 (227 )         408           (176 )         351
Total expenses                      $     1,563    $    1,910    $     3,303    $    4,081
Distributable income available
to unitholders                      $    20,582    $   27,212    $    45,045    $   54,038

Average Prices
Oil (per Bbl)(5)                    $     84.87    $    86.76    $     86.93    $    85.62
Natural gas (per Mcf)               $      4.64    $     3.73    $      4.12    $     3.46
Combined equivalent (per Boe)       $     51.20    $    51.51    $     51.01    $    49.62

Average Prices - including
impact of derivative settlements
and post-production expenses
Oil (per Bbl)(5)(6)                 $     89.02    $    99.46    $     91.37    $   100.32
Natural gas (per Mcf)               $      4.15    $     3.18    $      3.63    $     2.91
Combined equivalent (per Boe)       $     51.19    $    55.47    $     51.17    $    54.31

Expenses (per Boe)
Post-production                     $      1.71    $     1.79    $      1.72    $     1.85
Production taxes                    $      0.56    $     0.76    $      0.69    $     0.75



(1) Production volumes and related revenues and expenses for the three-month period ended June 30, 2014 (included in SandRidge's May 2014 net revenue distribution to the Trust) represent oil and natural gas production from December 1, 2013 to February 28, 2014.

(2) Production volumes and related revenues and expenses for the three-month period ended June 30, 2013 (included in SandRidge's May 2013 net revenue distribution to the Trust) represent oil and natural gas production from December 1, 2012 to February 28, 2013.

(3) Production volumes and related revenues and expenses for the six-month period ended June 30, 2014 (included in SandRidge's February 2014 and May 2014 net revenue distributions to the Trust) represent oil and natural gas production from September 1, 2013 to February 28, 2014.


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(4) Production volumes and related revenues and expenses for the six-month period ended June 30, 2013 (included in SandRidge's March 2013 and May 2013 net revenue distributions to the Trust) represent oil and natural gas production from September 1, 2012 to February 28, 2013.

(5) Includes NGLs, which comprised approximately 7%, 2%, respectively, of total production in the three-month periods ended June 30, 2014 and 2013 and approximately, 7% and 2%, respectively, of total production in the six-month periods ended June 30, 2014 and 2013.

(6) Includes impact of derivative settlements attributable to production from December 1, 2013 to February 28, 2014 for the three-month period ended June 30, 2014 and from December 1, 2012 to February 28, 2013 for the three-month period ended June 30, 2013. Includes impact of derivative settlements attributable to production from September 1, 2013 to February 28, 2014 for the six-month period ended June 30, 2014 and from September 1, 2012 to February 28, 2013 for the six-month period ended June 30, 2013.

Three Months Ended June 30, 2014 Compared to the Three Months Ended June 30, 2013

Revenues

Royalty Income. Royalty income received during the three-month period ended June 30, 2014 totaled $21.7 million compared to $26.7 million received during the three-month period ended June 30, 2013. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. The decrease in royalty income was primarily attributable to the decrease in total production resulting from natural declines in production from the Initial Wells and Trust Development Wells. Royalty income received during the three-month period ended June 30, 2014 was based upon production attributable to the Royalty Interests of 174 MBbls of oil and 1,500 MMcf of natural gas, or 424 MBoe of combined production, for the period from December 1, 2013 to February 28, 2014. Royalty income received during the three-month period ended June 30, 2013 was based upon production attributable to the Royalty Interests of 235 MBbls of oil and 1,702 MMcf of natural gas, or 518 MBoe of combined production, for the period from December 1, 2012 to February 28, 2013.

Derivative Settlements. The Trust's derivatives agreement with SandRidge reduces the Trust's exposure to commodity price volatility attributable to a portion of production from the Royalty Interests through December 31, 2015, including the effects of amendments executed in May 2014, by the use of oil fixed price swaps. Net cash settlements received related to the Trust's derivatives during the three-month period ended June 30, 2014 were approximately $454,000, and included
(i) approximately $419,000 received related to the conveyed contracts for production attributable to the Royalty Interests from December 1, 2013 to February 28, 2014, (ii) approximately $83,000 received from the counterparty to the novated contracts for production attributable to the Royalty Interests from January 1, 2014 to February 28, 2014 and (iii) approximately $48,000 paid to the counterparty to the novated contracts for March 2014 production. Total net derivative settlements received by the Trust for production from December 1, 2013 to February 28, 2014 were $721,000, including the impact of $219,000 received in February 2014 from the counterparty to the novated contracts for December 2013 production, which effectively increased the average price received for oil production for the related period by $4.15 per Bbl to $89.02 per Bbl. Derivative settlements received during the three-month period ended June 30, 2014 related to March 2014 production will be included in the Trust's August 2014 quarterly distribution. Net cash settlements received related to the Trust's derivatives during the three-month period ended June 30, 2013 were approximately $2.4 million, and included (i) approximately $1.4 million received related to the conveyed contracts for production attributable to the Royalty Interests from December 1, 2012 to February 28, 2013, (ii) approximately $0.6 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from January 1, 2013 to February 28, 2013 and (iii) approximately $0.4 million received from the counterparty to the novated contracts for March 2013 production. Total net derivative settlements received by the Trust for production from December 1, 2012 to February 28, 2013 were $3.0 million, including $1.0 million received from the counterparty to the novated contracts for December 2012 production, which effectively increased the average price received for oil production for the related period by $12.70 per Bbl to $99.46 per Bbl.

Expenses

Post-Production Expenses. The Trust bears post-production expenses attributable to production from the Royalty Interests. Post-production expenses generally consist of costs incurred to gather, store, compress, transport, process, treat, dehydrate and market the oil and natural gas produced. Post-production expenses for the three-month period ended June 30, 2014 totaled approximately $0.7 million compared to approximately $0.9 million for the three-month period ended June 30, 2013.

Property Taxes. The Trust paid approximately $0.4 million of its $0.7 million 2013 property tax assessment during the three-month period ended June 30, 2014. The other $0.3 million was paid during the three-month period ended December 31, 2013. The Trust did not pay any property taxes during the three-month period ended June 30, 2013.


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Production Taxes. Production taxes are calculated as a percentage of oil and natural gas revenues, excluding the effects of derivative settlements and net of any applicable tax credits. Production taxes for the three-month period ended June 30, 2014 totaled approximately $0.2 million, or $0.56 per Boe, and were approximately 1.1% of royalty income. Production taxes for the three-month period ended June 30, 2013 totaled approximately $0.4 million, or $0.76 per Boe, and were approximately 1.5% 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, 2014 totaled approximately $0.5 million compared to approximately $0.2 million for the three-month period ended June 30, 2013. The increase in expense is attributable to the timing of administrative expense payments.

Distributable Income

Distributable income for the three-month period ended June 30, 2014 was $20.6 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $0.2 million (approximately $0.8 million used to pay Trust expenses during the period partially offset by approximately $0.6 million withheld from the May 2014 cash distribution to unitholders). Distributable income for the three-month period ended June 30, 2013 was $27.2 million, which included a net addition to the cash reserve for payment of future Trust expenses of approximately $0.4 million (approximately $0.6 million withheld from the May 2013 cash distribution to unitholders partially offset by approximately $0.2 million used to pay Trust expenses during the period).

Distributions to Common and Subordinated Units. Holders of Trust common units received greater distributions than holders of Trust subordinated units during the three-month period ended June 30, 2014 as a result of the Trust's subordination provisions. Because income available for distribution on all Trust units for the May 2014 distribution was below the Subordination Threshold, no distributions were paid to the subordinated units for that period. As a result of the subordination provisions, holders of common units received approximately $5.2 million more in distributions for the three-month period ended June 30, 2014 than such holders would have received had the subordination provisions not existed. During the three-month period ended June 30, 2013 distributions per subordinated unit equaled distributions per common unit.

Six Months Ended June 30, 2014 Compared to the Six Months Ended June 30, 2013

Revenues

Royalty Income. Royalty income received during the six-month period ended June 30, 2014 totaled $46.6 million compared to $51.5 million received during the six-month period ended June 30, 2013. The decrease in royalty income was primarily attributable to the decrease in combined equivalent volumes produced resulting from natural declines in production from the Initial Wells and Trust Development Wells. The net revenue distributions from SandRidge received by the Trust during the six-month period ended June 30, 2014 included royalty income attributable to production for the six-month period from September 1, 2013 to February 28, 2014 of 386 MBbls of oil and 3,165 MMcf of natural gas, or 913 MBoe of combined production. The net revenue distribution from SandRidge received by the Trust during the six-month period ended June 30, 2013 included royalty income attributable to production for the six-month period from September 1, 2012 to February 28, 2013 of 462 MBbls of oil and 3,460 MMcf of natural gas, or 1,039 MBoe of combined production. The decrease in total production was slightly offset by increases in the average prices received for oil and natural gas production, excluding the impact of derivative settlements and post-production expenses. The average price received for oil increased to $86.93 per Bbl during the six-month period ended June 30, 2014 from $85.62 per Bbl during the same period in 2013, while the average price received for natural gas increased to $4.12 per Mcf during the six-month period ended June 30, 2014 from $3.46 per Mcf during the same period in 2013.

Derivative Settlements. Net cash settlements received related to the Trust's derivatives during the six-month period ended June 30, 2014 were approximately $1.8 million, and included (i) approximately $1.0 million received related to the conveyed contracts for production attributable to the Royalty Interests from September 1, 2013 to February 28, 2014, (ii) approximately $0.8 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from October 1, 2013 to February 28, 2014 and
(iii) approximately $48,000 paid to the counterparty to the novated contracts for March 2014 production. Total net derivative settlements received by the Trust for production from September 1, 2013 to February 28, 2014 were $1.7 million, including the impact of $0.1 million paid in November 2013 to the counterparty to the novated contracts for September 2013 production, which effectively increased the average price received for oil production for the related period by $4.44 per Bbl to $91.37 per Bbl. Net cash settlements received related to the Trust's derivatives during the six-month period ended June 30, 2013 were approximately $6.6 million, and included (i) approximately $2.7 million received related to the conveyed contracts for production attributable to the Royalty Interests from September 1, 2012 to February 28, 2013, (ii) approximately $3.5 million received from the counterparty to the novated contracts for production attributable to the Royalty Interests from October 1, 2012 to February 28, 2013 and (iii)


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approximately $0.4 million received from the counterparty to the novated contracts for March 2013 production. Total net derivative settlements received by the Trust for production from September 1, 2012 to February 28, 2013 were $6.8 million, including $0.6 million received in November 2012 from the counterparty to the novated contracts for September 2013 production, which effectively increased the average price received for oil production for the related period by $14.70 per Bbl to $100.32 per Bbl.

Expenses

Post-Production Expenses. Post-production expenses for the six-month period ended June 30, 2014 totaled approximately $1.6 million compared to approximately $1.9 million for the six-month period ended June 30, 2013. Post-production costs decreased as a result of decreased total production.

Property Taxes. Property taxes paid during the six-month period ended June 30, 2014 totaled approximately $0.4 million compared to approximately $0.3 million for the six-month period ended June 30, 2013.

Production Taxes. Production taxes for the six-month period ended June 30, 2014 totaled approximately $0.6 million, or $0.69 per Boe, and were approximately 1.4% of royalty income. Production taxes for the six-month period ended June 30, 2013 totaled approximately $0.8 million, or $0.75 per Boe, and were approximately 1.5% of royalty income.

Trust Administrative Expenses. Trust administrative expenses for the six-month period ended June 30, 2014 totaled approximately $0.9 million compared to approximately $0.8 million for the six-month period ended June 30, 2013.

Distributable Income

Distributable income for the six-month period ended June 30, 2014 was $45.0 million, which included a net reduction to the cash reserve for payment of future Trust expenses of approximately $0.2 million (approximately $1.3 million used to pay Trust expenses during the period partially offset by approximately . . .

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