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 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 September 30, 2017 and the distributable income and changes in trust corpus for the three- and nine-month periods ended September 30, 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 September 30, 2017, and for the three-month and nine-month periods ended September 30, 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 September 30, 2017, and the related condensed statements of distributable income and changes in trust corpus for the three-month and nine-month periods ended September 30, 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 interim 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
November 6, 2017
5
HUGOTON ROYALTY TRUST
Condensed Statements of Assets, Liabilities and
Trust Corpus
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
September 30,
2017
|
|
|
December 31,
2016
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
$
|
1,150,720
|
|
|
$
|
1,257,800
|
|
Net profits interests in oil and gas propertiesnet (Note 1)
|
|
|
18,582,882
|
|
|
|
26,885,503
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
19,733,602
|
|
|
$
|
28,143,303
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND TRUST CORPUS
|
|
|
|
|
|
|
|
|
Distribution payable to unitholders
|
|
$
|
150,720
|
|
|
$
|
257,800
|
|
Expense reserve
(a)
|
|
|
1,000,000
|
|
|
|
1,000,000
|
|
Trust corpus (40,000,000 units of beneficial interest authorized and outstanding)
|
|
|
18,582,882
|
|
|
|
26,885,503
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
19,733,602
|
|
|
$
|
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. As of September 30, 2017, the reserve currently established by the Trustee 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
September 30
|
|
|
Nine Months Ended
September 30
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Net profits income
|
|
$
|
688,252
|
|
|
$
|
1,253,498
|
|
|
$
|
4,236,724
|
|
|
$
|
1,516,605
|
|
Interest income
|
|
|
2,091
|
|
|
|
289
|
|
|
|
4,616
|
|
|
|
544
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total income
|
|
|
690,343
|
|
|
|
1,253,787
|
|
|
|
4,241,340
|
|
|
|
1,517,149
|
|
Administration expense
|
|
|
193,023
|
|
|
|
187,892
|
|
|
|
707,060
|
|
|
|
725,229
|
|
Cash reserves withheld (used) for Trust expenses
|
|
|
|
|
|
|
273,975
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income
|
|
$
|
497,320
|
|
|
$
|
791,920
|
|
|
$
|
3,534,280
|
|
|
$
|
791,920
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income per unit (40,000,000 units)
|
|
$
|
0.012433
|
|
|
$
|
0.019798
|
|
|
$
|
0.088357
|
|
|
$
|
0.019798
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
September 30
|
|
|
Nine Months Ended
September 30
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Trust corpus, beginning of period
|
|
$
|
20,063,091
|
|
|
$
|
28,801,000
|
|
|
$
|
26,885,503
|
|
|
$
|
86,900,231
|
|
Amortization of net profits interests
|
|
|
(1,480,209
|
)
|
|
|
(1,142,565
|
)
|
|
|
(8,302,621
|
)
|
|
|
(1,935,269
|
)
|
Impairment of net profits interest (Note 1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(57,306,527
|
)
|
Distributable income
|
|
|
497,320
|
|
|
|
791,920
|
|
|
|
3,534,280
|
|
|
|
791,920
|
|
Distributions declared
|
|
|
(497,320
|
)
|
|
|
(791,920
|
)
|
|
|
(3,534,280
|
)
|
|
|
(791,920
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Trust corpus, end of period
|
|
$
|
18,582,882
|
|
|
$
|
27,658,435
|
|
|
$
|
18,582,882
|
|
|
$
|
27,658,435
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 (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 the 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 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.
In light of lower long term prices used to develop projections
of future cash flows, continued excess costs on two conveyances and zero distributions to unitholders for the quarter ended June 30, 2016, the Trustee concluded in the second quarter of 2016 that the events or circumstances indicated the
carrying value may not be recoverable and an assessment of the forecasted net cash flows was performed for the NPI. The fair value of the NPI was developed using estimates for future oil and gas production attributable to the Trust, future crude oil
and natural gas commodity prices published by third-party industry experts (adjusted for basis differentials), estimated taxes, development and operating expenses, and a risk-adjusted discount rate. The result of the assessment indicated that the
estimated undiscounted future net cash flows from the NPI were below the carrying value of the NPI. The NPI was written down to its fair value of $28.8 million, resulting in a $57.3 million impairment charged directly to trust corpus,
which did not affect distributable income.
There was no impairment of the NPI during the quarter ended September 30, 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
$171,177,542 as of September 30, 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:
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30
|
|
|
Nine Months Ended
September 30
|
|
|
|
2017
|
|
|
2016
|
|
|
2017
|
|
|
2016
|
|
Cumulative actual costs under (over) the amount deductedbeginning of period
|
|
$
|
(83,055
|
)
|
|
$
|
438,751
|
|
|
$
|
56,243
|
|
|
$
|
239,528
|
|
Actual costs
|
|
|
(434,911
|
)
|
|
|
(502,300
|
)
|
|
|
(1,774,209
|
)
|
|
|
(1,228,077
|
)
|
Budgeted costs deducted
|
|
|
760,000
|
|
|
|
150,000
|
|
|
|
1,960,000
|
|
|
|
1,075,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative actual costs under (over) the amount deductedend of period
|
|
$
|
242,034
|
|
|
$
|
86,451
|
|
|
$
|
242,034
|
|
|
$
|
86,451
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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. XTO Energy has advised the Trustee that due to increased
non-operated
development activity on properties underlying
the Oklahoma net profits interests, it increased the monthly development cost deduction from $200,000 to $280,000 beginning with the August 2017 distribution. 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.
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. Impairments
recorded 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 an Oklahoma income tax return 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 income tax 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 impose 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 more detailed discussion of federal and state tax matters.
11
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 10th Circuit Court of Appeals reversed the certification of the class and remanded the case back to the trial court for further proceedings. XTO
Energy has informed the Trustee that it has reached a tentative settlement for the matter and continues to negotiate the final settlement agreement. The Trustee has requested the settlement amount from XTO Energy and has been informed that at this
time, the amount that XTO Energy believes should be charged to the Trust has not been determined. XTO Energy has advised the Trustee that the settlement will be allocated to all of XTO Energys Oklahoma wells, the majority of which are not
properties in which the Trust owns an underlying net profits interest.
The Trustee has informed XTO Energy that it intends to review any
claimed reductions in payment to the Trust based on the facts and circumstances of such settlement. 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 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 profits interests of the case, as applicable, for several monthly distributions, depending on the size of the 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 payments made to 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.
12
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, cumulative excess costs balance and accrued interest to be recovered 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
|
)
|
Net excess costs (recovery) for the quarter ended 6/30/17
|
|
|
10,426
|
|
|
|
44,584
|
|
|
|
55,010
|
|
Net excess costs (recovery) for the quarter ended 9/30/17
|
|
|
(125,539
|
)
|
|
|
(403,898
|
)
|
|
|
(529,437
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 9/30/17
|
|
|
857,819
|
|
|
|
111,968
|
|
|
|
969,787
|
|
Accrued interest at 9/30/17
|
|
|
102,255
|
|
|
|
72,387
|
|
|
|
174,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total remaining to be recovered at 9/30/17
|
|
$
|
960,074
|
|
|
$
|
184,355
|
|
|
$
|
1,144,429
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
)
|
Net excess costs (recovery) for the quarter ended 6/30/17
|
|
|
8,341
|
|
|
|
35,667
|
|
|
|
44,008
|
|
Net excess costs (recovery) for the quarter ended 9/30/17
|
|
|
(100,431
|
)
|
|
|
(323,118
|
)
|
|
|
(423,549
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 9/30/17
|
|
|
686,256
|
|
|
|
89,575
|
|
|
|
775,831
|
|
Accrued interest at 9/30/17
|
|
|
81,803
|
|
|
|
57,909
|
|
|
|
139,712
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total remaining to be recovered at 9/30/17
|
|
$
|
768,059
|
|
|
$
|
147,484
|
|
|
$
|
915,543
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Improved gas prices in relation to costs resulted in the partial recovery of excess costs on properties
underlying the Kansas and Wyoming net profits interests for the quarter ended September 30, 2017.
Underlying cumulative excess costs
for the Kansas and Wyoming conveyances remaining as of September 30, 2017 totaled $1.1 million, including accrued interest of $0.2 million.
XTO Energy advised the Trustee that the August 2016 distribution
included a
one-time
reimbursement to the Trust of approximately $450,000 related to operated overhead corrections for the period of January 2014 through May 2016. This reimbursement affected the net profits
income under the Oklahoma conveyance.
XTO Energy advised the Trustee that the May 2016 distribution included a
one-time
reimbursement to the Trust of approximately $788,000 related to operated overhead corrections for the period of January 2014 through February 2016. The reimbursement affected the net profits income under
the Kansas, Oklahoma and Wyoming conveyances by approximately $186,000, $320,000 and $282,000 respectively.
13
7.
|
Taxes, Transportation and Other Deductions
|
XTO Energy advised the Trustee that net
profits income for August 2016 included a deduction of approximately $500,000 in additional gathering fees for the period of December 2015 through May 2016 related to a renegotiated gas purchase contract that included production from properties
underlying the Oklahoma conveyance. The current contract term is December 1, 2015 until November 30, 2017.
Effective October 19, 2017, Simmons First National Corporation
(SFNC) completed its acquisition of First Texas BHC, Inc., the parent company of Southwest Bank, the Trustee of the Trust. SFNC is the parent of Simmons Bank. SFNC has announced that it intends to operate Southwest Bank as a separate
bank subsidiary for an interim period, after which it intends to merge it into Simmons Bank. The Trustee does not anticipate any material impact to the Trust as a result of the acquisition.