Mesabi Trust — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended October 31, 2019; comparisons are with the corresponding 2018 periods. Mesabi Trust is a pass-through royalty trust whose income primarily depends on iron ore shipments and sales by Northshore Mining Company, a subsidiary of Cleveland-Cliffs. The interim financial statements are unaudited.
Financial performance
| Metric | Three months 2019 | Three months 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Royalty income | $6.49 million | $13.89 million | $26.15 million | $39.66 million |
| Total revenue | $6.56 million | $13.97 million | $26.37 million | $39.81 million |
| Expenses | $0.41 million | $0.39 million | $1.40 million | $1.04 million |
| Net income | $6.15 million | $13.59 million | $24.97 million | $38.77 million |
| Net income per unit | $0.4688 | $1.0354 | $1.9034 | $2.9552 |
| Distributions declared per unit | $0.87 | $0.94 | $1.97 | $1.61 |
Net income as a percentage of total revenue was approximately 93.7% for the quarter and 94.7% year to date, versus 97.2% and 97.4%, respectively, in 2018. The Trust declared a $0.87-per-unit distribution payable November 20, 2019; it reported that payment was made.
For the nine months, operating cash flow was $25.60 million, down from $33.34 million. Distributions paid were $32.67 million, compared with $24.27 million. Cash and cash equivalents were $0.38 million at October 31, 2019; U.S. Government securities were $25.56 million. The Trust reported total liabilities of $12.53 million, including $11.41 million of distributions payable and a $0.94 million contract liability. No debt is reported on the balance sheet. Unallocated reserve was $15.93 million, down from $16.81 million at January 31, 2019.
Changes and operating drivers
- Quarterly royalty income fell $7.40 million, and nine-month royalty income fell $13.51 million. The Trust attributed the declines mainly to lower shipments and pricing; lower shipments also reduced net income.
- Quarterly base overriding royalties declined $4.67 million and bonus royalties declined $2.78 million year over year. Nine-month declines were $8.58 million and $5.01 million, respectively. Fee royalties increased modestly in both periods.
- Trust-land pellet shipments were 1.23 million tons for the quarter, down from 1.56 million; nine-month shipments were 3.35 million tons, down from 4.19 million. Quarterly production from Trust lands rose to 1.22 million tons from 0.94 million, while nine-month production fell to 3.58 million from 3.74 million.
- Quarterly expenses rose $22,000, primarily due to legal costs. Nine-month expenses rose $362,000, mainly from higher legal and consulting fees.
Outlook, risks and unusual items
- The filing gives no formal financial guidance. Northshore had not provided the Trust with expected 2019 shipments, except as noted for direct-reduced-grade pellets. Future distributions depend on shipments, sales prices, actual royalty receipts, expenses and reserve decisions; winter shipping activity is typically reduced.
- Royalties use estimated prices subject to interim and final adjustments tied to market and inflation indexes. Adjustments can be negative and could materially reduce or offset future royalties and distributions. Accrued income and contract assets are not distributable until the related royalties are received.
- On December 9, 2019, after the quarter-end, the Trust announced arbitration against Northshore and Cliffs. It alleges royalty amounts for the second and third quarters of 2019 were improperly recorded or calculated, including amounts related to DR-grade pellets, and seeks damages and other relief. The outcome and any recovery are uncertain; the dispute is an added risk and may entail significant costs.
- Cliffs and AK Steel announced a merger agreement on December 3, 2019, with a closing then expected in the first half of 2020, subject to approvals and other conditions. The filing does not quantify an effect on Mesabi Trust.
- The Trust relies on information from Cliffs and Northshore, which control operations and key data. Northshore has declined to provide a written certification regarding its disclosure controls; the Trust supplements its reliance with annual certifications, consultant reviews and accounting due diligence. Trustees concluded the Trust’s own disclosure controls were effective.
- The Trust is a grantor trust: taxable income is attributed to unitholders whether or not distributed. Unitholders should consider their individual tax circumstances.
Important facts for investors to verify
- Follow the arbitration, its scope and outcome, and whether royalty calculations or payments are revised.
- Check subsequent shipment and pricing data, including final price adjustments under Cliffs’ customer contracts and the proportion of shipments attributable to Trust lands.
- Compare royalty cash receipts with recognized income, accrued receivables, contract liabilities, reserve levels and declared distributions.
- Monitor Northshore’s operating plans, customer demand and the potential implications of the Cliffs–AK Steel transaction for shipments and royalty income.
- Review the Trust’s annual report risk factors and consult a tax adviser regarding grantor-trust income allocations.