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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
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OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______ to _________
Commission File Number 1-12474
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Torch Energy Royalty Trust
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(Exact name of registrant as specified in its charter)
Delaware 74-6411424
-------------------------------- ----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
1100 North Market Street, Wilmington, Delaware 19890
- ----------------------------------------------- ------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code 302/651-8584
------------
Not Applicable
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Former name, former address and former fiscal year,
if changed 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 X No
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<PAGE>
TORCH ENERGY ROYALTY TRUST
PART 1 - FINANCIAL INFORMATION
ITEM I. FINANCIAL STATEMENTS
This document includes "forward looking statements" within the meaning of
Section 27A of the Securities Act of 1993, as amended (the "Securities Act"),
and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act"). All
statements other than statements of historical facts included in this document,
including without limitation, statements under "Discussion and Analysis of
Financial Condition and Results of Operations" regarding the financial position,
reserve quantities and values of the Torch Energy Royalty Trust ("Trust") and
the Y2k issue are forward-looking statements. Torch Energy Advisors
Incorporated ("Torch") and the Trust can give no assurances that the assumptions
upon which these statements are based will prove to be correct. Factors which
could cause such forward looking statements not to be correct include, among the
other cautionary statements set forth in the Trust's Annual Report on Form 10-K
filed with the Securities Exchange Commission, the volatility of oil and gas
prices, future production costs, operating hazards and environmental conditions.
INTRODUCTION
The financial statements included herein have been prepared by Torch, pursuant
to an administrative services agreement between Torch and the Trust, pursuant to
the rules and regulations of the Securities and Exchange Commission. Wilmington
Trust Company serves as the trustee ("Trustee") of the Trust pursuant to the
trust agreement dated October 1, 1993. Certain information and footnote
disclosures normally included in the annual financial statements have been
omitted pursuant to such rules and regulations, although Torch believes that the
disclosures are adequate to make the information presented not misleading.
These financial statements should be read in conjunction with the December 31,
1998 financial statements and notes thereto included in the Trust's latest
annual report on Form 10-K. In the opinion of Torch, all adjustments necessary
to present fairly the assets, liabilities and trust corpus of the Trust as of
March 31, 1999 and December 31, 1998, the distributable income and changes in
trust corpus for the three-month periods ended March 31, 1999 and 1998 have been
included. All such adjustments are of a normal recurring nature. The
distributable income for such interim periods is not necessarily indicative of
the distributable income for the full year.
The financial statements as of March 31, 1999 and for the three-month periods
ended March 31, 1999 and 1998 included herein have been reviewed by KPMG LLP,
independent certified public accountants, as stated in their report appearing
herein.
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INDEPENDENT ACCOUNTANTS' REPORT
Wilmington Trust Company
as Trustee of Torch Energy Royalty Trust
and the Unitholders:
We have reviewed the accompanying statement of assets, liabilities and trust
corpus of the Torch Energy Royalty Trust as of March 31, 1999 and the related
statements of distributable income and changes in trust corpus for the three-
month periods ended March 31, 1999 and 1998. These financial statements are the
responsibility of the Trustee.
We conducted our reviews 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 of 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.
As described in Note 2 to the financial statements, these financial statements
were prepared on the modified cash basis of accounting, 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 such financial statements 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 Torch Energy
Royalty Trust as of December 31, 1998, and the related statements of
distributable income and changes in trust corpus for the year then ended (not
presented herein); and in our report dated March 26, 1999, we expressed an
unqualified opinion on those financial statements. In our opinion, the
information set forth in the accompanying 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 from which
it has been derived.
/s/ KPMG LLP
- ------------
KPMG LLP
Houston, Texas
April 29, 1999
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TORCH ENERGY ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
(In thousands)
ASSETS
<TABLE>
<CAPTION>
March 31, 1999 December 31,1998
----------------- ----------------
(Unaudited)
<S> <C> <C>
Cash................................................. $ 4 $ 4
Net profits interests in oil and gas properties
(Net of accumulated amortization of $125,723 and
$123,589 at March 31, 1999 and December 31, 1998,
respectively)........................................ 54,877 57,011
----------- -------------
$54,881 $57,015
=========== =============
LIABILITIES AND TRUST CORPUS
Trust expense payable................................ $ 183 $ 155
Trust corpus......................................... 54,698 56,860
----------- -------------
$54,881 $57,015
=========== =============
</TABLE>
See notes to financial statements and
accompanying accountant's review report.
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TORCH ENERGY ROYALTY TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except per Unit amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------------------------
1999 1998
---------------- -------------------
<S> <C> <C>
Net profits income................... $2,470 $4,152
Interest income...................... 3 6
---------------- -------------------
2,473 4,158
---------------- -------------------
General and
administrative expenses............. 179 175
---------------- -------------------
Distributable income................. $2,294 $3,983
---------------- -------------------
Distributable income
per Unit (8,600,000 Units)......... $ .27 $ .46
---------------- -------------------
Distributions per Unit............... $ .27 $ .46
---------------- -------------------
</TABLE>
See notes to financial statements and
accompanying accountants' review report.
5
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TORCH ENERGY ROYALTY TRUST
STATEMENTS OF CHANGES IN TRUST CORPUS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------------
1999 1998
------------------ -------------------
<S> <C> <C>
Trust corpus, beginning of period..... $56,860 $100,668
Amortization of Net Profits Interests. (2,134) (3,803)
Distributable income.................. 2,294 3,983
Distributions to Unitholders.......... (2,322) (3,990)
------------------ -------------------
Trust corpus, end of period........... $54,698 $ 96,858
================== ===================
</TABLE>
See notes to financial statements and
accompanying accountants' review report.
6
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TORCH ENERGY ROYALTY TRUST
1. Trust Organization and Nature of Operations
The Torch Energy Royalty Trust ("Trust") was formed effective October 1, 1993
under the Delaware Business Trust Act pursuant to a trust agreement ("Trust
Agreement") among Wilmington Trust Company, as trustee ("Trustee"), Torch
Royalty Company ("TRC") and Velasco Gas Company, Ltd. ("Velasco"), as owners of
certain oil and gas properties ("Underlying Properties"), and Torch Energy
Advisors Incorporated ("Torch") as grantor. TRC and Velasco created net profits
interests ("Net Profits Interests") and conveyed such interests to Torch. Torch
conveyed the Net Profits Interests to the Trust in exchange for an aggregate of
8,600,000 units of beneficial interest ("Units"). Such Units were sold to the
public through various underwriters beginning November 1993. Pursuant to an
administrative services agreement with the Trust, Torch provides accounting,
bookkeeping, informational and other services related to the Net Profits
Interests.
The Underlying Properties constitute working interests in the Chalkley Field in
Louisiana ("Chalkley Field"), the Robinson's Bend Field in the Black Warrior
Basin in Alabama ("Robinson's Bend Field"), fields that produce from the Cotton
Valley formations in Texas ("Cotton Valley Fields") and fields that produce from
the Austin Chalk formation in Texas ("Austin Chalk Fields"). Sales of coal seam
and tight sands gas attributable to the Net Profits Interests between November
23, 1993 and January 1, 2003 result in the unitholders ("Unitholders") receiving
quarterly allocations of tax credits under Section 29 of the Internal Revenue
Code of 1986 ("Section 29 Credits"). The Section 29 Credits available for 1998
and 1997 production from qualifying coal seam properties were approximately
$1.05 and $1.03, respectively, for each MMBtu of gas produced and sold during
the years ended December 31, 1998 and 1997. This rate is adjusted annually for
inflation. The Section 29 Credit available for production from qualifying tight
sands properties is approximately $0.52 for each MMBtu of gas produced and sold
and such amount is not adjusted for inflation.
The only assets of the Trust, other than cash and temporary investments being
held for the payment of expenses and liabilities and for distribution to
Unitholders, are the Net Profits Interests. The Net Profits Interests (other
than the Net Profits Interest covering the Robinson's Bend Field) entitle the
Trust to receive 95% of the net proceeds ("Net Proceeds") attributable to oil
and gas produced and sold from wells (other than infill wells) on the Underlying
Properties. Net Proceeds are generally defined as gross revenues received from
the sale of production attributable to the Underlying Properties during any
period less property, production, severance and similar taxes, and development,
operating, and certain other costs. In calculating Net Proceeds from the
Robinson's Bend Field, operating and development costs incurred prior to January
1, 2003 are not deducted. In addition, the amounts paid to the Trust from the
Robinson's
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TORCH ENERGY ROYALTY TRUST
Bend Field during any calendar quarter are subject to a volume limitation
("Volume Limitation") equal to the gross proceeds from the sale of 912.5 MMcf of
gas, less property, production, severance and related taxes. Production for the
three-month periods ended March 31, 1999 and 1998 from the Underlying Properties
in the Robinson's Bend Field was approximately 28% (254 MMcf) and 21% (194
MMcf), respectively, below the Volume Limitation. If average gas prices
following 2002 do not substantially exceed prices received in December 1998, the
Trust anticipates that it will not receive net profits payments attributable to
the Robinson's Bend Field after 2002.
The Net Profits Interests also entitle the Trust to 20% of the Net Proceeds
(defined below) of wells drilled on the Underlying Properties since the Trust's
establishment into formations in which the Trust has an interest, other than
wells drilled to replace damaged or destroyed wells ("Infill Wells"). Infill
Well Net Proceeds represent the aggregate gross revenues received from Infill
Wells less the aggregate amount of the following Infill Well costs: i)
property, production, severance and similar taxes; ii) development costs; iii)
operating costs; and iv) interest on the recovered portion, if any, of the
foregoing costs computed at a rate of interest announced publicly by Citibank,
N.A. in New York as its base rate.
2. Basis of Accounting
The financial statements of the Trust are prepared on a modified cash basis and
are not intended to present the financial position and results of operations in
conformity with generally accepted accounting principles ("GAAP"). Preparation
of the Trust's financial statements on such basis includes the following:
- - Revenues are recognized in the period in which amounts are received by the
Trust. Therefore, revenues recognized during the three-month periods ended
March 31, 1999 and 1998 are derived from oil and gas production sold during
the three-month periods ended December 31, 1998 and 1997, respectively.
General and administrative expenses are recognized on an accrual basis.
- - Amortization of the Net Profits Interests is calculated on a unit-of-
production basis and charged directly to trust corpus.
- - Distributions to Unitholders are recorded when declared by the Trustee.
- - An impairment loss is recognized when the net carrying value of the Net
Profits Interests exceeds the sum of the estimated undiscounted future cash
flows attributable to the Trust's oil and gas reserves plus the estimated
future tax credits under Section 29 of the Internal Revenue Code of 1986
("Section 29
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TORCH ENERGY ROYALTY TRUST
Credit") for Federal income tax purposes. The impairment loss is equal to
the difference between the carrying value of the Net Profits Interest and
the fair value of the Net Profits Interest.
In computing the estimated undiscounted future cash flows attributable to
the Net Profits Interest, estimated future oil and gas prices, as
determined by Torch management, are applied to estimated future production
of oil and gas reserves over the economic lives of the reserves. If the
aforementioned undiscounted future cash flows and Section 29 Credits are
less than the carrying value of the Net Profits Interest, an impairment
provision is recognized. The fair value of the Net Profits Interest is
computed by discounting the aforementioned cash flows and Section 29
Credits by 10%. Additionally, it is assumed for these computations that
TEMI continues its Minimum Price commitment (see Note 5), pursuant to the
Purchase Contract, until the Trust dissolves. Based on the aforementioned
impairment procedures, no impairment loss was recognized during the first
quarter of 1999 and 1998. An impairment loss of $29.1 million was
recognized during the fourth quarter of 1998.
The financial statements of the Trust differ from financial statements prepared
in accordance with GAAP because net profits income is not accrued in the period
of production and amortization of the Net Profits Interests is not charged
against operating results.
3. Federal Income Taxes
Tax counsel has advised the Trustee that, under current tax law, the Trust is
classified as a grantor trust for Federal income tax purposes. However, the
opinion of tax counsel is not binding on the Internal Revenue Service. As a
grantor trust, the Trust is not subject to Federal income tax.
Because the Trust is treated as a grantor trust for Federal income tax purposes
and a Unitholder is treated as directly owning an interest in the Net Profits
Interests, each Unitholder is taxed directly on such Unitholder's pro rata share
of income attributable to the Net Profits Interests consistent with the
Unitholder's method of accounting and without regard to the taxable year or
accounting method employed by the Trust. Amounts payable with respect to the
Net Profits Interests are paid to the Trust on the quarterly record date
established for quarterly distributions in respect to each calendar quarter
during the term of the Trust, and the income, deductions and income tax credits
relating to Section 29 Credits resulting from such payments are allocated to the
Unitholders of record on such date.
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TORCH ENERGY ROYALTY TRUST
4. Distributions and Income Computations
Distributions are determined for each quarter and are based on the amount of
cash available for distribution to Unitholders. Such amount (the "Quarterly
Distribution Amount") is equal to the excess, if any, of the cash received by
the Trust, on the last day of the second month following the previous calendar
quarter (or the next business day thereafter) ending prior to the dissolution of
the Trust, from the Net Profits Interests then held by the Trust plus, with
certain exceptions, any other cash receipts of the Trust during such quarter,
subject to adjustments for changes made during such quarter in any cash reserves
established for the payment of contingent or future obligations of the Trust.
Based on the payment procedures relating to the Net Profits Interests, cash
received by the Trust on the last day of the second month of a particular
quarter from the Net Profits Interests generally represents proceeds from the
sale of oil and gas produced from the Underlying Properties during the preceding
calendar quarter. The Quarterly Distribution Amount for each quarter is payable
to Unitholders of record on the last day of the second month of the calendar
quarter unless such day is not a business day in which case the record date is
the next business day thereafter. The Quarterly Distribution Amount is
distributed within approximately ten days after the record date to each person
who was a Unitholder of record on the associated record date.
5. Related Party Transactions
Marketing Arrangements
TRC and Velasco, as owners of the Underlying Properties subject to and burdened
by the Net Profits Interests, contracted to sell the oil and gas production from
such properties to Torch Energy Marketing, Inc. ("TEMI"), a subsidiary of Torch,
under a purchase contract ("Purchase Contract"). Under the Purchase Contract,
TEMI is obligated to purchase all net production attributable to the Underlying
Properties for an index price for oil and gas ("Index Price"), less certain
gathering, treating and transportation charges, which are calculated monthly.
The Index Price equals 97% of the average spot market prices of oil and gas
("Average Market Prices") at the four locations where TEMI sells production,
which, prior to September 1, 2000, is adjusted to reflect the terms of a hedge
contract ("Hedge Contract") to which TEMI is a party. Under the Hedge Contract,
TEMI receives prices specified in the Hedge Contract ("Specified Prices") for
quantities of oil and gas specified therein ("Specified Quantities"). While the
Index Price calculation reflects the terms of the Hedge Contract, the Trust's
net profits income is not impacted by payments or receipts made by or received
by TEMI in connection with its participation in the Hedge Contract. In
calculating the Index Price for gas (which represents approximately 97% of the
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TORCH ENERGY ROYALTY TRUST
estimated reserves as of January 1, 1999, on an Mcfe basis), the Specified
Prices received weightings ranging from 40% to 70% pertaining to production
prior to September 1, 1997 and thereafter, the Specified Prices receive
weightings of approximately 10% and less. The Average Market Prices receive the
balance of the weighting. The Specified Prices for gas increase each year from
$1.84 per MMBtu in 1997 to $1.89 per MMBtu in 2000 and are adjusted to reflect
the difference between the settlement prices for oil and gas in the futures
markets and the Average Market Prices.
The Purchase Contract also provides that the minimum price paid by TEMI for gas
production is $1.70 per MMBtu ("Minimum Price"). When TEMI pays a purchase
price based on the Minimum Price, it receives price credits ("Price Credits")
equal to the difference between the Index Price and the Minimum Price that it is
entitled to deduct in determining the purchase price when the Index Price for
gas exceeds the Minimum Price. During the three months ended March 31, 1999,
the deduction of Price Credits in calculating the purchase price of gas reduced
distributions received by the Unitholders by $97,000. As of March 31, 1999,
TEMI had no accumulated Price Credits remaining. In addition, if the Index
Price for gas exceeds $2.10 per MMBtu, TEMI is entitled to deduct 50% of such
excess ("Price Differential") in calculating the purchase price. The deduction
of the Price Differential in calculating the purchase price of gas resulted in
distributions received by Unitholders during the quarter ended March 31, 1998
being reduced by $605,000. Distributions received by Unitholders during the
three months ended March 31, 1999 were not impacted by the Price Differential.
Beginning January 1, 2002, TEMI has an annual option to discontinue the Minimum
Price commitment. However, if TEMI discontinues the Minimum Price commitment,
it will no longer be entitled to deduct the Price Differential in calculating
the purchase price and will forfeit all accrued Price Credits. TEMI has
purchased put option contracts granting TEMI the right to sell estimated gas
production in excess of the Specified Quantities at a price intended to limit
TEMI's losses in the event the Index Price falls below the Minimum Price.
Gross revenues (before deductions for applicable gathering, treating and
transportation charges) from TEMI included in net profits income for the three
months ended March 31, 1999 and 1998 were $3,589,000 and $5,574,000,
respectively.
Gathering, Treating and Transportation Arrangements
The Purchase Contract entitles TEMI to deduct certain gas gathering, treating
and transportation costs in calculating the purchase price for gas in the
Robinson's Bend, Austin Chalk and Cotton Valley Fields. The amounts that may be
deducted in calculating the purchase price for such gas are set forth in the
Purchase Contract and
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TORCH ENERGY ROYALTY TRUST
are not affected by the actual costs incurred by TEMI to gather, treat and
transport gas. In the Robinson's Bend Field, TEMI is entitled to deduct a
gathering, treating and transportation fee of $0.26 per MMBtu adjusted for
inflation ($0.274 per MMBtu for 1998 and 1997 production), plus fuel usage equal
to 5% of revenues, payable to Bahia Gas Gathering, Ltd. ("Bahia"), an affiliate
of Torch, pursuant to a gas gathering agreement. Additionally, a fee of $0.05
per MMBtu, representing a gathering fee payable to a non-affiliate of TEMI, is
deducted in calculating the purchase price for production from 68 of 394 wells
in the Robinson's Bend Field. TEMI also deducts $0.38 per MMBtu plus 17% of
revenues in calculating the purchase price for production from the Austin Chalk
Fields, as a fee to gather, treat and transport gas production. TEMI deducts
from the purchase price for gas in the Cotton Valley Fields a transportation fee
of $0.045 per MMBtu for production attributable to certain wells. Such
transportation fee is paid to a third party. During the three months ended March
31, 1999 and 1998, gathering, treating and transportation fees deducted by TEMI
in calculating the purchase price for production during the three months ended
December 31, 1998 and 1997 in the Robinson's Bend, Austin Chalk and Cotton
Valley Fields, totaled $344,000 and $464,000, respectively. No amounts for
gathering, treating or transportation are deducted in calculating the purchase
price from the Chalkley Field.
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TORCH ENERGY ROYALTY TRUST
Administrative Services Agreement
Pursuant to the Trust Agreement, Torch and the Trust entered into an
administrative services agreement effective October 1, 1993. The Trust is
obligated, throughout the term of the Trust, to pay to Torch each quarter an
administrative services fee for accounting, bookkeeping, informational and other
services relating to the Net Profits Interests. The administrative services fee
is $87,500 per calendar quarter commencing October 1, 1993. The amount of the
administrative services fee is adjusted annually based upon the change in the
Producer's Price Index as published by the Department of Labor, Bureau of Labor
Statistics. Administrative services during the three months ended March 31,
1999 and 1998 were $94,000 and $92,000, respectively.
Compensation of the Trustee and Transfer Agent
The Trust Agreement provides that the Trustee be compensated for its
administrative services, out of the Trust assets, in an annual amount of
$41,000, plus an hourly charge for services in excess of a combined total of 250
hours annually at its standard rate. The Trustee receives a transfer agency fee
of $5.00 annually per account (minimum of $15,000 annually), subject to change
each December, beginning December 1994, based upon the change in the Producer's
Price Index as published by the Department of Labor, Bureau of Labor Statistics,
plus $1.00 for each certificate issued. Total administrative and transfer agent
fees during the three months ended March 31, 1999 and 1998 were $14,000 per
period. The Trustee is also entitled to reimbursement for out-of-pocket
expenses.
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TORCH ENERGY ROYALTY TRUST
ITEM 2. DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
YEAR 2000 ISSUES
The Year 2000 problem ("Y2k") refers to the inability of computer and other
information technology systems to properly process date and time information.
The problem was caused, in part, by the outdated programming practice of using
two digits rather than four to represent the year in a date. The consequence of
the Y2k problem is that information technology and embedded processing systems
are at risk of malfunction, particularly during the transition between 1999 to
2000.
The effects of the Y2k are exacerbated by the interdependence of computer and
telecommunication systems throughout the world. This interdependence affects
the Trust, the Trust's administrative services provider, Torch, and their
vendors, customers, business partners, as well as government agencies.
The risks of Y2k fall into three general areas: 1) Corporate Systems, 2) Field
Systems and 3) Third Party Exposure. Torch has formed a Y2k Team comprised of
representatives from senior management, exploration, exploitation, accounting,
legal and internal audit. The costs of these assessments will not impact the
Trust's distributions as such costs are borne by Torch pursuant to the
Administrative Services Agreement between Torch and the Trustee. Torch intends
to address each of these areas through a readiness process as described below:
a) Planning and Awareness
b) Inventory and Assessment
c) Identify Potential Problems and their Business Impact
d) Identify/Approve Solutions
e) Test and Implement Solutions
f) Contingency Planning
CORPORATE SYSTEMS
1. Planning and Awareness. All Torch employees have attended Y2k informational
programs including a general discussion of what Y2k is and how it could affect
the business. Employees of all levels of the organization have been asked to
participate in the identification of potential Y2k risks.
2. Inventory and Assessment. The Company has completed an inventory of the
traditional computing platforms including client/server systems, LAN systems
and
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TORCH ENERGY ROYALTY TRUST
PC systems, as well as in inventory of all systems software and operating
systems for each computing system. In addition, third party service
interfaces, banking/treasury interfaces and telecommunications have been
cataloged.
Assessment of component compliance (compliant, non-compliant, expected date
of compliance, etc.) has been completed and included research of product
information on the Internet, contacting peer group companies and accessing
information that peer group companies have already found.
3. Identification. The failure to identify and correct a material Y2k problem
in the Corporate Systems could result in inaccurate or untimely financial
information provided to the Trustee and Unitholders. At this time, Torch
believes that any Y2k disruptions associated with its financial and
administration systems will not have a material effect on the Trust.
4. Identify/Approve Solutions. Based upon the assessments of components'
compliance, solutions are determined. These solutions include: 1) fix or
replace the non-compliant component, 2) buy patches or replacement items, 3)
develop workarounds, 4) identify alternate automated processes, 5) design
manual procedures and 6) develop business continuity plans for specific items
or systems.
5. Test and Implement Solution. Since April 1998 Torch has been working on a
upgrade to its accounting software and is expected to achieve full Y2k
compliance in the first half of 1999. In addition, all network and desktop
applications used by Torch have been inventoried and are generally Y2k
compliant.
6. Contingency Planning. Notwithstanding the foregoing, should there be
significant unanticipated disruptions in Torch's financial and administrative
systems, a number of accounting processes that are currently automated will
need to be performed manually. Torch is currently considering its options
with respect to contingency arrangement for temporary staffing to accommodate
such situations.
FIELD SYSTEMS
1. Planning and Awareness. Employees at all levels of the organization have
been asked to participate in the identification of potential Y2k risk
impacting Torch's field systems, including management of field and facility
assets.
2. Inventory and Assessment. All embedded chip technology used in the field
operations including safety systems, measurement devices, overflow valves,
SCADA systems and other field processes that are date-or-time sensitive were
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TORCH ENERGY ROYALTY TRUST
located. During the assessment stage a list of assets to be tested was
assembled. Consideration was given to 1) issues of health and safety, 2)
environmental concerns, 3) economic factors and 4) other business risks as
appropriate. Vendors and manufacturers have been contacted as well as
product research through the Internet and the use of peer group company
shared information. To date, the majority of embedded components researched
have been deemed either date-insensitive or Y2k compliant. However, the
complexity of embedded systems is such that a small minority of non-compliant
components, even a single non-compliant component, can corrupt an entire
system. The component level evaluation is substantially complete and a
broader evaluation at the system level has commenced. Torch anticipates that
the system level evaluation will be completed by the end of the second
quarter 1999.
3. Identification. The failure to identify and correct a material Y2k problem
could result in outcomes ranging from errors in data reporting to
curtailments or shutdowns in production. Torch is actively engaged in a
program to prioritize the remediation of embedded components and systems
which are either known to be Y2k non-compliant or which have higher risk of
Y2k failures, and to further prioritize remediation targets by the
anticipated financial impact of any such failures on the Trust. To assist in
this effort, Torch has retained consultants who are knowledgeable and
experienced in the assessment of Y2k issues impacting field operations.
Torch intends to give extremely high priority to the remediation of any
situation that impacts employee health and safety or environmental security.
At this time, Torch is unable to express any degree of confidence that there
will not be material production disruptions associated with Y2k compliance.
Depending on the magnitude of any such disruptions and the time required to
correct them, such failures could materially and adversely impact
distributions, depletion deductions and Section 29 credits available for
allocation by the Trust to the Unitholders.
4. Identify/Approve Solutions. Based upon the assessment of field systems,
regarding compliance or non-compliance, solutions are determined. These
potential solutions include 1) fix or replace non-compliant items, 2) buy
patches or replacement items, 3) develop workarounds, 4) identify alternative
automated processes, 5) design manual procedures and 6) develop business
continuity plans for specific items or systems.
5. Test and Implement Solutions. Once identified, assessed and prioritized,
Torch intends to test, upgrade and certify those embedded components and
systems in field process control units deemed to pose the greatest risk of
significant non-compliance. It is important to note that in some
circumstances, the procedures used to test embedded components for Y2k
compliance themselves pose a risk of
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TORCH ENERGY ROYALTY TRUST
damaging the component or corrupting the system. Accordingly, there may be
situations in which a decision not to test may be deemed the most prudent.
6. Contingency Planning. Should material production disruptions occur as a
result of Y2k failures in the field operations, the Trust's financial
condition will be impacted. This contingency is being factored into
deliberations on capital budgeting and liquidity.
THIRD PARTY EXPOSURES
1. Planning and Awareness. Torch has been involved in informational programs
with its employees who have significant interaction with outside vendors,
customers and business partners which may have an impact on the Trust's
financial condition. All levels of employees in the organization have
participated in the identification of potential third party Y2k risk.
2. Inventory and Assessment. Surveys of general Y2k readiness have been sent to
third parties such as vendors, customers and business partners which impact
the Trust's financial condition. An assessment has been made regarding the
impact associated with such third parties' Y2k compliance on the Trust.
3. Identification. Certain third parties' failure to identify Y2k problems can
have significant adverse effects on the Trust. For example, an Underlying
Property third party operator's failure to identify Y2k problems may result
in adverse outcomes such as data reporting error, curtailments and production
shutdowns. Additionally, Y2k problems in connection with the possible
interruption of TEMI's third party gathering, treating, processing or
transportation arrangements relating to the Underlying Properties can affect
TEMI's obligation under the Purchase Contract. Other significant concerns
include the integrity of global telecommunication systems, the readiness of
commercial banks to execute electronic fund transfers and the financial
community ability to maintain an orderly market of the Trust's Units. All
such events could materially or eliminate entirely distributions, depletion
deductions and Section 29 Credits available for allocation by the Trust to
the Unitholders.
4. Identify/Approve Solutions. By prioritizing the various third party risks
mentioned above, a list of critical third party vendors, customers and
business partners has been determined. By cross-referencing the results of
the aforementioned Y2k readiness survey with this list of critical third
parties, solutions can be determined. Field visits, office visits and
additional meetings to access the third party's Y2k compliance may be
necessary.
17
<PAGE>
TORCH ENERGY ROYALTY TRUST
5. Test and Implement Solutions. Where Torch perceives significant risk of Y2k
non-compliance of a third party that may have a material impact on the
financial condition of the Trust, joint testing may be undertaken during
1999. Joint testing would occur following upgrades and other remediation to
hardware, software and communications links, as applicable, with the intent
of determining that the remediation system being tested will perform as
expected after December 31, 1999.
6. Contingency Planning. Should material production disruptions occur as a
result of Y2k failures of third parties, the distributions, depletion
deductions and Section 29 Credits available for allocation by the Trust to
the Unitholders will be impacted. This contingency is being considered for
capital budgeting and liquidity purposes. It is Torch's and the Trustee's
intention to maintain adequate financial flexibility to sustain the Trust
during any such period of cash flow disruption.
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
Because a modified cash basis of accounting is utilized by the Trust, net
profits income of the Trust for the three months ended March 31, 1999 and 1998
is derived from actual oil and gas produced during the three months ended
December 31, 1998 and 1997, respectively. Oil and gas sales attributable to the
working interests burdened by the Underlying Properties for such periods are as
follows:
Three Months Ended March 31,
---------------------------------------
1999 1998
------------------ ------------------
Bbls Mcf Bbls Mcf
of Oil of Gas of Oil of Gas
------ --------- ------ ---------
Chalkley Field 5,692 681,010 7,258 837,776
Robinson's Bend Field --- 693,417 --- 756,886
Cotton Valley Fields 1,150 325,842 1,665 378,529
Austin Chalk Fields 6,937 71,177 11,326 111,166
------ --------- ------ ---------
13,779 1,771,446 20,249 2,084,357
====== ========= ====== =========
For the three months ended March 31, 1999, net profits income was $2,470,000,
down 41% from net profits income of $4,152,000 for the same period in 1998.
Such decrease is due to significant declines in the average price paid for gas
production attributable to the Underlying Properties during 1999 as compared to
1998.
Gas production attributable to the Underlying Properties for the three months
ended December 31, 1998 was 1,771,446 Mcf, or 15% lower than gas production of
2,084,357 Mcf for the same period in 1997. Oil production attributable to the
Underlying
18
<PAGE>
TORCH ENERGY ROYALTY TRUST
Properties for the three months ended December 31, 1998 was 13,779 Bbls as
compared to 20,249 Bbls for the same period in 1997. Such decreases in
production are mainly due to normal production declines.
The average price paid for gas production attributable to the Underlying
Properties during the three months ended March 31, 1999 was $1.87 per MMBtu for
gas and $9.45 per Bbl for oil as compared to $2.39 per MMBtu for gas and $16.04
per Bbl for oil during the same period in 1998. When TEMI pays a purchase price
for gas based on the Minimum Price of $1.70 per MMBtu, TEMI receives Price
Credits which it is entitled to deduct in determining the purchase price when
the Index Price for gas exceeds the Minimum Price. Net Price Credits in the
amount of $97,000 were deducted in calculating the purchase price related to
distributions received by Unitholders during the three months ended March 31,
1999 and as of March 31, 1999, TEMI had no remaining accumulated Price Credits.
No Price Credits were deducted in calculating the purchase price related to
distributions received by Unitholders during the quarter ended March 31, 1998.
Additionally, if the Index Price for gas exceeds $2.10 per MMBtu, TEMI is
entitled to deduct 50% of such excess in calculating the purchase price. The
deduction of the Price Differential in calculating the purchase price had the
effect of reducing distributions received by Unitholders during the three months
ended March 31, 1998 by $605,000. Distributions received by Unitholders during
the quarter ended March 31, 1999 were not impacted by the Price Differential.
General and administrative expenses amounted to $179,000 for the three months
ended March 31, 1999 as compared to $175,000 during the three months ended March
31, 1998. These expenses primarily relate to administrative services provided
by Torch and the Trustee.
The foregoing resulted in distributable income of $2,294,000, or $.27 per Unit,
for the three months ended March 31, 1999, as compared to $3,983,000, or $.46
per Unit, for the same period in 1998. On March 11, 1999, the Trust made a
distribution to Unitholders of record on March 1, 1999. The Section 29 Credits
relating to these distributions, generated from production during the three
months ended December 31, 1998 and 1997, were approximately $0.09 and $0.10 per
Unit for each period, respectively.
19
<PAGE>
TORCH ENERGY ROYALTY TRUST
Net profits income (in thousands) received by the Trust during the three month
periods ended March 31, 1999 and 1998, derived from production sold during the
three months ended December 31, 1998 and 1997, respectively, was computed as
shown in the following table:
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999 THREE MONTHS ENDED MARCH 31, 1998
--------------------------------------------- -------------------------------------------
CHALKLEY, CHALKLEY,
COTTON VALLEY COTTON VALLEY
AND AUSTIN ROBINSON'S AND AUSTIN ROBINSON'S
CHALK FIELDS BEND FIELD Total CHALK FIELDS BEND FIELD TOTAL
------------ ---------- ----- ------------ ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Oil and gas revenues................ $ 2,164 $ 1,081 $ 3,537 $ 1,573
------- ------- ------- -------
Direct operating expenses:
Lease operating expenses and
property tax...................... 493 --- 477 ---
Severance tax...................... 87 31 119 78
------- ------- ------- -------
580 31 596 78
------- ------- ------- -------
Net proceeds before capital
expenditures....................... 1,584 1,050 2,941 1,495
Capital expenditures................ 35 --- 65 ---
------- ------- ------- -------
Net proceeds........................ 1,549 1,050 2,876 1,495
Net profits percentage.............. 95% 95% 95% 95%
------- ------- ------- -------
Net profits income.................. $ 1,472 $ 998 $ 2,470 $ 2,732 $ 1,420 $ 4,152
======= ======= ======= ======= ======= =======
</TABLE>
In calculating amounts paid to the Trust, lease operating expenses in the
Robinson's Bend Field are not deducted until after 2002. When these amounts are
deducted, the amounts paid to the Trust attributable to the Robinson's Bend
Field will be reduced substantially. If gas prices after 2002 are not
substantially greater than gas prices in December 1998, the Trust's current
reserve reports indicate that the Trust will not receive any payments
attributable to the Robinson's Bend Field after 2002.
An impairment loss is recognized when the net carrying value of the Net Profits
Interests exceeds the sum of the estimated undiscounted future cash flows
attributable to the Trust's oil and gas reserves plus the estimated future
Section 29 Credits. The impairment loss is equal to the difference between the
carrying value of the Net Profits Interest and the fair value of the Net Profits
Interest.
In computing the estimated undiscounted future cash flows, estimated future oil
and gas prices, as determined by Torch management, are applied to estimated
future production of oil and gas reserves over the economic lives of the
reserves. If the aforementioned undiscounted future cash flows and Section 29
Credits are less than the carrying value of the Net Profits Interest, an
impairment provision is recognized. The fair value of the Net Profits Interest
is computed by discounting the aforementioned cash flows and Section 29 Credits
by 10%. Additionally, it is assumed for these computations that TEMI continues
its Minimum Price commitment, pursuant to
20
<PAGE>
TORCH ENERGY ROYALTY TRUST
the Purchase Contract, until the Trust dissolves. Based on the aforementioned
impairment procedures, no impairment loss was recognized during the first
quarter of 1999 or 1998. An impairment loss of $29.1 million was recognized
during the fourth quarter of 1998.
Based on Torch management's pricing assumptions and production estimates by
independent reserve engineers at December 31, 1998, the present value of the
estimated pre-tax future net cash flow, discounted at 10%, for the proved
reserves attributable to the Net Profits Interest will be less than $25 million
in 2003. Pursuant to the Trust Agreement, it was assumed for impairment
calculation purposes that the Trust would then dissolve and the remaining assets
of the Trust would be sold and the proceeds therefrom would be distributed to
the Unitholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Trust is exposed to market risk, including adverse changes in commodity
prices. The Trust's assets constitute Net Profits Interests in the Underlying
Properties. As a result, the Trust's operating results can be significantly
affected by fluctuations in commodity prices caused by changing market forces
and the price received for production from the Underlying Properties.
All production from the Underlying Properties is sold pursuant to a Purchase
Contract between TRC and Velasco, as the owners of the Underlying Properties,
and TEMI. Pursuant to the Purchase Contract, TEMI is obligated to purchase all
net production attributable to the Underlying Properties for an Index Price,
less certain other charges. Substantially all of the Index Price is calculated
based on market prices of oil and gas and therefor is subject to commodity price
risk. The Purchase Contract expires upon termination of the Trust and provides a
Minimum Price of $1.70 per MMBtu paid by TEMI for gas until December 31, 2001.
When TEMI pays a purchase price based on the Minimum Price, it receives Price
Credits equal to the difference between the Index Price and the Minimum Price
that it is entitled to deduct when the Index Price exceeds the Minimum Price.
Additionally, if the Index Price exceeds $2.10 per MMBtu, TEMI is entitled to
deduct 50% of such excess, the Price Differential. Beginning January 1, 2002,
TEMI has an annual option to discontinue the Minimum Price commitment. However,
if TEMI discontinues the Minimum Price commitment, it will no longer be entitled
to deduct the Price Differential and will forfeit all accrued Price Credits.
21
<PAGE>
TORCH ENERGY ROYALTY TRUST
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF UNITHOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit 27 - Financial Data Schedule.
22
<PAGE>
TORCH ENERGY ROYALTY TRUST
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.
TORCH ENERGY ROYALTY TRUST
By: Wilmington Trust Company,
Trustee
By: /s/ BRUCE L. BISSON
-------------------------
Bruce L. Bisson
Vice President
Date: May 3, 1999
(The Trust has no employees, directors or executive officers.)
23
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<CASH> 4
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 54,877
<DEPRECIATION> 0
<TOTAL-ASSETS> 54,881
<CURRENT-LIABILITIES> 183
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 54,698
<TOTAL-LIABILITY-AND-EQUITY> 0
<SALES> 0
<TOTAL-REVENUES> 2,473
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 179
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,294
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,294
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
