SJT

Business Context and Reporting Period

Company: San Juan Basin Royalty Trust (Trust)

Reporting Period: Quarterly period ended June 30, 2018 (Form 10-Q)

Business Overview: The Trust is an express trust holding a 75% net overriding royalty interest in oil and gas properties located in the San Juan Basin of northwestern New Mexico. The Trustee is Compass Bank. The principal operator of the underlying properties is Hilcorp San Juan L.P. (Hilcorp), which acquired the interests from Burlington Resources in July 2017. The Trust has no employees; all administrative functions are performed by the Trustee.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Royalty income decreased 54% for the three months ended June 30, 2018, and 36% for the six-month period compared to 2017. Distributable income per unit dropped from $0.128333 to $0.054322 for the quarter.
• Price Impact: The average natural gas price fell from $2.63 per Mcf in Q2 2017 to $1.65 per Mcf in Q2 2018. For the six-month period, the average price dropped from $2.78 to $1.83 per Mcf.
• True-Ups: A significant portion of the revenue decline is attributed to "true-ups" (adjustments) by Hilcorp reconciling estimated revenues from the transition period (post-Burlington acquisition) with actual data. Aggregate true-ups in 2018 reduced Royalty Income by approximately $1.74 million for the quarter and six-month periods.
• Production Volumes: Despite lower prices, natural gas production from the Subject Interests increased approximately 40% for the quarter and 27% for the six-month period compared to 2017.
• Expenses: Lease operating expenses and property taxes increased by 7% for the quarter and 4% for the six-month period, primarily due to increased activity and operator differences. General and administrative expenses remained relatively flat, decreasing slightly.

Outlook, Risks, and Contingencies

• Transition Uncertainty: Hilcorp is still reconciling historical information from Burlington. As of the filing date, estimates for December 2017, January 2018, and June 2018 distributions had not been fully actualized. Future distributions may be adjusted downward or upward based on these reconciliations.
• Capital Expenditures: Hilcorp's 2018 capital expenditure budget for the Subject Interests is estimated at $0.54 million. Capital expenditures increased 45% in Q2 2018 compared to the prior year due to well recompletion and facility projects.
• Liquidity: The Trust maintains a $1.00 million cash reserve to cover general and administrative expenses. The Trustee does not anticipate increasing this reserve in 2018 but cannot guarantee it will not do so.
• Market Risk: The Trust's income is heavily dependent on natural gas prices. There have been no material changes to market risk exposure, but the Trust remains sensitive to commodity price fluctuations.
• Controls and Procedures: The Trustee relies on Hilcorp for financial data. While internal controls are deemed effective, the transition has required additional auditing processes to ensure data accuracy.

Key Facts for Investor Verification

• Revenue Volatility: Verify the impact of ongoing "true-ups" on future distributions, as current reported income includes adjustments for prior estimated periods.
• Commodity Prices: Monitor natural gas prices, as a significant drop from $2.63/Mcf to $1.65/Mcf was the primary driver of the 58% decrease in quarterly distributable income.
• Operator Transition: Confirm the status of Hilcorp's reconciliation of Burlington's historical data, as unresolved estimates for late 2017 and mid-2018 could alter future cash flows.
• Production vs. Revenue: Note that while production volumes increased significantly (40% in Q2), revenue declined due to price drops and revenue adjustments, highlighting the Trust's exposure to pricing over volume.
• Debt and Liabilities: The Trust has no debt and is not liable for production costs; however, distributions are reduced if production costs exceed gross proceeds (though no such excess was reported in this period).