PER SandRidge Permian Trust

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2019

OR

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to

Commission File Number: 001-35274

SANDRIDGE PERMIAN TRUST

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(512) 236-6555

Former name, former address and former fiscal year, if changed since last report: Not applicable

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes o  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

As of November, 7 2019, 52,500,000 units of Beneficial Interest in SandRidge Permian Trust were outstanding.

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The accompanying notes are an integral part of these financial statements.

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The accompanying notes are an integral part of these financial statements.

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SANDRIDGE PERMIAN TRUST

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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 United States Securities and Exchange Commission (“SEC”) as specified by Staff Accounting Bulletin Topic 12: E, Financial Statements of Royalty Trusts.  Amortization of investment in the Royalty Interests, calculated on a unit-of-production basis, and any impairments are charged directly to the trust corpus.  Distributions to unitholders are recorded when declared.

Significant Accounting Policies.  Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, which may require such entities to accrue or defer revenues and expenses in a period other than when such revenues are received, or expenses are paid. Because the Trust’s financial statements are prepared on the modified cash basis as described above, most accounting pronouncements are not applicable to the Trust’s financial statements.

The Trust is treated for federal and applicable state income tax purposes as a partnership.  For U.S. federal income tax purposes, a partnership is not a taxable entity and incurs no U.S. federal income tax liability.

With respect to state taxation, a partnership is typically treated in the same manner as it is for U.S. federal income tax purposes.  However, the Trust’s activities result in the Trust having nexus in Texas and, therefore, make it subject to Texas franchise tax.  Texas franchise tax is treated as an income tax for financial statement purposes.  The Trust is required to pay Texas franchise tax each year at a maximum effective rate (subject to changes in the statutory rate) of 0.525% of its gross income, all of which is realized from activities in Texas. The Trust records Texas franchise tax when paid.

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.  There were no impairments in the carrying value of the investment in the Royalty Interests during the nine-month periods ended September 30, 2019 and 2018.  Material write-downs in subsequent periods may occur if commodity prices decline.  Any impairment would result in a non-cash charge to the trust corpus and would not affect the Trust’s distributable income. See “Risks and Uncertainties” in Note 5 below for further discussion.

Distributable Income Per Unit. Distributable income per unit amounts as calculated for the periods presented in the accompanying unaudited statements of distributable income may differ from declared distribution amounts per unit due to rounding and the timing of the Trust’s payment of Trust administrative expenses and other costs.

Interim Financial Statements.  The accompanying unaudited interim financial statements have been prepared in accordance with the accounting policies stated in the audited financial statements contained in the 2018 Form 10-K and reflect all adjustments that are, in the opinion of the Trustee, necessary to state fairly the information in the Trust’s unaudited interim financial statements. The accompanying statement of assets and trust corpus as of December 31, 2018 has been derived from audited financial statements.  The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the 2018 Form 10-K.

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3. Distributions to Unitholders

The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter.  Distributions cover a three-month production period consisting of the first two months of the most recently ended quarter and the final month of the preceding quarter.  See Note 6 for discussion of the Trust’s quarterly distribution to be paid in November 2019.  A summary of the Trust’s distributions to unitholders during the nine-month period ended September 30, 2019 and the year ended December 31, 2018 is as follows:

4. Related Party Transactions

Trustee Administrative Fee.  Under the terms of the Trust Agreement, the Trust pays the Trustee an annual administrative fee, which prior to 2017 was $150,000. The annual fee can be adjusted for inflation by no more than 3% in any year.  The Trustee’s administrative fees paid during the three-month periods ended September 30, 2019 and 2018 totaled approximately $39,000.  The Trustee’s administrative fees paid during the nine-month periods ended September 30, 2019 and 2018 totaled approximately $118,000 and $116,000, respectively.

Registration Rights Agreement.  The Trust is party to a registration rights agreement pursuant to which the Trust has agreed to register the offering of the Trust units now held by Avalon upon request by Avalon.  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 Avalon (as the assignee of SandRidge) that obligates the Trust to pay Avalon an annual administrative services fee for accounting, tax preparation, bookkeeping and informational services performed by Avalon on behalf of the Trust.  For its services under the Administrative Services Agreement, Avalon receives an annual fee of $300,000, which is payable in equal quarterly installments and will remain fixed for the life of the Trust. Avalon is also entitled to receive reimbursement for its out-of-pocket fees, costs and expenses incurred in connection with the provision of any of the services under the Administrative Services Agreement.  The Administrative Services Agreement will terminate on the earliest to occur of: (i) the date the Trust shall have dissolved and commenced winding up in accordance with the Trust Agreement, (ii) the date that all of the Royalty Interests have been terminated or are no longer held by the Trust, (iii) pertaining to services to be provided with respect to any Underlying Properties transferred by Avalon, the date that either Avalon 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 Avalon and (iv) a date mutually agreed by Avalon and the Trustee. There were no amounts paid to Avalon or SandRidge during the three-month periods ended September 30, 2019 and September 30, 2018, respectively, as in each case the related quarterly administrative fee was paid during a prior period.  During each of the nine-month periods ended September 30, 2019 and 2018, the Trust paid administrative fees in the amount of $150,000 and $225,000 to Avalon and SandRidge, respectively.

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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, Avalon (as the assignee of SandRidge) will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses.  Any funds loaned by Avalon 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 Avalon 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 in full, with interest, unless Avalon consents to any further distributions.  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 Avalon and an unaffiliated third party.  No such loan from Avalon was outstanding at September 30, 2019 or December 31, 2018.

Risks and Uncertainties.  The Trust’s revenue and distributions are substantially dependent upon the prevailing and future prices for oil, natural gas and NGL, each of which depends on numerous factors beyond the Trust’s control such as overall oil, natural gas and NGL production and inventories in the Permian Basin, economic conditions impacting the energy industry generally, 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.  In the absence of derivative arrangements, low levels of future production and low commodity prices would reduce the Trust’s revenues and distributable income available to unitholders.

Following the closing of the Sale Transaction, the Trust is highly dependent on Avalon for multiple services, including the operation of the oil and gas wells burdened by the Royalty Interests, remittance of net proceeds from the sale of production from such wells to the Trust, administrative services such as accounting, tax preparation, bookkeeping and information services performed on behalf of the Trust.  Avalon and its affiliates are each recently formed companies with no significant operating history.  Their activities to date have been limited to organizational efforts, assembling a management team, raising capital, developing and implementing its business plan and operating the Underlying Properties. The ability of Avalon and its affiliates to continue operation of the Underlying Properties depends on Avalon’s future financial condition and economic performance, access to capital, and other factors, many of which are out of its control.

6. Subsequent Events

Distribution to Unitholders. On October 24, 2019, the Trust declared a cash distribution of $0.073 per unit covering production for the three-month period from June 1, 2019 to August 31, 2019.  The distribution will be paid on or about November 25, 2019 to record holders as of November 8, 2019.  Distributable income for June 1, 2019 to August 31, 2019 was calculated as follows (in thousands, except for unit and per unit amounts):

(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.

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Commodity Price Volatility. The Trust’s quarterly cash distributions are highly dependent upon the prices realized from the sale of oil, natural gas and NGL.  The markets for these commodities are volatile and have experienced significant fluctuations since January 1, 2018.  While oil, natural gas and NGL prices rose during the first nine months of 2018, they fell significantly from September 2018 to September 2019 (from $73.25/bbl for West Texas Intermediate crude oil to $56.49/bbl) as a result of increasing global supply, restraints on trade concerns and reduced demand.  As a result, there can be no assurance that prices for oil, natural gas and NGL will be maintained at a constant level for any significant period of time.

Properties. As of September 30, 2019, the Trust’s properties consisted of Royalty Interests in oil and natural gas wells, all of which are located in Andrews County, Texas.

Distributions. The Trust makes quarterly cash distributions of substantially all of its cash receipts, after deducting amounts for the Trust’s administrative expenses, property tax and Texas franchise tax and cash reserves withheld by the Trustee, on or about the 60th day following the completion of each quarter. Trust unitholders are responsible for all federal and state tax liabilities associated with distributions they receive from the Trust.

Pursuant to Internal Revenue Code (“IRC”) Section 1446, withholding tax on income effectively connected to a United States trade or business allocated to foreign partners should be made at the highest marginal rate.  Under IRC Section 1441, withholding tax on fixed, determinable, annual, periodic income from United States sources allocated to foreign partners should be made at 30% of gross income unless the rate is reduced by treaty.  This is intended to be a qualified notice to nominees and brokers as provided for under Treasury Regulation Section 1.1446-4(b) by the Trust, and while specific relief is not specified for IRC Section 1441 income, this disclosure is intended to suffice.  Nominees and brokers should withhold at the highest marginal rate on the distribution made to foreign partners.

Results of Trust Operations

The primary factors affecting the Trust’s revenues and costs are the quantity of oil, natural gas and NGL production attributable to the Royalty Interests, the prices received for such production and post-production costs (primarily transportation).  Royalty income, post-production expenses and certain taxes are recorded on a cash basis when net revenue distributions are received by the Trust from Avalon.  Information regarding the Trust’s production, pricing and costs for the three-and nine-month periods ended September 30, 2019 and 2018 is presented below.

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(1)         Production volumes and related revenues and expenses for the three-month period ended September 30, 2019 (included in Avalon’s August 2019 net revenue distribution to the Trust) represent production from March 1, 2019 to May 31, 2019.

(2)         Production volumes and related revenues and expenses for the three-month period ended September 30, 2018 (included in SandRidge’s August 2018 net revenue distribution to the Trust) represent production from March 1, 2018 to May 31, 2018.

(3)         Production volumes and related revenues and expenses for the nine-month period ended September 30, 2019 (included in Avalon’s February 2019, May 2019 and August 2019 net revenue distributions to the Trust) represent production from September 1, 2018 to May 31, 2019.

(4)         Production volumes and related revenues and expenses for the nine-month period ended September 30, 2018 (included in SandRidge’s February 2018, May 2018 and August 2018 net revenue distributions to the Trust) represent production from September 1, 2017 to May 31, 2018.

Three Months Ended September 30, 2019 Compared to the Three Months Ended September 30, 2018

Revenues

Royalty Income. Royalty income is a function of production volumes sold attributable to the Royalty Interests and associated prices received. Royalty income received during the three-month period ended September 30, 2019 totaled $6.1 million compared to $8.0 million received during the three-month period ended September 30, 2018. The approximate $1.9 million decrease in royalty income consisted of approximately $1.1 million attributable to a decrease in total volumes produced and approximately $0.8 million attributable to a decrease in prices received.  The average number of producing wells in the three-month period ended September 30, 2019 decreased by 35 from 1,058 wells in the three-month period ended September 30, 2018, because wells that could not produce minerals in commercial quantities due to a continuing decline in production were shut in.

Expenses

Property Taxes.  There were no property taxes paid during the three months ended September 30, 2019 or September 30, 2018 as in each case the applicable taxes were paid during a prior period.

Production Taxes.  Production taxes are calculated as a percentage of oil and natural gas revenues, net of any applicable tax credits. Production taxes for the three-month period ended September 30, 2019 totaled approximately $0.3 million, or $2.28 per Boe, and were approximately 4.7% of royalty income.  Production taxes for the three-month period ended September 30, 2018 totaled approximately $0.4 million, or $2.56 per Boe, and were approximately 4.7% 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 Avalon, 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 September 30, 2019 totaled approximately $0.1 million compared to approximately $0.3 million for the three-month period ended September 30, 2018.  The decrease during the 2019 period primarily relates to the timing of administrative expense payments.

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Distributable Income

Distributable income for the three-month period ended September 30, 2019 was $4.7 million, which included a net addition of approximately $1.0 million to the cash reserve for the payment of future Trust expenses, reflecting approximately $1.1 million withheld from the August 2019 cash distribution to unitholders partially offset by approximately $0.1 million used to pay Trust expenses during the period.  Distributable income for the three-month period ended September 30, 2018 was $6.8 million, which included a net addition of approximately $0.5 million to the cash reserve for payment of future Trust expenses, reflecting approximately $0.8 million withheld from the August 2018 cash distribution to unitholders partially offset by approximately $0.3 million used to pay Trust expenses during the period.

Nine Months Ended September 30, 2019 Compared to the Nine Months Ended September 30, 2018

Revenues

Royalty Income. Royalty income received during the nine-month period ended September 30, 2019 totaled $17.2 million compared to $22.6 million received during the nine-month period ended September 30, 2018.  The approximate $5.4 million decrease in royalty income consisted of approximately $3.2 million attributable to a decrease in total volumes produced and approximately $2.2 million attributable to a decrease in prices received.  The average number of producing wells in the nine-month period ended September 30, 2019 decreased by 29 from 1,065 wells in the nine-month period ended September 30, 2018, because wells that could not economically produce due to continued declining production were shut-in.

Expenses

Property Taxes. There were no property taxes paid during the nine months ended September 30, 2019 or September 30, 2018 as in each case the applicable taxes were paid during a prior period.

Production Taxes. Production taxes for the nine-month period ended September 30, 2019 totaled approximately $0.8 million, or $2.12 per Boe, and were approximately 4.8% of royalty income. Production taxes for the nine-month period ended September 30, 2018 totaled approximately $1.1 million, or $2.54 per Boe, and were approximately 4.8% of royalty income.

Trust Administrative Expenses. Trust administrative expenses for the nine-month period ended September 30, 2019 totaled approximately $1.2 million compared to approximately $0.9 million for the nine-month period ended September 30, 2018.  The increase during the 2019 period primarily relates to the timing of administrative expense payments.

Distributable Income. Distributable income for the nine-month period ended September 30, 2019 was $13.4 million, which included a net addition of approximately $1.7 million to the cash reserve for payment of future Trust expenses, reflecting approximately $2.9 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. Distributable income for the nine-month period ended September 30, 2018 was $19.3 million, which included a net addition of approximately $1.3 million to the cash reserve for payment of future Trust expenses, reflecting approximately $2.3 million withheld in aggregate from the February 2018, May 2018 and August 2018 cash distributions to unitholders partially offset by approximately $1.0 million used to pay Trust expenses during the period.

Liquidity and Capital Resources

The Trust has no source of liquidity or capital resources other than cash flow generated from the Royalty Interests and borrowings to fund administrative expenses, including any amounts borrowed under Avalon’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, the payment of Trust administrative expenses, establishing reserves (as determined by the Trustee) for future liabilities, the payment of applicable taxes and the payment of expense reimbursements to Avalon for out-of-pocket expenses incurred on behalf of the Trust. The Trust does not have any obligation to pay any costs associated with the operation of the Underlying Properties or the wells located thereon.

Administrative expenses include payments to the Trustee and the Delaware Trustee as well as a quarterly fee of $75,000 paid to Avalon pursuant to the Administrative Services Agreement.  Each quarter, the Trustee determines the amount of funds available for distribution. Available funds are the excess cash, if any, received by the Trust from the sale of production attributable to the Royalty Interests during that quarter over the Trust’s expenses for the quarter.  If at any time the Trust’s cash on hand (including available cash reserves) is not sufficient to pay the Trust’s ordinary course administrative expenses as they become due, the Trust may borrow funds from the Trustee or other lenders, including Avalon, to pay such expenses. The Trustee does not intend to lend funds to the Trust.

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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, Avalon (as the assignee of SandRidge) will, at the Trustee’s request, loan funds to the Trust necessary to pay such expenses.  Any funds loaned by Avalon 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 Avalon 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 in full, with interest, unless Avalon consents to any further distributions.  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 Avalon and an unaffiliated third party. No such loan was outstanding at September 30, 2019 or December 31, 2018.

Commencing with the distribution to unitholders paid in the first quarter of 2019, the Trustee has withheld, and in the future intends to withhold, the greater of $190,000 or 3.5% of the funds otherwise available for distribution to Trust unitholders each quarter to gradually increase cash reserves for the payment of future known, anticipated or contingent expenses or liabilities by a total of approximately $2,275,000. In February, May and August 2019, the Trustee withheld an aggregate of $570,000 from the funds otherwise available for distribution to Trust unitholders. The withholding related to the distribution to Trust unitholders that is expected to occur on or before November 25, 2019 is $190,000.

The Trust is highly dependent on Avalon for multiple services, including the operation of the oil and gas wells burdened by the Royalty Interests, remittance of net proceeds from the sale of associated production to the Trust, administrative services such as accounting, tax preparation, bookkeeping, regulatory filings and information services performed on behalf of the Trust, and potentially for loans to pay Trust administrative expenses.  Avalon and its affiliates are each recently formed companies with no significant operating history.  Their activities to date have been limited to organizational efforts, assembling a management team, raising capital, developing and implementing its business plan and operating the Underlying Properties. The ability of Avalon and its affiliates to continue operation of the Underlying Properties depends on Avalon’s future financial condition and economic performance, access to capital, and other factors, many of which are out of its control.

2019 Trust Distributions to Unitholders. During the nine-month period ended September 30, 2019, the Trust’s distributions to unitholders were as follows:

Future Trust Distributions to Unitholders. During the three-month production period from June 1, 2019 to August 31, 2019, combined sales volumes were lower than the previous period and the average price received per Boe from the sale of oil, natural gas and NGLs attributable to the Royalty Interests decreased as compared to the three-month period ended May 31, 2019.  On October 24, 2019, the Trust declared a cash distribution of $0.073 per unit covering production for the period.

The distribution will be paid on or about November 25, 2019 to record unitholders as of November 8, 2019 and was calculated as follows (in thousands, except for unit and per unit amounts):

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(1) Includes amounts withheld for payment of future Trust administrative expenses.

(2) Cash reserve increase for the payment of future known, anticipated or contingent expenses or liabilities.

As no additional development wells will be drilled, the Trust’s production is expected to decline each quarter during the remainder of its life.

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