The condensed financial statements included herein are presented, without audit,
pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted pursuant to such rules and regulations,
although the trustee believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the Trusts financial statements and the notes thereto
included in the Trusts latest Annual Report on Form
10-K.
In the opinion of the trustee, all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the assets,
liabilities and trust corpus of the Hugoton Royalty Trust at March 31, 2017 and the distributable income and changes in trust corpus for the three-month periods ended March 31, 2017 and 2016 have been included. Distributable income for
such interim periods is not necessarily indicative of the distributable income for the full year. The condensed financial statements as of March 31, 2017, and for the three-month periods ended March 31, 2017 and 2016 have been subjected to
a review by PricewaterhouseCoopers LLP, the Trusts independent registered public accounting firm, whose report is included herein.
Report of Independent Registered Public Accounting Firm
To the Unitholders of Hugoton Royalty Trust and
Southwest Bank,
Trustee:
We have reviewed the accompanying condensed statement of assets, liabilities and trust corpus of Hugoton Royalty Trust (the Trust)
as of March 31, 2017, and the related condensed statements of distributable income and changes in trust corpus for the three-month periods ended March 31, 2017 and 2016. These interim financial statements are the responsibility of the
Trustee.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim
financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards
of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
As described in Note 1, these financial statements were prepared on the modified cash basis of accounting, which is a comprehensive basis of accounting other
than accounting principles generally accepted in the United States of America.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed interim financial statements for them to be in conformity with the basis of accounting described in Note 1.
We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the statement of assets, liabilities
and trust corpus as of December 31, 2016, 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 10, 2017, we expressed an unqualified
opinion on those financial statements. In our opinion, the information set forth in the accompanying condensed statement of assets, liabilities and trust corpus as of December 31, 2016 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/ PricewaterhouseCoopers LLP
Dallas, TX
May 5, 2017
5
HUGOTON ROYALTY TRUST
Condensed Statements of
Assets, Liabilities and Trust Corpus
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
March 31,
|
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
$
|
1,937,200
|
|
|
$
|
1,257,800
|
|
Net profits interests in oil and gas properties - net (Note 1)
|
|
|
22,781,888
|
|
|
|
26,885,503
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24,719,088
|
|
|
$
|
28,143,303
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND TRUST CORPUS
|
|
|
|
|
|
|
|
|
Distribution payable to unitholders
|
|
$
|
937,200
|
|
|
$
|
257,800
|
|
Expense reserve
(a)
|
|
|
1,000,000
|
|
|
|
1,000,000
|
|
Trust corpus (40,000,000 units of beneficial interest authorized and outstanding)
|
|
|
22,781,888
|
|
|
|
26,885,503
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
24,719,088
|
|
|
$
|
28,143,303
|
|
|
|
|
|
|
|
|
|
|
(a)
|
The expense reserve allows the trustee to pay its obligations should it be unable to pay them out of the net profits income. The reserve is fully funded at $1,000,000.
|
The accompanying notes to condensed financial statements are an integral part of these statements.
6
HUGOTON ROYALTY TRUST
Condensed Statements of
Distributable Income
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31
|
|
|
|
2017
|
|
|
2016
|
|
Net profits income
|
|
$
|
2,223,626
|
|
|
$
|
63,562
|
|
Interest income
|
|
|
920
|
|
|
|
82
|
|
|
|
|
|
|
|
|
|
|
Total income
|
|
|
2,224,546
|
|
|
|
63,644
|
|
Administration expense
|
|
|
337,866
|
|
|
|
343,847
|
|
Cash reserves withheld (used) for Trust expenses
|
|
|
|
|
|
|
(280,203
|
)
|
|
|
|
|
|
|
|
|
|
Distributable income
|
|
$
|
1,886,680
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income per unit (40,000,000 units)
|
|
$
|
0.047167
|
|
|
$
|
0.000000
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes to condensed financial statements are an integral part of these statements.
7
HUGOTON ROYALTY TRUST
Condensed Statements of
Changes in Trust Corpus
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31
|
|
|
|
2017
|
|
|
2016
|
|
Trust corpus, beginning of period
|
|
$
|
26,885,503
|
|
|
$
|
86,900,231
|
|
Amortization of net profits interests
|
|
|
(4,103,615
|
)
|
|
|
(171,280
|
)
|
Distributable income
|
|
|
1,886,680
|
|
|
|
|
|
Distributions declared
|
|
|
(1,886,680
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust corpus, end of period
|
|
$
|
22,781,888
|
|
|
$
|
86,728,951
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes to condensed financial statements are an integral part of these statements.
8
HUGOTON ROYALTY TRUST
Notes to Condensed
Financial Statements
(Unaudited)
The financial statements of Hugoton Royalty Trust (the
Trust) are prepared on the following basis and are not intended to present financial position and results of operations in conformity with U.S. generally accepted accounting principles (GAAP):
|
|
|
Net profits income recorded for a month is the amount computed and paid by XTO Energy Inc., the owner of the underlying properties, to Southwest Bank, as trustee for the Trust. XTO Energy is a wholly owned subsidiary of
Exxon Mobil Corporation. Net profits income consists of net proceeds received by XTO Energy from the underlying properties in the prior month, multiplied by a net profits percentage of 80%.
|
Costs deducted in the calculation of net proceeds for the 80% net profits interests generally include applicable taxes, transportation,
marketing and legal costs, production expense, development costs, operating charges and other costs.
|
|
|
Net profits income is computed separately for each of three conveyances under which the net profits interests were conveyed to the Trust. If monthly costs exceed revenues for any conveyance, such excess costs must be
recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from the other conveyances.
|
|
|
|
Interest income and distribution payable to unitholders include interest earned on the previous months investment.
|
|
|
|
Trust expenses are recorded based on liabilities paid and cash reserves established by the trustee for liabilities and contingencies.
|
|
|
|
Distributions to unitholders are recorded when declared by the trustee.
|
|
|
|
The Trust may dispose of all or part of the net profits interests if approved by a vote of holders of 80% or more of the outstanding Trust units, or upon Trust termination. Otherwise, the Trust is required to sell up to
1% of the value of the net profits interests in any calendar year, pursuant to notice from XTO Energy of its desire to sell the related underlying properties. Any sale must be for cash with 80% of the proceeds distributed to the unitholders on the
next declared distribution.
|
The Trusts financial statements differ from those prepared in conformity with U.S. GAAP
because revenues are recognized when received rather than accrued in the month of production, expenses are recognized when paid rather than when incurred and certain cash reserves may be established by the trustee for contingencies which would not
be recorded under U.S. GAAP. This comprehensive basis of accounting other than U.S. GAAP corresponds to the accounting permitted for royalty trusts by the U.S. Securities and Exchange Commission, as specified by Staff Accounting Bulletin Topic 12:E,
Financial Statements of Royalty Trusts.
Most accounting pronouncements apply to entities whose financial statements are prepared in
accordance with U.S. GAAP, directing such entities to accrue or defer revenues and expenses in a period other than when such revenues were received or expenses were paid. Because the Trusts financial statements are prepared on the modified
cash basis, as described above, most accounting pronouncements are not applicable to the Trusts financial statements.
9
Impairment of Net Profits Interest
The trustee reviews the Trusts net profits interests (NPI) in oil and gas properties for impairment whenever events or
circumstances indicate that the carrying value of the NPI may not be recoverable. In general, the trustee does not view temporarily low prices as an indication of impairment. The markets for crude oil and natural gas have a history of significant
price volatility and though prices will occasionally drop significantly, industry prices over the long term will continue to be driven by market supply and demand. If events and circumstances indicated that the carrying value may not be recoverable,
the trustee would use the estimated undiscounted future net cash flows from the NPI to evaluate the recoverability of the Trust assets. If the undiscounted future net cash flows from the NPI are less than the NPI carrying value, the Trust would
recognize an impairment loss for the difference between the NPI carrying value and the estimated fair value of the NPI. The determination as to whether the NPI is impaired requires a significant amount of judgment by the trustee and is based on the
best information available to the trustee at the time of the evaluation. There was no impairment of the NPI during the quarter ended March 31, 2017.
Net profits interests in oil and gas properties
The initial carrying value of the net profits interests of $247,066,951 represents XTO Energys historical net book value for the
interests on December 1, 1998, the date of the transfer to the Trust. During the second quarter 2016, the carrying value of the NPI was written down to its fair value of $28,801,000, resulting in an impairment of $57,306,527 charged directly to
Trust corpus. Amortization of the net profits interests is calculated on a
unit-of-production
basis and charged directly to trust corpus. Accumulated amortization was
$166,978,536 as of March 31, 2017 and $162,874,921 as of December 31, 2016.
The following summarizes actual development costs, budgeted
development costs deducted in the calculation of net profits income, and the cumulative actual costs compared to the amount deducted for the underlying properties:
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
|
March 31
|
|
|
|
2017
|
|
|
2016
|
|
Cumulative actual costs under (over) the amount deducted - beginning of period
|
|
$
|
56,243
|
|
|
$
|
239,528
|
|
Actual costs
|
|
|
(729,553
|
)
|
|
|
(509,689
|
)
|
Budgeted costs deducted
|
|
|
600,000
|
|
|
|
675,000
|
|
|
|
|
|
|
|
|
|
|
Cumulative actual costs under (over) the amount deducted - end of period
|
|
$
|
(73,310
|
)
|
|
$
|
404,839
|
|
|
|
|
|
|
|
|
|
|
The monthly deduction is based on the current level of development expenditures, budgeted future development
costs and the cumulative actual costs under (over) previous deductions. XTO Energy has advised the trustee that 2017 budgeted development costs for the underlying properties are between $2 million and $4 million. The 2017 budget year
generally coincides with the Trust distribution months from April 2017 through March 2018. Changes in oil or natural gas prices could impact future development plans on the underlying properties. XTO Energy has advised the trustee that this monthly
deduction will continue to be evaluated and revised as necessary.
10
For federal income tax purposes, the Trust constitutes a fixed investment
trust that is taxed as a grantor trust. A grantor trust is not subject to tax at the trust level. Accordingly, no provision for income taxes has been made in the financial statements. The unitholders are considered to own the Trusts income and
principal as though no trust were in existence. The income of the Trust is deemed to have been received or accrued by each unitholder at the time such income is received or accrued by the Trust and not when distributed by the Trust. Impairment for
book purposes will not result in a loss for tax purposes for the unitholders until the loss is recognized.
All revenues from the Trust are
from sources within Kansas, Oklahoma or Wyoming. Because it distributes all of its net income to unitholders, the Trust has not been taxed at the trust level in Kansas or Oklahoma. While the Trust has not owed tax, the trustee is required to file a
return with Oklahoma reflecting the income and deductions of the Trust attributable to properties located in the state, along with a schedule that includes information regarding distributions to unitholders. The Trust does not expect to file a
Kansas return for the 2017 tax year because it expects to have no revenues, income or deductions in 2017 attributable to properties located in Kansas. The Trust did not file a return with Kansas for the 2016 and 2015 tax years for the same reason.
Wyoming does not have a state income tax.
Each unitholder should consult his or her own tax advisor regarding income tax requirements, if any, applicable to such persons ownership
of Trust units.
Unitholders should consult the Trusts latest annual report on Form
10-K
for
a complete discussion of federal and state tax matters.
In December 2010, a royalty class action lawsuit was filed against XTO
Energy styled
Chieftain Royalty Company v. XTO Energy Inc.
in Coal County District Court, Oklahoma. XTO Energy removed the case to federal court in the Eastern District of Oklahoma. The plaintiffs allege that XTO Energy wrongfully deducted
fees from royalty payments on Oklahoma wells, failed to make diligent efforts to secure the best terms available for the sale of gas and its constituents, and demand an accounting to determine whether they have been fully and fairly paid gas royalty
interests. The case was certified as a class action in April 2012; however, on appeal in June 2012, the 10
th
Circuit Court of Appeals reversed the certification of the class and remanded the case
back to the trial court for further proceedings. Pretrial discovery continues.
XTO Energy has informed the trustee that it believes that
XTO Energy has strong defenses to the
Chieftain
lawsuit and intends to vigorously defend its position. However, XTO Energy has informed the trustee that it is cognizant of other, similar litigation. As these cases develop, XTO Energy will
assess its legal position accordingly. If XTO Energy ultimately makes any settlement payments or receives a judgment against it in
Chieftain
, XTO Energy has advised the trustee that the Trust should bear its 80% share of such settlement or
judgment, including any future royalty adjustments that would reduce net proceeds. The trustee intends to review any claimed reductions in payment to the Trust based on the facts and circumstances of such settlement or judgment. In light of a 2014
arbitration decision in which a three panel tribunal decided that the settlement in
Fankhouser v. XTO Energy, Inc.
, including a new royalty calculation for future royalty payments, could not be charged to the Trust, to the extent that the
claims in
Chieftain
are similar to those in
Fankhouser
the trustee would likely object to such claimed reductions. Should there be a disagreement as to whether the Trust should bear its share of a settlement or judgment the matter will
be resolved by binding
11
arbitration through the American Arbitration Association under the terms of the Indenture creating the Trust. XTO Energy has informed the trustee that, although the amount of any reduction in net
proceeds is not presently determinable, in its managements opinion, the amount is not currently expected to be material to the Trusts financial position or liquidity though it could be material to the Trusts annual distributable
income. Additionally, XTO Energy has advised the trustee that any reductions would result in costs exceeding revenues on the properties underlying the net profit interests of the case, as applicable, for several monthly distributions, depending on
the size of the judgment or settlement, if any, and the net proceeds being paid at that time, which would result in the net profits interest being limited until such time that the revenues exceed the costs for those net profit interests.
Certain of the underlying properties are involved in various other lawsuits and governmental proceedings arising in the ordinary course of
business. XTO Energy has advised the trustee that it does not believe that the ultimate resolution of these claims will have a material effect on the financial position or liquidity of the Trust, but may have an effect on annual distributable
income.
Other
Several states have enacted legislation requiring state income tax withholding from nonresident recipients of oil and gas proceeds. After
consultation with its tax counsel, the trustee believes that it is not required to withhold on payments made to the unitholders. However, regulations are subject to change by the various states, which could change this conclusion. Should amounts be
withheld on payments made to the Trust or the unitholders, distributions to the unitholders would be reduced by the required amount, subject to the filing of a claim for refund by the Trust or unitholders for such amount.
If monthly costs exceed revenues for any of the three conveyances (one for
each of the states of Kansas, Oklahoma and Wyoming), such excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from other conveyances.
The following summarizes excess costs activity and cumulative balances by conveyance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underlying
|
|
|
|
KS
|
|
|
WY
|
|
|
Total
|
|
Cumulative excess costs remaining at 12/31/16
|
|
$
|
1,049,601
|
|
|
$
|
1,158,205
|
|
|
$
|
2,207,806
|
|
Net excess costs (recovery) for the quarter ended 3/31/17
|
|
|
(76,669
|
)
|
|
|
(686,923
|
)
|
|
|
(763,592
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 3/31/17
|
|
$
|
972,932
|
|
|
$
|
471,282
|
|
|
$
|
1,444,214
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NPI
|
|
|
|
KS
|
|
|
WY
|
|
|
Total
|
|
Cumulative excess costs remaining at 12/31/16
|
|
$
|
839,681
|
|
|
$
|
926,564
|
|
|
$
|
1,766,245
|
|
Net excess costs (recovery) for the quarter ended 3/31/17
|
|
|
(61,335
|
)
|
|
|
(549,538
|
)
|
|
|
(610,873
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 3/31/17
|
|
$
|
778,346
|
|
|
$
|
377,026
|
|
|
$
|
1,155,372
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Improved gas prices resulted in the partial recovery of excess costs on properties underlying the Kansas and
Wyoming net profits interests for the quarter ended March 31, 2017.
Underlying cumulative excess costs for the Kansas and Wyoming
conveyances remaining as of March 31, 2017 totaled $1,444,214 (NPI $1,155,372).
12