SANDRIDGE MISSISSIPPIAN TRUST II Introduction
The following discussion and analysis is intended to help the reader understand the financial condition, results of operations, liquidity and capital resources ofSandRidge 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 2019 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 had 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 had an interest. Until the sale of the Royalty Interests to SandRidge (the "Asset Sale") as discussed below in "-Early Termination of the Trust; Sale of Trust Assets," the Trust derived all or substantially all of its income and cash flow from the Royalty Interests. The Trust is currently in the process of winding up its affairs, as discussed below in "-Early Termination of the Trust; Sale of Trust Assets." The Trust is treated as a partnership for federal income tax purposes. Commodity Price Volatility; COVID-19 Pandemic. The Trust's quarterly cash distributions were 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 2019 and have declined in 2020 attributable primarily to the economic effects of the dispute over production levels betweenRussia and the members of theOrganization of Petroleum Exporting Countries ("OPEC"), and the global outbreak of the novel form of coronavirus known as COVID-19. The spot price for WTI crude oil has decreased from$61.17 onJanuary 2, 2020 to$36.60 onNovember 2, 2020 . Crude oil reached a closing NYMEX price low of negative$37.63 per barrel inApril 2020 . The responses by federal, state and local governmental authorities to the pandemic have also resulted in significant business and operational disruptions, including business closures, supply chains disruptions, travel restrictions, stay-at-home orders and limitations on the availability of workforces. Impairment of Investment in Royalty Interests. During the nine-month periods endedSeptember 30, 2020 and 2019, the Trust recorded impairments to the carrying value of the Investment in Royalty Interests of$8.7 million and$16.7 million , respectively. The impairments resulted in non-cash charges to trust corpus and did not affect the Trust's distributable income. 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
Distributions. Prior to the Asset Sale, the Trust made 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
non-U.S. persons ("ECI") 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 non-U.S. persons 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 non-U.S. persons. The Tax Cuts and Jobs Act (the "TCJA")
enacted in December 2017 treats a non-U.S. holder's gain on the sale of Trust
units as ECI to the extent such holder would have had ECI if the Trust had sold
all of its assets at fair market value on the date of the exchange. The TCJA
also requires the transferee of units to withhold 10% of the amount realized on
the sale of exchange of units (generally, the purchase price) unless the
transferor certifies that it is not a nonresident alien individual or foreign
corporation. Pending the finalization of proposed regulations under IRC Section
1446, the IRS has suspended this new withholding obligation with respect to
publicly traded partnerships such as the Trust, which is classified as a
partnership for federal and state income tax purposes.
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Early Termination of the Trust; Sale of Trust Assets. As discussed in "Early
Termination of the Trust" in Note 1 to the unaudited interim financial
statements contained in Part I, Item 1 of this Quarterly Report, winding up
procedures for the Trust commenced at the close of business on February 14,
2020 . Accordingly, the Trustee was required to sell all of the Trust's assets,
either by private sale or public auction.
As required by the trust agreement, the Trustee engaged a third-party advisor to
assist with the marketing and sale of the Trust's assets. The advisor conducted
a bid solicitation process that concluded in June 2020 , and the Trustee, with
the assistance of the advisor, after considering the proposed price, financing
conditions and other terms of each bid, selected what was determined to be the
strongest bid received. After the Trustee provided notice to SandRidge of the
proposed bid, SandRidge notified the Trustee on August 6, 2020 , that SandRidge
was exercising its right of first refusal to purchase the Royalty Interests from
the Trust for a purchase price of $5.25 million , subject to the execution of a
definitive agreement and the closing of the transaction. On September 10, 2020 ,
the Trust and SandRidge Exploration and Production, LLC , a wholly owned
subsidiary of SandRidge, entered into a Purchase and Sale Agreement (the
"Agreement") for the sale of all of the Royalty Interests for a purchase price
of $5,250,000 . The Asset Sale closed on September 10, 2020 , with an effective
date of July 1, 2020 . The net proceeds of the Asset Sale will be distributed to
the Trust unitholders on or before November 23, 2020 (the "November
Distribution") after payment, or reasonable provision for payment, of all Trust
liabilities, including the establishment of cash reserves deemed appropriate by
the Trustee for the payment of all claims and obligations of the Trust,
including any contingent, conditional or unmatured claims and obligations, in
accordance with the Delaware Statutory Trust Act.
As provided in the trust agreement, because SandRidge exercised its right of
first refusal under the trust agreement and completed the purchase of the
Royalty Interests from the Trust, the proposed third-party purchaser was
entitled to receive reimbursement from SandRidge and the Trust for such proposed
third-party purchaser's reasonable and documented expenses incurred in
connection with its review and analysis of the subject properties and bid
preparation, up to a maximum amount representing 5% of the sale price, with the
Trust obligated to pay 50% of such reimbursement. The Trust's share of these
reimbursed expenses was approximately $41,000 .
As of the effective date of the Asset Sale, the Trust no longer receives any
income derived from the Underlying Properties . Therefore, there will be no
further quarterly cash distributions to Trust unitholders reflecting quarterly
revenues generated from the Underlying Properties . 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.
As previously disclosed, beginning with the distribution to unitholders paid in
the first quarter of 2019, the Trustee had been withholding the greater of
$50,000 or 3.5%, increasing to $195,000 for the fourth quarter 2019
distribution, 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 . The
targeted reserve amount has been funded; however, because the amount of
distributable income for the three months ended June 30, 2020 was only $20,000 ,
the Trustee, in its discretion, elected to withhold that amount for inclusion in
the cash reserve for future liabilities. Approximately $1.3 million of the
Trust's cash reserves previously withheld by the Trustee is being released and
distributed to the Trust unitholders as part of the November Distribution.
Although the November Distribution is expected to be the final distribution to
be made to the Trust unitholders, if there are any cash reserves remaining after
the payment of all expenses and liabilities of the Trust the Trustee may make a
final distribution to unitholders of such amount prior to the completion of the
winding up process.
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The primary factors that affected the Trust's revenues and costs were the quantity of oil, natural gas and NGL production attributable to the Royalty Interests and the prices received for such production. Royalty income, post-production expenses and certain taxes were recorded on a cash basis when net revenue distributions were received by the Trust from SandRidge. Information regarding the Trust's production, pricing and costs for the three- and nine-month periods endedSeptember 30, 2020 and 2019 is presented below. Three Months Ended September Nine Months Ended September 30, 30, 2020(1) 2019(2) 2020(3) 2019(4) Production Data Oil (MBbls) 7 10 23 33 NGL (MBbls) 42 52 124 144 Natural gas (MMcf) 311 486 1,135 1,457 Combined equivalent volumes (MBoe) 101 143 337 420 Average daily combined equivalent volumes (MBoe/d) 1.1 1.6 1.2 1.5 Well Data Initial and Trust Development Wells producing - average 90 119 98 123 Revenues (in thousands) Royalty income$ 710 $ 2,406 $ 4,014 $ 8,391 Proceeds from sale of Trust assets 5,250 - 5,250 - Total revenue 5,960 2,406 9,264 8,391 Expenses (in thousands) Post-production expenses$ 279 $ 418 $ 980 $ 1,235 Production taxes 33 142 220 511 Trust administrative expenses 638 304 1,612 1,242 Cash reserves (used) withheld for current Trust expenses, net of amounts withheld (used) (240) 154 (231) 159 Total expenses 710 1,018 2,581 3,147 Distributable income available to unitholders$ 5,250 $ 1,388 $ 6,683 $ 5,244 Average Prices Oil (per Bbl)$ 21.32 $ 58.75 $ 45.24 $ 57.84 NGL (per Bbl)$ 5.24 $ 17.10 $ 11.15 $ 20.98 Combined oil and NGL (per Bbl)$ 7.47 $ 23.73 $ 16.52 $ 27.76 Natural gas (per Mcf)$ 1.11 $ 1.91 $ 1.38 $ 2.37 Combined equivalent (per Boe)$ 7.06 $ 16.76 $ 11.89 $ 19.91 Average Prices - including impact of post-production expenses Natural gas (per Mcf)$ 0.22 $ 1.05 $ 0.52 $ 1.52 Combined equivalent (per Boe)$ 4.29 $ 13.83 $ 8.98 $ 16.97 Expenses (per Boe) Post-production$ 2.77 $ 2.93 $ 2.91 $ 2.94 Production taxes$ 0.32 $ 1.00 $ 0.66 $ 1.22 ____________________ 1.Production volumes and related revenues and expenses for the three-month period endedSeptember 30, 2020 (included in SandRidge'sAugust 2020 net revenue distribution to the Trust) represent production fromMarch 1, 2020 toMay 31, 2020 . 2.Production volumes and related revenues and expenses for the three-month period endedSeptember 30, 2019 (included in SandRidge'sAugust 2019 net revenue distribution to the Trust) represent production fromMarch 1, 2019 toMay 31, 2019 . 3.Production volumes and related revenues and expenses for the nine-month period endedSeptember 30, 2020 (included in SandRidge's February, May andAugust 2020 net revenue distribution to the Trust) represent production fromSeptember 1, 2019 toMay 31, 2020 . 4.Production volumes and related revenues and expenses for the nine-month period endedSeptember 30, 2019 (included in SandRidge's February, May andAugust 2019 net revenue distribution to the Trust) represent production fromSeptember 1, 2018 toMay 31, 2019 . 13 --------------------------------------------------------------------------------
Three Months Ended
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 endedSeptember 30, 2020 totaled$0.7 million compared to$2.4 million received during the three-month period endedSeptember 30, 2019 . The approximate$1.7 million decrease in royalty income consisted of approximately$1.0 million attributable to a decrease in prices received and approximately$0.7 million attributable to a decrease in total volumes produced. The average number of producing wells in the three-month period endedSeptember 30, 2020 decreased by 29 from 119 in the three-month period endedSeptember 30, 2019 , because wells that could not economically produce due to continued declining production and current pricing 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 endedSeptember 30, 2020 totaled approximately$33,000 , or$0.32 per Boe, and were approximately 4.6% of royalty income. Production taxes for the three-month period endedSeptember 30, 2019 totaled approximately$0.1 million , or$1.00 per Boe, and were approximately 5.9% of royalty income.
Distributable Income
There was no distributable income for the three-month period endedSeptember 30, 2020 related to production attributable to the Trust's interests as costs, charges and expenses attributable to the properties in which the Trust holds royalty interests exceeded the revenue received. The Trustee completed the sale of the Trust's assets toSandRidge Exploration and Production, LLC , a wholly owned subsidiary of SandRidge, onSeptember 10, 2020 for a sale price of$5.25 million and will distribute the net proceeds of the sale to the Trust unitholders inNovember 2020 . Distributable income for the three-month period endedSeptember 30, 2019 was$1.4 million , which included a net addition to the cash reserve for payment of future Trust expenses of approximately$154,000 , reflecting approximately$458,000 withheld from theAugust 2019 cash distribution to unitholders partially offset by approximately$304,000 used to pay Trust expenses during the period.
Nine Months Ended
Revenues Royalty Income. Royalty income received during the nine-month period endedSeptember 30, 2020 totaled$4.0 million compared to$8.4 million received during the nine-month period endedSeptember 30, 2019 . The approximate$4.4 million decrease in royalty income consisted of approximately$2.7 million attributable to a decrease in prices received and approximately$1.7 million attributable to a decrease in total volumes produced. The average number of producing wells in the nine-month period endedSeptember 30, 2020 decreased by 25 from 123 in the nine-month period endedSeptember 30, 2019 , because wells that could not economically produce due to continued declining production and current pricing 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 nine-month period endedSeptember 30, 2020 totaled approximately$220,000 , or$0.66 per Boe, and were approximately 5.5% of royalty income. Production taxes for the nine-month period endedSeptember 30, 2019 totaled approximately$0.5 million , or$1.22 per Boe, and were approximately 6.1% of royalty income.
Distributable Income
Distributable income related to production for the nine-month period ended
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aggregate from the February 2020 and May 2020 cash distributions to unitholders
and the August 2020 production period. The Trustee completed the sale of the
Trust's assets to SandRidge Exploration and Production, LLC , a wholly owned
subsidiary of SandRidge, on September 10, 2020 for a sale price of $5.25 million
and will distribute the net proceeds of the sale to the Trust unitholders in
November 2020 . Distributable income for the nine-month period ended
September 30, 2019 was $5.2 million , which included a net addition to the cash
reserve for payment of future Trust expenses of approximately $0.2 million ,
reflecting approximately $1.4 million withheld in aggregate from the February
2019 , May 2019 and August 2019 cash distributions to unitholders partially
offset by approximately $1.2 million used to pay Trust expenses during the
period.
Liquidity and Capital Resources
Prior to the sale of the Royalty Interests, the Trust had 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 did not and 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 determined the amount of funds available for distribution. Available funds were 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) was not sufficient to pay the Trust's ordinary course administrative expenses as they became due, the Trust could 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 were borrowed, no further distributions would be made to unitholders (except in respect of any previously determined quarterly distribution amount) until the borrowed funds had been repaid. No such loan was outstanding atSeptember 30, 2020 orDecember 31, 2019 . Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee had been withholding, the greater of$50,000 or 3.5%, increasing to$195,000 for the fourth quarter 2019 distribution, 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 . The targeted reserve amount has been funded; however, because the amount of distributable income for the three months endedJune 30, 2020 was only$20,000 , the Trustee, in its discretion, elected to withhold that amount for inclusion in the cash reserve for future liabilities. Approximately$1.3 million of the Trust's cash reserves previously withheld by the Trustee is being released and distributed to the Trust unitholders as part of the November Distribution. Although the November Distribution is expected to be the final distribution to be made to the Trust unitholders, if there are any cash reserves remaining after the payment of all expenses and liabilities of the Trust, the Trustee may make a final distribution to unitholders of such amount prior to the completion of the winding up process. These cash reserves, if needed, are expected to be sufficient to fund the Trust's expenses for the next 12 months. The Trust is highly dependent on its Trustor, SandRidge, for multiple services, including administrative services such as accounting, tax preparation, bookkeeping and informational services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses. 2020 Trust Distributions to Unitholders. During the nine-month period endedSeptember 30, 2020 , the Trust's distributions to unitholders were as follows: Total Covered Distribution Production Period Date Declared Date Paid PaidCalendar Quarter 2020 September 1, 2019 - First Quarter November 30, 2019 January 23, 2020 February 28, 2020$ 696,150 December 1, 2019 - Second Quarter February 29, 2020 April 23, 2020 May 29, 2020$ 745,875 March 1, 2020 - May 31, Third Quarter 2020 July 23, 2020 N/A $ - 15
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Future Trust Distributions to Unitholders. OnOctober 23, 2020 , the Trust announced that there would be a cash distribution inNovember 2020 , reflecting the net proceeds received from the sale of the Trust's assets to SandRidge onSeptember 10, 2020 as discussed above, as well as the release of approximately$1.3 million of cash reserves previously withheld by the Trustee for the payment of future known, anticipated or contingent expenses or liabilities of the Trust. See "Distribution to Unitholders" in Note 6 to the unaudited interim financial statements contained in Part I, Item 1 of this Quarterly Report for additional discussion of this future distribution. In addition, as discussed above under "Overview-Early Termination of the Trust; Sale of Trust Assets," as of the effective date of the Asset Sale, the Trust no longer receives any income derived from theUnderlying Properties . Therefore, there will be no further quarterly cash distributions to Trust unitholders reflecting quarterly revenues generated from theUnderlying Properties .
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