<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 1999
-------------
Commission File No. 1-10476
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HUGOTON ROYALTY TRUST
Texas I.R.S. No. 58-6379215
Bank of America, N.A.
P.O. Box 830650
Dallas, Texas 75283-0650
Telephone Number 877/228-5083
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 and (2) has been subject to such filing requirements for
the past 90 days. Yes X No
----- -----
Number of units of beneficial interest outstanding at August 1, 1999: 40,000,000
----------
<PAGE>
HUGOTON ROYALTY TRUST
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
- ------------------------------------------------------
INDEX
Page
----
GLOSSARY OF TERMS................................................. 3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.............................................. 4
Report of Independent Public Accountants.......................... 5
Condensed Statements of Assets, Liabilities and Trust Corpus
at June 30, 1999 and December 31, 1998........................... 6
Condensed Statements of Distributable Income
for the Three and Six Months Ended June 30, 1999................. 7
Condensed Statements of Changes in Trust Corpus
for the Three and Six Months Ended June 30, 1999................. 8
Notes to Condensed Financial Statements........................... 9
Item 2. Trustee's Discussion and Analysis................................. 13
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 17
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................. 18
Item 6. Exhibits and Reports on Form 8-K.................................. 18
Signatures........................................................ 20
2
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HUGOTON ROYALTY TRUST
GLOSSARY OF TERMS
- -----------------
The following are definitions of significant terms used in this Form 10-Q:
Bbl Barrel (of oil)
Mcf Thousand cubic feet (of natural gas)
Mcfe Thousand cubic feet (of natural gas) equivalent,
computed with one barrel of oil as the energy
equivalent of six Mcf of natural gas.
net profits interest An interest in an oil and gas property measured by net
profits from the sale of production, rather than a
specific portion of production.
net proceeds Gross proceeds received by Cross Timbers from sale of
production from the underlying properties, less
applicable costs.
underlying properties Cross Timbers' interest in certain oil and gas
properties from which the net profits interests were
carved. The underlying properties include working
interests in predominantly gas-producing properties
located in Kansas, Oklahoma and Wyoming.
3
<PAGE>
HUGOTON ROYALTY TRUST
PART I - FINANCIAL STATEMENTS
- -----------------------------
Item 1. Financial Statements.
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 Registration Statement on Form S-
1. 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, 1999, and the
distributable income and changes in trust corpus for the three- and six-month
periods ended June 30, 1999, have been included. Distributable income for such
interim periods is not necessarily indicative of the distributable income for
the full year.
4
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Bank of America, N.A., as Trustee
for the Hugoton Royalty Trust:
We have reviewed the accompanying condensed statements of assets, liabilities
and trust corpus of the Hugoton Royalty Trust as of June 30, 1999 and the
related condensed statements of distributable income and changes in trust corpus
for the three- and six-month periods ended June 30, 1999. These financial
statements are the responsibility of the trustee.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. 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 generally accepted auditing standards, 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 2 which is a comprehensive basis of accounting other
than generally accepted accounting principles.
Based on our review, we are not aware of any material modifications that should
be made to the financial statements referred to above for them to be in
conformity with the basis of accounting described in Note 2.
We have previously audited, in accordance with generally accepted auditing
standards, the statement of assets, liabilities and trust corpus of the Hugoton
Royalty Trust as of December 31, 1998 included in the trust's Registration
Statement on Form S-1, and in our report dated March 15, 1999, we expressed an
unqualified opinion on that statement. In our opinion, the information set
forth in the accompanying condensed statement of assets, liabilities and trust
corpus as of December 31, 1998 is fairly stated in all material respects in
relation to the statement of assets, liabilities and trust corpus included in
the trust's financial statements from which they have been derived.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
August 6, 1999
5
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HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statements of Assets, Liabilities and Trust Corpus
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and short-term investments............... $ 3,027,680 $ 1,000
Net profits interests in oil and gas
properties - net (Notes 1 and 2)............ 241,540,064 247,066,951
------------ ------------
$244,567,744 $247,067,951
============ ============
LIABILITIES AND TRUST CORPUS
Distribution payable to unitholders........... $ 3,027,680 $ -
Trust corpus (40,000,000 units of beneficial
interest authorized and outstanding)........ 241,540,064 247,067,951
------------ ------------
$244,567,744 $247,067,951
============ ============
</TABLE>
The accompanying notes to condensed financial statements are an integral part of
these statements.
6
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HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statement of Distributable Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999 June 30, 1999
------------- -------------
<S> <C> <C>
Royalty income............................... $ 8,854,991 $ 12,420,066
Interest income.............................. 8,536 8,536
------------- -------------
Total income................................. 8,863,527 12,428,602
Administration expense....................... 30,073 33,073
------------- -------------
Distributable income......................... $ 8,833,454 $ 12,395,529
------------- -------------
Distributable income per unit
(40,000,000 units).......................... $ 0.220838 $ 0.309890
============= =============
</TABLE>
The accompanying notes to condensed financial statements are an integral part of
these statements.
7
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HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statement of Changes in Trust Corpus (Unaudited)
<TABLE>
<CAPTION>
Three Months Six Months
Ended Ended
June 30, 1999 June 30, 1999
-------------- --------------
<S> <C> <C>
Trust corpus, beginning of period.......... $ 245,471,651 $ 247,067,951
Amortization of net profits interests...... (3,930,587) (5,526,887)
Return of initial contribution to grantor.. (1,000) (1,000)
Distributable income....................... 8,833,454 12,395,529
Distributions declared..................... (8,833,454) (12,395,529)
-------------- --------------
Trust corpus, end of period................ $ 241,540,064 $ 241,540,064
============== ==============
</TABLE>
The accompanying notes to condensed financial statements are an integral part of
these statements.
8
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HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Notes to Condensed Financial Statements (Unaudited)
1. Trust Organization and Provisions
Hugoton Royalty Trust was created on December 1, 1998 by Cross Timbers Oil
Company. Effective on that date, Cross Timbers conveyed 80% defined net
profits interests in certain predominantly gas-producing working interest
properties in Kansas, Oklahoma and Wyoming to the trust under three separate
conveyances.
In exchange for the property conveyances to the trust, 40,000,000 units of
beneficial interest in the trust were issued to Cross Timbers. On April 8,
1999, Cross Timbers sold 15,000,000 units in the trust's initial public
offering. On May 7, 1999, Cross Timbers sold an additional 2,004,000 units
pursuant to the underwriters' overallotment option. The trust did not
receive any proceeds from the sale of trust units.
Bank of America, N.A. is the trustee for the trust. The trust indenture
provides, among other provisions, that:
- the trust shall not engage in any business or commercial activity or
acquire any asset other than the net profits interests initially
conveyed to the trust;
- the trust may sell or otherwise dispose of all or any part of the net
profits interests if approved by at least 80% of the unitholders, or
upon termination of the trust. Otherwise, the trust may only sell up to
1% of the value of the net profits interests in any calendar year,
pursuant to notice from Cross Timbers of its desire to sell the related
underlying properties. Any such sale must be for cash with the proceeds
promptly distributed to the unitholders;
- the trustee may establish a cash reserve for payment of any liability
which is contingent, uncertain in amount or that is not currently due
and payable;
- the trustee is authorized to borrow funds required to pay liabilities
of the trust, provided that such borrowings are repaid in full prior to
further distributions to unitholders;
- the trustee will make monthly cash distributions to unitholders as
provided in the trust indenture (see Note 3); and
- the trust will terminate upon the first occurrence of:
- disposition of all net profits interests pursuant to terms of the
trust indenture,
- gross proceeds from the underlying properties is less than $1
million per year for two successive years after the year 1999, or
- a vote of at least 80% of the trust unitholders to terminate the
trust in accordance with provisions of the trust indenture.
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2. Basis of Accounting
The financial statements of the trust are prepared on the following basis
and are not intended to present financial position and results of operations
in conformity with generally accepted accounting principles ("GAAP"):
- Royalty income is recorded in the month received by the trustee.
- Trust expenses are recorded based on liabilities paid and cash reserves
established by the trustee.
- Distributions to unitholders are recorded when declared by the trustee.
The trust's financial statements differ from those prepared in conformity
with 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 certain contingencies which would not be recorded under GAAP.
The initial carrying value of the net profits interests of $247,066,951
represents Cross Timbers' 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 as of June 30, 1999 is $5,526,887.
3. Distributions to Unitholders
The trustee determines the amount to be distributed to unitholders each
month by totaling royalty income, interest income and other cash receipts,
and subtracting liabilities paid and adjustments in cash reserves
established by the trustee. The resulting amount is distributed to
unitholders of record generally within ten business days after the monthly
record date, the last business day of the month.
Royalty income received by the trustee is equal to the net proceeds received
in the prior month by the owners of the underlying properties, multiplied by
80%. Net proceeds are the gross proceeds received from the sale of
production from the underlying properties, less applicable costs. Such costs
generally include applicable taxes, transportation, legal and marketing
charges, production costs, development and drilling costs, and overhead
(Note 5).
For trust distributions declared through March 2000, the related royalty
income will be based on gross proceeds equal to the greater of:
- the actual amount received from sales of production, or
- the imputed amount that would be received from sales of production at a
gas price of $2.00 per Mcf. During the three months and six months
ended June 30, 1999, imputed proceeds based on a $2.00 gas price
exceeded actual proceeds by $3,777,078 ($3,021,663 net to the trust)
and $4,727,214 ($3,781,771 net to the trust), respectively.
Cross Timbers, as owner of the underlying properties, computes royalty
income separately for each of the three conveyances (Note 1). If costs
exceed gross proceeds for any conveyance, such excess costs cannot be used
to reduce the amounts to be received under the other conveyances. The trust
is not liable for
10
<PAGE>
excess costs; however, future royalty income from the net profits interests
created by that conveyance will be reduced by such excess costs plus accrued
interest.
4. Federal Income Taxes
Tax counsel has advised the trust that, under current tax laws, the trust
will be classified as a grantor trust for federal income tax purposes and
therefore is not subject to taxation at the trust level. However, the
opinion of tax counsel is not binding on the Internal Revenue Service.
For federal income tax purposes, unitholders are considered to own the
trust's income and principal as though no trust were in existence. The
income of the trust is deemed to be received or accrued by the unitholders
at the time such income is received or accrued by the trust, rather than
when distributed by the trust.
Cross Timbers has advised the trustee that the trust receives royalty income
from tight sands gas wells. Production from tight sands gas wells drilled
between December 31, 1979 and January 1, 1993 qualifies for the federal
income tax credit for producing nonconventional fuels under Section 29 of
the Internal Revenue Code. This tax credit is recalculated annually based on
each year's qualifying production through the year 2002. Such credit, based
on the unitholder's pro rata share of qualifying production, may not reduce
his regular tax liability (after the foreign tax credit and certain other
non-refundable credits) below his tentative minimum tax. Any part of the
Section 29 credit not allowed for the tax year solely because of this
limitation is subject to certain carryover provisions. The 1999 tight sands
tax credit is estimated to be $0.02 per unit. Final 1999 tight sands tax
credit data will be provided to unitholders with year-end tax information.
Unitholders should consult their tax advisors regarding use of this credit
and other trust tax compliance matters.
5. Cross Timbers Oil Company
Cross Timbers operates approximately 90% of the wells on the underlying
properties. In computing net proceeds, Cross Timbers deducts an overhead
charge for reimbursement of administrative expenses on the underlying
properties it operates. Overhead charges are approximately $575,000 per
month and are subject to annual adjustment based on an oil and gas industry
index.
As of August 1, 1999, Cross Timbers owns 22,922,316 units, or 57.3% of the
trust.
6. Contingencies
Cross Timbers is a defendant in two separate lawsuits that could, if
adversely determined, decrease future trust distributable income. Damages
relating to production prior to the formation of the trust will be borne by
Cross Timbers.
A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was
filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by
royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that
since 1991 the Company has underpaid royalty owners as a result of reducing
royalties for improper charges for production, marketing, gathering,
processing and transportation costs and selling natural gas through
affiliated companies at prices less favorable from those paid by third
parties. The
11
<PAGE>
plaintiffs are seeking an accounting and payment of the monies allegedly owed
to them. Cross Timbers believes that it has strong defenses to this lawsuit
and intends to vigorously defend its position. However, 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. The amount of any reduction in net proceeds is not
presently determinable, but, in Cross Timbers' management's opinion, is not
expected to be material to the trust's annual distributable income, financial
position or liquidity.
A second lawsuit, 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. This action alleges that Cross Timbers
underpaid royalties on natural gas produced from federal leases and lands
owned by Native Americans by at least 20% during the past 10 years as a result
of mismeasuring the volume of natural gas and wrongfully analyzing its heating
content. The suit, which was brought under the qui tam provisions of the U.S.
False Claims Act, seeks treble damages for the unpaid royalties (with
interest), civil penalties between $5,000 and $10,000 for each violation of
the U.S. False Claims Act, and an order for Cross Timbers to cease the
allegedly improper measuring practices. According to the U. S. Department of
Justice, the plaintiff has made similar allegations in actions filed against
over 300 other companies. Royalties paid by Cross Timbers for production from
underlying properties on federal and Native American lands during 1998 totaled
approximately $2.8 million. After its review, the U. S. Department of Justice
decided in April 1999 not to intervene and asked the court to unseal the case.
The court unsealed the case in May 1999 and the Company agreed to file an
answer without receiving service of the complaint. Cross Timbers believes
that the allegations of this lawsuit are without merit. 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 Cross Timbers' management's opinion, is not expected
to be material to the trust's annual distributable income, financial position
or liquidity.
12
<PAGE>
Item 2. Trustee's Discussion and Analysis.
DISTRIBUTABLE INCOME
Quarter
For the quarter ended June 30, 1999 royalty income was $8,854,991. After adding
interest income of $8,536 and deducting administration expense of $30,073,
distributable income for the quarter ended June 30, 1999 was $8,833,454, or
$0.220838 per unit of beneficial interest. Distributions to unitholders for the
quarter ended June 30, 1999 were:
<TABLE>
<CAPTION>
Distribution
Record Date Payment Date per Unit
--------------- -------------- ------------
<S> <C> <C>
April 30, 1999 May 14,1999 $ 0.065120
May 28, 1999 June 14, 1999 0.080026
June 30, 1999 July 15, 1999 0.075692
------------
$ 0.220838
============
</TABLE>
Six Months
For the six months ended June 30, 1999 royalty income was $12,420,066. After
considering interest income of $8,536 and administration expense of $33,073,
distributable income for the six months ended June 30, 1999 was $12,395,529, or
$0.309890 per unit of beneficial interest.
ROYALTY INCOME
Royalty income is recorded when received by the trust, which is the month
following receipt by Cross Timbers, and generally two months after oil and gas
production. Royalty income is generally affected by three major factors:
- oil and gas sales volumes,
- oil and gas sales prices, and
- costs deducted in the calculation of royalty income.
13
<PAGE>
The following are prices, volumes and costs for the underlying properties and
the calculation of royalty income for the quarter and six months ended June 30,
1999:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 (a) June 30, 1999 (a)
------------------ ------------------
<S> <C> <C> <C> <C>
Sales Volumes
Gas (Mcf).............. 9,572,424 15,087,211
Average per day....... 107,555 99,915
Oil (Bbls)............. 115,384 180,908
Average per day....... 1,296 1,198
Mcfe................... 10,264,728 16,172,659
Average per day....... 115,334 107,104
Sales Prices
Gas (per Mcf) (b)...... $ 2.00 $ 2.00
Oil (per Bbl).......... $ 13.64 $ 12.64
Per Mcfe Per Mcfe
-------- --------
Revenues
Gas sales.............. $ 19,144,848 $ 30,174,422
Oil sales.............. 1,574,132 2,286,000
------------------ ------------------
20,718,980 $ 2.02 32,460,422 $ 2.01
------------------ -------- ------------------ --------
Costs
Taxes, transportation
and other............ 2,137,938 0.21 3,522,886 0.22
Production expense..... 2,944,690 0.28 5,258,915 0.32
Development costs...... 2,842,806 0.28 4,803,107 0.30
Overhead (c)........... 1,724,807 0.17 3,350,431 0.21
------------------ -------- ------------------ --------
Total Costs........... 9,650,241 0.94 16,935,339 1.05
------------------ -------- ------------------ --------
Net Proceeds............ 11,068,739 $ 1.08 15,525,083 $ 0.96
======== ========
Net Profits Percentage.. 80% 80%
------------------ ------------------
Royalty Income.......... $ 8,854,991 $ 12,420,066
================= ==================
</TABLE>
(a) Because of the two-month interval between time of production and receipt of
royalty income by the trust, (1) oil and gas sales for the quarter ended
June 30 generally represent production for the period February 1999 through
April 1999 and (2) oil and gas sales for the six months ended June 30
generally represent production for the period December 1998 through April
1999.
(b) See Note 3 to condensed financial statements.
(c) See Note 5 to condensed financial statements.
SALES VOLUMES
Second quarter 1999 includes three months of oil and gas sales volumes, as
compared with approximately two months included in first quarter 1999. Daily
oil and gas sales volumes were lower in the first quarter and the six months
ended June 30, 1999 because of the time lag effect on cash receipts in the
trust's initial accounting period. Also, some proceeds were not received until
the second quarter from underlying properties that Cross Timbers acquired in
November 1998 and from several development projects completed in late 1998 and
early 1999.
14
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SALES PRICES
Gas
The average gas price is the $2.00 per Mcf minimum price, which exceeded the
actual average price by $0.43 per Mcf for the second quarter and $0.34 for the
year to date. See Note 3 to the condensed financial statements. The actual
average gas price of $1.57 per Mcf for the quarter and $1.66 per Mcf for the
six-month period reflects the effects of an abnormally warm winter experienced
across the United States. The average gas price related to royalty income
received by the trust in July was $1.95 per Mcf, reflecting the effect of prices
that began to strengthen in April.
Oil
The average second quarter 1999 oil price was $13.64 per Bbl, a 26% increase
over first quarter's average oil price of $10.86. The second quarter average
price reflects the effect of improvements that began in March 1999 because of
production cuts by OPEC and other leading oil producers.
COSTS
Costs deducted in the calculation of royalty income totaled $9,650,241 for the
quarter and $16,935,339 for the six-month period. Costs for the quarter reflect
Cross Timbers' disbursements for the three months March through May 1999, while
costs for the year to date reflect Cross Timbers' disbursements for the six
months of December 1998 through May 1999. Production expenses and development
costs for the second quarter were 35% higher than the first quarter primarily
because of the interval between the time maintenance and development projects
occur and when billings are paid. However, costs per Mcfe declined in the
second quarter generally because of an additional month of oil and gas sales
recorded in the second quarter (see "Sales Volumes" above). Development costs
are primarily associated with drilling and workovers on operated properties in
Oklahoma and Wyoming.
15
<PAGE>
OIL AND GAS SALES VOLUMES FOR THE ROYALTY TRUST INTERESTS
Oil and gas sales volumes are allocated to the royalty trust interests based
upon a formula that considers oil and gas prices and the total amount of
production expenses and development costs. Changes in any of these factors may
result in disproportionate fluctuations in volumes allocated to the royalty
trust interests. Therefore, comparative discussion of oil and gas sales volumes
is based on the underlying properties.
Oil and gas sales volumes attributable to the royalty trust interests are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, 1999 June 30, 1999
------------------ ----------------
<S> <C> <C>
Gas Sales (Mcf)................ 4,491,137 6,315,141
Oil Sales (Bbls)............... 57,084 82,636
</TABLE>
YEAR 2000
- ---------
"Year 2000," or the ability of computer systems to process dates with years
beyond 1999, affects almost all companies and organizations. Computer systems
that are not Year 2000 compliant by January 1, 2000 may have material adverse
effects on companies and organizations that rely upon those systems.
The trust's timely receipt of royalty income and disbursement of distributable
income to unitholders is largely dependent upon performance of computer systems
and computer-controlled equipment of Cross Timbers, ChaseMellon Shareholder
Services, L.L.C. and other third parties, including oil and natural gas
purchasers and significant service providers such as electric utility companies
and natural gas plant, pipeline and gathering system operators. Since the trust
does not use the trustee's computer systems in any significant capacity, the
trustee's Year 2000 compliance will not materially affect the trust.
Cross Timbers is in the process of reviewing its computer systems and computer-
controlled field equipment and making the necessary modifications for Year 2000
compliance. Cross Timbers has completed modifications and testing of its
primary accounting and land computer programs. The remaining computer systems
have been inventoried and assessed. Remediation and testing of significant
remaining systems are expected to be complete by August 1999.
Some of Cross Timbers' critical field equipment, such as natural gas processors,
are partially controlled or regulated by embedded computer chips. Based on a
preliminary review of all operating areas, Cross Timbers has identified no
significant compliance exceptions. As of April 1999, the types of field
equipment in all operated areas have been inventoried. Cross Timbers plans to
complete remediation and testing of any identified exceptions for significant
computer-controlled field equipment by the end of August 1999.
Based on its review, remediation efforts and the results of testing to date,
Cross Timbers does not believe that timely modification of its computer systems
and computer-controlled equipment for Year 2000 compliance represents a material
risk to the trust. No costs of such modifications will be incurred by the
trust.
Cross Timbers has identified significant third parties whose Year 2000
compliance could affect Cross Timbers and is in the process of formally
inquiring about their Year 2000 status. Cross Timbers has received responses to
approximately 56% of its inquiries. Approximately 99% of respondents have
indicated that they will be Year
16
<PAGE>
2000 compliant by January 1, 2000. ChaseMellon Shareholder Services L.L.C. has
notified Cross Timbers that it is Year 2000 compliant. Despite their efforts to
assure that such third parties are Year 2000 compliant, neither the trustee nor
Cross Timbers can provide assurance that all significant third parties will
achieve timely Year 2000 compliance. Such failure to achieve Year 2000
compliance could have a material adverse impact on timely trust distributions to
unitholders. The potential effect of Year 2000 non-compliance by third parties
is currently unknown.
Cross Timbers is currently identifying appropriate contingency plans in the
event of potential problems resulting from failure of its computer systems on
January 1, 2000. Cross Timbers has not completed any contingency plans to date.
Specific contingency plans will be developed in response to the results of
testing scheduled to be complete by the end of August 1999, as well as the
assessed probability and risk of system or equipment failure. Contingency plans
may include installing backup computer systems or equipment, temporarily
replacing systems or equipment with manual processes and identifying alternative
suppliers, service companies and purchasers. Cross Timbers expects its
contingency plans to be complete by October 1999.
FORWARD LOOKING STATEMENTS
- --------------------------
This report on 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 contained in this "Trustee's Discussion and
Analysis" regarding the net profits interests and industry conditions, are
forward looking statements. Although the trustee and Cross Timbers believe that
the expectations reflected in such forward looking statements are reasonable,
they can give no assurance that such expectations will prove to be correct.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The only assets of and sources of income to the trust are the net profits
interests, which generally entitle the trust to receive a share of the net
profits from oil and gas production from the underlying properties.
Consequently, the trust is exposed to market risk from fluctuations in oil and
gas prices. The trust is a passive entity and, other than the trust's ability
to periodically borrow money as necessary to pay expenses, liabilities and
obligations of the trust that cannot be paid out of cash held by the trust, the
trust is prohibited from engaging in borrowing transactions. The amount of any
such borrowings is unlikely to be material to the trust. In addition, the
trustee is prohibited by the trust indenture from engaging in any business
activity or causing the trust to enter into any investments other than investing
cash on hand in specific short-term cash investments. Therefore, the trust
cannot hold any derivative financial instruments. As a result of the limited
nature of the trust's borrowing and investing activities, the trust is not
subject to any material interest rate market risk. Additionally, any gains or
losses from any hedging activities conducted by Cross Timbers are specifically
excluded from the calculation of net proceeds due the trust under the forms of
the conveyances. The trust does not engage in transactions in foreign
currencies which could expose the trust to any foreign currency related market
risk.
17
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on
April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners
of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the
Company has underpaid royalty owners as a result of reducing royalties for
improper charges for production, marketing, gathering, processing and
transportation costs and selling natural gas through affiliated companies at
prices less favorable from those paid by third parties. The plaintiffs are
seeking an accounting and payment of the monies allegedly owed to them. Cross
Timbers believes that it has strong defenses to this lawsuit and intends to
vigorously defend its position. However, 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. The
amount of any reduction in net proceeds is not presently determinable, but, in
Cross Timbers' management's opinion, is not expected to be material to the
trust's annual distributable income, financial position or liquidity.
A second lawsuit, 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. This action alleges that Cross Timbers underpaid
royalties on natural gas produced from federal leases and lands owned by Native
Americans by at least 20% during the past 10 years as a result of mismeasuring
the volume of natural gas and wrongfully analyzing its heating content. The
suit, which was brought under the qui tam provisions of the U.S. False Claims
Act, seeks treble damages for the unpaid royalties (with interest), civil
penalties between $5,000 and $10,000 for each violation of the U.S. False Claims
Act, and an order for Cross Timbers to cease the allegedly improper measuring
practices. According to the U. S. Department of Justice, the plaintiff has made
similar allegations in actions filed against over 300 other companies.
Royalties paid by Cross Timbers for production from underlying properties on
federal and Native American lands during 1998 totaled approximately $2.8
million. After its review, the U. S. Department of Justice decided in April
1999 not to intervene and asked the court to unseal the case. The court
unsealed the case in May 1999 and the Company agreed to file an answer without
receiving service of the complaint. Cross Timbers believes that the allegations
of this lawsuit are without merit. 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 Cross Timbers' management's opinion, is not expected to be material to the
trust's annual distributable income, financial position or liquidity.
Items 2 through 5. Not applicable.
Item 6. (a) Exhibits.
Exhibit Number
and Description Page
--------------- ----
(4) (a) Hugoton Royalty Trust Indenture by and between NationsBank,
N.A. (now Bank of America, N.A.), as trustee and Cross
Timbers Oil Company heretofore filed as Exhibit 4.1 to the
trust's Registration Statement No. 333-68441 on Form S-1
filed with the Securities and Exchange Commission on December
4, 1998, is incorporated herein by reference.
(b) Net Overriding Royalty Conveyance (Hugoton Royalty Trust, 80%
- Kansas) as amended and restated from Cross Timbers Oil
Company to NationsBank, N.A. (now Bank of America, N.A.), as
trustee, dated December 1, 1998 heretofore filed as Exhibit
10.1.1 to Amendment No. 2 to the trust's Registration
Statement No. 333-68441 on Form S-1 filed with the
Securities and Exchange Commission on March 16, 1999,
is incorporated herein by reference.
18
<PAGE>
(c) Net Overriding Royalty Conveyance (Hugoton Royalty Trust, 80%
- Oklahoma) as amended and restated from Cross Timbers Oil
Company to NationsBank, N.A. (now Bank of America, N.A.), as
trustee, dated December 1, 1998, heretofore filed as Exhibit
10.2.1 to Amendment No. 2 to the trust's Registration
Statement No. 333-68441 on Form S-1 filed with the Securities
and Exchange Commission on March 16, 1999, is incorporated
herein by reference.
(d) Net Overriding Royalty Conveyance (Hugoton Royalty Trust, 80%
- Wyoming) as amended and restated from Cross Timbers Oil
Company to NationsBank, N.A. (now Bank of America, N.A.), as
trustee, dated December 1, 1998, heretofore filed as Exhibit
10.3.1 to Amendment No. 2 to the trust's Registration Statement
No. 333-68441 on Form S-1 filed with the
Securities and Exchange Commission on March 16, 1999, is
incorporated herein by reference.
(15) Awareness letter of Arthur Andersen LLP
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the quarter for which this
report is filed.
19
<PAGE>
SIGNATURES
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.
HUGOTON ROYALTY TRUST
By BANK OF AMERICA, N.A., TRUSTEE
By RON E. HOOPER
------------------------------
Ron E. Hooper
Vice President
CROSS TIMBERS OIL COMPANY
Date: August 13, 1999 By BENNIE G. KNIFFEN
------------------------------
Bennie G. Kniffen
Senior Vice President and
Controller
20
<PAGE>
EXHIBIT 15
Bank of America, N.A. as Trustee
for the Hugoton Royalty Trust:
We are aware that Cross Timbers Oil Company has incorporated by reference in its
Registration Statement No. 333-81849 on Form S-8, Hugoton Royalty Trust's Form
10-Q for the quarter ended June 30, 1999, which includes our report dated August
6, 1999, covering the unaudited interim financial information contained therein.
Pursuant to Regulation C of the Securities Act of 1933, that report is not
considered a part of the registration statement prepared or certified by our
firm or a report prepared or certified by our firm within the meaning of
Sections 7 and 11 of the Act.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
August 13, 1999
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