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 March 31, 2018 and the distributable income and changes in
trust corpus for the three-month periods ended March 31, 2018 and 2017 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, 2018, and for the three-month periods ended March 31, 2018 and 2017 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
Simmons Bank,
Trustee:
Results of Review of Financial Statements
We have reviewed the accompanying condensed statement of assets, liabilities and trust corpus of Hugoton Royalty Trust (the Trust) as of
March 31, 2018, and the related condensed statements of distributable income and of changes in trust corpus for the three-month periods ended March 31, 2018 and 2017, including the related notes (collectively referred to as the
interim financial statements). Based on our reviews, we are not aware of any material modifications that should be made to the accompanying interim financial statements for them to be in conformity with the modified cash basis of
accounting described in Note 1.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the statements of assets, liabilities and trust corpus as of December 31, 2017, and the related statements of distributable income and of changes in trust corpus for the year then ended (not presented herein), and in our report dated
March 12, 2018, which included a paragraph describing the modified cash basis of accounting, 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, 2017, is fairly stated, in all material respects, in relation to the statements of assets, liabilities and trust corpus from which it has been derived.
Basis for Review Results
These interim financial
statements are the responsibility of the Trusts management. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to
the Trust in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our review in accordance with the standards of the PCAOB. 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 PCAOB, 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.
Basis of Accounting
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.
/s/ PricewaterhouseCoopers LLP
Dallas, TX
May 10, 2018
5
HUGOTON ROYALTY TRUST
Condensed Statements of Assets, Liabilities and Trust Corpus
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
March 31,
2018
|
|
|
December 31,
2017
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Cash and short-term investments
|
|
$
|
1,922,409
|
|
|
$
|
1,433,640
|
|
Net profits interests in oil and gas properties net (Note 1)
|
|
|
15,816,990
|
|
|
|
16,379,749
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
17,739,399
|
|
|
$
|
17,813,389
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND TRUST CORPUS
|
|
|
|
|
|
|
|
|
Distribution payable to unitholders
|
|
$
|
|
|
|
$
|
433,640
|
|
Expense reserve
(a)
|
|
|
1,922,409
|
|
|
|
1,000,000
|
|
Trust corpus (40,000,000 units of beneficial interest authorized and outstanding)
|
|
|
15,816,990
|
|
|
|
16,379,749
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
17,739,399
|
|
|
$
|
17,813,389
|
|
|
|
|
|
|
|
|
|
|
(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 Trustee increased the expense reserve in light of the activity described in Note 2.
Development Costs and Note 4. Contingencies to Condensed Financial Statements.
|
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
|
|
|
|
2018
|
|
|
2017
|
|
Net profits income
|
|
$
|
1,590,949
|
|
|
$
|
2,223,626
|
|
Interest income
|
|
|
3,298
|
|
|
|
920
|
|
|
|
|
|
|
|
|
|
|
Total income
|
|
|
1,594,247
|
|
|
|
2,224,546
|
|
Administration expense
|
|
|
301,798
|
|
|
|
337,866
|
|
Cash reserves withheld (used) for Trust expenses
|
|
|
922,409
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distributable income
|
|
$
|
370,040
|
|
|
$
|
1,886,680
|
|
|
|
|
|
|
|
|
|
|
Distributable income per unit (40,000,000 units)
|
|
$
|
0.009251
|
|
|
$
|
0.047167
|
|
|
|
|
|
|
|
|
|
|
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
|
|
|
|
2018
|
|
|
2017
|
|
Trust corpus, beginning of period
|
|
$
|
16,379,749
|
|
|
$
|
26,885,503
|
|
Amortization of net profits interests
|
|
|
(562,759
|
)
|
|
|
(4,103,615
|
)
|
Distributable income
|
|
|
370,040
|
|
|
|
1,886,680
|
|
Distributions declared
|
|
|
(370,040
|
)
|
|
|
(1,886,680
|
)
|
|
|
|
|
|
|
|
|
|
Trust corpus, end of period
|
|
$
|
15,816,990
|
|
|
$
|
22,781,888
|
|
|
|
|
|
|
|
|
|
|
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 Simmons Bank, as trustee (the 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.
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.
9
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, 2018.
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 $173,943,434 as of March 31,
2018 and $173,380,675 as of December 31, 2017.
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
|
|
|
|
2018
|
|
|
2017
|
|
Cumulative actual costs under (over) the amount deducted
beginning of
period
|
|
$
|
537,144
|
|
|
$
|
56,243
|
|
Actual costs
|
|
|
(849,546
|
)
|
|
|
(729,553
|
)
|
Budgeted costs deducted
|
|
|
840,000
|
|
|
|
600,000
|
|
|
|
|
|
|
|
|
|
|
Cumulative actual costs under (over) the amount deducted
end of period
|
|
$
|
527,598
|
|
|
$
|
(73,310
|
)
|
|
|
|
|
|
|
|
|
|
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 2018 budgeted development costs for the underlying properties are between $25 million and $30 million. The 2018 budget year generally
coincides with the Trust distribution months from April 2018 through March 2019. 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 times 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.
10
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 generally required to file Kansas and Oklahoma income tax returns reflecting
the income and deductions of the Trust attributable to properties located in each state, along with a schedule that includes information regarding distributions to unitholders. However, the Trust does not expect to file a Kansas income tax return
for the 2018 tax year because it expects to have no revenues, income or deductions in 2018 attributable to properties located in Kansas. The Trust did not file a Kansas income tax return for the 2017 and 2016 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.
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. XTO Energy filed an appeal of the class certification to the 10th Circuit Court of Appeals on April 26, 2012, which was granted on June 26, 2012. The court reversed the
certification of the class and remanded the case back to the trial court for further proceedings. A non-binding mediation occurred September 1, 2016, but was unsuccessful.
XTO Energy has advised the Trustee that in December 2017, it reached a tentative settlement with the plaintiffs for $80 million and an
additional $750 thousand for costs to administer the settlement following final approval. XTO Energy has advised the Trustee that on March 27, 2018, the judge signed orders approving the settlement, including the plaintiffs initial plan
to allocate the net settlement fund among the wells covered by the
Chieftain
class. Prior to plaintiffs filing their initial plan of allocation, XTO Energy advised the Trustee that it believed the portion of the settlement that relates to the
Trust could be as much as $20 million. However, the portion of the settlement allocable to the Trust cannot be finally determined until after the judge approves the final plan of allocation, which the plaintiffs are scheduled to submit by
July 30, 2018. XTO Energy has advised the Trustee that depending on the final plan of allocation, the portion of the settlement XTO Energy believes should be allocated to the Trust may exceed $20 million. The Trustee has asked for additional
information regarding the allocation of the settlement amount and has asked to be advised by XTO Energy as the matter progresses. XTO Energy has confirmed that they do not have additional information at this time, but will provide an update once it
becomes available. Once additional information is made available, the Trustee intends to review any claimed reductions in payment to the Trust based on the facts and circumstances of the settlement. In light of a 2014 arbitration decision in which a
three-arbitrator 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
11
that the claims in
Chieftain
are similar to those in
Fankhouser
the Trustee had informed XTO Energy that it would likely object to such claimed reductions. On May 2, 2018, the
Trustee submitted a demand for arbitration styled
Simmons Bank (successor to Southwest Bank and Bank of America, N.A.) vs. XTO Energy Inc.
(the Arbitration) through the American Arbitration Association seeking a declaratory
judgment that the
Chieftain
settlement is not a production cost and that XTO Energy is prohibited from charging the settlement as a production cost under the conveyance or otherwise reducing the Trusts payments now or in the future as a
result of the
Chieftain
litigation. In the Arbitration, the Trustee also made claims for disputed amounts on the computation of the Trusts net proceeds for 2014 through 2016 in excess of $5 million. Due to the recent date of the
filing of the demand for arbitration, XTO Energy has advised that it is currently reviewing the arbitration documents and will respond in due course.
If $20 million or more of the
Chieftain
settlement is required to be borne by the Trust, it would result in excess costs under the
Oklahoma conveyance that, based on recent distribution levels under such conveyance, would likely result in no distributions under the Oklahoma conveyance for several years.
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.
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 other conveyances.
The following summarizes excess costs activity, cumulative excess costs balance and accrued interest to be recovered by conveyance:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Underlying
|
|
|
|
KS
|
|
|
OK
|
|
|
WY
|
|
|
Total
|
|
Cumulative excess costs remaining at 12/31/17
|
|
$
|
771,556
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
771,556
|
|
Net excess costs (recovery) for the quarter ended 3/31/18
|
|
|
72,191
|
|
|
|
|
|
|
|
32,365
|
|
|
|
104,556
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 3/31/18
|
|
|
843,747
|
|
|
|
|
|
|
|
32,365
|
|
|
|
876,112
|
|
Accrued interest at 3/31/18
|
|
|
122,204
|
|
|
|
|
|
|
|
207
|
|
|
|
122,411
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total remaining to be recovered at 3/31/18
|
|
$
|
965,951
|
|
|
$
|
|
|
|
$
|
32,572
|
|
|
$
|
998,523
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NPI
|
|
|
|
KS
|
|
|
OK
|
|
|
WY
|
|
|
Total
|
|
Cumulative excess costs remaining at 12/31/17
|
|
$
|
617,246
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
617,246
|
|
Net excess costs (recovery) for the quarter ended 3/31/18
|
|
|
57,752
|
|
|
|
|
|
|
|
25,892
|
|
|
|
83,644
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative excess costs remaining at 3/31/18
|
|
|
674,998
|
|
|
|
|
|
|
|
25,892
|
|
|
|
700,890
|
|
Accrued interest at 3/31/18
|
|
|
97,763
|
|
|
|
|
|
|
|
166
|
|
|
|
97,929
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total remaining to be recovered at 3/31/18
|
|
$
|
772,761
|
|
|
$
|
|
|
|
$
|
26,058
|
|
|
$
|
798,819
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12
Lower gas prices in relation to costs resulted in net excess costs on properties underlying the
Kansas and Wyoming net profits interests for the quarter ended March 31, 2018.
Underlying cumulative excess costs for the Kansas and
Wyoming conveyances remaining as of March 31, 2018 totaled $1.0 million, including accrued interest of $0.1 million.
XTO Energy has advised the Trustee that in April 2018, increased
budgeted development costs, primarily related to the projected drilling of four horizontal wells in Major County, Oklahoma during the second half of 2018, caused costs to exceed revenues by $1,557,000 on properties underlying the Oklahoma net
profits interests. Underlying cumulative excess costs remaining on the Kansas, Oklahoma and Wyoming net profits interests as of April 30, 2018 totaled $2.6 million, including accrued interest of $0.1 million.