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HUGOTON ROYALTY TRUST 10-Q 2008 UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-Q
x QUARTERLY
REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For
the
quarterly period ended June
30, 2008
OR
o
TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
Commission
File Number: 1-10476
Hugoton
Royalty Trust
(Exact
name of registrant as specified in its charter)
(877)
228-5083
(Registrant’s
telephone number, including area code)
NONE
(Former
name, former address and former fiscal year, if change since last
report)
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 þ
No
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company.
See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act (check one):
Indicate
by check mark whether the registrant is a shell company (as defined in Exchange
Act Rule 12b-2). Yes o
No
þ
Indicate
the number of units of beneficial interest outstanding, as of the latest
practicable date:
Outstanding
as of July 1, 2008
40,000,000
HUGOTON
ROYALTY TRUST
FORM
10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2008
HUGOTON
ROYALTY TRUST
The
following are definitions of significant terms used in this Form
10-Q:
HUGOTON
ROYALTY TRUST
The
condensed financial statements included herein are presented, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in annual
financial statements have been condensed or omitted pursuant to such rules
and
regulations, although the trustee believes that the disclosures are adequate
to
make the information presented not misleading. These condensed financial
statements should be read in conjunction with the trust’s financial statements
and the notes thereto included in the trust’s Annual Report on Form 10-K. In the
opinion of the trustee, all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly the assets, liabilities and trust
corpus of the Hugoton Royalty Trust at June 30, 2008 and the distributable
income and changes in trust corpus for the three- and six-month periods ended
June 30, 2008 and 2007 have been included. Distributable income for such interim
periods is not necessarily indicative of the distributable income for the full
year. Bank
of
America, N.A., as Trustee
for
the
Hugoton Royalty Trust:
We
have
reviewed the accompanying condensed statement of assets, liabilities and trust
corpus of the Hugoton Royalty Trust as of June 30, 2008 and the related
condensed statements of distributable income and changes in trust corpus for
the
three- and six-month periods ended June 30, 2008 and 2007. These condensed
financial statements are the responsibility of the trustee.
We
conducted our review in accordance with standards established by the Public
Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical procedures
to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted
in
accordance with the standards of the Public Company Accounting Oversight Board
(United States), the objective of which is the expression of an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
The
accompanying condensed financial statements are prepared on a modified cash
basis as described in Note 1 which is a comprehensive basis of accounting
other than accounting principles generally accepted in the United States of
America.
Based
on
our review, we are not aware of any material modifications that should be made
to the condensed financial statements referred to above for them to be in
conformity with the basis of accounting described in Note 1.
We
have
previously audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the statement of assets, liabilities
and trust corpus of the Hugoton Royalty Trust as of December 31, 2007, and
the
related statements of distributable income and changes in trust corpus for
the
year then ended (not presented herein), included in the trust’s 2007 Annual
Report on Form 10-K, and in our report dated February 25, 2008, we expressed
an
unqualified opinion on those financial statements. In our opinion, the
information set forth in the accompanying condensed statement of assets,
liabilities and trust corpus as of December 31, 2007 is fairly stated, in
all material respects, in relation to the statement of assets, liabilities
and
trust corpus included in the trust’s 2007 Annual Report on Form 10-K from which
it has been derived.
KPMG
LLP
Fort
Worth, Texas
July
21,
2008 HUGOTON
ROYALTY TRUST
The
accompanying notes to condensed financial statements are an integral part of
these statements. HUGOTON
ROYALTY TRUST
The
accompanying notes to condensed financial statements are an integral part of
these statements. HUGOTON
ROYALTY TRUST
The
accompanying notes to condensed financial statements are an integral part of
these statements. HUGOTON
ROYALTY TRUST
The
financial statements of Hugoton Royalty Trust are prepared on the following
basis and are not intended to present financial position and results of
operations in conformity with U.S. generally accepted accounting principles
(“GAAP”):
Costs
deducted in the calculation of net proceeds for the 80% net profits interests
generally include applicable taxes, transportation, marketing and legal costs,
production expense, development costs, operating charges and other
costs.
The
trust’s financial statements differ from those prepared in conformity with U.S.
GAAP because revenues are recognized when received rather than accrued in the
month of production, expenses are recognized when paid rather than when incurred
and certain cash reserves may be established by the trustee for contingencies
which would not be recorded under U.S. GAAP. This comprehensive basis of
accounting other than U.S. GAAP corresponds to the accounting permitted for
royalty trusts by the U.S. Securities and Exchange Commission, as specified
by
Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty
Trusts.
Most
accounting pronouncements apply to entities whose financial statements are
prepared in accordance with U.S. GAAP, directing such entities to accrue or
defer revenues and expenses in a period other than when such revenues were
received or expenses were 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
initial carrying value of the net profits interests of $247,066,951 represents
XTO Energy’s historical net book value for the interests on December 1, 1998,
the date of the transfer to the trust. Amortization of the net profits interests
is calculated on a unit-of-production basis and charged directly to trust
corpus. Accumulated amortization was $96,053,185 as of June 30, 2008 and
$91,246,918 as of December 31, 2007.
The
following summarizes actual development costs, budgeted development costs
deducted in the calculation of net profits income, and the cumulative actual
costs compared to the amount deducted:
As
a
result of decreased development activity in first quarter 2007 and based on
the
development budget for 2007, the development cost deduction was lowered to
$3.75
million per month beginning with the February 2007 distribution. Because of
lower than anticipated actual costs as a result of the timing of expenditures,
the development cost deduction was lowered to $2.0 million for the April and
May
2007 distributions, but was increased to $3.75 million with the June 2007
distribution and was maintained at $3.75 million for the remainder of 2007
through second quarter 2008.
XTO
Energy has advised the trustee that total 2008 budgeted development costs for
the underlying properties are approximately $46.0 million. The 2008 budget
year
generally coincides with the trust distribution months from April 2008 through
March 2009. Based on the development budget for 2008, the development cost
deduction is expected to be maintained at $3.75 million for the remainder of
2008. The monthly development cost deduction will be reevaluated by XTO Energy
and revised as necessary, based on the 2008 budget and the timing and amount
of
actual expenditures.
Litigation
On
October 17, 1997, an action, styled United
States of America ex rel. Grynberg v. Cross Timbers Oil Company, et
al.,
was
filed in the United States District Court for the Western District of Oklahoma
by Jack J. Grynberg on behalf of the United States under the qui
tam
provisions of the U.S. False Claims Act against XTO Energy. The plaintiff
alleges that XTO Energy underpaid royalties on natural gas produced from federal
leases and lands owned by Native Americans in amounts in excess of 20% as a
result of mismeasuring the volume of natural gas, incorrectly analyzing its
heating content and improperly valuing the natural gas during at least the
past
ten years. The plaintiff seeks treble damages for the unpaid royalties (with
interest, attorney’s fees and expenses), civil penalties between $5,000 and
$10,000 for each violation of the U.S. False Claims Act, and an order for XTO
Energy to cease the allegedly improper measuring practices. This lawsuit against
XTO Energy and similar lawsuits filed by Grynberg against more than 300 other
companies was consolidated in the United States District Court for Wyoming.
In
October 2002, the court granted a motion to dismiss Grynberg’s royalty valuation
claims, and Grynberg’s appeal of this decision was dismissed for lack of
appellate jurisdiction in May 2003. In response to a motion to dismiss filed
by
XTO Energy and other defendants, in October 2006 the district judge held that
Grynberg failed to establish the jurisdictional requirements to maintain the
action against XTO Energy and other defendants and dismissed the actions for
lack of subject matter jurisdiction. Grynberg has filed an appeal of this
decision. While XTO Energy is unable to predict the final outcome of this case
or estimate the amount of any possible loss, it has informed the trustee that
it
believes that the allegations of this lawsuit are without merit and intends
to
vigorously defend the action. However, an order to change measuring practices
or
a related settlement could adversely affect the trust by reducing net proceeds
in the future by an amount that is presently not determinable, but, in XTO
Energy management’s opinion, is not currently expected to be material to the
trust’s annual distributable income, financial position or liquidity.
An
amended petition for a class action lawsuit, Beer,
et al. v. XTO Energy Inc.,
was
filed in January 2006, in the District Court of Texas County, Oklahoma by
royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that
XTO
Energy has not properly accounted to the plaintiffs for the royalties to which
they are entitled and seek an accounting regarding the natural gas and other
products produced from their wells and the prices paid for the natural gas
and
other products produced, and for payment of the monies allegedly owed since
June
2002, with a certain limited number of plaintiffs claiming monies owed for
additional time. XTO Energy removed the case to federal district court in
Oklahoma City. A hearing on the class certification has not been scheduled.
The
plaintiffs have not alleged in their petition an amount that they are seeking.
XTO Energy has informed the trustee that it believes that it has strong defenses
to this lawsuit and intends to vigorously defend its position. However, if
XTO
Energy ultimately makes any settlement payments or receives a judgment against
it, the trust will bear its 80% share of such settlement or judgment related
to
production from the underlying properties. Additionally, if a judgment or
settlement increases the amount of future payments to royalty owners, the trust
would bear its proportionate share of the increased payments through reduced
net
proceeds. XTO Energy has informed the trustee that, although the amount of
any
reduction in net proceeds is not presently determinable, in its management’s
opinion, the amount is not currently expected to be material to the trust’s
annual distributable income, financial position or liquidity.
Certain
of the underlying properties are involved in various other lawsuits and certain
governmental proceedings arising in the ordinary course of business. XTO Energy
has advised the trustee that it does not believe that the ultimate resolution
of
these claims will have a material effect on trust annual distributable income,
financial position or liquidity.
Other
Several
states have enacted legislation to require state income tax withholding from
nonresident recipients of oil and gas proceeds. After consultation with its
state tax counsel, XTO Energy has advised the trustee that it believes the
trust
is not subject to these withholding requirements. However, regulations could
be
issued by the various states which could change this conclusion. Should the
trust be required to withhold state taxes, distributions to the unitholders
would be reduced by the required amount, subject to the unitholder’s right to
file a state tax return to claim any refund due.
Costs
exceeded revenues by $853,468 ($682,774 net to the trust) on properties
underlying the Wyoming net profits interests in November and December 2007.
Limited pipeline capacity for shipping from the Rocky Mountain region and excess
regional supply led to significantly lower realized regional gas prices for
production. These lower gas prices caused costs to exceed revenues on properties
underlying the Wyoming net profits interests, however, these excess costs did
not reduce net proceeds from the remaining conveyances.
XTO
Energy advised the trustee that with the onset of winter demand and the
completion of the first phase of a major pipeline expansion in January 2008,
Rocky Mountain gas prices increased and the excess costs, plus accrued interest
of $10,090 ($8,072 net to the trust), were fully recovered by February
2008. The
following discussion should be read in conjunction with the trustee’s discussion
and analysis contained in the trust’s 2007 annual report, as well as the
condensed financial statements and notes thereto included in this quarterly
report on Form 10-Q. The trust’s Annual Report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K and all amendments to those reports
are available on the trust’s web site at www.hugotontrust.com.
Distributable
Income
Quarter
For
the
quarter ended June 30, 2008, net profits income was $33,899,248, as compared
to
$21,251,246 for second quarter 2007. This 60% increase in net profits income
is
primarily the result of higher oil and gas prices and increased oil and gas
sales volumes, partially offset by higher development costs and higher taxes,
transportation and other costs. See “Net Profits Income” on the following page.
After
adding interest income of $18,965 and deducting administration expense of
$363,293, distributable income for the quarter ended June 30, 2008 was
$33,554,920, or $0.838873 per unit of beneficial interest. Administration
expense for the first six months of 2008 was lower than in the first six months
of 2007 primarily because of the timing of expenditures. For second quarter
2007, distributable income was $20,846,000, or $0.521150 per unit. Distributions
to unitholders for the quarter ended June 30, 2008 were:
Six
Months
For
the
six months ended June 30, 2008, net profits income was $55,935,102 compared
with
$37,986,631 for the same 2007 period. This 47% increase in net profits income
is
primarily the result of higher oil and gas prices and increased oil and gas
sales volumes partially offset by higher development costs and higher taxes,
transportation and other costs. See “Net Profits Income” on the following
page.
After
adding interest income of $42,751 and deducting administration expense of
$653,773, distributable income for the six months ended June 30, 2008 was
$55,324,080, or $1.383102 per unit of beneficial interest. Administration
expense for the first six months of 2008 was lower than in the first six months
of 2007 primarily because of lower costs related to unitholder tax reporting,
as
a result of a decrease in the number of unitholders and the timing of
expenditures. For the six months ended June 30, 2007, distributable income
was
$37,088,280, or $0.927207 per unit. Net
Profits Income
Net
profits income is recorded when received by the trust, which is the month
following receipt by XTO Energy, and generally two months after oil and gas
production. Net profits income is generally affected by three major
factors:
The
following is a summary of the calculation of net profits income received by
the
trust:
The
following are explanations of significant variances on the underlying properties
from second quarter 2007 to second quarter 2008 and from the first six months
of
2007 to the comparable period in 2008:
Sales
Volumes
Gas
Gas
sales
volumes increased 5% for the second quarter and 3% for the six-month period.
Increased gas sales volumes are primarily because of increased production from
new wells and workovers and the timing of cash receipts, partially offset by
natural production decline.
Oil
Oil
sales
volumes increased 21% for the second quarter and 15% for the six-month period
primarily because of increased production from new wells and workovers and
the
timing of cash receipts, partially offset by natural production decline. In
addition, oil sales volumes increased for the six-month period because of prior
period volume adjustments in 2007.
Sales
Prices
Gas
The
second quarter 2008 average gas price was $8.26 per Mcf, a 33% increase from
the
first quarter 2007 average gas price of $6.21 per Mcf. For the six-month period,
the average gas price increased 21% to $7.37 per Mcf in 2008 from $6.07 per
Mcf
in 2007. Although the U.S. entered the winter with above average gas in storage,
a normal winter and lower liquified natural gas imports led to normal gas
storage levels. As a result of tighter storage levels and higher oil prices,
recent gas prices have reached as high as $13.00 per MMBtu. Prices will continue
to be affected by weather, oil prices, the U.S. economy, the level of North
American production and import levels of liquified natural gas. Natural gas
prices are expected to remain volatile. The second quarter 2008 gas price is
primarily related to production from February through April 2008, when the
average NYMEX price was $8.83 per MMBtu. The average NYMEX price for May and
June 2008 was $11.60 per MMBtu. At July 15, 2008, the average NYMEX futures
price for the following twelve months was $11.64 per MMBtu. Recent trust gas
prices have averaged approximately 6% lower than the NYMEX price.
Oil
The
second quarter 2008 average oil price was $102.16 per Bbl, a 74% increase from
the second quarter 2007 average oil price of $58.60 per Bbl. The year-to-date
average oil price increased 70% to $98.69 per Bbl in 2008 from $57.94 per Bbl
in
2007. Oil prices have risen primarily because of increasing global demand and
supply shortage concerns, inadequate sour crude refining capacity and political
instability. In the last few months of 2007 and first half of 2008, continued
tension in the Middle East, weakness in the U.S. dollar and strong demand caused
prices to reach record levels of above $147.00 per Bbl. Oil prices are expected
to remain volatile. The second quarter 2008 oil price is primarily related
to
production from February through April 2008, when the average NYMEX price was
$104.21 per Bbl. The average NYMEX price for May and June 2008 was $130.14
per
Bbl. At July 15, 2008, the average NYMEX futures price for the following twelve
months was $140.40 per Bbl. Recent trust oil prices have averaged approximately
1% lower than the NYMEX price. Costs
Taxes,
Transportation and Other
Taxes,
transportation and other increased 30% for the quarter and 21% for the six-month
period primarily because of increased production taxes related to higher oil
and
gas revenues.
Production
Production
expense increased 14% for the quarter and 13% for the six-month period primarily
because of increased repair and maintenance, labor and fuel costs, partially
offset by mechanical and marketing rebates.
Development
Development
costs deducted in the calculation of net profits income are based on the
development budget. These development costs increased 45% for the second quarter
and 11% for the six-month period primarily because of the timing of development
activity. During the first half of 2008, 12 wells were completed on the
underlying properties and 17 wells were pending completion at June 30.
As
of
December 31, 2007, cumulative actual costs exceeded cumulative budgeted costs
deducted by approximately $0.7 million. In calculating net profits income,
XTO
Energy deducted budgeted development costs of $11.3 million for the quarter
and
$22.5 million for the six-month period. After considering actual development
costs of $8.0 million for the quarter and $17.1 million for the six-month
period, cumulative budgeted costs deducted exceeded actual costs by
approximately $4.7 million at June 30, 2008.
XTO
Energy has advised the trustee that total 2008 budgeted development costs for
the underlying properties are approximately $46.0 million. The 2008 budget
year
generally coincides with the trust distribution months from April 2008 through
March 2009. Based on the development budget for 2008, the development cost
deduction is expected to be maintained at $3.75 million for the remainder of
2008. The monthly development cost deduction will be reevaluated by XTO Energy
and revised as necessary, based on the 2008 budget and the timing and amount
of
actual expenditures. See Note 2 to Condensed Financial Statements.
Overhead
Overhead
increased 8% for the quarter and 6% for the six-month period primarily because
of the annual rate adjustment based on an industry index.
Excess
Costs
Costs
exceeded revenues by $853,468 ($682,774 net to the trust) on properties
underlying the Wyoming net profits interests in November and December 2007.
Limited pipeline capacity for shipping from the Rocky Mountain region and excess
regional supply led to significantly lower realized regional gas prices for
production. These lower gas prices caused costs to exceed revenues on properties
underlying the Wyoming net profits interests, however, these excess costs did
not reduce net proceeds from the remaining conveyances.
XTO
Energy advised the trustee that with the onset of winter demand and the
completion of the first phase of a major pipeline expansion in January 2008,
Rocky Mountain gas prices increased and the excess costs, plus accrued interest
of $10,090 ($8,072 net to the trust), were fully recovered by February
2008. Forward-Looking
Statements
This
Form
10-Q includes “forward-looking statements” within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. All statements other than statements of
historical fact included in this Form 10-Q, including, without limitation,
statements regarding the net profits interests, underlying properties,
development activities, annual and monthly development, production and other
costs and expenses, oil and gas prices and differentials to NYMEX prices, supply
shortages, future drilling, workover and restimulation plans, distributions
to
unitholders and industry and market conditions, are forward-looking statements
that are subject to risks and uncertainties which are detailed in Part I, Item
1A of the trust’s Annual Report on Form 10-K for the year ended
December 31, 2007, which is incorporated by this reference as though fully
set forth herein. Although XTO Energy and the trustee believe that the
expectations reflected in such forward-looking statements are reasonable,
neither XTO Energy nor the trustee can give any assurance that such expectations
will prove to be correct.
There
have been no material changes in the trust’s market risks, as disclosed in Part
II, Item 7A of the trust’s Annual Report on Form 10-K for the year ended
December 31, 2007.
As
of the
end of the period covered by this report, the trustee carried out an evaluation
of the effectiveness of the trust’s disclosure controls and procedures pursuant
to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, the trustee
concluded that the trust’s disclosure controls and procedures are effective in
timely alerting the trustee to material information relating to the trust
required to be included in the trust’s periodic filings with the Securities and
Exchange Commission. In its evaluation of disclosure controls and procedures,
the trustee has relied, to the extent considered reasonable, on information
provided by XTO Energy. There has not been any change in the trust’s internal
control over financial reporting during the period covered by this report that
has materially affected, or is reasonably likely to materially affect, the
trust’s internal control over financial reporting. Item
1.
Not
applicable.
There
have been no material changes in the risk factors disclosed under Part I, Item
1A of the trust’s Annual Report on Form 10-K for the year ended December 31,
2007.
Items
2 through 5.
Not
applicable.
Exhibit
Number
and
Description
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant
has
duly caused this Report to be signed on its behalf by the undersigned thereunto
duly authorized.
19
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