<PAGE>
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 June 30, 1999
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
Torch Energy Royalty Trust
------------------------------------------------------------
(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
--------------
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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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 1933, as amended and Section 21E of the
Securities Exchange Act of 1934. 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 Year 2000 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 and
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
June 30, 1999 and December 31, 1998, the distributable income and changes in
trust corpus for the three-month and six-month periods ended June 30, 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 June 30, 1999 and for the three-month and six-
month periods ended June 30, 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 June 30, 1999 and the related
statements of distributable income and changes in trust corpus for the three-
month 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 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.
________________________
KPMG LLP
Houston, Texas
July 27, 1999
3
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<TABLE>
<CAPTION>
TORCH ENERGY ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
(In thousands)
ASSETS
June 30, 1999 December 31,1998
------------- ----------------
(Unaudited)
<S> <C> <C>
Cash............................................... $ 3 $ 4
Net profits interests in oil and gas properties
(Net of accumulated amortization of $127,777
and $123,589 at June 30, 1999 and
December 31, 1998, respectively).................. 52,823 57,011
------------- ----------------
$52,826 $57,015
============= ================
LIABILITIES AND TRUST CORPUS
Trust expense payable.............................. $ 177 $ 155
Trust corpus....................................... 52,649 56,860
------------- ----------------
$52,826 $57,015
============= ================
</TABLE>
See notes to financial statements and
accompanying accountants' review report.
4
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TORCH ENERGY ROYALTY TRUST
STATEMENTS OF DISTRIBUTABLE INCOME
(In thousands, except per Unit amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
1999 1998 1999 1998
---------- -------- --------- ---------
<S> <C> <C> <C> <C>
Net profits income...................... $2,213 $3,518 $4,683 $7,670
Interest income......................... 2 6 5 12
-------- -------- ------- -------
2,215 3,524 4,688 7,682
-------- -------- ------- -------
General and
administrative expenses............... 172 198 351 373
-------- -------- ------- -------
Distributable income.................... $2,043 $3,326 $4,337 $7,309
======== ======== ======= =======
Distributable income per Unit
(8,600 Units)......................... $ .24 $ .39 $ . 50 $ .85
======== ======== ======= =======
Distributions per Unit.................. $ .24 $ .39 $ .51 $ .85
======== ======== ======= =======
</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 Six Months Ended
June 30, June 30,
---------------------------------- ------------------------------------
1999 1998 1999 1998
-------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Trust corpus, beginning of period.......... $54,698 $96,858 $56,860 $100,668
Amortization of net profits interests...... (2,054) (3,773) (4,188) (7,576)
Distributable income....................... 2,043 3,326 4,337 7,309
Distributions to Unitholders............... (2,038) (3,354) (4,360) (7,344)
-------------- -------------- --------------- ---------------
Trust corpus, end of period................ $52,649 $93,057 $52,649 $ 93,057
============== ============== =============== ===============
</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 estimated Section 29 Credit rate for
1999 coal seam production is $1.06 for each MMBtu of gas produced and sold. The
Section 29 Credits available for 1998 and 1997 production from qualifying coal
seam properties were approximately $1.05 for each MMBtu of gas produced and
sold. This rate is adjusted annually for inflation. The Section 29 Credit
available for production from qualifying tight sands properties is $0.517 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 35% (322 MMcf) and 26% (237
MMcf), respectively, below the Volume Limitation. Production for the six-month
periods ended March 31, 1999 and 1998 from the Underlying Properties in the
Robinson's Bend Field was approximately 32% (576 MMcf) and 24% (431 MMcf),
respectively, below the Volume Limitation. 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.
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 unrecovered 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.
As of June 30, 1999, six Infill Wells have been drilled. Distributions received
by Unitholders have not been impacted by these wells as gross revenues have not
exceeded costs and expenses for each of the Infill Wells.
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 and six-month
periods ended June 30, 1999 and 1998 are derived from oil and gas
production sold during the three-month and six-month periods ended March
31, 1999 and 1998, respectively. General and administrative expenses are
recognized on an accrual basis.
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TORCH ENERGY ROYALTY TRUST
- - 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.
- - 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 Net Profits Interest plus the estimated
future tax credits under Section 29 of the Internal Revenue Code of 1986
("Section 29 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 management of Torch, 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 six-
month periods ending June 30, 1999 and 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.
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.
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TORCH ENERGY ROYALTY TRUST
3. Federal Income Taxes
Tax counsel has advised the Trust that, under current tax law, the Trust is
classified as a grantor trust for Federal income tax purposes and not an
association taxable as a corporation. 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.
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.
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TORCH ENERGY ROYALTY TRUST
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
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. As of June 30, 1999, TEMI had accumulated Price
Credits of $81,000, net to the Trust, attributable to distributions received by
Unitholders during the quarter ended June 30, 1999. There was no Price Credit
activity attributable to distributions received by Unitholders during the six
months ended June 30, 1998. 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. No Price Differential
adjustments were deducted in calculating the purchase price relating to
distributions received by the Unitholders during the six-month period ended June
30, 1999. The deduction of the
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TORCH ENERGY ROYALTY TRUST
Price Differential in calculating the purchase price had the effect of reducing
distributions received by Unitholders during the six-month period ended June 30,
1998 by $605,000.
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-
month periods ended June 30, 1999 and 1998 were $3,140,000 and $4,674,000,
respectively. Such gross revenues for the six-month periods ended June 30, 1999
and 1998 were $6,729,000 and $10,247,000, 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 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 annually for inflation ($0.281 per MMBtu for 1999 production and $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-month periods
ended June 30, 1999 and 1998, gathering, treating and transportation fees
deducted by TEMI in calculating the purchase price for production during the
three-month periods ended March 31, 1999 and 1998 in the Robinson's Bend, Austin
Chalk and Cotton Valley Fields, totaled $302,000 and $395,000,
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TORCH ENERGY ROYALTY TRUST
respectively. During the six-month periods ended June 30, 1999 and 1998, such
fees, attributable to production during the six-month periods ended March 31,
1999 and 1998, totaled $646,000 and $859,000, respectively. No amounts for
gathering, treating or transportation are deducted in calculating the purchase
price from the Chalkley Field.
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 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-month periods ended June
30, 1999 and 1998 were $94,000 and $92,000, respectively. During the six-month
periods ended June 30, 1999 and 1998, such fees were $188,000 and $184,000,
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 also receives a transfer
agency fee of $5.00 annually per account (minimum of $15,000 annually). Such
fees are subject to change each December 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-month periods ended June 30, 1999 and 1998 were $14,000
per period. Such fees during the six-month periods June 30, 1999 and 1998 were
$28,000 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 issue ("Y2k") refers to the inability of computer and other
information technology systems to properly process date and time information.
The issue 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 issue 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, and representatives from the
exploration, exploitation, accounting, legal and internal audit departments.
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 attended Y2k meetings to discuss
Y2k issues and to identify 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 personal computer systems, as well as an inventory of all systems
software and
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TORCH ENERGY ROYALTY TRUST
operating systems for each computing system. In addition, third party service
interfaces, banking/treasury interfaces and telecommunications have been
cataloged.
The assessment of component compliance (compliant, non-compliant, expected
date of compliance, etc.) has been completed and included research of product
information on the Internet and contacting component manufacturers.
3. Identification. The failure to identify and correct a material Y2k issue 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 were determined. These solutions included: 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. Torch has completed an upgrade to its
accounting software and achieved full Y2k compliance during the quarter ended
June 30, 1999. In addition, Torch's network and desktop applications have
been inventoried and are Y2k compliant.
6. Contingency Planning. 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 developed a business continuity plan which would be utilized in such
situations.
FIELD SYSTEMS
1. Planning and Awareness. Employees at all levels of the organization
participated 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-sensitive were
identified. A list of assets to be tested was assembled considering the
following issues: 1) health and safety issues; 2) environmental concerns; 3)
economic factors; and 4) other
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TORCH ENERGY ROYALTY TRUST
business risks. Vendors and manufacturers were contacted and product research
was performed utilizing the Internet and peer group company shared
information. The majority of embedded components 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
and system level evaluations have been completed.
3. Identification. The failure to identify and correct a material Y2k issue
could result in outcomes ranging from errors in data reporting to
curtailments or shutdowns in production. Embedded components and systems
known to be Y2k non-compliant or which have higher risk of Y2k failures were
identified. To assist in this effort, Torch retained consultants experienced
in the assessment of Y2k issues impacting field operations. Torch has given
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, the following solutions were
determined: 1) fix or replace non-compliant items; 2) buy patches or
replacement items;3) develop workarounds; 4) design manual procedures; and 5)
develop business continuity plans for specific items or systems.
5. Test and Implement Solutions. Torch has tested, upgraded and certified
embedded components and systems in field process control units deemed to pose
a significant non-compliance risk impacting the Trust's financial condition.
All patches and upgrades relating to the Trust properties have been installed
and tested. Additionally, an emergency response plan has been developed by
Torch to handle outages of specific systems.
6. Contingency Planning. Should material production disruptions occur as a
result of Y2k failures in the field operations, the Trust's financial
condition may be impacted. This contingency is being factored 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.
16
<PAGE>
TORCH ENERGY ROYALTY TRUST
THIRD PARTY EXPOSURES
1. Planning and Awareness. Torch conducted informational meetings 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. Potential third party Y2k risks were identified.
2. Inventory and Assessment. Surveys of general Y2k readiness were sent to
third parties such as vendors, customers and business partners which impact
the Trust's financial condition. An assessment was made regarding the impact
of such third parties' Y2k compliance on the Trust.
3. Identification. Certain third parties' failure to identify Y2k issues can
have significant adverse effects on the Trust. For example, an Underlying
Property third party operator's failure to identify Y2k issues 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's ability to maintain an orderly market of the Trust's Units. All
such events could materially or entirely eliminate distributions, depletion
deductions and Section 29 Credits available for allocation by the Trust to
the Unitholders.
4. Identify/Approve Solutions. A list of critical third party vendors, customers
and business partners was compiled. Information regarding certain third
parties' Y2k compliance was assessed by Torch regarding the impact of such
third parties' Y2k compliance on the Trust. If Torch perceived 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 would be undertaken
during 1999 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.
5. Test and Implement Solutions. Third party joint testing has not been
considered necessary based on Torch's assessments of certain third parties'
Y2k compliance information.
17
<PAGE>
TORCH ENERGY ROYALTY TRUST
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 may 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.
Results of Operations
Because a modified cash basis of accounting is utilized by the Trust, net
profits income of the Trust for the three-month periods ended June 30, 1999 and
1998 is derived from actual oil and gas produced during the three-month periods
ended March 31, 1999 and 1998, respectively. Net profits income for the six-
month periods ended June 30, 1999 and 1998 is derived from actual oil and gas
produced during the six-month periods ended March 31, 1999 and 1998. Oil and
gas sales attributable to the working interests burdened by the Underlying
Properties for such periods are as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30,
---------------------------------------
1999 1998
------------------ ------------------
Bbls Mcf Bbls Mcf
of Oil of Gas of Oil of Gas
------ --------- ------ ---------
<S> <C> <C> <C> <C>
Chalkley Field 5,498 711,178 7,299 864,519
Robinson's Bend Field --- 621,694 --- 710,891
Cotton Valley Fields 929 300,054 2,319 385,241
Austin Chalk Fields 7,901 66,479 11,016 103,798
------ --------- ------ ---------
14,328 1,699,405 20,634 2,064,449
====== ========= ====== =========
Six Months Ended June 30,
---------------------------------------
1999 1998
------------------ ------------------
Bbls Mcf Bbls Mcf
of Oil of Gas of Oil of Gas
------ --------- ------ ---------
Chalkley Field 11,190 1,392,188 14,557 1,702,295
Robinson's Bend Field --- 1,315,111 --- 1,467,777
Cotton Valley Fields 2,079 625,896 3,984 763,770
Austin Chalk Fields 14,838 137,656 22,342 214,964
------ --------- ------ ---------
28,107 3,470,851 40,883 4,148,806
====== ========= ====== =========
</TABLE>
18
<PAGE>
TORCH ENERGY ROYALTY TRUST
THREE-MONTH PERIOD ENDED JUNE 30, 1999 COMPARED TO THREE-MONTH PERIOD ENDED
JUNE 30, 1998
For the three-month period ended June 30, 1999, net profits income was
$2,213,000, down 37% from net profits income of $3,518,000 for the same period
in 1998. Such decrease is due to significant declines in the average prices
paid for oil and gas production attributable to the Underlying Properties
combined with normal declines in oil and gas production.
Gas production attributable to the Underlying Properties for the three-month
period ended March 31, 1999 was 1,699,405 Mcf, or 18% lower than gas production
of 2,064,449 Mcf for the same period in 1998. Oil production attributable to
the Underlying Properties for the three-month period ended March 31, 1999 was
14,328 Bbls as compared to 20,634 Bbls for the same period in 1998. Such
decreases in production are mainly due to normal production declines.
The average prices paid for production attributable to the Underlying Properties
during the three-month period ended March 31, 1999 was $1.70 per MMBtu for gas
and $7.66 per Bbl for oil as compared to $2.03 per MMBtu for gas and $12.36 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. As of June 30, 1999, TEMI had
accumulated Price Credits of $81,000, net to the Trust. Such Price Credits are
related to distributions received by Unitholders during the quarter ended June
30, 1999. There was no Price Credit adjustment for determining the purchase
price attributable to distributions received by Unitholders during the quarter
ended June 30, 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. No Price Differential adjustment was deducted in determining the
purchase price for distributions received by Unitholders during the three-month
periods ended June 30, 1999 and 1998.
General and administrative expenses amounted to $172,000 for the three-month
period ended June 30, 1999 as compared to $198,000 during the three-month period
ended June 30, 1998. These expenses primarily relate to administrative services
provided by Torch and the Trustee.
The foregoing resulted in distributable income of $2,043,000, or $0.24 per Unit,
for the three-month period ended June 30, 1999, as compared to $3,326,000, or
$0.39 per Unit, for the same period in 1998. Cash distributions of $2,038,000,
or $0.24 per Unit, were made during the quarter ended June 30, 1999 as compared
to $3,354,000, or
19
<PAGE>
TORCH ENERGY ROYALTY TRUST
$0.39 per Unit, for the same period in 1998. The Section 29 Credits relating to
the distributions received by Unitholders during the quarter ended June 30, 1999
and 1998, generated from production during the three-month periods ended March
31, 1999 and 1998, were approximately $.08 and $0.09 per Unit, respectively.
SIX-MONTH PERIOD ENDED JUNE 30, 1999 COMPARED TO SIX-MONTH PERIOD ENDED
JUNE 30, 1998
For the six-month period ended June 30, 1999, net profits income was $4,683,000,
down 39% from net profits income of $7,670,000 for the same period in 1998.
Such decrease is due to significant declines in the average prices paid for oil
and gas production attributable to the Underlying Properties combined with
normal declines in oil and gas production.
Gas production attributable to the Underlying Properties for the six-month
period ended March 31, 1999 was 3,470,851 Mcf, or 16% lower than gas production
of 4,148,806 Mcf for the same period in 1998. Oil production attributable to
the Underlying Properties for the six-month period ended March 31, 1999 was
28,107 Bbls, as compared to 40,883 Bbls for the same period in 1998. Such
decreases in production are mainly due to normal production declines.
The average price paid for production attributable to the Underlying Properties
during the six-month period ended March 31, 1999 was $1.79 per MMBtu for gas and
$8.54 per Bbl for oil as compared to $2.21 per MMBtu for gas and $14.18 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. As of June 30, 1999, TEMI had accumulated
Price Credits of $81,000, net to the Trust. Such Price Credits are related to
distributions received by Unitholders during the quarter ended June 30, 1999.
Net Price Credits totaling $16,000 were deducted in calculating the purchase
price related to distributions received by Unitholders during the six-month
period ended June 30, 1999. No price credits were deducted in calculating the
purchase price related to distributions received by Unitholders during the six
months ended June 30, 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. No Price Differential adjustment was deducted in calculating
the purchase price relating to distributions received by Unitholders during the
six-month period ended June 30, 1999. The deduction of the Price Differential in
calculating the purchase price had the effect of reducing distributions received
by Unitholders during the six-month period ended June 30, 1998 by $605,000.
20
<PAGE>
TORCH ENERGY ROYALTY TRUST
General and administrative expenses amounted to $351,000 for the six-month
period ended June 30, 1999 as compared to $373,000 during the six-month period
ended June 30, 1998. These expenses primarily relate to administrative services
provided by Torch and the Trustee.
The foregoing resulted in distributable income of $4,337,000, or $0.50 per Unit,
for the six-month period ended June 30, 1999 as compared to $7,309,000, or $0.85
per Unit, for the same period in 1998. During the six-month period ended June
30, 1999, the Trust made distributions to Unitholders of $4,360,000, or $0.51
per Unit, as compared to $7,344,000, or $0.85 per Unit, for the same period in
1998. The Section 29 Credits relating to these distributions, generated from
production during the six-month periods ended March 31, 1999 and 1998, were
approximately $0.17 and $0.19, respectively.
Net profits income (in thousands) received by the Trust during the three-month
and six- month periods ended June 30, 1999 and 1998, derived from production
sold during the three-month and six-month periods ended March 31, 1999 and 1998,
respectively, was computed as shown in the following tables:
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 1999 THREE MONTHS ENDED JUNE 30, 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............... $1,969 $869 $3,041 $1,238
------------ ------------- ------------ -------------
Direct operating expenses:
Lease operating expenses and
property tax..................... 405 --- 385 ---
Severance tax..................... 86 15 111 48
------------ ------------- ------------ -------------
491 15 496 48
------------ ------------- ------------ -------------
Net proceeds before capital
expenditures...................... 1,478 854 2,545 1,190
Capital expenditures............... 2 --- 32 ---
------------ ------------- ------------ -------------
Net proceeds....................... 1,476 854 2,513 1,190
Net profits percentage............. 95% 95% 95% 95%
------------ ------------- ------------ -------------
Net profits income................. $1,402 $811 $2,213 $2,387 $1,131 $3,518
============= ============= ========= ============= ============= ========
</TABLE>
21
<PAGE>
TORCH ENERGY ROYALTY TRUST
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999 SIX MONTHS ENDED JUNE 30, 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................ $4,133 $1,950 $6,578 $2,810
------------ ------------- ------------ -------------
Direct operating expenses:
Lease operating expenses and
property tax...................... 898 --- 862 ---
Severance tax...................... 173 46 230 126
------------ ------------- ------------ -------------
1,071 46 1,092 126
------------ ------------- ------------ -------------
Net proceeds before capital
expenditures....................... 3,062 1,904 5,486 2,684
Capital expenditures................ 37 --- 97 ---
------------ ------------- ------------ -------------
Net proceeds........................ 3,025 1,904 5,389 2,684
Net profits percentage.............. 95% 95% 95% 95%
------------ ------------- ------------ -------------
Net profits income.................. $2,874 $1,809 $4,683 $5,120 $2,550 $7,670
============ =========== ======== ============ ============ =========
</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 Net Profits Interest 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
as defined below.
In computing the estimated undiscounted future cash flows attributable to the
Net Profits Interest, estimated future oil and gas prices, as determined by
management of Torch, are applied to estimated future production of oil and gas
reserves over the
22
<PAGE>
TORCH ENERGY ROYALTY TRUST
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 the Purchase
Contract, until the Trust dissolves. Based on the aforementioned impairment
procedures, no impairment loss was recognized during the six-month periods ended
June 30, 1999 and 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 therefore 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.
23
<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
4. Instruments of defining the rights of security holders,
including indentures.
4.1 Form of Torch Energy Royalty Trust Agreement*
4.2 Form of Louisiana Trust Agreement
4.3 Specimen Trust Unit Certificate*
4.4 Designation of Ancillary Trustee*
27. - Financial Data Schedule.
*Incorporated by reference from Registration Statements on Form S-1 of Torch
Energy Advisors Incorporated (Registration No. 33-68688) dated November 16,
1993.
24
<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: August 6, 1999
(The Trust has no employees, directors or executive officers.)
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 3
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 52,823
<DEPRECIATION> 0
<TOTAL-ASSETS> 52,826
<CURRENT-LIABILITIES> 177
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 52,649
<TOTAL-LIABILITY-AND-EQUITY> 52,826
<SALES> 0
<TOTAL-REVENUES> 2,215
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 172
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,043
<INCOME-TAX> 0
<INCOME-CONTINUING> 2,043
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,043
<EPS-BASIC> 0
<EPS-DILUTED> 0
</TABLE>
