Mesabi Trust — Q2 2019 Form 10-Q
Business context and period. Mesabi Trust is a pass-through royalty trust with no employees or operating business. Its revenue primarily depends on royalties from iron ore mined and shipped by Northshore Mining, a Cleveland-Cliffs subsidiary. This report covers the three and six months ended July 31, 2019; interim financial statements are unaudited.
Key financial metrics
| Metric | Three months 2019 | Three months 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Royalty income | $14.30 million | $19.13 million | $19.66 million | $25.77 million |
| Total revenue | $14.34 million | $19.15 million | $19.81 million | $25.84 million |
| Expenses | $0.43 million | $0.28 million | $0.99 million | $0.65 million |
| Net income | $13.91 million | $18.87 million | $18.82 million | $25.19 million |
| Net income per unit | $1.0603 | $1.4384 | $1.4346 | $1.9198 |
| Distributions declared per unit | $0.21 | $0.22 | $1.10 | $0.67 |
Net margin, calculated as net income divided by total revenue, was approximately 97.0% for the quarter and 95.0% for the six-month period, versus 98.5% and 97.5%, respectively, in 2018.
Cash flow and liquidity. Six-month operating cash flow was $13.85 million, down from $15.37 million. Distributions paid were $29.91 million, compared with $21.39 million. At July 31, cash was $0.45 million and U.S. Government securities were $16.48 million; the Trust reported a $21.20 million unallocated reserve. Total liabilities were $2.96 million, principally distributions payable and accrued expenses. No debt is reported in the filing.
Material changes and operating drivers
- Quarterly royalty income fell 25% year over year, and six-month royalty income fell 24%, mainly because shipments declined. Quarterly pellet production from Trust lands was 1.10 million tons versus 1.42 million; shipments were 1.60 million versus 2.00 million.
- For the six months, production was 2.36 million tons versus 2.80 million, and shipments were 2.12 million versus 2.63 million. Management attributed lower activity to anticipated customer demand.
- Quarterly base overriding royalties declined to $8.33 million from $11.45 million and bonus royalties to $5.82 million from $7.52 million. Six-month declines were $3.91 million and $2.22 million, respectively.
- Expenses rose, primarily from higher legal and consulting fees. The reserve increased $4.39 million from January 31, 2019, while it was lower than the prior-year July balance, primarily reflecting lower accrued income receivable.
Outlook, risks, and contingencies
- The Trust provided no formal shipment or royalty forecast. Future distributions depend on royalties actually received, shipment volumes and sales prices, expenses, and the Trustees’ reserve decisions. The Trust notes that shipping activity typically declines in winter.
- Royalties use estimated iron ore prices and are subject to interim and final adjustments tied to market and inflation indexes. Negative adjustments may materially reduce future royalties and distributions. Accrued income and contract assets are not distributable until collected.
- Northshore reported 1.545 million tons credited to the Trust in calendar Q2 2019 versus 1.764 million a year earlier. The Trust received $11.88 million in royalty payments on July 30, including base and bonus royalties, with an $8,840 negative pricing adjustment.
- Cliffs said Northshore DR-grade pellet production began ahead of schedule and indicated expected intercompany sales of 800,000 long tons in Q3. Cliffs also expected its Toledo HBI plant to begin commercial production in the first half of 2020. These are Cliffs statements, not Mesabi Trust guidance.
- The Trust cannot control Northshore’s operating, mining, or customer-contract decisions and relies on information from Northshore and Cliffs. The Trustees said disclosure controls were effective; they also noted Northshore had declined to provide a written certification on its controls. No legal proceedings or material risk-factor changes were reported.
Important facts for investors to verify
- Subsequent shipment volumes and final price adjustments, which may differ from estimates used to recognize royalty income.
- Cash royalties actually received versus accrued income and contract assets, and the effect on distributable funds.
- Northshore’s production and shipment plans, including the extent to which shipments originate from Trust lands.
- Future distributions and reserve levels; declared distributions do not necessarily equal reported net income.
- Tax treatment: the Trust is a grantor trust, and unitholders may owe tax on allocated income whether or not it is distributed.