<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 September 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 November 1, 1999:
40,000,000
- ----------
<PAGE>
HUGOTON ROYALTY TRUST
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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 September 30, 1999 and December 31, 1998................... 6
Condensed Statements of Distributable Income
for the Three and Nine Months Ended September 30, 1999........ 7
Condensed Statements of Changes in Trust Corpus
for the Three and Nine Months Ended September 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 September 30, 1999, and the
distributable income and changes in trust corpus for the three and nine-month
periods ended September 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 September 30, 1999 and the
related condensed statements of distributable income and changes in trust corpus
for the three and nine-month periods ended September 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
November 4, 1999
5
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HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statements of Assets, Liabilities and Trust Corpus
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Cash and short-term investments............... $ 2,983,720 $ 1,000
Net profits interests in oil and gas
properties - net (Notes 1 and 2)............ 237,895,580 247,066,951
------------ ------------
$240,879,300 $247,067,951
============ ============
LIABILITIES AND TRUST CORPUS
Distribution payable to unitholders........... $ 2,983,720 $ -
Trust corpus (40,000,000 units of beneficial
interest authorized and outstanding)........ 237,895,580 247,067,951
------------ ------------
$240,879,300 $247,067,951
============ ============
</TABLE>
The accompanying notes to condensed financial statements are an integral part of
these statements.
6
<PAGE>
HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statement of Distributable Income (Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
1999 1999
------------- -------------
<S> <C> <C>
Royalty income..................................... $8,541,670 $20,961,736
Interest income.................................... 15,980 24,516
---------- -----------
Total income....................................... 8,557,650 20,986,252
Administration expense............................. 29,330 62,403
---------- -----------
Distributable income............................... $8,528,320 $20,923,849
========== ===========
Distributable income per unit (40,000,000 units)... $ 0.213208 $ 0.523098
========== ===========
</TABLE>
The accompanying notes to condensed financial statements are an integral part of
these statements.
7
<PAGE>
HUGOTON ROYALTY TRUST
- --------------------------------------------------------------------------------
Condensed Statement of Changes in Trust Corpus (Unaudited)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
1999 1999
-------------- --------------
<S> <C> <C>
Trust corpus, beginning of period.......... $241,540,064 $247,067,951
Amortization of net profits interests...... (3,644,484) (9,171,371)
Return of initial contribution to grantor.. - (1,000)
Distributable income....................... 8,528,320 20,923,849
Distributions declared..................... (8,528,320) (20,923,849)
------------ ------------
Trust corpus, end of period................ $237,895,580 $237,895,580
============ ============
</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.
9
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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 recorded for a month is the amount computed and paid by
the interest owner, Cross Timbers, to Bank of America, N.A., as
trustee for the trust. Royalty income consists of net proceeds
received by Cross Timbers from the underlying properties in the prior
month, multiplied by a net profit percentage of 80%.
- Applicable costs deducted in the calculation of net proceeds for the
80% net profits interests generally include applicable taxes,
transportation, marketing and legal costs, production expenses,
development costs, operating charges and other costs.
- Royalty income is computed separately for each of three conveyances
under which the net profits interests were conveyed to the trust. If
monthly costs exceed revenues for any conveyance, such excess costs
cannot reduce royalty income from other conveyances, but are carried
forward with accrued interest to be recovered from future net proceeds
of that conveyance. See Note 4.
- Trust expenses are recorded based on liabilities paid and cash
reserves established by the trustee for liabilities and contingencies.
- 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 contingencies which would not be recorded under GAAP.
The initial carrying value of the net profits interests of $247,066,951
represents Cross Timbers' 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 as of September
30, 1999 is $9,171,371.
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 6).
10
<PAGE>
For monthly 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. As of September 30, 1999, imputed
proceeds based on a $2.00 gas price exceeded actual proceeds by
$109,715 ($87,772 net to the trust) for the three months then ended
and $4,977,110 ($3,981,688 net to the trust) for the nine months then
ended.
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 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. See Note 4.
4. Excess Costs
Cross Timbers has advised the trustee that costs exceeded revenues by
$35,718 from the underlying properties of the Wyoming net profits interests
in August 1999. These excess costs plus accrued interest of $250 were fully
recovered in September 1999. Excess costs were primarily the result of new
well drilling projects.
5. 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. 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.
6. 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
11
<PAGE>
the underlying properties it operates. Overhead charges are approximately
$590,000 per month and are subject to annual adjustment based on an oil and
gas industry index.
As of November 1, 1999, Cross Timbers owns 22,922,316 units, or 57.3% of
the trust.
7. 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 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 over 70 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. A federal multi-
district litigation panel has ordered that most of the suits filed by
Grynberg be transferred and consolidated to the federal district court in
Wyoming. Although the lawsuit against Cross Timbers has not yet been
transferred, Cross Timbers anticipates that the lawsuit will be transferred
and intends to file a motion to dismiss the lawsuit in the Wyoming federal
district court. 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 September 30, 1999 royalty income was $8,541,670. After
adding interest income of $15,980 and deducting administration expense of
$29,330, distributable income for the quarter ended September 30, 1999 was
$8,528,320, or $0.213208 per unit of beneficial interest. Distributions to
unitholders for the quarter ended September 30, 1999 were:
<TABLE>
<CAPTION>
Distribution
Record Date Payment Date per Unit
------------------ ------------------ ------------
<S> <C> <C>
July 30, 1999 August 13, 1999 $ 0.075591
August 31, 1999 September 15, 1999 0.063024
September 30, 1999 October 15, 1999 0.074593
-----------
$ 0.213208
===========
</TABLE>
Nine Months
For the nine months ended September 30, 1999 royalty income was $20,961,736.
After considering interest income of $24,516 and administration expense of
$62,403, distributable income for the nine months ended September 30, 1999 was
$20,923,849, or $0.523098 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 nine months ended
September 30, 1999:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1999 (a) September 30, 1999 (a)
--------------------- ---------------------
<S> <C> <C> <C> <C>
Sales Volumes
Gas (Mcf).................. 9,515,797 24,603,008
Average per day........... 103,433 101,247
Oil (Bbls)................. 104,133 285,041
Average per day........... 1,132 1,173
Mcfe....................... 10,140,595 26,313,254
Average per day........... 110,224 108,285
Sales Prices
Gas (per Mcf) (b).......... $2.01 $2.00
Oil (per Bbl).............. $18.18 $14.66
Per Mcfe Per Mcfe
-------- --------
Revenues
Gas sales.................. $19,118,253 $49,292,675
Oil sales.................. 1,892,765 4,178,765
----------- -----------
21,011,018 $ 2.07 53,471,440 $ 2.03
----------- -------- ----------- --------
Costs
Taxes, transportation
and other................. 2,097,817 0.21 5,620,703 0.21
Production expense......... 2,791,131 0.28 8,050,046 0.31
Development costs.......... 3,693,053 0.36 8,496,160 0.32
Overhead (c)............... 1,751,680 0.17 5,102,111 0.19
Excess costs (d)........... (35,718) (0.00) (35,718) (0.00)
Recovery of excess costs
and accrued interest (d).. 35,968 0.00 35,968 0.00
----------- -------- ----------- --------
Total Costs............. 10,333,931 1.02 27,269,270 1.03
----------- -------- ----------- --------
Net Proceeds................ 10,677,087 $ 1.05 26,202,170 $ 1.00
======== ========
Net Profits Percentage...... 80% 80%
----------- -----------
Royalty Income.............. $ 8,541,670 $20,961,736
=========== ===========
</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
September 30 generally represent production for the period May 1999 through
July 1999 and (2) oil and gas sales for the nine months ended September 30
generally represent production for the period December 1998 through July
1999.
(b) See Note 3 to condensed financial statements.
(c) See Note 6 to condensed financial statements.
(d) See Note 4 to condensed financial statements.
14
<PAGE>
Sales Volumes
Daily gas sales volumes were lower in the nine-month period than in the three-
month period because of the time lag effect on cash receipts in the trust's
initial accounting period. Compared to the second quarter, gas sales volumes
declined 4% to 103,433 Mcf per day and oil sales volumes declined 13% to 1,132
barrels per day during the three months ended September 30, 1999. This decrease
in volumes was primarily because of higher second quarter volumes related to
proceeds received from underlying properties that Cross Timbers acquired in
November 1998 and from several development projects completed in late 1998 and
early 1999.
Sales Prices
Gas
The third quarter average gas price of $2.01 approximated the actual average
price before adjustment to provide the monthly $2.00 per Mcf minimum price. See
Note 3 to the condensed financial statements. The year-to-date minimum price of
$2.00 per Mcf exceeded the actual average price by $0.22 for the year to date.
The actual average gas price of $1.78 per Mcf for the nine-month period reflects
high levels of gas in storage resulting from the previous two abnormally warm
winters. Gas prices have trended higher during 1999 as gas in storage has
declined.
Oil
The average third quarter 1999 oil price was $18.18 per Bbl, which is a 33%
increase over the second quarter average oil price of $13.64 and a 67% increase
over the first quarter average oil price of $10.86. Prices began to rise in
second quarter due largely to the effect of production cuts by OPEC and other
leading oil exporters that began in March 1999.
Costs
Costs deducted in the calculation of royalty income totaled $10,333,931 for the
quarter and $27,269,270 for the nine-month period. Costs for the quarter
reflect Cross Timbers' disbursements for the three months of June through August
1999, while costs for the year to date reflect Cross Timbers' disbursements for
the nine months of December 1998 through August 1999. Development costs for the
third quarter were 30% higher than the second quarter primarily because of the
timing of development projects and payment of related billings. Development
costs are primarily associated with drilling and workovers on operated
properties in Oklahoma and Wyoming. Primarily because of new wells drilled,
costs exceeded revenues from properties underlying the Wyoming net profits
interests in August 1999. All excess costs and accrued interest were fully
recovered by September 30, 1999.
15
<PAGE>
Oil and Gas Sales Volumes for the Net Profits Interests
Oil and gas sales volumes are allocated to the net profits 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 net profits interests.
Therefore, comparative discussion of oil and gas sales volumes is based on the
underlying properties.
Oil and gas sales volumes attributable to the net profits interests are as
follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, 1999 September 30, 1999
------------------ ------------------
<S> <C> <C>
Gas Sales (Mcf)......... 4,164,330 10,479,471
Oil Sales (Bbls)........ 55,660 138,296
</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 has completed remediation and testing of its significant computer
systems and computer-controlled field equipment. The remaining less critical
computer systems have been inventoried and assessed. Functional solutions and
remediation of less critical items is expected to be complete by the end of
December 1999. Less critical items are components that are not critical for
production, safety or sales. Based on its remediation efforts and the results of
testing to date, Cross Timbers does not believe that 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 have
been or 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 58% of its inquiries. Approximately 99% of respondents have
indicated that they will be Year 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.
16
<PAGE>
Cross Timbers Oil is currently identifying appropriate contingency plans in the
event of potential problems resulting from failure of its computer systems on
January 1, 2000. Contingency plans will focus on computer, network and
communications equipment, electronic data interchange with business partners,
and field operations automated well control systems. No contingency plans have
been completed to date; Cross Timbers Oil expects contingency plans to be
complete by November 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, industry conditions and Year 2000
compliance, 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 over 70 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. A federal multi-district litigation panel has
ordered that most of the suits filed by Grynberg be transferred and consolidated
to the federal district court in Wyoming. Although the lawsuit against Cross
Timbers has not yet been transferred, Cross Timbers anticipates that the lawsuit
will be transferred and intends to file a motion to dismiss the lawsuit in the
Wyoming federal district court. 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.
18
<PAGE>
(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.
(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 21
(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 /s/ RON E. HOOPER
------------------------------
Ron E. Hooper
Vice President
CROSS TIMBERS OIL COMPANY
Date: November 12, 1999 By /s/ LOUIS G. BALDWIN
------------------------------
Louis G. Baldwin
Executive Vice President
and Chief Financial Officer
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 September 30, 1999, which includes our report dated
November 4, 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
November 12, 1999
21
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