MTR

Mesa Royalty Trust - Q1 2018 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2018. Mesa Royalty Trust is a passive entity created in 1979 that holds an overriding royalty interest equal to 11.44% of 90% of the Net Proceeds from specific oil and gas properties in the Hugoton field (Kansas) and the San Juan Basin (New Mexico and Colorado). The Trust has no employees; administrative functions are performed by The Bank of New York Mellon Trust Company, N.A. As of May 15, 2018, there were 1,863,590 Units of Beneficial Interest outstanding.

Key Financial Metrics

Note: Net Overriding Royalty Interest is calculated as Gross Asset ($42,498,034) less Accumulated Amortization.

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased by approximately 19% ($170,921) compared to Q1 2017. This was primarily driven by lower natural gas prices, decreased net production volumes of natural gas, natural gas liquids, and oil/condensate, and an increase in operating expenses.
• Expense Increase: General and administrative expenses increased significantly to $116,757 from $48,250. This increase was largely due to the timing of payments, specifically $70,460 in expenses incurred in December 2017 that were paid in January 2018.
• Production Costs: Operating costs for the Hugoton Royalty Properties increased by 266% year-over-year, attributed to the timing of ad valorem tax payments and higher transportation charges.
• Asset Amortization: Amortization of the net overriding royalty interest was $70,591 for the quarter, reducing the Trust Corpus.

Outlook, Commentary, and Risks

• Operator Changes:
  • Hugoton: Linn Energy, Inc. is the current operator. On April 18, 2018, Linn announced a plan to separate into two stand-alone public companies, expected in Q3 2018. The Trustee is discussing the impact of this separation.
  • San Juan Basin (NM): Hilcorp San Juan LP became the operator in July 2017 following the acquisition of ConocoPhillips' assets. Payments are currently estimated and subject to future reconciliation, which may affect future Net Proceeds.
• Contingent Reserve: The Trustee maintains a Contingent Reserve of $1,055,725 (included in cash) for unknown future liabilities. During Q1 2018, the reserve was increased by $55,725 and decreased by $119,671 due to timing adjustments of royalty income and expenses.
• Excess Production Costs: Total excess production costs (costs exceeding revenue that must be recovered before distribution) stood at $17,458 as of March 31, 2018, down from $22,014 at year-end 2017.
• Legal Proceedings: No pending legal proceedings name the Trust as a party. However, operators advise that the Trust may be subject to ordinary course litigation regarding the properties, which could materially impact future income if settled adversely.
• Interest Rate Environment: The Trustee was unable to secure an account yielding the required 1.5% below prime rate. Consequently, a portion of Trustee fees is being allocated to meet the minimum interest obligation to the Trust.

Investor Verification Checklist

• Operator Separation Impact: Verify the outcome of Linn Energy's planned separation and its effect on the Hugoton Royalty Properties' operations and payments.
• Hilcorp Reconciliation: Monitor the reconciliation of estimated payments made by Hilcorp for the San Juan Basin (NM) properties to ensure no material adjustments reduce future distributions.
• Commodity Price Sensitivity: Assess the Trust's exposure to natural gas price volatility, given that lower gas prices were the primary driver of the 19% revenue decline.
• Expense Timing: Review future quarters to confirm if the spike in G&A expenses was a one-time timing anomaly or indicative of rising administrative costs.
• Contingent Reserve Usage: Track the balance of the $1.05 million Contingent Reserve to determine if it is being drawn down for actual liabilities or if it remains a buffer.