AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 4, 1998.
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
ON
FORM S-1 FORM S-3
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HUGOTON ROYALTY TRUST CROSS TIMBERS OIL COMPANY
(EXACT NAME OF CO-REGISTRANT AS
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(EXACT NAME OF CO-REGISTRANT AS SPECIFIED IN ITS CHARTER)
SPECIFIED IN ITS CHARTER)
DELAWARE
TEXAS (STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
58-6379215 75-2347769
(I.R.S. EMPLOYER IDENTIFICATION NO.)
(I.R.S. EMPLOYER IDENTIFICATION NO.)
901 MAIN ST., 17TH FLOOR 810 HOUSTON STREET, SUITE 2000
DALLAS, TEXAS 75202 FORT WORTH, TEXAS 76102
(214) 508-2440 (817) 870-2800
(ADDRESS, INCLUDING ZIP CODE, AND (ADDRESS, INCLUDING ZIP CODE, AND
TELEPHONE TELEPHONE
NUMBER, INCLUDING AREA CODE, OF NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE REGISTRANT'S PRINCIPAL EXECUTIVE
OFFICES) OFFICES)
FRANK G. MCDONALD, ESQ. BOB R. SIMPSON
901 MAIN ST., 17TH FLOOR 810 HOUSTON STREET, SUITE 2000
DALLAS, TEXAS 75202 FORT WORTH, TEXAS 76102
(214) 508-2400 (817) 870-2800
(NAME, ADDRESS, INCLUDING ZIP CODE, (NAME, ADDRESS, INCLUDING ZIP CODE, AND
AND TELEPHONE NUMBER, INCLUDING AREA CODE,
TELEPHONE NUMBER, INCLUDING AREA CODE, OF
OF AGENT FOR SERVICE)
AGENT FOR SERVICE)
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COPIES TO:
F. RICHARD BERNASEK, ESQ. JAMES M. PRINCE, ESQ.
KELLY, HART & HALLMAN, P.C. ANDREWS & KURTH L.L.P.
201 MAIN STREET, SUITE 2500 600 TRAVIS, SUITE 4200
FORT WORTH, TEXAS 76102 HOUSTON, TEXAS 77002
(817) 332-2500 (713) 220-4300
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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [_]
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_]
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF SECURITIES TO BE REGISTERED AGGREGATE OFFERING PRICE(1) REGISTRATION FEE ------------------------------------------------------------------------- Units of Beneficial Interest.............. $89,700,000 $24,936.60 ------------------------------------------------------------------------- ------------------------------------------------------------------------- |
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o).
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY + +NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN + +OFFER TO SELL THESE SECURITIES AND WE ARE NOT SOLICITING OFFERS TO BUY THESE + +SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED. + |
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Subject to Completion. Dated December 4, 1998.
HUGOTON ROYALTY TRUST
6,000,000 Trust Units
This is an initial public offering of units of beneficial interest in the Hugoton Royalty Trust. Cross Timbers Oil Company is offering all of the Trust Units to be sold in this offering and the Company will receive all proceeds from the offering. The Trust will not receive any proceeds from the offering.
There is currently no public market for the Trust Units. The Company expects that the public offering price will be between $ and $ per Trust Unit. The Company will apply to list the Trust Units on the New York Stock Exchange under the symbol " ".
THE TRUST. The Company organized the Trust in December 1998 by conveying to the Trust net profits interests in oil and natural gas producing properties in exchange for all beneficial units of the Trust. The net profits interests are carved from the Company's interests in long-lived, principally natural gas, properties located in the Hugoton area of Kansas and Oklahoma, the Anadarko Basin of Oklahoma and the Green River Basin of Wyoming.
THE TRUST UNITS. Trust Units are units of beneficial ownership of the Trust and represent undivided interests in the Trust. They do not represent any interest in the Company. The Company currently owns 100% of the Trust Units and after the offering will own approximately 85% of the Trust Units.
THE TRUST UNITHOLDERS. Trust Unitholders will receive monthly distributions of cash that the Trust receives for its net profits interests from the sale of oil and natural gas produced from the underlying properties.
See "Risk Factors" beginning on page 10 to read about certain information you should consider before purchasing Trust Units.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Per
Trust
Unit Total
----- -----
Public offering price............................................... $ $
Underwriting discounts.............................................. $ $
Proceeds, before expenses, to Cross Timbers Oil Company............. $ $
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The underwriters may, under certain circumstances, purchase from the Company up to an additional 900,000 Trust Units at the initial public offering price less the underwriting discount.
The underwriters expect to deliver the Trust Units against payment in New York on , 1999.
GOLDMAN, SACHS & CO.
LEHMAN BROTHERS
BEAR, STEARNS & CO. INC.
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
DONALDSON, LUFKIN & JENRETTE
A.G. EDWARDS & SONS, INC.
Prospectus dated , 1999.
[GRAPHIC HERE]
Hugoton Royalty Trust
Map of Major Producing Areas
PROSPECTUS SUMMARY
This summary highlights some information from this prospectus. It is not
complete and may not contain all of the information that is important to you.
To understand this offering fully, you should read the entire prospectus
carefully, including the risk factors and the financial statements and notes to
those statements. You will find definitions for terms relating to the oil and
gas business in "Glossary of Certain Oil and Gas Terms."
HUGOTON ROYALTY TRUST
Hugoton Royalty Trust (the "Trust") is a grantor trust formed in December 1998 by Cross Timbers Oil Company (the "Company"). The Trust provides tax- advantaged cash distributions from net profits interests carved from substantially all of the Company's existing interests in oil and natural gas properties located in the Hugoton area of Kansas and Oklahoma, the Anadarko Basin of Oklahoma and the Green River Basin of Wyoming. The Company's interests in these properties are referred to as the "Underlying Properties." The Underlying Properties are long-lived, principally natural gas, properties with well-established production histories, substantially all of which are working interests. More than 90% of the properties are operated by the Company, with the balance operated by major oil companies or established independents.
The Trust is a passive entity, and NationsBank, N.A., as trustee (the "Trustee"), only has powers to collect and distribute proceeds received by the Trust and to pay Trust liabilities and expenses. The Trustee does not participate in business decisions of the Company and did not participate in the decision of the Company to sell any Trust Units.
Ownership of the Trust is divided into 40,000,000 units of beneficial interest (the "Trust Units"). The Trust Units do not constitute an interest in or security of the Company or the Trustee. See "The Trust."
The Trust's business address is 901 Main Street, 17th Floor, Dallas, Texas
75202.
THE TRUST ASSETS
The assets of the Trust consist of net profits interests (the "Net Profits Interests") carved from the Underlying Properties. The Net Profits Interests entitle the Trust to receive 80% of the Net Proceeds (as defined below) from the sale of production from the Underlying Properties.
"Net Proceeds" are determined monthly on a state-by-state basis. They are proceeds received by the Company as the owner of the Underlying Properties, after deducting property and production taxes, overhead fees and development and production costs. Because the Company deducts development and production costs from sales proceeds, the Net Profits Interests payable to the Trust are dependent upon both production quantities and sales prices of oil and natural gas and the costs to develop and produce the oil and natural gas. If at any time development and production costs should exceed gross proceeds, neither the Trust nor the holders of beneficial interests in the Trust (the "Trust Unitholders") would be liable for the excess costs. However, the Trust would not receive any Net Proceeds until future Net Proceeds exceed the total of those excess costs, plus interest at the prime rate. The Company does not expect future production costs for the Underlying Properties to change significantly relative to recent historical costs. Moreover, the Company expects the level of development costs to decline significantly as compared to recent historical amounts. See "Risk Factors--Development Costs" and "Computation of Net Proceeds--Net Profits Interests."
The Trust may sell the Net Profits Interests if the Trustee receives the affirmative consent of the holders of 80% of the Trust Units. The Trust must sell the Net Profits Interests if annual gross proceeds from the Underlying Properties are less than $1 million for each of two consecutive years after 1999. The Trustee would then distribute the net proceeds of the sale to Trust Unitholders.
THE UNDERLYING PROPERTIES
The Underlying Properties are located in three of the best known and most prolific gas producing areas in the United States. As of November 30, 1998, proved reserves of the Underlying Properties were estimated at 518 Bcfe, of which approximately 60% were located in Oklahoma, 29% were located in Wyoming and 11% were located in Kansas. These areas are characterized by low natural decline rates, low production costs and extensive production histories, which in some cases date back to the 1920s. Reserve estimates for properties with long production histories are generally more reliable than estimates for properties with recently established production.
The Company has a proven record of adding reserves at a low cost. The Company has experienced upward revisions of estimates of proved reserves on many of the Underlying Properties. These upward revisions resulted from better than projected production performance and development results, reduced production costs, increased oil and gas prices in some years, gathering system improvements and improved technology. There is no assurance that the Underlying Properties will experience upward revisions of proved reserves in the future.
The average reserve-to-production index of the Underlying Properties is approximately 12 years. The reserve-to-production index is calculated by dividing proved reserves by projected annual production. This is an indication of reserve longevity, but not an adequate indication of remaining economic productive life, which is expected to exceed 40 years for the Underlying Properties.
Natural production decline rates for the Underlying Properties, assuming no additional development expenditures, typically would range between 6% and 10% annually. The Company, however, increased production from the Underlying Properties by 12% during the past three years. Development costs during this period averaged $29 million per year, or approximately 50% of average annual cash flow generated from production. Going forward, the Company anticipates development costs of $12 million per year. The Company believes that there are significant additional low risk and relatively low cost development opportunities available to partially offset the natural decline rate on the Underlying Properties. See "Productive Areas and Additional Development Potential."
The Company operates more than 90% of the wells on the Underlying Properties. The wells that are not operated by the Company are generally operated by established independents or major oil companies. Through operations, the Company can control the timing and level of discretionary expenditures for operational improvements, the development of existing proved reserves and the finding and development of new reserves. The Company has a proven record of successfully operating the Underlying Properties and other similar properties. Its historical five-year average finding cost for its development program is $0.48 per Mcfe, which is one of the lowest in the industry.
The Company and its affiliates operate gas gathering systems for approximately 70% of the production from the Underlying Properties. Controlling the gas gathering systems allows the Company to assure that gathering operations will be managed to maintain optimum gas production.
The Company may drill additional wells on the Underlying Properties, but no additional properties will be contributed to the Trust.
Estimated proved reserves of the Underlying Properties are approximately 95% natural gas and 5% oil, based on the discounted present value of estimated future net revenues as of November 30, 1998. Proved developed reserves for the Underlying Properties represent approximately 93% of the discounted present value of estimated future net revenues. See "The Net Profits Interests and the Underlying Properties--Producing Acreage and Well Counts."
The following table sets forth, as of November 30, 1998, estimated proved oil and gas reserves, estimated future net revenues and discounted estimated future net revenues for the Underlying Properties and the Net Profits Interests:
PROVED RESERVES (a)
---------------------------
FUTURE
NET REVENUES FROM
GAS PROVED RESERVES (a)(b)
OIL GAS EQUIVALENTS ---------------------------
(MBBLS) (MMCF) (MMCFE) UNDISCOUNTED DISCOUNTED (c)
------- ------- ----------- ------------ --------------
(IN THOUSANDS, EXCEPT
PER UNIT DATA)
Underlying Properties
(100%):
Oklahoma.............. 4,054 286,680 311,004 $441,992 $231,427
Wyoming............... 217 149,250 150,552 130,416 68,286
Kansas................ 57 56,004 56,346 61,607 32,257
----- ------- ------- -------- --------
Total............... 4,328 491,934 517,902 $634,015 $331,970
===== ======= ======= ======== ========
Underlying Properties
(80%).................. 3,462 393,547 414,322 $507,212 $265,576
Net Profits Interests
(d).................... 2,398 272,492 286,880 $507,212 $265,576
Per Trust Unit.......... -- -- -- $ 12.68 $ 6.64
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PRODUCTIVE AREAS AND ADDITIONAL DEVELOPMENT POTENTIAL
The Company believes that it will have substantial economic incentive to further develop the Underlying Properties due to its large ownership interest in Trust Units and its 20% retained interest in Net Proceeds. The Company intends to develop the Underlying Properties as discussed below under most reasonably anticipated market conditions, but the Company is not obligated to the Trust to develop the Underlying Properties.
Hugoton Area
Natural gas was discovered in 1922 in the Hugoton area, the largest gas
producing area in North America, covering parts of Texas, Oklahoma and Kansas
with an estimated five million productive acres. The Permian-aged Chase
formation is the major productive
formation in the Hugoton area, ranging in depth from 2,700 to 2,900 feet. There are more than 7,200 Chase wells currently producing. More than 64 trillion cubic feet of natural gas has been produced in the Hugoton area.
The Company's current net production from the Underlying Properties in the Hugoton area averages approximately 30,000 Mcf of gas per day and 260 Bbls of oil per day.
In the Hugoton area, the Company's development plan includes additional compression to lower line pressures, pumping unit installations, deeper drilling of existing wells to capture additional pay zones, and development drilling activity. The Company plans to develop the Chase formation primarily through infill drilling of up to 40 wells in Kansas. If new legislation is enacted in Oklahoma allowing for reduced spacing and the Company receives regulatory approval, it will have approximately 200 potential infill well locations in Oklahoma. The Company also plans to develop the other formations, including the Council Grove, Chester, Morrow and St. Louis formations that underlie the 79,500 net acres held by production by the Chase formation wells. The Company has participated in 3-D seismic shoots covering 30,000 acres of the Company's net acreage position beneath the Chase formation.
Anadarko Basin
The Company is one of the largest producers in the Ringwood, Northwest Okeene and Cheyenne Valley fields in Major County, Oklahoma. Current net daily production from the Underlying Properties exceeds 34,000 Mcf of gas and 1,100 Bbls of oil.
Oil and gas were first discovered in the Major County area in 1945. The fields in the Major County area are located in the Anadarko Basin and are characterized by oil and gas production from a variety of structural and stratigraphic traps. Productive zones range from 6,500 to 9,400 feet and include the Oswego, Red Fork, Chester, Manning, Mississippian, Hunton and Arbuckle formations.
The Company plans to develop these properties through artificial lift installations, recompletions to add additional pay zones, restimulations of existing pay zones and infill and development drilling. Development will target the Chester, Mississippian, Red Fork and Hunton formations.
Green River Basin
The Green River Basin is located in southwestern Wyoming. The Company's current net daily production from the Underlying Properties in the Fontenelle field is approximately 26,700 Mcf of gas and 70 Bbls of oil.
Gas was discovered in the Fontenelle area in the early 1970s. The producing reservoirs are the Cretaceous-aged Frontier and Dakota sandstones at depths ranging from 7,500 to 10,000 feet. Potential development activities for the fields in this area include restimulations, recompletions and development drilling of the Frontier Sands. Additionally, there is the potential to recomplete wells to the Baxter Sands.
Development Costs
The Company acquired a significant portion of the Underlying Properties in 1995 and 1996. After these acquisitions, the Company began an aggressive development program, spending $19.8 million in 1996, $38.9 million in 1997 and $28.6 million in 1998 in order to increase production. The Company expects a significant reduction in development costs to a level of approximately $12 million annually. While the Company does not expect this development program to continue to increase production, it expects a significant mitigation of the natural decline in production of the Underlying Properties.
Any increase or decrease in production and development costs will directly affect the Net Proceeds payable to the Trust. See "Risk Factors--Development Costs." For a summary
of development and operating costs over the last three years, see "The Net Profits Interests and the Underlying Properties--Pro Forma Distributable Income and Oil and Gas Sales Volumes."
PRO FORMA TRUST DISTRIBUTIONS AND RELATED DATA
The following table sets forth oil and gas sales volumes and average sales prices for the Underlying Properties and the calculation of distributable income (1) for the years ended December 31, 1996, 1997 and 1998 based on historical net proceeds from the Underlying Properties, (2) for the year ended December 31, 1998 on an adjusted basis using development costs of $12 million, as is budgeted for 1999, and (3) for the year ended December 31, 1999 on a hypothetical basis using the assumptions and methodology described under "Hypothetical Annual Cash Distributions" and using hypothetical prices of $10.00 ($11.00 realized) for oil and $2.00 for gas.
The hypothetical amounts are not a projection or forecast of the actual or estimated results from an investment in the Trust Units. They are intended only to demonstrate the calculation of distributable income based on assumed prices and costs. See "Hypothetical Annual Cash Distributions."
YEAR ENDED DECEMBER 31,
------------------------- ADJUSTED HYPOTHETICAL
1996(a) 1997(a) 1998(a) 1998 (b) 1999 (c)
------- ------- ------- -------- ------------
(IN THOUSANDS, EXCEPT PER UNIT DATA)
Underlying Properties
Sales Volumes:
Gas (Mcf)............ 36,143 37,172 38,535 38,535 40,347
Oil (Bbls)........... 455 471 479 479 483
Average Price:
Gas (per Mcf)........ $ 1.67 $ 2.21 $ 2.00 $ 2.00 $ 2.00
Oil (per Bbl)........ $ 19.95 $ 20.63 $ 14.78 $ 14.78 $ 11.00
Calculation of
Distributable Income
Revenues:
Gas sales............ $60,502 $82,192 $77,124 $77,124 $80,694
Oil sales............ 9,075 9,704 7,083 7,083 5,313
------- ------- ------- ------- -------
Total.............. 69,577 91,896 84,207 84,207 86,007
Costs:
Taxes on production
and property........ 5,919 9,173 9,170 9,170 7,677
Production expenses.. 11,359 12,837 13,031 13,031 10,264
Development costs.... 19,797 38,875 28,600 12,000 12,000
Overhead............. 4,557 5,354 6,198 6,198 6,200
------- ------- ------- ------- -------
Total............. 41,632 66,239 56,999 40,399 36,141
------- ------- ------- ------- -------
Net proceeds........... 27,945 25,657 27,208 43,808 49,866
Net profits
percentage............ 80% 80% 80% 80% 80%
------- ------- ------- ------- -------
Trust royalty income... 22,356 20,526 21,766 35,046 39,893
Trust administrative
expense............... 300 300 300 300 300
------- ------- ------- ------- -------
Trust distributable
income (d)............ $22,056 $20,226 $21,466 $34,746 $39,593
======= ======= ======= ======= =======
Trust distributable
income per Trust
Unit (d).............. $ 0.55 $ 0.51 $ 0.54 $ 0.87 $ 0.99
======= ======= ======= ======= =======
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For additional financial information regarding the Underlying Properties and the Trust, see the Financial Statements of the Underlying Properties and the Trust included in this prospectus.
THE COMPANY
Cross Timbers Oil Company is a leading United States independent energy company engaged in the acquisition, development and exploration of oil and natural gas properties, and in the production, processing, marketing and transportation of oil and natural gas. The Company organized the Trust in December 1998 and conveyed to the Trust Net Profits Interests in the Underlying Properties in exchange for all of the Trust Units. The Company continues to own the Underlying Properties, which are burdened by the Net Profits Interests conveyed to the Trust.
The Company has announced a strategy of forming up to three royalty trusts, including the Trust, over the next several years. The Company will sell approximately 15% of the Trust Units in this offering, and over time, intends to distribute some of the remaining Trust Units, together with units of other royalty trusts formed by the Company, to its stockholders. It also may exchange the remaining Trust Units for oil and gas properties or use them for other corporate purposes. The Company currently anticipates distributing Trust Units to its stockholders beginning no earlier than the fourth quarter of 1999, and potentially as frequently as each quarter. The Company expects to distribute royalty trust units representing a then market value of approximately $2.00 per year for each share of Company common stock. For example, a stockholder with 100 shares of Common Stock would potentially receive annual distributions of royalty trust units with a value of $200.
As the owner of the Underlying Properties as well as a substantial number of the Trust Units, the Company will have a strong incentive to continue to operate the Underlying Properties in an efficient and cost effective manner.
The Company's 1998 Royalty Trust Option Plan provides for the issuance of options to purchase from the Company up to $12 million of Trust Units. The Company has granted options to its executive officers covering all $12 million of Trust Units in the plan. The options will be exercisable for three years at a price per Trust Unit equal to the public offering price in this offering. The executive officers will not receive any Trust distributions on the option Trust Units until their options are exercised.
The Company's principal executive offices are located at 810 Houston Street, Suite 2000, Fort Worth, Texas 76102 and its telephone number is (817) 870-2800.
THE OFFERING
Trust Units offered....... 6,000,000 Trust Units are being offered by the
Company, excluding 900,000 Trust Units that the
Underwriters may purchase from the Company upon
exercise of their over-allotment option.
Trust Units outstanding... 40,000,000 Trust Units are outstanding. No
additional Trust Units can be issued.
Use of Proceeds........... The Trust will not receive any of the proceeds from
the sale of Trust Units. The Company will receive
all net proceeds,
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anticipated to be approximately $ ($ if the
underwriters fully exercise their over-allotment
option), and will use the proceeds to repay
indebtedness under its revolving credit facility.
NYSE Symbol...............
Cash distributions........ The first cash distribution on Trust Units will be
made in April 1999 to record holders as of March
31, 1999, and will include Net Proceeds received,
less Trustee's expenses, during the period December
1, 1998 through February 28, 1999. This initial
distribution will also be adjusted to exclude any
development charges on the Underlying Properties
incurred through December 31, 1998, which the
Company will bear. Thereafter, the Trustee will
distribute available cash on or before the tenth
business day of each month to holders of record of
Trust Units on the last business day of the prior
month. The Trust generally receives the Net
Proceeds from the Net Profits Interests two to
three months following the production of the
applicable oil and gas.
Federal income tax
consequences of
distributions.............
Trust Unitholders will be taxed directly on the
income from the Net Profits Interests. Trust
Unitholders may claim tax deductions for depletion
and Trust administrative expenses and may claim a
tax credit under Section 29 of the Internal Revenue
Code (the "Section 29 tax credit") for qualifying
tight sands gas production from the Underlying
Properties that relates to the Trust's Net Profits
Interest. The Company estimates the Section 29 tax
credit will be approximately $.02 per year per
Trust Unit. Trust Unitholders will also be allowed
a deduction for the greater of cost depletion or
percentage depletion. The Company believes that
cost depletion will be more advantageous than
percentage depletion for most Trust Unitholders.
The amount of cost depletion deduction available to
Trust Unitholders depends on the Trust Unitholder's
cost of Trust Units, purchase date and prior
allowable depletion. The Section 29 tax credit and
depletion deduction will shelter a portion of the
Trust distributions from federal income taxation.
Income distributed from the Trust to Trust
Unitholders that are tax-exempt organizations does
not constitute unrelated business taxable income
for those organizations, if Trust Units are not
debt-financed within the meaning of Section 514 of
the Internal Revenue Code. See "Federal Income Tax
Consequences."
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RISK FACTORS
EFFECT OF CHANGING OIL AND GAS PRICES
The Trust's distributions are affected by the prices realized from the sale of oil and natural gas. Oil and gas prices fluctuate widely in response to relatively minor changes in supply, market uncertainty and a variety of additional factors that are beyond the control of the Trust and the Company. These factors include, among others:
. political conditions in the Middle East;
. activities of OPEC;
. the foreign supply of oil and gas;
. the price of foreign imports;
. the level of consumer product demand;
. worldwide economic conditions;
. weather conditions;
. government regulations;
. the price and availability of alternative fuels;
. the proximity to, and capacity of, transportation facilities; and
. worldwide energy conservation measures.
Lower oil and gas prices may reduce the amount of oil and gas that is economic to produce. The volatility of energy prices reduces the accuracy of estimates of future cash distributions to Trust Unitholders and the value of the Trust Units.
MARKET FOR NATURAL GAS
Approximately 95% of the estimated proved reserves of the Underlying Properties at November 30, 1998 are composed of natural gas, based on the discounted present value of estimated future net revenues of proved reserves. The revenues of the Trust and the amount of cash distributions made by the Trust will depend upon, among other things, the volume of natural gas produced and the price at which it is sold.
Due to the seasonal nature of demand for natural gas and its effect on sales prices and production volumes, the cash distributions by the Trust may vary substantially throughout the year. Generally, gas production volumes and prices tend to be higher during the first and fourth quarters of the calendar year. Trust distributions generally are not made until three or four months after the sale of production from the Underlying Properties. As a result, increased distributions from higher gas prices are usually delayed for that period of time. See "Computation of Net Proceeds."
UNCERTAINTY OF RESERVE ESTIMATES
The value of the Trust Units will depend upon, among other things, the proved reserves attributable to the Net Profits Interests. Estimating reserves is inherently uncertain. The oil and natural gas reserves data in this prospectus represent estimates based on reports prepared by the Company's internal petroleum engineers. Petroleum engineering is not an exact science, however, and estimates of economically recoverable oil and natural gas reserves and of future net cash flows depend on a number of variable factors and assumptions, such as:
. historical production from the area compared with production rates from other producing areas;
. the assumed effect of governmental regulation; and
. assumptions about future commodity prices, production costs, severance and excise taxes, capital expenditures and workover and remedial costs.
Estimates of reserves and expected future cash flows prepared by different engineers (or by the same engineers at different times) may differ substantially because of changes in relevant factors or the use of different assumptions. Ultimately, actual production, revenues and expenditures for the Underlying Properties will vary from estimated reserves, and those variations could be material.
The Trust's reserve quantities and revenues are based on estimates of
reserves
and revenues for the Underlying Properties. Because the Trust holds Net Profits Interests and does not own a specific ownership percentage of the oil and gas reserves, the amount of reserves allocated to the Trust for its Net Profits Interests has been reduced to take into account the estimated production and development costs deducted in calculating Net Proceeds.
NO CONTROL OF OPERATIONS AND DEVELOPMENT
Neither the Trustee nor the Trust Unitholders are able to influence or control the operation or future development of the Underlying Properties. Additionally, the Company does not operate or control as much as 10% of the Underlying Properties, and the Company is unable to significantly influence the operations or future development of those properties.
The current operators of the Underlying Properties are under no obligation to continue operating the properties. Neither the Trustee, Trust Unitholders nor the Company has a right to replace an operator. See "The Net Profits Interests and the Underlying Properties--Producing Acreage and Well Counts."
PRODUCTION COSTS
The owner of each working interest in a property that is included in the Underlying Properties must pay its proportionate share of production expenses. Accordingly, higher or lower production expenses on the Underlying Properties will directly decrease or increase the amount received by the Trust for its Net Profits Interests. For a summary of these expenses for the last three years, see "The Net Profits Interests and the Underlying Properties--Pro Forma Distributable Income and Oil and Gas Sales Prices."
DEVELOPMENT COSTS
Each Underlying Property may undergo development activities intended to increase or maintain production levels. If the requisite percentage of working interest holders approves a development project, all working interest holders may be required to pay their proportionate share of development costs. The Company's working interests generally are sufficiently large to allow it to veto or control a development decision, but neither the Trust nor the Trust Unitholders will have that power. The Trust will not be liable for any development costs, but the amount of development costs reduces the Net Proceeds payable to the Trust. Significant increases in development costs could materially reduce distributions from the Trust. The Company expects $12 million of development costs for the Underlying Properties per year.
If development and production costs for a particular state exceed the proceeds of production, the Trust will not receive Net Proceeds for those properties until future proceeds from production in that state exceed the total of the excess costs and expenses plus accrued interest during the deficit period.
Development activities, such as infill drilling, may not generate sufficient additional revenue to repay the costs.
PRODUCTION RISKS
The occurrence of drilling, production or transportation accidents at any of the Underlying Properties will reduce Trust distributions by the amount of uninsured costs. These accidents may result in personal injuries, property damage, damage to productive formations or equipment and environmental damages.
TRANSFER OF UNDERLYING PROPERTIES AND
NET PROFITS INTERESTS; ABANDONMENT
The Company owns the Underlying Properties that are subject to the Trust's Net Profits Interests. The Company may at any time transfer all or part of the Underlying Properties, although it currently has no intention to do so. You will not be entitled to vote on any transfer, and the Trust will not receive any proceeds of the transfer. Following any material transfer, the Underlying Properties will continue to be burdened by the Net Profits Interests, and the
Net Proceeds from the transferred property will be calculated separately and paid by the transferee. The transferee will be responsible for all of the Company's obligations relating to the Net Profits Interest burdening the portion of the Underlying Properties transferred, and the Company would have no continuing obligation to the Trust with respect to those properties. The Trust Indenture does not provide you with any right to compel the Trustee to sue the Company or a transferee for any failure to honor its obligations.
The Trustee may sell the Net Profits Interests if the holders of 80% or more of the Trust Units approve the sale. It must sell the Net Profits Interests if the annual gross proceeds from the Underlying Properties are less than $1 million for each of two consecutive years after 1999. Sale of all the Net Profits Interests will terminate the Trust. The net proceeds of any sale will be distributed to the Trust Unitholders. See "Description of the Trust Indenture--Duration of the Trust; Sale of Net Profits Interests."
The Company and any transferee may abandon any well or property if it believes that the well or property can no longer produce in commercially paying quantities. The portion of the Net Profits Interests relating to the abandoned property would then be extinguished.
PAYMENTS TO THE COMPANY AND ITS AFFILIATES
The Company and some of its affiliates will receive payments for services rendered to the Trust or as the operator of Underlying Properties. Those payments will be deducted from Gross Proceeds in determining Net Proceeds payable to the Trust. This will reduce the amounts available for distribution to the Trust Unitholders. Payments to the Company and its affiliates will include:
. payments to the Company for production and development costs to operate wells;
. payments to Company affiliates for marketing, gathering, processing and transportation services; and
. overhead fees to operate the Underlying Properties, which includes accounting and other administrative functions.
Company affiliates also purchase approximately 64% of the production from the Underlying Properties.
In some cases, the Company sets the amounts of these payments without any negotiation or other involvement by independent third parties. The Company believes, however, that the payments are reasonable for the services rendered.
POTENTIAL CONFLICTS OF INTEREST
Because the Company has interests in oil and gas properties not included in the Trust, the interests of the Company and the Trust Unitholders may not always be in common. For example, in setting budgets for development and production expenditures for the Company properties, including the Underlying Properties, the Company may make decisions that could adversely affect future production from the Underlying Properties. In addition, the Company could continue to operate a property included in the Underlying Properties and earn an overhead fee even though abandonment of the property might be more beneficial to Trust Unitholders. Moreover, the Company could decide to sell or abandon some or all of the Underlying Properties, and that decision may not be in the best interests of the Trust Unitholders. Except for specified matters that require approval of the Trust Unitholders (as described in "Description of the Trust Indenture") the documents governing the Trust do not provide a mechanism for resolving these conflicting interests.
LIMITED VOTING RIGHTS OF TRUST UNITHOLDERS
Your voting rights as a Trust Unitholder are more limited than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of Trust Unitholders or for an annual or other periodic re- election of the Trustee.
AMENDMENT OF THE TRUST INDENTURE
Trust Unitholders may amend the Trust Indenture by a vote of the holders of 80% or more of the outstanding Trust Units. Any amendment will be binding on you, regardless of whether you voted for or against the amendment. Some provisions of the Trust Indenture cannot be amended. See "Description of the Trust Indenture--Creation and Organization of the Trust; Amendments."
LIABILITY OF TRUST UNITHOLDERS
The Trustee must ensure that all contractual liabilities of the Trust are limited to the assets of the Trust, and the Trustee will be liable for its failure to do so. If a contractual liability were not limited to the assets of the Trust and the liability were larger than the net assets of the Trust and the Trustee, Texas law is unclear whether a Trust Unitholder would be responsible for that liability. The Company believes that it is unlikely that you would have any liability from the Trust because of the value and passive nature of the Trust assets and the restrictions in the Trust Indenture on the power of the Trustee to incur liabilities.
OWNERSHIP AND DISPOSITION OF
REMAINING TRUST UNITS
The Company currently owns 100% of the Trust Units and will sell approximately 15% of the Trust Units in this offering. The Company may use the remaining 85% of the Trust Units for a number of corporate purposes, including:
. distributing them to its common stockholders as dividends;
. granting options to executive officers to purchase some of them; and
. exchanging them for interests in oil and gas properties or securities of oil and gas companies.
The Company has previously announced that it plans to form up to three royalty trusts and to distribute to its stockholders units of beneficial interest (including the Trust Units) in those royalty trusts. The Company expects to distribute, as frequently as quarterly, royalty trust units having a market value of approximately $2.00 per year (based on value at the time of declaration of the dividend) for each share of common stock. A stockholder with 100 shares, for example, would receive royalty trust units with a market value of $200.00. The Company plans to start these dividends no sooner than the fourth quarter of 1999.
If the Company distributes Trust Units to its stockholders as dividends or to its executives upon exercise of options, or if it exchanges Trust Units in connection with acquisitions, then additional Trust Units will be available for sale in the market. The Company expects these additional Trust Units to increase market liquidity, but the Company cannot presently determine whether they will increase or decrease the market price for Trust Units. The release of these additional Trust Units may cause the market price to decrease. See "Selling Trust Unitholder."
OWNERSHIP OF DEPLETING ASSETS
The Net Proceeds payable to the Trust are derived from the sale of depleting assets. Accordingly, the portion of the distributions to Trust Unitholders attributable to depletion may be considered a return of capital. The reduction in proved reserve quantities is a common measure of the depletion. Future maintenance and development projects on the Underlying Properties will affect the quantity of proved reserves. The timing and size of these projects will depend on the market prices of oil and natural gas. If operators of the properties do not implement additional maintenance and development projects, the future decline rate of proved reserves may be higher than the rate during the past three years. For federal income tax purposes, depletion is reflected as a deduction, which is anticipated to be $0.90 per Trust Unit in 1999 based on a Trust Unit price of $11.00. See "Federal Income Tax Consequences--Royalty Income and Depletion."
TAX CONSIDERATIONS
The Trust has received an opinion of tax counsel that:
. the Trust is a "grantor trust" for federal income tax purposes;
. you will be taxed directly on your pro rata share of the income of the Trust;
. you will be allowed (1) depletion deductions equal to the greater of percentage depletion or cost depletion (computed on the tax basis of your Trust Units) and (2) your pro rata share of other deductions of the Trust; and
. you will be allowed the tax credit for qualifying gas production from tight sands provided under Section 29 of the Internal Revenue Code, subject to limitations described in this prospectus.
See "Federal Income Tax Consequences." Tax counsel believes that its
opinion is in accordance with the present position of the Internal Revenue
Service (the "IRS") regarding grantor trusts. Neither the Company nor the
Trustee has requested a ruling from the IRS regarding these tax questions.
There can be no assurance that the Company or the Trust would be granted such
a ruling if requested or that the IRS will continue this position in the
future. Trust Unitholders should be aware of possible state tax implications
of owning Trust Units. See "State Tax Considerations."
FORWARD-LOOKING STATEMENTS
Some statements made by the Company and the Trust in this prospectus under
"Hypothetical Annual Cash Distributions," in addition to statements contained
elsewhere in this prospectus, are prospective and constitute forward-looking
statements. These forward-looking statements involve known and unknown risks,
uncertainties and other factors that could cause actual results to differ
materially from future results expressed or implied by the forward-looking
statements. The most significant risks, uncertainties and other factors are
discussed under "Risk Factors" above.
USE OF PROCEEDS
The Trust will not receive any proceeds from the sale of the Trust Units.
The Company will receive all proceeds (net of underwriting discounts and costs
of the offering paid by the Company) from the sale of its Trust Units of
approximately $ ($ if the Underwriters exercise their over-allotment in
full). The Company intends to apply the net proceeds from the offering to
repay outstanding indebtedness under the Company's bank revolving credit
facility, which bears interest at a floating rate based on LIBOR, currently
7%, and matures on June 30, 2003. Indebtedness under the revolving credit
agreement was incurred to finance recent acquisitions of oil and gas producing
properties.
THE TRUST
The Trust was formed in December 1998 by execution of the Trust Indenture between NationsBank, N.A., as trustee, and the Company. In connection with the formation of the Trust, the Company carved the Net Profits Interests from the Underlying Properties and conveyed the Net Profits Interests to the Trust in exchange for all 40,000,000 of the Trust Units.
The Company owns the Underlying Properties, subject to the Net Profits Interests. As owner of the Underlying Properties, the Company receives payments for the sale of the oil and gas production from purchasers or from the other operators of the properties. On a state-by-state basis, the Company combines these payments, deducts costs and expenses where applicable, and pays to the Trust each month 80% of the Net Proceeds.
The Trustee can authorize the Trust to borrow money to pay expenses that
exceed cash held by the Trust. The Trustee may authorize the Trust to borrow
from the Trustee
as a lender. Because the Trustee is a fiduciary, the terms of the loan must be fair to the Trust Unitholders. The Trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the Trust at least equals amounts paid by the Trustee on similar deposits.
The Trustee will be paid a fee of $35,000 per year. The Trustee will
receive a fee of $15,000 for services to terminate the Trust. The Trust will
also incur legal, accounting and engineering fees, printing costs and other
expenses that are deducted from the 80% of Net Proceeds received by the Trust
before distributions are made to Trust Unitholders.
HYPOTHETICAL ANNUAL CASH DISTRIBUTIONS
Estimated proved reserves of the Underlying Properties are composed of approximately 95% natural gas and 5% oil, based on the discounted present value of estimated future net revenues as of November 30, 1998. The amount of Trust revenues and cash distributions to Trust Unitholders will depend on oil and gas prices, the volume of oil and gas sold and production and development costs. The Company prepared the following unaudited tables, which demonstrate the hypothetical effect that changes in the prices for oil and gas could have on Trust distributions. The tables below show:
. the hypothetical annual cash distributions per Trust Unit for calendar year 1999 on the accrual or production basis;
. the resulting hypothetical annual cash distributions per Trust Unit as a percentage of the purchase price of the Trust Unit ("Hypothetical Pre-Tax Yield"); and
. the resulting hypothetical annual yield following payment of all federal income tax at the highest individual tax rate of 39.6% ("Hypothetical After-Tax Yield").
The data in the tables are based on:
. an assumed purchase price of $11.00 per Trust Unit;
. various hypothetical oil and gas sales prices, which were chosen solely for illustrative purposes. See "The Net Profits Interests and the Underlying Properties--Pro Forma Distributable Income and Oil and Gas Sales Prices" for historical weighted average oil and gas prices; and
. the other assumptions described below under "--Assumptions and Methodology."
THE TABLES ARE NOT A PROJECTION OR FORECAST OF THE ACTUAL OR ESTIMATED RESULTS FROM AN INVESTMENT IN THE TRUST UNITS. THE PURPOSE OF THE TABLES IS TO ILLUSTRATE THE SENSITIVITY OF CASH DISTRIBUTIONS AND HYPOTHETICAL PRE-TAX AND HYPOTHETICAL AFTER-TAX YIELDS TO VARIATIONS IN THE PRICE OF OIL AND GAS. THERE IS NO ASSURANCE THAT THE ASSUMPTIONS DESCRIBED BELOW WILL ACTUALLY OCCUR OR THAT THE PRICE OF OIL OR GAS WILL NOT DECLINE OR INCREASE BY AMOUNTS DIFFERENT FROM THOSE SHOWN IN THE TABLES.
Due to the varying demand for natural gas, the amount of monthly cash distributions from the Trust may vary on a seasonal basis. Additionally, month-to-month distributions will vary based on the timing of development expenditures and the net revenues, if any, generated by development projects.
AS A RESULT OF NATURAL PRODUCTION DECLINES, PRODUCTION ESTIMATES GENERALLY DECREASE FROM YEAR TO YEAR. ACCORDINGLY, THE HYPOTHETICAL CASH DISTRIBUTIONS FOR 1999 PRODUCTION DO NOT NECESSARILY INDICATE THE AMOUNT OF DISTRIBUTIONS FOR FUTURE YEARS.
HYPOTHETICAL ANNUAL CASH DISTRIBUTIONS PER TRUST UNIT
ATTRIBUTABLE TO ESTIMATED 1999 PRODUCTION(a)
HYPOTHETICAL WELLHEAD
HYPOTHETICAL POSTED GAS
OIL PRICE PER BBL(b) PRICE PER MCF(c)
-------------------- --------------------------
$1.50 $2.00 $2.50 $3.00
----- ----- ----- -----
$10.00........................................... $0.61 $0.99 $1.37 $1.74
15.00........................................... 0.66 1.04 1.41 1.79
20.00........................................... 0.70 1.08 1.46 1.83
25.00........................................... 0.75 1.13 1.50 1.88
HYPOTHETICAL PRE-TAX YIELD AT A TRUST UNIT PRICE OF $11.00
ATTRIBUTABLE TO ESTIMATED 1999 PRODUCTION(a)
HYPOTHETICAL WELLHEAD
HYPOTHETICAL POSTED GAS
OIL PRICE PER BBL(b) PRICE PER MCF(c)
-------------------- --------------------------
$1.50 $2.00 $2.50 $3.00
----- ----- ----- -----
$10.00........................................... 5.5% 9.0% 12.5% 15.8%
15.00........................................... 6.0 9.5 12.8 16.3
20.00........................................... 6.4 9.8 13.3 16.6
25.00........................................... 6.8 10.3 13.6 17.1
HYPOTHETICAL AFTER-TAX YIELD AT A TRUST UNIT PRICE OF $11.00
ATTRIBUTABLE TO ESTIMATED 1999 PRODUCTION(a)(d)
HYPOTHETICAL WELLHEAD
HYPOTHETICAL POSTED GAS
OIL PRICE PER BBL(b) PRICE PER MCF(c)
-------------------- --------------------------
$1.50 $2.00 $2.50 $3.00
----- ----- ----- -----
$10.00........................................... 6.7% 8.8% 10.9% 13.0%
15.00........................................... 7.1 9.1 11.2 13.3
20.00........................................... 7.3 9.4 11.5 13.5
25.00........................................... 7.5 9.6 11.6 13.7
|
The following table shows the calculation of the hypothetical 1999 cash distribution per Trust Unit, pre-tax and after-tax yields, based on the assumptions described under "Assumptions and Methodology" below and assuming a $10.00 posted West Texas Intermediate crude oil price ($11.00 realized), a $2.00 wellhead gas price and a $11.00 Trust Unit price:
HYPOTHETICAL 1999 CASH DISTRIBUTIONS
VOLUMES AMOUNT
------- -------
(IN THOUSANDS,
EXCEPT PER
TRUST UNIT DATA
AND
PERCENTAGES)
TRUST DISTRIBUTABLE INCOME:
Gas(a)...................................................... 40,347 $80,694
Oil(b)...................................................... 483 5,313
-------
Total revenues.............................................. 86,007
-------
Production and property taxes(c)............................ 7,677
Production expenses......................................... 10,264
Development costs........................................... 12,000
Overhead.................................................... 6,200
-------
Total expenses.............................................. 36,141
-------
Net Proceeds................................................ 49,866
Net profits percentage...................................... 80%
-------
Trust royalty income........................................ 39,893
Trust administrative expense................................ 300
-------
Trust distributable income.................................. $39,593
=======
ANNUAL
YIELD
AMOUNT (d)
------- -------
PER TRUST UNIT (40,000,000 TRUST UNITS):
Total distributions......................................... $ 0.99 9.0%
Cost depletion deduction(e)................................. (0.90)
------
Taxable income.............................................. 0.09
Income tax rate............................................. 39.6%
------
Income tax expense.......................................... 0.04
Section 29 tax credit(f).................................... (0.02)
------
Net tax..................................................... 0.02
------
Total distributions after tax............................... $ 0.97 8.8%
======
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ASSUMPTIONS AND METHODOLOGY
TIMING OF ACTUAL DISTRIBUTIONS
In preparing the tables above, the revenues and expenses of the Trust were calculated based on the terms of the conveyances creating the Net Profits Interests as described under "Computation of Net Proceeds," except that amounts were calculated on an accrual or production basis rather than the cash basis prescribed by the conveyances. As a result, the proceeds for production for the final one or two months of 1999, and reflected in the tables above, will actually enter into the calculation of Net Proceeds to be received by the Trust in 2000. Similarly, Net Proceeds from production during December 1998 will in fact be distributed from the Trust in 1999. Accordingly, the hypothetical cash distributions attributable to 1999 production represent hypothetical cash distributions from the Trust from February or March 1999 through January or February 2000.
PRODUCTION ESTIMATES
Production estimates for 1999 were based on the reserve report for the Underlying Properties prepared by the Company's internal engineers. The reserve report assumed constant prices at November 30, 1998, based on a West Texas Intermediate crude oil price of $8.50 ($9.50 realized) per Bbl and the weighted average wellhead gas price at November 30, 1998 of $2.00 per Mcf. Production from the Underlying Properties for 1999 is estimated to be 483,000 Bbls of oil and 40,347,000 Mcf of gas, based on 1998 year-end reserve estimates by the Company's internal engineers. See "Oil and Gas Prices" below for a description of changes in production due to price variations. Sales for the 12 months ended November 30, 1998 were 479,000 Bbls of oil and 38,535,000 Mcf of gas. For purposes of computing the amount of Section 29 tax credit, tight sands gas production from the Underlying Properties is estimated to be 2,752,000 Mcf during 1999 (1,376,000 Mcf net to the Trust). Differing levels of production will result in different levels of distributions and yields.
OIL AND GAS PRICES
Oil prices shown in the above tables are hypothetical posted oil prices. Posted price is the price paid for oil at a specific point, unadjusted for gravity and other factors. Published benchmark prices are typically based upon West Texas Intermediate crude, a light, sweet oil of a particular gravity. These prices differ from the average or actual price received by the Company, which takes into account gravity, quality, transportation and marketing costs. Differentials between posted oil prices and the prices actually received for the oil production may vary significantly due to market conditions. In the computation of hypothetical distributions in the above tables, $1.00 per barrel is added to the hypothetical posted oil price to reflect these adjustments. This addition is based on the average difference between the posted price of West Texas Intermediate crude and the price received by the Company during 1998. Pro forma average oil prices appearing in this prospectus have been adjusted for these differentials.
Gas prices shown in the above tables are hypothetical wellhead prices for natural gas. Wellhead price is the net price received for natural gas and natural gas liquids after all deductions for transportation, marketing and gathering. The weighted average price of natural gas production from the Underlying Properties from December 1997 through November 1998 was $2.00 per Mcf, which was approximately $0.25 below the average of the monthly closing NYMEX natural gas futures contract prices for the same period. However, if previously occurring location, quality and other differentials continue in the future, there may be more significant differences between the natural gas price received and the NYMEX price.
The foregoing adjustments to posted oil prices and wellhead gas prices applied in the hypothetical distribution and yield analyses are based upon an analysis by the Company of the historic price differentials for production from the Underlying Properties with consideration given to other factors that may affect these differentials in 1999. There is no assurance that these assumed differentials will be similar to the actual price differentials for 1999.
When oil and gas prices decline, the operators of the Underlying Properties may
elect to reduce or completely suspend production. No adjustments have been made to estimated 1999 production to reflect potential reductions or suspensions of production.
PRODUCTION EXPENSES, DEVELOPMENT COSTS AND OVERHEAD
For 1999, the Company estimates production expenses to be $10.3 million, development costs to be $12 million and overhead to be $6.2 million. Overhead is the estimated fee for all Company-operated properties that is deducted by the Company in calculating Net Proceeds. For a description of production expenses and development costs, see "Computation of Net Proceeds."
ADMINISTRATIVE EXPENSE
Trust administrative expense for 1999 is assumed to be $300,000 ($0.0075 per Trust Unit). See "The Trust."
HYPOTHETICAL AFTER-TAX YIELD
Because the Trust Units are a depleting asset, a portion of this yield may be considered a return of capital.
The Hypothetical After-Tax Yield was computed by determining the amount of
federal income tax that would be paid on the hypothetical distributions at the
highest individual marginal tax rate for 1999 (39.6%) after taking into account
cost depletion deduction of $0.90 per Trust Unit and the Section 29 tax credit
of $0.02 per Trust Unit. (Cost depletion is calculated by multiplying the
assumed Trust Unit price of $11.00 by the cost depletion rate of 8.2%, which is
computed by dividing estimated 1999 production by November 30, 1998 proved
reserves. The Section 29 tax credit was based on estimated tight sands gas
production of 1,376,000 Mcf for the Net Profits Interests at $0.52 per MMBtu.)
This income tax amount was then subtracted from the hypothetical cash
distribution per Trust Unit, and the result divided by $11.00 per Trust Unit to
provide the Hypothetical After-Tax Yield. When the hypothetical distributions
are less than $0.94 per Trust Unit, the Hypothetical After-Tax Yield would be
the same or greater than the Hypothetical Pre-Tax Yield because of cost
depletion and the Section 29 tax credit. In all instances, each Trust
Unitholder is assumed to have a regular federal income tax liability sufficient
to utilize the Section 29 tax credit and the depletion deduction. Alternative
minimum tax implications have not been considered. The Section 29 tax credit
cannot be used to reduce a Trust Unitholder's regular tax below his tentative
minimum tax, calculated as provided in the alternative minimum tax computation
rules. See "Federal Income Tax Consequences--Section 29 Tight Sands Gas Tax
Credit." The effect of state income taxes has not been taken into account in
computing the Hypothetical After-Tax Yield. See "State Tax Considerations."
THE NET PROFITS INTERESTS AND THE UNDERLYING PROPERTIES
GENERAL
The Company created the Net Profits Interests through three conveyances to
the Trust of 80% net profits interests carved from the Company's interests in
properties in Kansas, Oklahoma and Wyoming. The Net Profits Interests entitle
the Trust to receive 80% of the Net Proceeds from the sale of oil and gas
attributable to the Underlying Properties. Net Proceeds equal the gross
proceeds received by the Company from the sale of production less property and
production
taxes, overhead fees and production and development costs. Underlying
Properties that are royalty and overriding royalty interests, are not burdened
by production and development costs or overhead fees. For a more detailed
description of Net Proceeds, see "Computation of Net Proceeds."
The Company owns the Underlying Properties, subject to the Net Profits Interests conveyed to the Trust. The Company may, at any time, sell all or any portion of the Underlying Properties, subject to and burdened by the Net Profits Interests. It has no present intention to do so.
PRO FORMA DISTRIBUTABLE INCOME AND OIL AND GAS SALES VOLUMES
The following table sets forth oil and gas sales volumes and average sales prices for the Underlying Properties and the calculation of distributable income (1) for the years ended December 31, 1996, 1997 and 1998 based on historical net proceeds from the Underlying Properties, (2) for the year ended December 31, 1998 on a hypothetical basis using development costs of $12 million, as is budgeted for 1999, and (3) for the year ended December 31, 1999 on a hypothetical basis using the assumptions and methodology described under "Hypothetical Annual Cash Distributions" and using hypothetical prices of $10.00 ($11.00 realized) for oil and $2.00 for gas. The hypothetical amounts are not a projection or forecast of the actual or estimated results from an investment in the Trust Units. They are intended only to demonstrate distributable income based on assumed prices and costs.
YEAR ENDED DECEMBER 31,
------------------------- ADJUSTED HYPOTHETICAL
1996(a) 1997(a) 1998(a) 1998 (b) 1999 (c)
------- ------- ------- -------- ------------
(IN THOUSANDS, EXCEPT PER UNIT DATA)
Underlying Properties
Sales Volumes:
Gas (Mcf)............ 36,143 37,172 38,535 38,535 40,347
Oil (Bbls)........... 455 471 479 479 483
Average Price:
Gas (per Mcf)........ $ 1.67 $ 2.21 $ 2.00 $ 2.00 $ 2.00
Oil (per Bbl)........ $ 19.95 $ 20.63 $ 14.78 $ 14.78 $ 11.00
Calculation of
Distributable Income
Revenues:
Gas sales............ $60,502 $82,192 $77,124 $77,124 $80,694
Oil sales............ 9,075 9,704 7,083 7,083 5,313
------- ------- ------- ------- -------
Total.............. 69,577 91,896 84,207 84,207 86,007
------- ------- ------- ------- -------
Costs:
Taxes on production
and property........ 5,919 9,173 9,170 9,170 7,677
Production expenses.. 11,359 12,837 13,031 13,031 10,264
Development costs.... 19,797 38,875 28,600 12,000 12,000
Overhead............. 4,557 5,354 6,198 6,198 6,200
------- ------- ------- ------- -------
Total.............. 41,632 66,239 56,999 40,399 36,141
------- ------- ------- ------- -------
Net proceeds........... 27,945 25,657 27,208 43,808 49,866
Net profits
percentage............ 80% 80% 80% 80% 80%
------- ------- ------- ------- -------
Trust royalty income... 22,356 20,526 21,766 35,046 39,893
Trust administrative
expense............... 300 300 300 300 300
------- ------- ------- ------- -------
Trust distributable
income (d)............ $22,056 $20,226 $21,466 $34,746 $39,593
======= ======= ======= ======= =======
Trust distributable
income per Trust
Unit (d).............. $ 0.55 $ 0.51 $ 0.54 $ 0.87 $ 0.99
======= ======= ======= ======= =======
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DISCUSSION AND ANALYSIS OF
PRO FORMA DISTRIBUTABLE INCOME
Trust royalty income from the Net Profits Interests was $22,356,000 for 1996, $20,526,000 for 1997 and $21,766,000 for 1998. The changes in royalty income were primarily related to changes in volumes, prices and development costs. Gas sales were 89% of total revenues for the three-year period ended December 31, 1998. Trust royalty income is recorded when received by the Trust, which is the month following receipt by the Company, and generally two months after the related oil and gas production.
VOLUMES
Gas sales volumes from the Underlying Properties increased 3% from 1996 to 1997, and 4% from 1997 to 1998. Oil sales volumes from the Underlying Properties increased 4% from 1996 to 1997, and 2% from 1997 to 1998. The increases were primarily attributable to the timing of development projects.
PRICES
The average gas price increased 32% from $1.67 per Mcf in 1996 to $2.21 in 1997, and decreased 10% from 1997 to $2.00 in 1998. The 1996 prices were at the beginning of an upturn in gas prices that lasted through the summer of 1998. The average oil price increased 3% from $19.95 per Bbl in 1996 to $20.63 in 1997, and decreased 28% from 1997 to $14.78 in 1998. The lower 1998 oil prices were caused by increased global production without a corresponding increase in consumption. The weighted average price of oil for November 1998 (related to Trust distributable income for January 1999) is estimated to be $11.34.
COSTS
Total costs deducted in the calculation of royalty income increased 59% from $41,632,000 in 1996 to $66,239,000 in 1997, followed by a 14% decrease to $56,999,000 in 1998. The primary reason for the fluctuation among the three years was the timing of development projects. Many of the Underlying Properties were purchased by the Company in 1995 and 1996, leading to large development expenditures in 1997 and 1998. Development costs rose 96% from $19,797,000 in 1996 to $38,875,000 in 1997, and decreased 26% to $28,600,000 in 1998 as development projects were completed. Going forward the Company expects development costs of $12,000,000 per year.
Production expense rose 13% from $11,359,000 in 1996 to $12,837,000 in 1997, and increased 2% to $13,031,000 from 1997 to 1998. Most of the increase is related to the timing of major remedial projects such as workovers and subsurface maintenance and to increases in production volumes. On a per Mcfe basis, production costs declined from $.32 in 1997 to $.31 in 1998. Taxes on production and property have generally fluctuated in relation to revenue levels.
Overhead expenses charged to the Underlying Properties by the Company were $4,557,000 for 1996, $5,354,000 for 1997 and $6,198,000 for 1998. Fluctuations resulted from changes in the number of active operated wells and the increase in overhead rates per well.
PRODUCING ACREAGE AND WELL COUNTS
For the following data, "gross" refers to the total wells or acres in which the Company owns a working interest and "net" refers to gross wells or acres multiplied by the percentage working interest owned by the Company. Although many of the Company's wells produce both oil and gas, a well is categorized as an oil well or a gas well based upon the ratio of oil to gas production.
The Underlying Properties are interests in developed properties located primarily in gas producing regions of Kansas, Oklahoma and Wyoming. The following is a summary of approximate producing acreage of the Underlying Properties at November 30, 1998. Undeveloped acreage is not significant.
Gross Net
------- -------
Oklahoma........................................................ 341,987 274,001
Kansas.......................................................... 72,253 60,485
Wyoming......................................................... 40,141 28,258
------- -------
Total........................................................... 454,381 362,744
======= =======
|
The following is a summary of the producing wells on the Underlying Properties as of November 30, 1998:
OPERATED NON-OPERATED
WELLS WELLS TOTAL
------------- ------------- -------------
GROSS NET GROSS NET GROSS NET
----- ------- ------------- ----- -------
Gas................................... 1,007 915.6 254 59.9 1,261 975.5
Oil................................... 146 129.0 7 1.5 153 130.5
----- ------- ----- ------ ----- -------
Total................................. 1,153 1,044.6 261 61.4 1,414 1,106.0
===== ======= ===== ====== ===== =======
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The following is a summary of the number of development wells drilled by the Company on the Underlying Properties during the years indicated:
YEAR ENDED DECEMBER 31
--------------------------------
1996 1997 1998
---------- ---------- ----------
GROSS NET GROSS NET GROSS NET
----- ---- ----- ---- ----- ----
Completed as--
Gas wells (a).................................. 39 30.9 79 68.8 64 43.7
Oil wells...................................... 2 2.0 1 1.0 -- --
Non-productive................................. -- -- 2 1.5 1 1.0
--- ---- --- ---- --- ----
Total (b)...................................... 41 32.9 82 71.3 65 44.7
=== ==== === ==== === ====
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OIL AND GAS SALES PRICES AND PRODUCTION COSTS
The following table shows the average sales prices per Bbl of oil and Mcf of gas produced and the production costs and production and property taxes per Mcfe for the Underlying Properties:
YEAR ENDED DECEMBER 31
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1996 1997 1998
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Sales prices:
Gas (per Mcf)......................................... $ 1.67 $ 2.21 $ 2.00
Oil (per Bbl)......................................... 19.95 20.63 14.78
Production costs per Mcfe.............................. 0.29 0.32 0.31
Taxes on production and property per Mcfe.............. 0.15 0.23 0.22
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MAJOR PRODUCING AREAS
HUGOTON AREA
Natural gas was discovered in 1922 in the Hugoton area, the largest gas producing area in North America, covering parts of Texas, Oklahoma and Kansas with an estimated five million productive acres. The Permian-aged Chase formation is the major productive formation in the Hugoton area, ranging in depth from 2,700 to 2,900 feet. There are more than 7,200 Chase wells currently producing. More than 64 trillion cubic feet of natural gas have been produced from the Hugoton area.
Additional productive formations in the Hugoton area include the Council Grove between 2,950 and 3,400 feet, the Chester between 6,350 and 6,700 feet and the Morrow between 6,000 and 6,300 feet. The Company is actively exploring and developing these additional formations on the properties included in the Underlying Properties.
The Company's current net production from the Underlying Properties averages approximately 30,000 Mcf of gas per day and 260 Bbls of oil per day.
The Company delivers approximately 70% of its Hugoton gas production to a gathering and processing system operated by a subsidiary. This system collects 71% of its throughput from Underlying Properties, which, in recent months, has been approximately 24,600 Mcf per day from 243 wells. The subsidiary purchases the gas from the Company at the wellhead, gathers and transports the gas to its plant, treats and processes the gas at the plant, and then transports the gas to the marketing pipelines. The Company sells the gas to the subsidiary under long-term contracts at a price equal to 80% to 85% of the price received by the subsidiary for the gas, and the price is adjusted based upon the Btu content of the gas. The subsidiary sells the gas to a marketing affiliate of the Company based upon the average price of several published indices less any pipeline access fees incurred by the marketing subsidiary. Pipeline access fees currently are approximately $0.02 per Mcf.
Other Hugoton gas production is delivered under a third party contract. Under the contract, the Company receives 74.5% of the net proceeds received from the sale of the residue gas and liquids.
While much of the Kansas portion of the Hugoton Field has been infill drilled on 320-acre spacing, the Company believes there are up to 40 additional potential infill drilling locations. The Oklahoma portion is drilled on 640- acre spacing. If new legislation is enacted in Oklahoma, the Company believes that with regulatory approval there are approximately 200 potential infill drilling locations in that state.
The Company drilled 12 gross (10.9 net) wells in 1997, and 17 gross (10.5 net) wells in 1998, to the Chester, Council Grove and Chase formations, all of which were successfully completed.
ANADARKO BASIN
Major County Area
The Company is one of the largest producers in the Ringwood, Northwest Okeene and Cheyenne Valley fields in Major County, Oklahoma. Current net daily gas production from the Underlying Properties is approximately 31,100 Mcf and oil production is approximately 1,000 Bbls.
Oil and gas were first discovered in the Major County area in 1945. The fields in the Major County area are characterized by oil and gas production from a variety of structural and stratigraphic traps. Productive zones range from 6,500 to 9,400 feet and include the Oswego, Red Fork, Chester, Manning, Mississippian, Hunton and Arbuckle formations.
The Company develops the Major County area primarily through mechanical improvements, restimulations, recompletions to shallower zones and development drilling. The Company drilled 25 gross (20.3 net) wells in 1997, and 23 gross (16.3 net) wells in 1998, in the western portion of Major County, targeted at the Mississippian and Chester formations. All of these wells were successfully completed.
A gathering subsidiary of the Company operates a 300-mile gathering system and pipeline in the Major County area. The gathering subsidiary and a third party processor purchase gas produced at the wellhead from the Company and other producers in the area under life of production contracts. The gathering subsidiary gathers and transports the gas to a third party processor, which processes the gas and pays the Company and other producers for 50% to 70% of the liquids processed. After the gas is processed, the gathering subsidiary transports the gas via a 26-mile pipeline to a connection with other pipelines. The gathering subsidiary sells the residue gas to the marketing subsidiary of the Company based upon the average price of several published indices. The gathering subsidiary pays this price to the Company less a gathering fee of $.313 per Mcf of residue gas. This gathering fee was previously approved by the Federal Energy Regulatory Commission when the gathering subsidiary was regulated. In recent months, the gathering system has been collecting approximately 25,500 Mcf per day from over 400 wells, 70% of which the Company operates. Estimated capacity of the gathering system is 40,000 Mcf per day. The gathering subsidiary also provides contract operating services to properties in Woodward County, collecting approximately 80,000 Mcf per month from 25 wells, for a historical average fee of approximately $.125 per Mcf.
The Company also markets gas to its marketing subsidiary, which sells the gas to third parties. The price paid to the Company is based upon the average price of several published indices, less any transportation fees charged by the third party.
Elk City Field
The Elk City Field is located in Beckham and Washita Counties of Western Oklahoma. Current net production of Underlying Properties in the Elk City Field is approximately 130 Bbls of oil and 3,300 Mcf of gas per day.
The Elk City Field was discovered in 1947 and has been extensively developed. Production is from the Hoxbar (9,500 feet), Atoka (13,100 feet) and Morrow (15,500 feet) zones. The Company has enhanced production primarily by adding mechanical efficiencies and recompleting additional productive intervals. Opportunities remain for additional recompletions and zone isolations in the field.
The Company added significant additional reserves through recent recompletions to the Atoka Formation.
Gas produced from the Elk City Field is processed by a third party which pays the Company 80% of the proceeds received from the sale of the liquids. The Company sells the residue gas to its marketing subsidiary, which pays the Company the average price of several published indices.
GREEN RIVER BASIN
The Green River Basin is located in southwestern Wyoming. The Company's current net daily production from the Underlying Properties in the Fontenelle field is approximately 26,700 Mcf of gas and 70 Bbls of oil.
Gas was discovered in the Fontenelle area in the early 1970s. The producing reservoirs are the Cretaceous-aged Frontier and Dakota sandstones at depths ranging from 7,500 to 10,000 feet. Potential development activities for the fields in this area include restimulations, recompletions and development drilling in the Frontier Sandstone. Additionally, there is the potential to recomplete wells to the Baxter Sand.
The Company markets the gas produced from the Fontenelle Unit and nearby properties, under three different marketing arrangements. Under the agreement covering 70% of the gas sold, the Company compresses the gas on the lease, transports it off the lease and compresses the gas again prior to entry into the marketing pipeline. The Company sells the gas to its marketing subsidiary. The marketing subsidiary delivers the gas to the processor, which takes delivery of the gas at the entry into the marketing pipeline, transports it 35 miles to its plant, processes the gas and redelivers it to the marketing subsidiary and charges a fee of $.0792 per MMBtu for the transportation and processing. The marketing subsidiary then sells the residue gas based upon a spot sales price, and pays the Company the net proceeds that the marketing subsidiary receives. Condensate is sold at the lease to an independent third party at market rates. The gas not sold under the above arrangement is sold either under a similar arrangement where the fee is $.145 per MMBtu, or under a contract where the Company directly sells the gas to a third party on the lease at an adjusted index price.
The Company drilled 35 gross (34 net) wells in 1997 and 16 gross (16 net) wells in 1998 in the Fontenelle Unit, all of which were successfully completed.
During 1997, the Company installed additional field compression to lower overall field operating pressures and improve overall field performance. The Company also completed an interconnect to another pipeline in the southeastern part of the Fontenelle field that added an additional market for gas.
OIL AND GAS RESERVES
GENERAL
The Company's internal engineers estimated oil and gas reserves attributable to the Net Profits Interests as of November 30, 1998. Numerous uncertainties are inherent in estimating reserve volumes and values, and the estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production of the reserves may vary significantly from the original estimates.
The Company's internal engineers calculated reserve quantities and revenues for the Net Profits Interests from projections of reserves and revenues attributable to the combined interests of the Trust and the Company in the Underlying Properties. Because the Trust owns Net Profits Interests and not a specific ownership percentage of the oil and gas reserve quantities, the amount of reserves allocated to the Trust's Net Profits Interests have been reduced to adjust for its allocated payment of 80% of applicable production and development costs.
The standardized measure of discounted future net cash flows and changes in discounted cash flows presented below were prepared using assumptions required by the
Financial Accounting Standards Board. These assumptions include the use of year-end prices for oil and gas and year-end costs for estimated future development and production expenditures to produce the proved reserves.
Because natural gas prices are influenced by seasonal demand, use of year- end prices, as required by the Financial Accounting Standards Board, may not be the most accurate basis for estimating future revenues or reserve data. Future net cash flows are discounted at an annual rate of 10%. There is no provision for federal income taxes because future net revenues are not subject to taxation at the Trust level.
Oil prices used to determine the standardized measure at November 30, 1998 were based on West Texas Intermediate crude prices of $8.50 ($9.50 realized) per Bbl. The weighted average November 30, 1998 wellhead gas price used to determine the standardized measure was $2.00 per Mcf.
PROVED RESERVES
The following table shows proved reserves and proved developed reserves at November 30, 1998 for the Underlying Properties and the Net Profits Interests (in thousands). Proved reserves for the Net Profits Interests are calculated by subtracting from 80% of proved reserves of the Underlying Properties, quantities of a sufficient value to pay 80% of the future estimated costs deducted in calculating Net Proceeds. Accordingly, proved reserves for the Net Profits Interests reflect quantities that are free of future costs and expenses based on the price and cost assumption used in the reserve estimates.
80% OF
UNDERLYING PROPERTIES UNDERLYING PROPERTIES NET PROFITS INTERESTS
------------------------- ------------------------- -------------------------
GAS GAS GAS
OIL GAS EQUIVALENTS OIL GAS EQUIVALENTS OIL GAS EQUIVALENTS
MBBLS MMCF MMCFE MBBLS MMCF MMCFE MBBLS MMCF MMCFE
----- ------- ----------- ----- ------- ----------- ----- ------- -----------
Proved reserves......... 4,328 491,934 517,902 3,462 393,547 414,322 2,398 272,492 286,880
Proved developed
reserves............... 3,610 416,932 438,592 2,888 333,546 350,874 2,091 241,480 254,026
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The Company expects to spend $12 million per year for development of the Underlying Properties in the future and expects that development activities will moderate the rate of decline of proved reserves.
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVED RESERVES
The following table provides the summary calculation of the standardized measure of discounted future net cash flows of the Net Profits Interests as of December 31, 1998:
(IN THOUSANDS)
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Future cash flows................................................ $567,762
Future production taxes.......................................... 60,550
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Future net cash flows............................................ 507,212
10% discount factor.............................................. 241,636
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Standardized measure............................................. $265,576
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REGULATION
NATURAL GAS REGULATION
The availability, terms and cost of transportation significantly affect sales of natural gas. The interstate transportation and sale for resale of natural gas is subject to federal regulation, including transportation rates, storage tariffs and various other matters, primarily by the Federal Energy Regulatory Commission ("FERC"). Federal and state regulations govern the price and terms for access to natural gas pipeline transportation. The FERC's regulations for interstate natural gas transmission in some circumstances may also affect the intrastate transportation of natural gas.
While natural gas prices are currently unregulated, Congress historically has been active in the area of natural gas regulation. The Company cannot predict whether new legislation to regulate natural gas might be proposed, what proposals, if any, might actually be enacted by Congress or the various state legislatures, and what effect, if any, the proposals might have on the operations of the Underlying Properties.
Sales of crude oil, condensate and natural gas liquids are not currently regulated and are made at market prices. The FERC implemented regulations on January 1, 1995, to establish an indexing system for transportation rates for oil that could increase the cost of transporting oil to the purchaser. The Company is not able to predict what effect, if any, these regulations might have.
STATE REGULATION
The various states regulate the production and sale of oil and natural gas, including imposing requirements for obtaining drilling permits, the method of developing new fields, the spacing and operation of wells and the prevention of waste of oil and gas resources. States may regulate rates of production and may establish maximum daily production allowables from both oil and gas wells based on market demand or conservation, or both.
OTHER REGULATION
The Mineral Management Service of the United States Department of Interior is evaluating existing methods of settling royalties on federal and Native American oil and gas leases. A portion of the Underlying Properties, primarily those located in Wyoming, involve federal leases. Although the final rules could cause an increase in the federal royalties to be paid on these properties and, correspondingly, decrease the revenue to the Company and the Trust from these properties, the Company does not believe that the proposed rule changes will have a significant detrimental effect on the distributions from the Trust.
The petroleum industry is also subject to compliance with various other federal, state and local regulations and laws, including those relating to environmental protection, occupational safety, resource conservation and equal employment opportunity. The Company does not believe that compliance with these laws will have a material adverse effect upon the Trust Unitholders.
TITLE TO PROPERTIES
The Company believes that its title to the Underlying Properties is, and the Trust's title to the Net Profits Interest will be, good and defensible in accordance with standards generally accepted in the oil and gas industry.
The Underlying Properties are typically subject, in one degree or another, to one or more of the following:
. royalties, overriding royalties and other burdens, under oil and gas leases;
. contractual obligations (including, in some cases, development obligations) arising under operating agreements, farmout agreements, production sales contracts and other agreements that may affect the properties or their titles;
. liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing unpaid suppliers and contractors and contractual liens under operating agreements;
. pooling, unitization and commutation agreements, declarations and orders; and
. easements, restrictions, rights-of-way and other matters that commonly affect property.
To the extent that these burdens and obligations affect the Company's rights to production and the value of production from the Underlying Properties, they have been taken into account in calculating the Trust's interests and in estimating the size and the value of the reserves attributable to the Net Profits Interests. The Company believes that the burdens and obligations affecting the Underlying Properties and the Net Profits Interests are conventional in the industry for similar properties. The Company also believes that the burdens and obligations do not in the aggregate materially interfere with the use of the Underlying Properties and will not materially adversely affect the value of the Net Profits Interests.
Although the matter is not entirely free from doubt, the Company believes that the Net Profits Interests should constitute real property interests under Oklahoma and Wyoming law, but not under Kansas law. The Company will record the conveyances in the appropriate real property records of Kansas, Oklahoma and Wyoming, the states in which the Underlying Properties are located. If during the term of the Trust the Company should become a debtor in a bankruptcy proceeding, it is not entirely clear that the Net Profits Interests would be treated as real property interests under the laws of Oklahoma and Wyoming, and they would not be so treated under Kansas law. If a determination were made in a bankruptcy proceeding that a Net Profits Interest did not constitute a real property interest under applicable state law, it could be designated an executory contract. An executory contract is a term used, but not defined, in the federal bankruptcy code to refer to a contract under which the obligations of both the debtor and the other party are so unsatisfied that the failure of either to complete performance would constitute a material breach excusing performance by the other. If a Net Profits Interest were designated an executory contract and rejected in the bankruptcy proceeding, the Company would not be required to perform its obligations under the Net Profits Interest and the Trust would seek damages as one of the Company's unsecured creditors. Although no assurance can be given, the Company does not believe that the Net Profits Interests should be subject to rejection in a bankruptcy proceeding as executory contracts.
MARKETING
A subsidiary of the Company markets the Company's gas production and the gas output of the gathering and processing systems operated by other Company subsidiaries. The gas is sold on a monthly basis to third parties for the best available price, although the Company occasionally enters into forward contracts for future deliveries. Oil production is generally marketed at the wellhead to third parties at the best available price. The marketing subsidiary may arrange to accumulate oil from a number of different locations and transport it to a central point where the greater volume will provide a higher price, net of the transportation costs. The Company arranges for some of its gas to be processed by unaffiliated third parties and markets the natural gas liquids from that processing in a similar manner as it markets its oil. The gas attributable to the Underlying Properties will be marketed under the existing sales contracts. Contracts covering production from the Major County area are for the life of the lease, and
the contract for the majority of production from the Hugoton area expires in 2004. If new contracts are entered into with unaffiliated third parties, the proceeds from sales under those new contracts will be included in Gross Proceeds. If new contracts are entered into with the marketing subsidiary, it may charge the Company a fee that may not exceed 2% of the sales price of the oil and gas received from unaffiliated third parties. The sales price is net of any deductions for transportation from the wellhead to the unaffiliated third parties and any gravity or quality adjustments.
YEAR 2000
"Year 2000," or the ability of computer systems to process dates with years beyond 1999, affects almost all companies and organizations. Computer systems that are not Year 2000 compliant by January 1, 2000 may cause material adverse effects to companies and organizations that rely upon those systems. The Trust's timely receipt of royalty income and disbursement of distributable income to Trust Unitholders will largely be dependent upon performance of computer systems of the Company and other third parties. Because the Trust will not use the Trustee's computer systems to any significant degree, the Trustee's Year 2000 compliance should not significantly affect the Trust.
The Company is in the process of reviewing its computer systems and making the necessary modifications for Year 2000 compliance. The Company has completed most of the modifications of its primary accounting and land computer programs and is currently testing these modifications. Remediation and testing of all the Company's computer systems is expected to be completed by June 1999. Based on its review, remediation efforts and the results of testing to date, the Company does not believe that timely modification of its computer systems for Year 2000 compliance represents a material risk to the Trust. The Company's costs related to Year 2000 compliance efforts to date have not been material, and it expects that future costs will not be material. The Trust will not incur any of the Company's Year 2000 costs.
The Company has identified significant third parties whose Year 2000 compliance could affect the Company, and is in the process of formally inquiring about their Year 2000 status. Despite its efforts to assure that such third parties are Year 2000 compliant, the Company cannot provide assurance that all significant third parties will achieve compliance in a timely manner. Such failure to achieve Year 2000 compliance could have a material adverse effect on the Company's operations and cash flow, and therefore have a material adverse impact on timely Trust distributions to Trust Unitholders. The extent of that effect is currently unknown.
The Company is developing contingency plans in the event of potential problems resulting from failure of the Company's or significant third parties' computer systems on January 1, 2000. The Company expects these contingency plans to be completed by September 1999.
LITIGATION
The Company is a defendant in two lawsuits that could, if adversely determined, decrease the Net Proceeds from certain of the Underlying Properties.
A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the Company has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling gas through affiliated companies at prices less favorable than those paid by third parties. The Company believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, the Trust would bear its proportionate share of the increased royalties through reduced Net Proceeds. The amount of any reduction in Net
Proceeds is not presently determinable, but is not expected to be material.
A second lawsuit, United States of America ex rel. Grynberg v. Cross Timbers Oil Company, et al., was filed in the United States District Court for the Western District of Oklahoma. This action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, the Company has mismeasured the volume of gas and wrongfully analyzed its heating content. The suit, which was brought under the qui tam provisions of the U.S. False Claims Act, seeks treble damages for the unpaid royalties (with interest), civil penalties and an order for the Company to cease the allegedly improper measuring practices. This lawsuit is one of more than 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by the Company for production from Underlying Properties on federal and Native American lands during the 12 months ended November 30, 1998, totalled $2.8 million. The Company believes that the allegations of this lawsuit are without merit. However, an order to change measuring practices or a related settlement could adversely affect the Trust by reducing Net Proceeds in the future by an indeterminable amount.
Damages relating to production prior to the formation of the Trust will be
borne by the Company.
COMPUTATION OF NET PROCEEDS
The provisions governing the computation of the Net Proceeds are detailed and extensive. The following description of the Net Profits Interests and the computation of Net Proceeds is subject to and qualified by the more detailed provisions of the conveyances of the Net Profits Interests that are filed as exhibits to the registration statement. See "Available Information."
NET PROFITS INTERESTS
The Net Profits Interests are defined net profits interests carved from the Underlying Properties. Each Net Profits Interest entitles the Trust to receive 80% of the Net Proceeds from the sale of oil and natural gas produced from the Underlying Properties.
The amounts paid to the Trust for the Net Profits Interests are based on the definitions of "gross proceeds" and "net proceeds" set forth in the conveyances and described below. Under the conveyances, Net Proceeds are computed monthly (a "Computation Period"). The Company pays 80% of the aggregate Net Proceeds attributable to a Computation Period to the Trust on or before the last business day of the month following the Computation Period. The Company will not pay to the Trust interest on the Net Proceeds held by the Company prior to payment to the Trust. The Trustee makes distributions to Trust Unitholders monthly. See "Description of the Trust Units--Distributions and Income Computations."
Net Proceeds equal the excess of Gross Proceeds over Production Costs and Excess Production Costs attributable to a Computation Period. For royalty and overriding royalty interests, Production Costs are zero.
Gross Proceeds means the amounts received by the Company from sales of oil and gas produced from the Underlying Properties, after deducting:
. all general property (ad valorem), production, severance, sales, gathering, excise and other taxes and gathering costs if they are deducted or excluded from the proceeds of sales;
. any amounts attributable to nonconsent-operations as to which the Company is a nonconsenting party and that are dedicated to the reimbursement of costs and expenses of the consenting party; and
. any payment made to the owner of the Underlying Properties for gas not taken (but to the extent payments are allocated to gas taken in the future, payments are included, without interest, in Gross Proceeds when such gas is taken), damages (other than drainage or reservoir injury), rental for reservoir use and payments made to the owner of the Underlying Properties in connection with the drilling of any well.
Gross Proceeds does not include (1) consideration for the transfer or sale of the Underlying Properties or (2) any amount for oil and gas lost in production or marketing or used by the owner of the Underlying Properties in drilling, production and plant operations. Gross Proceeds includes payments for future production if they are not subject to repayment in the event of insufficient subsequent production.
Production Costs means, on a cash basis, generally the sum of:
. all royalties or other burdens against production,delay rentals, shut- in gas payments, minimum royalty or other payments for drilling or deferring drilling;
. any taxes paid by the owner of the Underlying Properties to the extent not deducted in calculating Gross Proceeds, including estimated and accrued ad valorem and other property taxes;
. costs paid by the owner of the Underlying Properties under any joint operating agreement;
. all other costs, expenses and liabilities of exploring for, drilling, operating and producing oil and gas, including allocated expenses (such as labor, vehicle and travel costs and materials);
. costs or charges associated with gathering, treating and processing gas;
. certain interest costs;
. any overhead charge;
. amounts previously included in gross proceeds but subsequently paid as a refund, interest or penalty;
. costs and expenses for renewals or extensions of leases; and
. at the option of the owner of the Underlying Properties, accruals for costs approved under authorizations for expenditure.
As is customary in the oil and gas industry, the Company charges an overhead fee to operate the Underlying Properties. The operating activities include various engineering, accounting and administrative functions. The fee is based on a monthly charge per active operated well, and it totalled $6.2 million in 1998 for all properties operated by the Company. The fee is adjusted annually and will increase or decrease each year based on changes in the year- end index of average weekly earnings of crude petroleum and gas workers.
Excess Production Costs are the excess of Production Costs over Gross Proceeds, plus interest accrued at the prime rate. Therefore, if Production Costs exceed Gross Proceeds for a Computation Period, the Trust will receive no payment for that period, and Excess Production Costs will be carried over to the following month as a Production Cost in determining the excess of Gross Proceeds over Production Costs for that following month.
Gross Proceeds and costs are calculated on a cash basis, except that certain costs, primarily ad valorem taxes and expenditures of a material amount, may be determined on an accrual basis. For convenience in complying with state tax laws, the Net Profits Interests were created by three separate conveyances, one for each of Kansas, Oklahoma and Wyoming, the three states in which the Underlying Properties are located. Net Proceeds are calculated separately for the Underlying Properties covered by each conveyance, so Excess Production Costs in one state do not reduce Net Proceeds from the others.
Cash distributions generally will include one month's Net Proceeds less related Trustee expenses and administrative charges. However, the first distribution, which will be made in April 1999 to record holders as of March 31, 1999, will include Net Proceeds received, less Trustee's expenses, during the period December 1, 1998 through February 28, 1999. This initial distribution will also be adjusted to exclude any development charges on the Underlying Properties incurred through December 31, 1998, which the Company will bear.
ADDITIONAL PROVISIONS
If a controversy arises as to the sales price of any oil or gas, then for purposes of determining Gross Proceeds:
. amounts withheld or placed in escrow by a purchaser are not considered to be received by the owner of the Underlying Property until actually collected;
. amounts received by the owner of the Underlying Property and promptly deposited with a nonaffiliated escrow agent will not be considered to have been received until disbursed to it by the escrow agent; and
. amounts received by the owner of the Underlying Property and not deposited with an escrow agent will be considered to have been received.
The Trust is not liable to the owner of the Underlying Properties or the operators for any operating, capital or other costs or liabilities attributable to the Underlying Properties. The Trustee is not obligated to return any income received from the Net Profits Interests, but overpayments made to the Trust will reduce future amounts payable to the Trust until the Company recovers the overpayments plus interest at the prime rate.
The conveyances permit the Company to assign without the consent or approval of the Trust Unitholders all or any part of the Underlying Properties, subject to the Net Profits Interests. The Trust Unitholders are not entitled to any proceeds of a transfer. Following a transfer, the Underlying Properties will continue to be burdened by the Net Profits Interests, and the Net Proceeds attributable to the transferred property will be calculated separately and paid by the transferee. The conveyances have been recorded in the appropriate real property records to give notice of the Net Profits Interests to the Company's creditors and transferees.
Upon notice from the Company, the Trust is required to sell for cash Net Profits Interests that relate to Underlying Properties which the Company is selling to an unaffiliated party. These types of sales may not exceed in any calendar year 1% of the discounted present value of estimated future net revenues for the proved reserves of the Underlying Properties allocated to the Trust's Net Profits Interests, as set forth in the most recent reserve report. The Trust will receive 80% of the net proceeds from a sale.
The Company, acting in good faith and as a reasonably prudent operator, may enter into farmout, operating, participation, joint venture and other similar agreements covering the Underlying Properties. The Company may enter into any of these agreements without the consent or approval of the Trustee or any Trust Unitholder. The Net Profits Interests held by the Trust would then be calculated on the interest retained by the Company under the agreement and not on the Company's original interest before any modification resulting from the agreement.
The Company and any transferee will have the right to abandon any well or property if it believes the well or property ceases to produce or is not capable of producing in commercially paying quantities. Upon termination of the lease, that portion of the Net Profits Interests relating to the abandoned property will be extinguished.
The Company must maintain books and records sufficient to determine the amounts payable for the Net Profits Interests. Quarterly and annually, the Company must deliver to the Trustee a statement of the computation of the Net Proceeds for each Computation Period. The Company will cause the annual computation of Net Proceeds to be audited. The audit cost will be borne by the Trust.
FEDERAL INCOME TAX CONSEQUENCES
This section summarizes the principal federal income tax consequences of the ownership and sale of Trust Units. Many aspects of federal income taxation that may be relevant to a particular taxpayer or to certain types of taxpayers subject to specific tax treatment are not addressed. In addition, the tax laws can and do change regularly and any future changes could have an adverse effect on the ownership or sale of Trust Units. The Trust will not request advance rulings from the IRS dealing with the tax consequences of ownership of Trust Units but will rely on the opinion of Butler & Binion, L.L.P. ("Tax Counsel") regarding the classification of the Trust and certain federal income tax consequences described below, which will be confirmed at the time of the closing. Tax Counsel believes that its opinion is in accordance with the present position of the IRS regarding grantor trusts. The tax opinion is not binding on the IRS or the courts, however, and no assurance can be given that the IRS or the courts will agree with the opinion.
SUMMARY OF LEGAL OPINIONS
Tax Counsel is of the opinion that, for federal income tax purposes, (1) the Trust will be treated as a grantor trust and not an association taxable as a corporation, (2) the income from the Net Profits Interests will be royalty income subject to an allowance for depletion, and (3) subject to the limitations described below, a Trust Unitholder will be allowed a Section 29 tax credit with respect to his share of qualifying gas production from tight sands attributable to the Net Profits Interests. Tax Counsel advises that, unless noted otherwise, legal conclusions stated in this section constitute the opinion of Tax Counsel. Tax Counsel's opinions are based on the Company's representation that none of the Underlying Properties are or will be the subject of any agreement that constitutes a partnership for federal income tax purposes.
No ruling is being requested from the IRS with respect to the Trust or Trust Unitholders. Therefore, the IRS could challenge the opinions and statements set forth herein (which do not bind the IRS or the courts), and the IRS could win in court if it did challenge these matters.
CLASSIFICATION AND TAXATION OF THE TRUST
In the opinion of Tax Counsel, under current law, the Trust will be taxable as a grantor trust and not as a business entity. As a grantor trust, the Trust will not be subject to tax at the trust level. For tax purposes, the grantors (in this case, the Trust Unitholders) will be considered to own the Trust's income and principal as though no trust were in existence. A grantor trust simply files an information return, reporting all items of income, credit or deductions which must be included in the tax returns of the grantors based on their respective accounting methods and taxable years without regard to the accounting method and tax year of the Trust. If, contrary to the opinion of Tax Counsel, the Trust was determined to be an unincorporated business entity, it would be taxable as a partnership unless it elected to be taxed as a corporation. The principal tax consequence of the Trust's being treated as a partnership for tax purposes would be that all Trust Unitholders would report their share of income from the Trust on the accrual method of accounting regardless of their own method of accounting.
DIRECT TAXATION OF TRUST UNITHOLDERS
Since the Trust will be treated as a grantor trust for federal income tax purposes, each Trust Unitholder will be taxed directly on his share of Trust income and will be entitled to claim his share of Trust deductions. Each Trust Unitholder will recognize taxable income when the Trust receives or accrues it, even if it is not distributed until later. Trust Unitholders will report their Trust income and expenses consistent with their method of accounting and their tax year.
REPORTING OF TRUST INCOME AND EXPENSES
The Trustee intends to treat each royalty payment it receives as the taxable income of the Trust Unitholders who own Trust Units on the day of receipt (i.e., the last business day of each calendar month). Similarly, the Trustee intends to pay expenses only on the day it receives a royalty payment and to treat all expenses paid on a royalty receipt day as the expenses of the Trust Unitholder to whom the royalty income received on that date is distributed. In most cases, therefore, the income and expenses of the Trust for a period will be reported as belonging to the Trust Unitholder to whom the distribution for that period is made and the amount of the distribution for a Trust Unit will generally equal the net income allocated to that Trust Unit, determined without regard to depletion. Such correlation may not exist if, for example, the Trustee establishes a cash reserve to pay estimated future expenses or pays an expense with borrowed funds. Moreover, it is possible that the IRS will attempt to impute income to persons who are Trust Unitholders when a royalty payment on the Net Profits Interests accrues, to disallow the deduction of administrative expenses to persons who are not Trust Unitholders when the expenses are incurred, or both. If the IRS were successful, Trust income might be taxed to Trust Unitholders other than those who received the distribution relating to that income. Also, an accrual basis Trust Unitholder might realize royalty income in a tax year earlier than that reported by the Trustee.
ROYALTY INCOME AND DEPLETION
In the opinion of Tax Counsel, the income from the Net Profits Interests will be royalty income qualifying for an allowance for depletion. The depletion allowance must be computed separately by each Trust Unitholder for each oil or gas property (within the meaning of Section 614 of the Internal Revenue Code of 1986, as amended (the "Code")). Tax Counsel understands that the IRS is presently taking the position that a net profits interest carved from multiple properties is a single property for depletion purposes. Accordingly, the Trust intends to take the position that each Net Profits Interest transferred to the Trust by a conveyance is a single property for depletion purposes. It would change this position if a different method were established by the IRS or the courts.
The deduction for depletion is determined annually and is the greater of cost depletion or, if allowable, percentage depletion. Royalty income from production attributable to Trust Units owned by "independent producers" will qualify for percentage depletion. An individual or entity with production of the equivalent of 1,000 barrels of oil per day or less is an "independent producer." Percentage depletion is a statutory allowance equal to 15% of the gross income from production from a property, subject to a net income limitation of 100% of the taxable income from the property, computed without regard to depletion deductions and certain loss carrybacks. The depletion deduction attributable to percentage depletion for a taxable year is limited to 65% of the taxpayer's taxable income for the year before allowance of "independent producers" percentage depletion. Unlike cost depletion, percentage depletion is not limited to the adjusted tax basis of the property, although it reduces such adjusted tax basis (but not below zero).
The Company believes that Trust Unitholders who purchase Trust Units in this offering will derive a substantially greater benefit from cost depletion than from percentage depletion.
In computing cost depletion for each property for any year, the adjusted tax basis of the property at the beginning of the year is divided by the estimated total units (e.g., Bbls of oil or Mcf of gas) recoverable from the property to determine the per-unit allowance for the property. The per-unit allowance is then multiplied by the number of units produced and sold from the property during the year. Cost depletion for a property cannot exceed the adjusted tax basis of the property. Since the Trust will be taxed as a grantor trust, each Trust Unitholder will be deemed to own an
undivided interest in the Net Profits Interests and other assets, if any, of the Trust and will compute cost depletion using his basis in his Trust Units. Information will be provided to each Trust Unitholder reflecting how his basis should be allocated among each property represented by his Trust Units. To the extent the depletion tax deduction exceeds cash distributions per Trust Unit, such excess can be deducted from the taxpayer's other sources of taxable income.
OTHER INCOME AND EXPENSES
It is anticipated that the only other income of the Trust will be interest income earned on funds held as a reserve. Other expenses of the Trust will include any state and local taxes imposed on the Trust and administrative expenses of the Trustee. Although the issue has not been finally resolved, Tax Counsel believes that all or substantially all of those expenses are deductible in computing adjusted gross income and, therefore, are not the type of miscellaneous itemized deductions that are allowable only to the extent that they aggregate more than 2% of adjusted gross income.
ALTERNATIVE MINIMUM TAX
All taxpayers are subject to an alternative minimum tax. Alternative minimum taxable income ("AMTI") is the taxpayer's taxable income recomputed with various "adjustments" plus "items of tax preference." In the case of persons other than "independent producers," tax preferences include the excess of the aggregate percentage depletion deductions with respect to an oil or gas property over the adjusted tax basis of the property. The alternative minimum tax rate for noncorporate taxpayers (other than married persons filing separately) is 26% up to $175,000 and 28% over $175,000 of AMTI in excess of an exemption amount, which varies between $45,000 and zero. Alternative minimum tax ("AMT") is the excess of a taxpayer's "tentative minimum tax" for a tax year over his "regular" tax for that year. The tentative minimum tax is determined by multiplying the excess of AMTI over the applicable exemption amount by 26% up to $175,000 and 28% over $175,000 and subtracting the AMT foreign tax credit. Reduced maximum AMT tax rates apply to net capital gains and certain other gains.
Since the effect of the AMT varies depending upon each Trust Unitholder's personal tax and financial position, each prospective investor is advised to consult with his own tax advisor concerning the effect of the AMT on him.
SECTION 29 TIGHT SANDS GAS TAX CREDIT
Some of the gas production attributable to the Net Profits Interests is produced from tight sands formations. Subject to certain statutory requirements, taxpayers are entitled to the Section 29 tax credit for production and sale of certain gas produced from tight formations ("tight sands"). The Section 29 tax credit applies to tight sands gas produced and sold to an unrelated party prior to January 1, 2003 from wells drilled prior to January 1, 1993 and after November 5, 1990 or after December 31, 1979 if the formation was dedicated to interstate commerce within the meaning of the NGPA as of April 20, 1977. The Section 29 tax credit for qualifying tight sands gas is equal to $3.00 per barrel of oil equivalent (i.e., 5.8 MMBtu), or approximately $.52 per MMBtu. The credit is reduced by a formula computation as the price of oil ("reference price") rises above an inflation adjusted amount. Because the calendar year 1997 reference price did not exceed the inflation adjusted amount, the credit was not reduced in 1997 and is not expected to be reduced in 1998 or 1999. In the opinion of Tax Counsel, if the requisite statutory requirements are met, the Trust Unitholders will be eligible to claim the Section 29 tax credit for sales of qualified tight sands gas production included in the calculation of the Net Profits Interests. The Company believes that all of the statutory requirements have been or will be met on substantially all of the tight sands wells.
The Section 29 tax credit allowable for any taxable year cannot exceed the excess (if any) of the taxpayer's regular tax liability for that taxable year, as reduced by the taxpayer's foreign tax credits and certain nonrefundable credits, over the taxpayer's tentative minimum
tax liability for that year. Any amount of Section 29 tax credit disallowed for the tax year solely because of this limitation will increase the taxpayer's credit for prior year minimum tax liability, which may be carried forward indefinitely as a credit against the taxpayer's regular tax liability, subject, however, to the limitation described in the preceding sentence. There is no provision for the carryback or carryforward of the Section 29 tax credit in any other circumstances. Hence, a Trust Unitholder may not receive the full benefit of the tax credit depending on his particular circumstances.
NON-PASSIVE ACTIVITY INCOME AND LOSS
The income and expenses of the Trust and the Section 29 tax credit will not be taken into account in computing the passive activity losses and income under Code Section 469 for a Trust Unitholder who acquires and holds Trust Units as an investment. Section 29 tax credits generated by an investment in the Trust Units, therefore, can be utilized to offset regular tax liability on income from any source, subject to the limitations discussed in "Section 29 Tight Sands Gas Tax Credit" above.
UNRELATED BUSINESS TAXABLE INCOME
Certain organizations that are generally exempt from tax under Code Section
501 are subject to tax on certain types of business income defined in Code
Section 512 as unrelated business income. In the opinion of Tax Counsel, the
income of the Trust will not be unrelated business taxable income so long as
the Trust Units are not "debt-financed property" within the meaning of Code
Section 514(b). In general, a Trust Unit would be debt-financed if the Trust
Unitholder incurs debt to acquire a Trust Unit or otherwise incurs or maintains
a debt that would not have been incurred or maintained if the Trust Unit had
not been acquired.
SALE OF TRUST UNITS; DEPLETABLE BASIS
Generally, a Trust Unitholder will realize gain or loss on the sale or exchange of his Trust Units measured by the difference between the amount realized on the sale or exchange and his adjusted basis for such Trust Units. Gain or loss on the sale of Trust Units by a Trust Unitholder who is not a dealer of the Trust Units will be a long-term capital gain (taxable at a maximum rate of 20%) if the Trust Units have been held for more than 12 months. A portion of the long-term gain will be treated as ordinary income to the extent of the depletion recapture amount explained below. A Trust Unitholder's basis in his Trust Units will be equal to the amount he paid for the Trust Units, reduced by deductions for depletion claimed by the Trust Unitholder (but not below zero). Upon the sale of the Trust Units, a Trust Unitholder must treat as ordinary income his depletion recapture amount, which is an amount equal to the lesser of (1) the gain on such sale or (2) the sum of the prior depletion deductions taken on the Trust Units (but not in excess of the initial basis of the Trust Units). It is possible that the IRS would take the position that a portion of the sales proceeds is ordinary income to the extent of any accrued income at the time of sale allocable to the Trust Units sold, but which has not been distributed to the selling Trust Unitholder.
TAXATION OF FOREIGN HOLDERS
Unless the election described below is made, a nonresident alien
individual, foreign corporation, or foreign estate or trust (a "Foreign
holder") will be subject to federal income withholding tax on his share of
gross royalty income from the Net Profits Interests at a 30% rate (or lower
treaty rate, if applicable), without any deductions. Gain realized on a sale of
a Trust Unit by a Foreign holder will be subject to federal income tax only if:
(1) the gain is otherwise effectively connected with business conducted by the
Foreign holder in the United States; (2) the Trust Unitholder is an individual
who is present in the United States for at least 183 days in the year of the
sale; (3) the Trust Unitholder owns more than a 5% interest in the Trust; or
(4) the Trust Units cease to be regularly traded on an established securities
exchange. Gain realized by a Foreign holder upon the sale by the Trust of all
or any
part of the Net Profits Interests would be subject to federal income tax.
The Trust Unitholders who are Foreign holders may elect under Code Section 871 or Section 882 or similar provisions of applicable treaties to treat income attributable to the Net Profits Interests as effectively connected with the conduct of a trade or business in the United States. The Foreign holder will then be taxed at regular federal income tax rates on the net income attributable to the Net Profits Interests (including gain recognized on the disposition of Trust Units). Absent a treaty exception, the net income of a corporate Foreign holder which has made such an election will also be subject to the "branch profits tax" imposed under Code Section 884. To claim the deductions allowable in computing net income, including cost depletion, an electing Foreign holder will have to file a United States income tax return. The election, once made, is irrevocable (unless an applicable treaty allows the election to be made annually) and is applicable to all income and gain realized by the Foreign holder on any real property interests located in the United States (including those interests held through partnerships, fixed investment trusts, and other pass-through entities).
BACKUP WITHHOLDING
In general, distributions of Trust income will not be subject to "backup withholding" unless: (1) the Trust Unitholder is an individual or other noncorporate taxpayer and (2) such Trust Unitholder fails to comply with certain reporting procedures.
TAX SHELTER REGISTRATION
The Company does not believe that the Trust will meet the requirements to register as a "tax shelter" under Code Section 6111. However, it is possible that those requirements may be met with respect to any Unitholders whose investment base is reduced by borrowing. To avoid any potential difficulty, the Trust will be registered as a tax shelter with the IRS. The Trustee will furnish the tax shelter registration number to each transferee of Trust Units and to each Trust Unitholder. Each Trust Unitholder must disclose this number by attaching Form 8271 to his tax return.
ISSUANCE OF A TAX SHELTER REGISTRATION NUMBER DOES NOT INDICATE THIS INVESTMENT OR THE CLAIMED TAX BENEFITS HAVE BEEN REVIEWED, EXAMINED OR APPROVED BY THE IRS.
REPORTS
The Trustee will furnish to Trust Unitholders of record quarterly and
annual reports in order to permit computation of their tax liability. See
"Description of the Trust Units--Periodic Reports."
STATE TAX CONSIDERATIONS
The following is a brief summary of information regarding state income
taxes and other state tax matters affecting the Trust and the Trust
Unitholders. Trust Unitholders are urged to consult their own legal and tax
advisors on these matters.
INCOME TAX CONSIDERATIONS
Wyoming presently does not have a state income tax on resident or nonresident individuals. Kansas and Oklahoma impose income taxes on residents and, for certain types of income, nonresidents. Trust Unitholders may also be subject to taxation by their state of residence on income derived from the Trust.
Kansas tax counsel, Morris, Laing, Evans, Brock & Kennedy, Chartered, is of the opinion that, although there is no determinative precedent and Kansas taxing authorities may adopt a contrary view:
. the activities of the Trust and the Trustee, as permitted under the Indenture and the conveyance, will not subject either the Trust or the Trustee to income taxation by the State of Kansas; and
. a Trust Unitholder who is not a Kansas resident will not be subject to Kansas income tax and will not be required to file a Kansas income tax return, if
-- the Trust Unit and the Trust Unitholder's indirect interest in the Net Profits Interest (through ownership of the Trust Unit) are not employed by the Trust Unitholder in a trade, business, profession or occupation carried on in Kansas, and
-- the Trust Unitholder is not otherwise subject to Kansas income tax.
In providing this opinion, Kansas tax counsel has assumed, among other things, that the Trust:
. will not own any property in Kansas other than the Net Profits Interests;
. will not conduct any activities in Kansas other than ownership of the Net Profits Interests for the benefit of Trust Unitholders; and
. is a grantor trust for federal income tax purposes.
The income tax law of Oklahoma is based on federal income tax laws. Assuming the Trust is taxed as a grantor trust for federal income tax purposes, the Trust Unitholders will be subject to Oklahoma income tax on their share of income from the Oklahoma Net Profits Interests. It is uncertain whether Trust Unitholders who are nonresidents of Oklahoma will be taxed in that state on gains from sales of Trust Units.
The Trustee will provide information concerning the Trust sufficient to identify the income of the Trust allocable to each state. Trust Unitholders should consult their own tax advisors to determine their income tax filing requirements for their share of income of the Trust allocable to states imposing an income tax on that income.
PROBATE AND PROPERTY
CONSIDERATIONS
Kansas tax counsel is also of the opinion, although there is no determinative precedent, that for purposes of Kansas law the Trust Units will be treated essentially the same as other securities--as interests in intangible personal property rather than as interests in tangible property with a situs in Kansas.
However, in the absence of controlling legal precedent, there is a possibility that under certain circumstances a Trust Unitholder could be treated as owning an interest in tangible property with a situs in Kansas. In that event, the estate tax, probate, devolution of title and administration laws of Kansas applicable to that property may apply to the Trust Units, even if held by a person who is not a Kansas resident. Application of these laws could make inheritance and related matters relating to the Trust Units more onerous than had the Trust Units been treated as interests in intangible personal property.
The Trust Units may constitute real property or an interest in real
property under the inheritance, estate and probate laws of Oklahoma and
Wyoming. If the Trust Units are held to be real property or an interest in real
property under the laws of those states, the Trust Units may be subject to
devolution, probate and administration and estate taxes under the laws of those
states.
ERISA CONSIDERATIONS
The Employee Retirement Income Security Act of 1974, as amended ("ERISA"), imposes requirements on pension, profit-sharing and other employee benefit plans to which it applies, and contains standards for persons who are fiduciaries of those plans. In addition, the Code provides similar requirements and standards which are applicable to these types of plans and to individual retirement accounts, whether or not subject to ERISA (collectively, "Qualified Plans").
A fiduciary of a Qualified Plan should carefully consider fiduciary
standards under ERISA regarding the Qualified Plan's particular circumstances
before authorizing an investment in Trust Units. A fiduciary should consider
(1) whether the investment satisfies the prudence requirements of Section
404(a)(1)(B) of ERISA, (2) whether the investment satisfies the diversification
requirements of Section 404(a)(1)(C) of ERISA and (3) whether the investment is
in accordance with the documents and instruments governing the Qualified Plan
as required by Section 404(a)(1)(D) of ERISA.
A fiduciary should also consider whether the acquisition of Trust Units and/or operation of the Trust might result in direct or indirect nonexempt prohibited transactions under Section 406 of ERISA and Code Section 4975. In deciding on the existence of a prohibited transaction, a fiduciary must determine whether "plan assets" are involved in the transaction. On November 13, 1986, the Department of Labor published final regulations concerning whether or not a Qualified Plan's assets (such as a Trust Unit) would be deemed to include an interest in the underlying assets of an entity (such as the Trust) for purposes of the reporting, disclosure and fiduciary responsibility provisions of ERISA and analogous provisions of the Code. These regulations provide that the underlying assets of an entity will not be considered "plan assets" if the equity interests in the entity are a publicly offered security. Trust Units are considered to be "publicly offered" for this purpose if they are part of a class of securities that is (1) widely held (i.e., owned by more than 100 investors independent of the issuer and each other), (2) freely transferable and (3) registered under Section 12(b) or 12(g) of the Securities Exchange Act of 1934. The Company expects that these requirements will be satisfied at the time of the sale of the Trust Units in this offering. Fiduciaries, however, will need to determine whether the acquisition of Trust Units is a nonexempt prohibited transaction under the general requirements of ERISA Section 406 and Code Section 4975.
Due to the complexity of the prohibited transaction rules and the penalties
imposed upon persons involved in prohibited transactions, potential Qualified
Plan investors should consult with their counsel regarding the consequences
under ERISA and the Code of their acquisition and ownership of Trust Units.
DESCRIPTION OF THE TRUST INDENTURE
The following information and the information set forth under "Description of the Trust Units" summarize information contained in the Trust Indenture and are subject to its detailed provisions. This summary is not meant to be a detailed description of the Trust Indenture and may not contain all the information that is important to you. For more detailed provisions concerning the Trust, you should read the Trust Indenture, a copy of which was filed as an exhibit to the Registration Statement. See "Available Information."
CREATION AND ORGANIZATION OF THE TRUST; AMENDMENTS
At the formation of the Trust, the Company carved the Net Profits Interests from the Underlying Properties and conveyed the Net Profits Interests to the Trust in exchange for 40,000,000 Trust Units.
The Company created the Trust under Texas law to acquire and hold the Net Profits Interests for the benefit of the Trust Unitholders. The Net Profits Interests are passive in nature, and the Trustee will have no control over and no responsibility for costs relating to the operation of the Underlying Properties. Neither the Company nor other operators of the properties included in the Underlying Properties have any contractual commitments to the Trust to conduct further drilling on the properties or to maintain their ownership interest in any of these properties. For a description of the Underlying Properties and other information relating to them, see "The Net Profits Interests and the Underlying Properties."
The beneficial interest in the Trust is divided into 40,000,000 Trust Units, each of which represents equal undivided portions of
the Trust. You will find additional information concerning the Trust Units, in "Description of the Trust Units."
Amendment of the Trust Indenture requires a vote of holders of 80% or more of the outstanding Trust Units. However, no amendment may--
. increase the power of the Trustee to engage in business or investment activities;
. alter the rights of the Trust Unitholders as among themselves; and
. permit the Trustee to distribute the Net Profits Interests in kind.
ASSETS OF THE TRUST
The assets of the Trust consist of Net Profits Interests and cash and temporary investments being held for the payment of expenses and liabilities and for distribution to the Trust Unitholders. You will find information relating to the assets of the Trust in "The Net Profits Interests and the Underlying Properties."
DUTIES AND LIMITED POWERS OF THE TRUSTEE
The duties of the Trustee are specified in the Trust Indenture and by the laws of the State of Texas. The Trustee's principal duties consist of:
. collecting income attributable to the Net Profits Interests;
. paying expenses, charges and obligations of the Trust from the Trust's income and assets;
. distributing distributable income to the Trust Unitholders; and
. taking any action it deems necessary and advisable to best achieve the purposes of the Trust.
If a liability is contingent or uncertain in amount or not yet currently due and payable, the Trustee may create a cash reserve to pay for the liability. If the Trustee determines that the cash on hand and the cash to be received is insufficient to cover the Trust's liability, the Trustee may borrow funds required to pay the liabilities. The Trustee may borrow the funds from any person, including itself. The Trustee may also encumber the assets of the Trust to secure payment of the indebtedness. If the Trustee borrows funds, the Trust Unitholders will not receive distributions until the borrowed funds are repaid.
Each month, the Trustee will pay Trust obligations and expenses and distribute to the Trust Unitholders the remaining proceeds received from the Net Profits Interests. The cash held by the Trustee as a reserve against future liabilities or for distribution at the next distribution date must be invested in:
. interest bearing obligations of the United States government;
. repurchase agreements secured by interest-bearing obligations of the United States government; or
. bank certificates of deposit.
The only asset the Trust may acquire is the Net Profits Interests and the only investment activity the Trustee may engage in is the investment of cash on hand.
At the request of the Company, the Trustee must sell Net Profits Interests that burden Underlying Properties sold by the Company to an unaffiliated third party. But without the consent of holders of 80% of the Trust Units, the Trustee cannot sell in any calendar year Net Profits Interests relating to more than 1% of the discounted present value of estimated future net revenues for the proved reserves of the Underlying Properties allocated to the Trust's Net Profits Interests, as set forth in the most recent reserve report.
The Trustee may sell the Net Profits Interests in any of the following circumstances:
. the sale does not involve a material part of the Trust's assets and is in the best interests of the Trust Unitholders. A majority of the Trust Units represented at a meeting of the Trust Unitholders where a quorum is present must approve the sale;
. the sale is in the best interests of the Trust Unitholders, constitutes a material part of the Trust's assets and holders representing 80% of the outstanding Trust Units approve the sale; or
. Upon termination of the Trust. No Trust Unitholder approval is required.
The Trustee will distribute the net proceeds from any sale of the Net Profits Interests to the Trust Unitholders.
The Trustee has the right to require any Trust Unitholder to dispose of his Trust Units if an administrative or judicial proceeding seeks to cancel or forfeit any of the property in which the Trust holds an interest because of the nationality or any other status of a Trust Unitholder. If a Trust Unitholder fails to dispose of his Trust Units, the Trustee has the right to purchase them and to borrow funds to make that purchase.
The Trustee is authorized to agree to modifications of the terms of the Conveyances or to settle disputes involving the Conveyances. The Trustee may not agree to modifications or settle disputes involving the royalty part of the Conveyances if these actions would change the character of the Net Profits Interests in such a way that (1) the Net Profits Interests become working interests, or (2) the Trust becomes an operating business.
LIABILITIES OF THE TRUST
Because the Trust assets are passive in nature and the Trustee has little power to incur obligations, the Company anticipates that the Trust will only incur liabilities for routine administrative expenses, such as the Trustee's fees and accounting, engineering, legal and other professional fees.
FIDUCIARY RESPONSIBILITY AND
LIABILITY OF THE TRUSTEE
The Trustee is a fiduciary for the Trust Unitholders and is required to act in the best interests of the Trust Unitholders at all times. The Trustee must exercise the same judgment and care in supervising and managing the Trust's assets as persons of ordinary prudence, discretion and intelligence would exercise. Under Texas law, the Trustee's duties to the Trust Unitholders are similar to the duty of care owed by a corporate director to the corporation and its shareholders. The primary difference between the Trustee's duties and a corporate director's duties is the absence of the legal presumption protecting the Trustee's decisions from challenge.
Due to the passive nature of the Trust, the Trustee generally will not make business decisions affecting the assets of the Trust. Therefore, substantially all of the Trustee's functions under the Trust Indenture are expected to be ministerial in nature. See "--Duties and Limited Powers of the Trustee," above. Under Texas law, the Trustee may not profit from any transaction with the Trust. The Trust Indenture, however, provides that the Trustee may:
. charge for its services as Trustee;
. retain funds to pay for future expenses and deposit them in its own account;
. lend funds at commercial rates to the Trust to pay the Trust's expenses; and
. seek reimbursement from the Trust for its out-of-pocket expenses.
In discharging its fiduciary duty to Trust Unitholders, the Trustee may act in its discretion and will be liable to the Trust Unitholders only for fraud, gross negligence or acts or omissions constituting bad faith. The Trustee will not be liable for any act or omission of its agents or employees unless the Trustee acted in bad faith or with gross negligence in their selection and retention. The Trustee will be indemnified for any liability or cost that it incurs in the administration of the Trust, except in cases of fraud, gross negligence or bad faith. The Trustee will have a lien on the assets of the Trust as security for this indemnification and its compensation earned as Trustee. The Trustee is entitled to indemnification from Trust assets or, to the extent that Trust assets are
insufficient, from the Company. Trust Unitholders will not be liable to the Trustee for any indemnification. See "Description of the Trust Units--Liability of Trust Unitholders." The Trustee must ensure that all contractual liabilities of the Trust are limited to the assets of the Trust and will be liable for its failure to do so.
Under Texas law, if the Trustee acts in bad faith, the Trustee will be liable to the Trust Unitholders for damages. Texas law also permits the Trust Unitholders to file actions seeking other remedies, including:
. removal of the Trustee;
. specific performance;
. appointment of a receiver;
. an accounting by the Trustee to Trust Unitholders; and
. punitive damages.
DURATION OF THE TRUST;
SALE OF NET PROFITS INTERESTS
The Trust will terminate if:
. the Trust sells all of the Net Profits Interests;
. annual gross proceeds attributable to the Underlying Properties are less than $1 million for each of two consecutive years after 1999;
. the holders of 80% or more of the outstanding Trust Units vote in favor of termination; or
. the Trust violates the "rule against perpetuities."
The Trustee would then sell all of the Trust's assets, either by private sale or public auction, and then distribute the net proceeds of the sale to the Trust Unitholders.
DISPUTE RESOLUTION
Any dispute, controversy or claim that may arise between the Company and the Trustee relating to the Trust will be submitted to binding arbitration before a tribunal of three arbitrators.
COMPENSATION OF THE TRUSTEE
The Trustee's compensation will be paid out of the Trust's assets. See "The Trust."
MISCELLANEOUS
The Trustee may consult with counsel, accountants, geologists and engineers (which also may be retained by the Company) and other parties the Trustee believes to be qualified as experts on the matters for which advice is sought. The Trustee will be protected for any action it takes in good faith reliance upon the opinion of the expert.
DESCRIPTION OF THE TRUST UNITS GENERAL
Each Trust Unit represents an undivided share of beneficial interest in the Trust. Each holder of a Trust Unit has the same rights as the holder of any other Trust Unit. The Trust has 40,000,000 Trust Units outstanding.
DISTRIBUTIONS AND INCOME COMPUTATIONS
Each month, the Trustee will determine the amount of funds available for distribution to the Trust Unitholders. Available funds will equal the excess cash received by the Trust from the Net Profits Interests and other sources that month, over the Trust's liabilities for that month. Available funds will be reduced by any cash the Trustee decides to hold as a reserve against future liabilities. Trust Unitholders that own their Trust Units on the close of business on the last business day of the month (the "Monthly Record Date") will receive a pro-rata distribution no later than 10 business days after the Monthly Record Date. The first distribution
will be made approximately April 10, 1999 to Trust Unitholders owning Trust Units on the last business day of March 1999.
Unless otherwise advised by counsel or the IRS, the Trustee will record the income and expenses of the Trust for each monthly period as belonging to the Trust Unitholders of record on the Monthly Record Date. Trust Unitholders will recognize income and expenses for tax purposes in the month of receipt or payment by the Trust, rather than in the month of distribution by the Trust. Minor variances may occur. For example, a reserve could be established in one monthly period that would not give rise to a tax deduction until a later monthly period, or an expenditure paid in one monthly period would be amortized for tax purposes over several monthly periods. See "Federal Income Tax Consequences."
TRANSFER OF TRUST UNITS
Trust Unitholders may transfer their Trust Units by surrendering their Trust Unit certificate in the form for transfer requested by the Trustee. No service charge will be made to the transferor or transferee for any transfer of a Trust Unit. The Trustee may require payment of any tax or other governmental charge imposed for a transfer. The Trustee may treat the owner of any Trust Unit as shown by its records as the owner of the Trust Unit. The Trustee will not be considered to know about any claim or demand on a Trust Unit by any party except the record owner. Any transfer of a Trust Unit will, as to the Trustee, transfer to the transferee as of the close of business on the date of transfer, all right, title and interest of the transferor in the Trust. However, a transfer of a Trust Unit after any Monthly Record Date will not transfer to the transferee the right to any distribution relating to the Monthly Record Date. The laws of the State of Texas will govern all matters affecting the title, ownership, warranty or transfer of Trust Units.
PERIODIC REPORTS
The Trustee will mail to each Trust Unitholder of record on a Monthly Record Date during each quarter (except the fourth) a report showing the assets, liabilities, receipts and disbursements of the Trust for the quarter. No later than 120 days following the end of each year the Trustee will mail to the Trust Unitholders of record, as of a date to be selected by the Trustee, an annual report containing audited financial statements of the Trust.
The Trustee will file all required Trust federal and state income tax and information returns. The Trustee will prepare and mail to Trust Unitholders quarterly and annually reports that Trust Unitholders need to correctly report their share of the income and deductions of the Trust.
Each Trust Unitholder and his representatives may examine, for any proper purpose, during reasonable business hours the records of the Trust and the Trustee.
LIABILITY OF TRUST UNITHOLDERS
The Trustee must ensure that all contractual liabilities of the Trust are limited to the assets of the Trust, and the Trustee will be liable for its failure to do so. Texas law is unclear whether a Trust Unitholder would be responsible for a liability that exceeds the net assets of the Trust and the Trustee. Because of the value and passive nature of the Trust assets and the restrictions in the Indenture on the power of the Trustee to incur liabilities, the Company believes it is unlikely that a Trust Unitholder would incur any liability from the Trust.
VOTING RIGHTS OF TRUST UNITHOLDERS
Trust Unitholders have more limited voting rights than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of Trust Unitholders or for annual or other periodic re- election of the Trustee.
The Trustee or Trust Unitholders owning at least 15% of the outstanding Trust Units may call meetings of Trust Unitholders. Meetings
must be held in Fort Worth, Texas. Written notice setting forth the time and place of the meeting and the matters proposed to be acted upon must be given to all of the Trust Unitholders of record at least 20 days and not more than 60 days before the meeting. The presence in person or by proxy of Trust Unitholders representing a majority of Trust Units outstanding constitutes a quorum. Each Trust Unitholder is entitled to one vote for each Trust Unit owned.
Unless otherwise required by the Trust Indenture, any matter may be approved by holders of a majority of Trust Units constituting a quorum, although less than a majority of the Trust Units then outstanding. The affirmative vote of the holders of 80% of the outstanding Trust Units is required to (1) terminate the Trust, (2) amend the Trust Indenture or (3) approve the sale of all or any material part of the assets of the Trust. The sale of all or any part of the assets of the Trust requires the prior consent of the Trustee except in connection with the termination of the Trust or limited sales directed by the Company in conjunction with its sale of Underlying Properties. The Trustee may be removed, with or without cause, by a vote of the holders of a majority of the outstanding Trust Units.
SELLING TRUST UNITHOLDER
The Company currently owns 100% of the 40,000,000 outstanding Trust Units and is offering 6,000,000 (15% of the outstanding) Trust Units in this offering, or 6,900,000 Trust Units if the underwriters exercise their over- allotment option in full. The Company has reserved $12 million of Trust Units for issuance in the Company's 1998 Royalty Trust Option Plan. The Company has granted options covering all $12 million of Trust Units in the Plan to its executive officers at an exercise price equal to the public offering price in this offering. The options are exercisable for a period of three years, beginning at the date of grant. Assuming the sale of all Trust Units offered in this offering and the exercise in full of the underwriters' over-allotment option, after taking into account the Trust Units reserved for the Company's 1998 Royalty Trust Option Plan, the Company will have Trust Units, or % of the outstanding Trust Units. Trust Units available for future sale or distribution.
The Company has announced that it intends to form up to three royalty trusts and distribute units of beneficial interest in those royalty trusts (including the Trust Units) as dividends to its stockholders. It also may exchange the remaining Trust Units for oil and gas properties or use them for other corporate purposes. The Company currently anticipates beginning distributions of units of royalty trusts to its stockholders no earlier than the fourth quarter of 1999. Those distributions could be made potentially as frequently as each quarter. The Company intends to distribute royalty trust units representing a then market value of approximately $2.00 per year for each share of Company common stock.
Prior to this offering there has been no public market for the Trust Units.
The Company cannot predict the effect on future market prices, if any, of
market sales of Trust Units or the availability of Trust Units for sale after
the Company's distribution to its shareholders of its remaining Trust Units.
Nevertheless, sales of substantial amounts of Trust Units in the public market
could adversely affect prevailing market prices.
LEGAL MATTERS
Counsel for the Company, Kelly, Hart & Hallman, P.C., Fort Worth, Texas,
will give a legal opinion that the Trust Units are valid. Counsel for the
Underwriters, Andrews & Kurth L.L.P., Houston, Texas, will give a legal opinion
to the Underwriters regarding other matters related to this offering. Butler &
Binion, L.L.P., Houston, Texas, will give the tax opinion set forth in the
section of this prospectus captioned "Federal Income Tax Consequences." Morris,
Laing, Evans, Brock & Kennedy, Chartered, Wichita, Kansas, will give the Kansas
tax
opinion set forth in the section of this prospectus captioned "State Tax Considerations." Certain members of Kelly, Hart & Hallman, P.C. currently own approximately 23,200 shares of the Company's common stock.
EXPERTS The financial statements of the Company incorporated by reference in this prospectus have been audited by Arthur Andersen, independent public accountants, as indicated in their reports with respect thereto, and are incorporated by reference herein in reliance upon the authority of said firm as experts in accounting and auditing.
AVAILABLE INFORMATION
The Company files annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any of these reports, statements or other information at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at the address in the previous sentence. To obtain information on the operation of the public reference rooms you may call the SEC at (800) SEC-0330. The Company's filings are also available to the public on the SEC Internet Web site at http://www.sec.gov.
The SEC allows the Company to "incorporate by reference" information the Company files with it, which means that the Company can disclose important information to you by referring you to those documents. The information incorporated by reference is considered to be part of this prospectus.
The Company incorporates by reference in this prospectus the following documents:
. the Company's Annual Report on Form 10-K for the year ended December 31, 1997;
. the Company's Quarterly Reports on Form 10-Q for the quarters ended March 31, 1998, June 30, 1998, and September 30, 1998;
. the Company's Current Reports on Form 8-K dated February 12, 1998, February 16, 1998 (Amendment No. 1 to Report dated December 1, 1997), February 18, 1998, February 25, 1998, April 13, 1998, April 17, 1998, April 21, 1998, April 24, 1998, May 19,1998, July 2, 1998 (Amendment No. 1 to Report dated April 24, 1998), and August 26, 1998; and
. all other documents filed by the Company pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 after the date of this prospectus and prior to termination of the offering of the Trust Units.
Information that the Company files later with the SEC will automatically update the information in this prospectus. In all cases, you should rely on the later information over different information included or incorporated by reference in this prospectus.
As a recipient of this prospectus, you may request a copy of any document the Company incorporates by reference, except exhibits to the documents (unless the exhibits are specifically incorporated by reference), at no cost to you by writing or calling the Company at 810 Houston Street, Suite 2000, Fort Worth, Texas 76102, Attention: Investor Relations, telephone (817) 870- 2800.
NationsBank, N.A. is Trustee of the Trust. The Trustee's address is 901
Main Street, 17th Floor, Dallas, Texas 75202, and its telephone number is
(214) 508-2400.
GLOSSARY OF CERTAIN OIL AND GAS TERMS
In this prospectus the following terms have the meanings specified below.
Bbl -- One stock tank barrel, or 42 US gallons liquid volume, of crude oil or other liquid hydrocarbons.
Bcf -- One billion cubic feet of natural gas.
Bcfe -- One billion cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf.
Btu -- A British Thermal Unit, a common unit of energy measurement.
Estimated Future Net Revenues -- Also referred to as "estimated future net cash flows." The result of applying current prices of oil and gas (with consideration of price changes only as provided by existing contractual arrangements) to estimated future production from oil and gas reserves, reduced by estimated future expenditures (based on current costs) to be incurred in developing and producing the proved reserves. Estimated future net revenues do not include the effects of the tight sands gas tax credit, since the Trust is not a taxable entity and the credit inures directly to the benefit of the Trust Unitholders.
Gas Revenue -- Includes revenue related to the sale of natural gas, natural gas liquids and plant products.
MBbl -- One thousand Bbl.
Mcf -- One thousand cubic feet of natural gas.
Mcfe -- One thousand cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf.
MMBtu--One million British Thermal Units (Btus).
MMcf--One million cubic feet of natural gas.
MMcfe--One million cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf.
Net Oil and Gas Wells or Acres--Determined by multiplying "gross" oil and gas wells or acres by the interest in such wells or acres represented by the Underlying Properties.
Oil Revenue--Includes revenue related to the sale of oil and condensate production.
Proved Developed Reserves--Proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods.
Proved Reserves--The estimated quantities of crude oil, natural gas and natural gas liquids which, upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable in the future from known oil and gas reservoirs under existing economic and operating conditions.
Proved Undeveloped Reserves--Proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required.
Reserve-to-Production Index--An estimate, expressed in years, of the total estimated proved reserves attributable to a producing property divided by the forecasted rate of production for the 12 months following the date as of which the proved reserves were estimated.
Royalty or Overriding Royalty Interest--A real property interest entitling the owner to receive a specified portion of the gross proceeds of the sale of oil and gas production or, if the conveyance creating the interest provides, a specific portion of oil and gas produced, without any deduction for the costs to explore for, develop or produce the oil and gas. A royalty or overriding royalty interest owner has no right to consent to or approve the operation and development of the property, while the owners of the working interest have the exclusive right to exploit the mineral on the land.
Standardized Measure of Discounted Future Net Cash Flows--Also referred to herein as "standardized measure." It is the present value of estimated future net revenues computed by discounting estimated future net revenues at a rate of 10% annually.
Working Interest--A real property interest entitling the owner to receive a specified percentage of the proceeds of the sale of oil and gas production or a percentage of the production, but requiring the owner of the working interest to bear the cost to explore for, develop and produce such oil and gas. A working interest owner who owns a portion of the working interest may participate either as operator or by voting his percentage interest to approve or disapprove the appointment of an operator and certain activities in connection with the development and operation of a property.
INDEX TO FINANCIAL STATEMENTS
UNDERLYING PROPERTIES Report of Independent Public Accountants................................ F-2 Statements of Revenues and Direct Operating Expenses for the Years Ended November 30, 1996, 1997 and 1998....................................... F-3 Notes to Financial Statements........................................... F-4 HUGOTON ROYALTY TRUST Report of Independent Public Accountants................................ F-8 Statement of Assets and Trust Corpus as of December 4, 1998............. F-9 Note to Statement of Assets and Trust Corpus............................ F-10 Pro Forma Statement of Assets and Trust Corpus as of December 31, 1998 (Unaudited)............................................................ F-11 Pro Forma Statement of Distributable Income for the Year Ended December 31, 1998 (Unaudited).......................................... F-12 Notes to Pro Forma Statement of Distributable Income (Unaudited)........ F-13 |
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Cross Timbers Oil Company:
We have audited the accompanying statements of revenues and direct operating expenses of the Underlying Properties of Cross Timbers Oil Company ("the Company") for each of the three years in the period ended November 30, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying statements of revenue and direct operating expenses have been prepared on the cash basis of accounting, as described in Note 2, and are not intended to be a presentation in conformity with generally accepted accounting principles.
In our opinion, the statements referred to above present fairly, in all material respects, the revenues and direct operating expenses of the Underlying Properties for each of the three years in the period ended November 30, 1998, in conformity with the basis of accounting described above and in Note 2.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
December 3, 1998
UNDERLYING PROPERTIES
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
FOR THE YEARS ENDED NOVEMBER 30, 1996, 1997 AND 1998
1996 1997 1998
------- ------- -------
(IN THOUSANDS)
Revenues
Gas sales............................................ $60,502 $82,192 $77,124
Oil sales............................................ 9,075 9,704 7,083
------- ------- -------
Total Revenues..................................... 69,577 91,896 84,207
------- ------- -------
Direct Operating Expenses
Taxes on production and property..................... 5,919 9,173 9,170
Production and other expenses........................ 11,359 12,837 13,031
------- ------- -------
Total.............................................. 17,278 22,010 22,201
------- ------- -------
Excess of Revenues over Direct Operating Expenses...... $52,299 $69,886 $62,006
======= ======= =======
|
See Accompanying Notes to Financial Statements.
UNDERLYING PROPERTIES
NOTES TO FINANCIAL STATEMENTS
1. UNDERLYING PROPERTIES
The Underlying Properties are predominantly working interests in producing properties currently owned by Cross Timbers Oil Company ("Company") in Kansas, Oklahoma and Wyoming. The Company will convey 80% defined net profits interests ("Net Profits Interests") in the Underlying Properties to the Hugoton Royalty Trust ("Trust") in December 1998. Estimated proved reserves attributable to the Underlying Properties are approximately 5% oil and 95% natural gas, based on discounted present value of estimated future net revenues as of November 30, 1998. See Note 5.
All of the Underlying Properties were acquired by the Company from 1986 through 1998. Significant property acquisitions were made by the Company during the three-year period presented in the accompanying financial statements. The statements include the historical revenues and direct operating expenses from these acquired properties for all years presented.
2. BASIS OF PRESENTATION
The statements of revenues and direct operating expenses of the Underlying Properties were derived from the historical accounting records of the Company, (and prior owners for acquisitions occurring during the three-year period presented) and are presented on the cash basis of accounting before the effects of conveyance of the Net Profits Interests. The statements do not include depreciation, depletion, and amortization, general and administrative or interest expenses.
Royalty income of the Trust is determined based on the defined 80% net profits interest percentage of Net Proceeds of the Underlying Properties. The computation also includes deductions for capital development expenditures on the properties of $19,797,000 in 1996, $38,875,000 in 1997 and $28,600,000 in 1998, as well as an overhead charge totalling $4,557,000 in 1996, $5,354,000 in 1997, and $6,198,000 in 1998. Accordingly, royalty income of the Trust is materially different from the excess of revenues over direct operating expenses from the Underlying Properties.
3. RELATED PARTY TRANSACTIONS
The Company sells a significant portion of gas production from the Underlying Properties to certain of the Company's wholly owned subsidiaries, generally at amounts approximating monthly spot market prices. Most of the production from the Hugoton area is sold under a contract to Timberland Gathering & Processing Company, Inc. ("TGPC"). Much of the gas production in Major County, Oklahoma is sold to Ringwood Gathering Company ("RGC") which retains a $0.313 per Mcf gathering fee, which the Company believes to be a competitive industry rate. TGPC and RGC sell gas to Cross Timbers Energy Services, Inc. ("CTES") which markets gas to third parties. The Company sells directly to CTES most gas production not sold directly to TGPC or RGC.
Sales from the Underlying Properties to the Company's wholly owned subsidiaries are as follows (in thousands):
1996 1997 1998
------- ------- -------
TGPC................................................. $12,348 $16,429 $14,519
RGC.................................................. 6,768 8,436 6,421
CTES................................................. 12,167 32,294 33,878
|
UNDERLYING PROPERTIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. CONTINGENCIES
The Company is a defendant in two separate lawsuits that could, if adversely determined, decrease future revenues from certain of the Underlying Properties. Damages relating to production prior to the formation of the Trust will be borne by the Company.
A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the Company has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling gas through affiliated companies at prices less favorable from those paid by third parties. The Company believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, revenues from the Underlying Properties will be reduced. The amount of any reduction in such revenues is not presently determinable, but is not expected to be material.
A second lawsuit, United States of America ex rel. Grynberg v. Cross Timbers Oil Company, et al., was filed in the United States District Court for the Western District of Oklahoma. This action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, the Company has mismeasured the volume of gas and wrongfully analyzed its heating content. The suit, which was brought under the qui tam provisions of the U.S. False Claims Act, seeks treble damages for the unpaid royalties (with interest), civil penalties and an order for the Company to cease the allegedly improper measuring practices. This lawsuit is one of more that 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by the Company for production from Underlying Properties on federal and Native American lands during the year ended November 30, 1998, totalled $2.8 million. The Company believes that the allegations of this lawsuit are without merit. However, an order to change measuring practices or a related settlement could adversely affect future revenues from the Underlying Properties by an indeterminable amount.
5. SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (UNAUDITED)
Proved oil and gas reserves of the Underlying Properties have been estimated as of November 30, 1998 by the Company's internal petroleum engineers. The reserve estimates provided for the Underlying Properties are before the effects of conveying the defined net profits interests to the Trust. In accordance with Statement of Financial Accounting Standards No. 69, estimates of future net revenues from proved reserves have been prepared using year-end oil and gas prices and current costs to produce and develop the proved reserves. The standardized measure of future net cash flows from oil and gas reserves is calculated based on discounting such future net cash flows at an annual rate of 10%. Year-end posted West Texas Intermediate crude oil prices were $18.00 per barrel for 1995, $24.25 per barrel for 1996, $15.50 per barrel for 1997, and $8.50 per barrel for 1998. Year-end weighted average spot gas prices were $1.53 per Mcf for 1995, $3.31 per Mcf for 1996, $2.07 per Mcf for 1997, and $2.00 per Mcf for 1998.
Year-end proved reserves prior to November 30, 1998 have been developed by adding back actual production volumes to arrive at estimated proved reserves at November 30, 1995, 1996 and 1997. As a result, changes in proved reserves during each of the three years presented do not include revisions of estimates or extensions and discoveries.
UNDERLYING PROPERTIES
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Estimated future production and development costs prior to November 30, 1998 have been developed by adding back actual costs to arrive at estimated future costs at November 30, 1995, 1996 and 1997. As a result, the changes in standardized measure of discounted future net cash flows from proved reserves for each of the three years presented do not reflect cost estimate revisions.
The standardized measure of future net cash flows is not intended to represent the fair value of the Underlying Properties. Numerous uncertainties are inherent in estimating volumes and values of proved reserves and in projecting future production rates and timing of development expenditures. Such reserve estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production may be substantially different from the original estimates. Also, because natural gas prices are influenced by seasonal demand, use of year-end prices, as required by the Financial Accounting Standards Board, may not be representative in estimating future revenues or reserve data.
GAS (MCF) OIL (BBLS)
PROVED RESERVES --------- ----------
(IN THOUSANDS)
Balance, November 30, 1995.............................. 603,784 5,733
Production............................................ (36,143) (455)
------- -----
Balance, November 30, 1996.............................. 567,641 5,278
Production............................................ (37,172) (471)
------- -----
Balance, November 30, 1997.............................. 530,469 4,807
Production............................................ (38,535) (479)
------- -----
Balance, November 30, 1998.............................. 491,934 4,328
======= =====
|
PROVED DEVELOPED RESERVES
GAS (MCF) OIL (BBLS)
--------- ----------
(IN THOUSANDS)
November 30, 1995....................................... 528,782 5,014
======= =====
November 30, 1996....................................... 492,639 4,559
======= =====
November 30, 1997....................................... 455,467 4,089
======= =====
November 30, 1998....................................... 416,932 3,610
======= =====
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STANDARDIZED MEASURE OF DISCOUNTED FUTURE
NET CASH FLOWS RELATING TO PROVED
RESERVES
NOVEMBER 30,
--------------------------------
1996 1997 1998
---------- ---------- ----------
(IN THOUSANDS)
Future cash inflows...................... $2,012,625 $1,177,862 $1,025,456
Future production and development costs.. 565,163 451,278 391,441
---------- ---------- ----------
Future net cash flows.................... 1,447,462 726,584 634,015
10% discount factor...................... 759,472 364,310 302,045
---------- ---------- ----------
Standardized measure of discounted future
net cash flows.......................... $ 687,990 $ 362,274 $ 331,970
========== ========== ==========
|
CHANGES IN STANDARDIZED MEASURE OF
DISCOUNTED FUTURE NET CASH FLOWS FROM
PROVED RESERVES
NOVEMBER 30,
-----------------------------
1996 1997 1998
-------- --------- --------
(IN THOUSANDS)
Standardized measure, beginning of year.... $219,537 $ 687,990 $362,274
-------- --------- --------
Sales of production, net of costs.......... (52,299) (69,886) (62,006)
Changes in price........................... 480,207 (360,026) (31,501)
Development costs incurred................. 19,797 38,875 28,600
Accretion of discount...................... 20,748 65,321 34,603
-------- --------- --------
468,453 (325,716) (30,304)
-------- --------- --------
Standardized measure, end of year.......... $687,990 $ 362,274 $331,970
======== ========= ========
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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Hugoton Royalty Trust:
We have audited the accompanying statement of assets and trust corpus of Hugoton Royalty Trust as of December 4, 1998. This financial statement is the responsibility of the management of Cross Timbers Oil Company. Our responsibility is to express an opinion on this financial statement based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the statement referred to above presents fairly, in all material respects, the assets and trust corpus of Hugoton Royalty Trust as of December 4, 1998, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
December 4, 1998
HUGOTON ROYALTY TRUST
STATEMENT OF ASSETS AND TRUST CORPUS
DECEMBER 4, 1998
Cash.................................................................. $1,000
======
Trust Corpus.......................................................... $1,000
======
|
See Note to Statement of Assets and Trust Corpus.
HUGOTON ROYALTY TRUST
NOTE TO STATEMENT OF ASSETS AND TRUST CORPUS
1. TRUST ORGANIZATION
Hugoton Royalty Trust ("Trust") is a grantor trust that was created on December 4, 1998 by Cross Timbers Oil Company ("Company"). The Statement of Assets and Trust Corpus reflects the Company's initial cash contribution to the Trust of $1,000.
The Trust was formed to hold net overriding royalty interests equivalent to 80% defined net profits interests in certain producing oil and gas properties in Kansas, Oklahoma and Wyoming to be conveyed by the Company effective December 1, 1998 in exchange for 40 million units of beneficial interest in the Trust ("Units").
The Trust will terminate upon the first occurrence of: (a) disposition of all Royalty Trust Interests pursuant to terms of the Trust Indenture, (b) when gross proceeds attributable to the Underlying Properties are less than $1 million per year for each of two successive years after 1999, or (c) a vote of at least 80% of the Trust Unitholders to terminate the Trust in accordance with provisions of the Trust Indenture.
HUGOTON ROYALTY TRUST
PRO FORMA STATEMENT OF ASSETS AND TRUST CORPUS (UNAUDITED)
DECEMBER 31, 1998
(IN THOUSANDS)
Cash........................................................... $ 1
Net overriding royalty interests in oil and gas properties..... 237,052
--------
Total Assets................................................. $237,053
========
Trust Corpus (40,000,000 units of beneficial interest
authorized and outstanding)................................... $237,053
========
|
See Accompanying Note to Statement of Assets and Trust Corpus.
HUGOTON ROYALTY TRUST
PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (UNAUDITED)
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT FOR PER UNIT AMOUNTS)
Gross Proceeds
Gas revenues....................................................... $77,124
Oil revenues....................................................... 7,083
-------
Total Revenues................................................... 84,207
Taxes on production and property................................... 9,170
-------
Total............................................................ 75,037
-------
Production and Development Costs
Production......................................................... 13,031
Development (Note 2)............................................... 28,600
-------
Total............................................................ 41,631
-------
Net proceeds before overhead......................................... 33,406
Overhead (Note 2).................................................... 6,198
-------
Net proceeds......................................................... 27,208
Net profits percentage............................................... 80%
-------
Trust royalty income................................................. 21,766
Administrative expense............................................... 300
-------
Distributable income................................................. $21,466
=======
Distributable income per Unit (40,000,000 Trust Units issued and
outstanding--Note 1)................................................ $ 0.54
=======
|
See Accompanying Notes to Unaudited Pro Forma Statement of Distributable Income.
HUGOTON ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (UNAUDITED)
1. BASIS OF PRESENTATION
The pro forma statement of assets and trust corpus has been prepared assuming that on December 31, 1998 net profits interests ("Net Profits Interests") were conveyed to the Trust from certain oil and gas properties ("Underlying Properties") owned by Cross Timbers Oil Company ("Company") in exchange for 40 million units of beneficial interest ("Units"). The initial pro forma carrying value of the net overriding royalty interests of $237,052,000 is based on the Company's estimated historical net book value (successful efforts method of accounting) on December 31, 1998.
The pro forma statement of distributable income of the Trust for the year ended December 31, 1998 has been prepared on a cash basis of accounting from the historical results (successful efforts method of accounting) of operations of the properties out of which the Net Profits Interests were carved and the following assumptions made:
a. The Trust was formed and the Net Profits Interests were conveyed to the Trust effective December 1, 1997.
A significant property acquisition was made by the Company during the year ended December 31, 1998. The pro forma statement of distributable income include the historical revenues and expenses of this acquisition.
b. Net proceeds related to the Net Profits Interests are received and recorded as royalty income by the Trust in the month following their receipt by the Company from the Underlying Properties.
Generally the Trust will receive and record royalty income two months after the month of production. This basis for recognizing royalty income differs from generally accepted accounting principles which requires that revenues be accrued in the month of production.
c. Royalty income is calculated based on 80% of the Net Proceeds from the Underlying Properties. Net Proceeds is a defined term in the Net Profits Interests conveyance to the Trust.
d. Administrative expense is estimated to be $300,000 annually. Such expense generally would include Trustee fees and costs incurred by the Trustee to administer the Trust and report Trust results to Unitholders, including the expense of attorneys, independent auditors, reservoir engineers, printing and mailing.
2. PRO FORMA ADJUSTMENTS
The following pro forma adjustments were made to the historical direct operating expenses of the Underlying Properties to present pro forma distributable income for the year ended December 31, 1998:
a. Historical development costs of $28,600,000 were deducted.
b. An overhead charge by the Company totalling $6,198,000 was deducted. This charge, based on a monthly count of active wells operated by the Company, is specified by the terms of the Net Profits Interest conveyance to the Trust. Such charge is deducted in the computation of Net Proceeds and represents reimbursement to the Company for costs associated with monitoring the Underlying Properties.
3. FEDERAL INCOME TAXES
As a grantor trust, the Trust will not be required to pay federal income taxes. Accordingly, the accompanying pro forma statement of distributable income does not include a provision for federal income taxes.
HUGOTON ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (UNAUDITED)--(CONTINUED)
4. CONTINGENCIES
The Company is a defendant in two separate lawsuits that could, if adversely determined, decrease future Trust distributable income. Damages relating to production prior to the formation of the Trust will be borne by the Company.
A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the Company has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling gas through affiliated companies at prices less favorable from those paid by third parties. The Company believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, the Trust would bear its proportionate share of the increased royalties through reduced Net Proceeds. The amount of any reduction in Net Proceeds is not presently determinable, but is not expected to be material.
A second lawsuit, United States of America ex rel. Grynberg v. Cross Timbers Oil Company, et al., was filed in the United States District Court for the Western District of Oklahoma. This action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, the Company has mismeasured the volume of gas and wrongfully analyzed its heating content. The suit, which was brought under the qui tam provisions of the U.S. False Claims Act, seeks treble damages for the unpaid royalties (with interest), civil penalties and an order for the Company to cease the allegedly improper measuring practices. This lawsuit is one of more than 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by the Company for production from Underlying Properties on federal and Native American lands during the 12 months ended November 30, 1998, totalled $2.8 million. The Company believes that the allegations of this lawsuit are without merit. However, an order to change measuring practices or a related settlement could adversely affect the Trust by reducing Net Proceeds in the future by an indeterminable amount.
5. PRO FORMA SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION
Proved oil and gas reserves of the Trust have been estimated as of December 31, 1998 by the Company's internal petroleum engineers. In accordance with Statement of Financial Accounting Standards No. 69, estimates of future net revenues from proved reserves have been prepared using year-end oil and gas prices and current costs to produce and develop the proved reserves. The standardized measure of future net cash flows from oil and gas reserves is calculated based on discounting such future net cash flows at an annual rate of 10%. Year-end posted West Texas Intermediate crude oil prices were $15.50 and $8.50 per barrel for 1997 and 1998, respectively. Year-end weighted average spot gas prices were $2.07, and $2.00 per Mcf for 1997 and 1998, respectively. As the Trust is not subject to taxation at the trust level, no provision is included for federal income taxes.
Reserve quantities and revenues for the Net Profits Interests were estimated from projections of reserves and revenues attributable to the Underlying Properties. Since the Trust has a defined net profits interests, the Trust does not own a specific ownership percentage of the oil and gas reserve or production quantities. Accordingly, reserves and production allocated to the Trust pertaining to its 80%
HUGOTON ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (UNAUDITED)--(CONTINUED)
net profits interest in the working interest properties have effectively been reduced to reflect recovery of the Trust's 80% portion of applicable production and development costs. Because Trust reserve quantities are determined using an allocation formula, any fluctuations in actual or assumed prices or costs will result in revisions to the estimated reserve quantities allocated to the Net Profits Interests.
Proved reserves at January 1, 1998 have been developed by adding back 1998 production volumes to the proved reserve estimate at December 31, 1998. As a result, changes in proved reserves for 1998 do not include revisions of estimates or extensions and discoveries.
The standardized measure of future net cash flows is not intended to represent the fair value of the Trust. Numerous uncertainties are inherent in estimating volumes and values of proved reserves and in projecting future production rates and timing of development expenditures. Such reserve estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production may be substantially different from the original estimates. Also, because natural gas prices are influenced by seasonal demand, use of year-end prices, as required by the Financial Accounting Standards Board, may not be representative in estimating future revenues or reserve data.
HUGOTON ROYALTY TRUST
NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (UNAUDITED)--(CONTINUED)
GAS (MCF) OIL (BBLS)
--------- ----------
(IN THOUSANDS)
PROVED RESERVES
Balance, January 1, 1998................................ 291,972 2,646
Revisions of prior estimates.......................... (5,755) (77)
Production............................................ (13,725) (171)
------- -----
Balance, December 31, 1998.............................. 272,492 2,398
======= =====
PROVED DEVELOPED RESERVES
January 1, 1998......................................... 259,050 2,325
======= =====
December 31, 1998....................................... 241,480 2,091
======= =====
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STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
RELATING TO PROVED RESERVES AT DECEMBER 31, 1998
(IN THOUSANDS)
Future cash inflows........................................ $567,762
Future production taxes.................................... 60,550
--------
Future net cash flows...................................... 507,212
10% discount factor........................................ 241,636
--------
Standardized measure of discounted future net cash flows... $265,576
========
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CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET
CASH FLOWS FROM PROVED RESERVES (IN THOUSANDS)
Standardized measure, January 1, 1998..................... $ 289,819
--------------
Trust royalty income ..................................... (21,766)
Changes in prices and other............................... (30,159)
Accretion of discount..................................... 27,682
--------------
(24,243)
--------------
Standardized measure, December 31, 1998................... $ 265,576
==============
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UNDERWRITING
The Company and the underwriters named below (the "Underwriters") have entered into an underwriting agreement with respect to the Trust Units being offered. Subject to certain conditions, each Underwriter has severally agreed to purchase the number of Trust Units indicated in the following table. Goldman, Sachs & Co., Lehman Brothers Inc., Bear, Stearns & Co., Inc., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation and A. G. Edwards & Sons, Inc. are representatives of the Underwriters.
Number of
Underwriter Trust Units
----------- -----------
Goldman, Sachs & Co.....
Lehman Brothers Inc.....
Bear, Stearns & Co.
Inc....................
Dain Rauscher Wessels a
division of Dain
Rauscher
Incorporated.....
Donaldson, Lufkin &
Jenrette Securities
Corporation............
A.G. Edwards & Sons,
Inc....................
---------
Total................. 6,000,000
=========
|
If the Underwriters sell more Trust Units than the total number set forth in the table above, the Underwriters have an option to buy up to an additional 900,000 Trust Units from the Company to cover such sales. They may exercise that option for 30 days. If any Trust Units are purchased pursuant to this option, the Underwriters will severally purchase Trust Units in approximately the same proportion as set forth in the table above.
The following table shows the per Trust Unit and total underwriting discounts and commissions to be paid to the Underwriters by the Company. Such amounts are shown assuming both no exercise and full exercise of the Underwriters' option to purchase 900,000 additional Trust Units.
Paid by the Company
-------------------------
No Exercise Full Exercise
----------- -------------
Per Trust Unit....................................... $ $
Total................................................ $ $
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Trust Units sold by the Underwriters to the public will initially be offered at the initial public offering price set forth on the cover of this prospectus. Any Trust Units sold by the Underwriters to securities dealers may be sold at a discount of up to $ per Trust Unit from the initial public offering price. Any such securities dealers may resell any Trust Units purchased from the Underwriters to certain other brokers or dealers at a discount of up to $ per Trust Unit from the initial public offering price. If all the Trust Units are not sold at the initial offering price, the representatives may change the offering price and the other selling terms.
The Company and its executive officers have agreed with the Underwriters not to dispose of or hedge any of their Trust Units or securities convertible into or exchangeable for Trust Units during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except with the prior written consent of the representatives. This agreement does not apply to any existing employee benefit plans.
Prior to the Offering, there has been no public market for the Trust Units. The initial public offering price has been negotiated among the Company and the representatives. Among the factors to be considered in determining the initial public offering price of the Trust Units, in addition to prevailing market conditions, will be estimates of distributions to Trust Unitholders and overall quality of the Underlying Properties.
The Company intends to list the Trust Units on the New York Stock Exchange under the symbol " ." In order to meet one of the requirements for listing the Trust Units on the New York Stock Exchange, the Underwriters have undertaken to sell lots of 100 or more Trust Units to a minimum of 2,000 beneficial holders.
In connection with the Offering, the Underwriters may purchase and sell Trust Units in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the Underwriters of a greater number of Trust Units than they are required to purchase in the Offering. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or retarding a decline in the market price of the Trust Units while the Offering is in progress.
The Underwriters also may impose a penalty bid. This occurs when a particular Underwriter repays to the Underwriters a portion of the underwriting discount it received because the representatives repurchased Trust Units sold by or for the account of such Underwriter in stabilizing or short covering transactions.
These activities by the Underwriters may stabilize, maintain or otherwise affect the marketprice of the Trust Units. As a result, the price of the Trust Units may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the Underwriters at any time. These transactions may be effected on the New York Stock Exchange, in the over-the-counter market or otherwise.
The Underwriters do not expect sales to discretionary accounts to exceed five percent of the total number of Trust Units offered.
The Company estimates that total expenses of the Offering, other than underwriting discounts and commissions, will be approximately $525,000.
The Company has agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary......................................................... 3
Risk Factors............................................................... 10
Forward Looking Statements................................................. 14
Use of Proceeds............................................................ 14
The Trust.................................................................. 14
Hypothetical Annual Cash Distributions..................................... 15
The Net Profits Interests and the Underlying Properties.................... 19
Computation of Net Proceeds................................................ 29
Federal Income Tax Consequences............................................ 32
State Tax Considerations................................................... 36
ERISA Considerations....................................................... 37
Description of the Trust Indenture......................................... 38
Description of the Trust Units............................................. 41
Selling Trust Unitholder................................................... 43
Legal Matters.............................................................. 43
Experts.................................................................... 44
Available Information...................................................... 44
Glossary of Certain Oil and Gas Terms...................................... 45
Index to Financial Statements.............................................. F-1
Underwriting............................................................... U-1
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Through and including , 1999 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.
6,000,000 Trust Units
HUGOTON ROYALTY TRUST
PROSPECTUS
GOLDMAN, SACHS & CO.
LEHMAN BROTHERS
BEAR, STEARNS & CO. INC.
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
DONALDSON, LUFKIN & JENRETTE
A.G. EDWARDS & SONS, INC.
REPRESENTATIVES OF THE UNDERWRITERS
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
All capitalized terms used and not defined in Part II of this Registration Statement shall have the meanings assigned to them in the Prospectus forming a part of this Registration Statement.
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
Except for the Registration Fee and the NASD Filing Fee, the following itemized table sets forth estimates of those expenses payable by the Company in connection with the offer and sale of the securities offered hereby:
Registration Fee................................................... $ 24,937
NASD Filing Fee.................................................... 9,470
Printing and Engraving Expenses.................................... 100,000
Legal Fees and Expenses............................................ 150,000
Accountants' Fees and Expenses..................................... 40,000
Miscellaneous Fees and Expenses.................................... 200,593
--------
Total.............................................................. $525,000
========
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ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 6.02 of the Trust Indenture provides that the Trustee will be indemnified by the Trust estate or, if Trust assets are insufficient, by the Company, against any and all liability and expenses incurred by it individually or as Trustee in the administration of the Trust and the Trust estate, except for any liability or expense resulting from fraud or gross negligence or acts or omissions in bad faith.
The Company is incorporated in Delaware. Under Section 145 of the Delaware General Corporation Law (the "DGCL"), a Delaware corporation has the power, under specified circumstances, to indemnify its directors, officers, employees and agents in connection with actions, suits or proceedings brought against them by a third party or in the right of the corporation, by reason that they were or are such directors, officers, employees or agents, against expenses and liabilities incurred in any such action, suit or proceeding so long as they acted in good faith and in a manner that they reasonably believed to be in, or not opposed to, the best interests of such corporation, and with respect to any criminal action, that they had no reasonable cause to believe their conduct was unlawful. With respect to suits by or in the right of such corporation, however, indemnification is generally limited to attorneys' fees and other expenses and is not available if such person is adjudged to be liable to such corporation unless the court determines that indemnification is appropriate. A Delaware corporation also has the power to purchase and maintain insurance for such persons. Article Nine of the Certificate of Incorporation of the Registrant permits indemnification of directors and officers to the fullest extent permitted by Section 145 of the DGCL. Reference is made to the Certificate of Incorporation of the Registrant.
Section 102(b)(7) of the DGCL provides that a certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provisions may not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 (relating to liability for unauthorized acquisitions or redemptions of, or dividends on, capital stock) of the DGCL or (iv) for any transaction from which the director derived an improper personal benefit. Article Ten of the Registrant's Certificate of Incorporation contains such a provision.
II-1
The above discussion of the Registrant's Certificate of Incorporation and of Sections 102(b)(7) and 145 of the DGCL is not intended to be exhaustive and is qualified in its entirety by such Certificate of Incorporation and statutes.
Additionally, the Company has acquired directors' and officers' insurance in the amount of $10 million, which provides an exclusion from coverage for liability under the federal securities laws.
ITEM 16. EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
1.1* --Form of Underwriting Agreement.
4.1 --Hugoton Royalty Trust Indenture.
5.1* --Opinion of Kelly, Hart & Hallman, P.C. as to legality of the
securities registered hereby.
8.1* --Opinion of Butler & Binion, L.L.P. regarding federal income tax
matters.
8.2* --Opinion of Morris, Laing, Evans, Brock & Kennedy, Chartered as to
Kansas State tax matters.
10.1* --Form of 80% Net Overriding Royalty Conveyance--Kansas.
10.2* --Form of 80% Net Overriding Royalty Conveyance--Oklahoma.
10.3* --Form of 80% Net Overriding Royalty Conveyance--Wyoming.
15.1 --Awareness letter of Arthur Andersen LLP.
23.1 --Consent of Arthur Andersen LLP.
--Consent of Kelly, Hart & Hallman, P.C. (set forth in their opinion
23.2* filed as Exhibit 5.1).
--Consent of Butler & Binion, L.L.P. (set forth in their opinion filed
23.3* as Exhibit 8.1).
--Consent of Morris, Laing, Evans, Brock & Kennedy, Chartered (set
23.4* forth in their opinion filed as Exhibit 8.2).
24.1 --Powers of attorney (set forth on the signature page hereof).
27.1 --Financial Data Schedule.
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ITEM 17. UNDERTAKINGS.
The Company hereby undertakes:
(a) that, for purposes of determining any liability under the Securities Act of 1933, each filing of the Company's annual reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
(b) to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser.
(c) for purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed a part of this registration statement as of the time it was declared effective.
(d) for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
II-2
Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore unenforceable. In the event that claim for indemnification against such liabilities (other than the payment by the Trust or Company of expenses incurred or paid by a director, officer or controlling person in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered the Trust or Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue.
II-3
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Company certifies that it has reasonable grounds to believe that it meets all the requirements for filing on Form S-3 and has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Fort Worth, State of Texas, on December 4, 1998.
CROSS TIMBERS OIL COMPANY,
By /s/ Bob R. Simpson ----------------------------------- BOB R. SIMPSON CHAIRMAN OF THE BOARD |
HUGOTON ROYALTY TRUST
By CROSS TIMBERS OIL COMPANY, as
sponsor
By /s/ Bob R. Simpson ------------------------------- BOB R. SIMPSON CHAIRMAN OF THE BOARD |
Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated. Each person whose signature appears below hereby authorizes and appoints J. Richard Seeds and Louis G. Baldwin, and each of them, any one of whom may act without the joinder of the other, as his attorney-in-fact to sign on his behalf individually and in the capacity stated below all amendments and post-effective amendments to this Registration Statement, and any related registration statement filed pursuant to Rule 462(b) under the Securities Act of 1933 and all amendments and post-effective amendments thereto, as such attorney-in-fact may deem necessary or appropriate.
/s/ Bob R. Simpson Director, Chairman of the December 4, 1998
______________________________________ Board and Chief Executive
BOB R. SIMPSON Officer (Principal
Executive Officer
/s/ Steffen E. Palko Director, Vice Chairman of December 4, 1998
______________________________________ the Board and President
STEFFEN E. PALKO
/s/ J. Richard Seeds Director, Executive Vice December 4, 1998
______________________________________ President
J. RICHARD SEEDS
/s/ J. Luther King, Jr. Director December 4, 1998
______________________________________
J. LUTHER KING, JR.
/s/ Jack P. Randall Director December 4, 1998
______________________________________
JACK P. RANDALL
/s/ Scott G. Sherman Director December 4, 1998
______________________________________
SCOTT G. SHERMAN
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II-4
/s/ Louis G. Baldwin Senior Vice President and December 4, 1998
______________________________________ Chief Financial Officer
LOUIS G. BALDWIN (Principal Financial
Officer)
/s/ Bennie G. Kniffen Senior Vice President and December 4, 1998
______________________________________ Controller (Principal
BENNIE G. KNIFFEN Accounting Officer)
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II-5
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- 4.1 --Hugoton Royalty Trust Indenture. 15.1 --Awareness letter of Arthur Andersen LLP. 23.1 --Consent of Arthur Andersen LLP. 24.1 --Powers of attorney (set forth on the signature page hereof). 27.1 --Financial Data Schedule. |
HUGOTON ROYALTY TRUST
ROYALTY TRUST INDENTURE
December 1, 1998
TABLE OF CONTENTS
ARTICLE I. DEFINITION............................................................ 1
Section 1.01. Defined Terms............................................. 1
ARTICLE II. NAME AND PURPOSE OF THE TRUST....................................... 4
Section 2.01. Name....................................................... 4
Section 2.02. Purposes................................................... 4
Section 2.03. Nature of the Trust........................................ 5
Section 2.04. Transfer of Trust Property to the Trust; Closing Matters... 5
ARTICLE III. ADMINISTRATION OF THE TRUST........................................ 6
Section 3.01. General.................................................... 6
Section 3.02. Limited Power to Dispose of Royalties...................... 6
Section 3.03. No Power to Engage in Business or Make Investments......... 7
Section 3.04. Interest on Cash on Hand................................... 7
Section 3.05. Power to Settle Claims..................................... 7
Section 3.06. Power to Contract for Services............................. 7
Section 3.07. Payment of Liabilities of Trust............................ 8
Section 3.08. Establishment of Reserves.................................. 8
Section 3.09. Limited Power to Borrow.................................... 8
Section 3.10. Income and Principal....................................... 8
Section 3.11. Term of Contracts.......................................... 8
Section 3.12. Transactions between Related Parties....................... 9
Section 3.13. No Bond Required........................................... 9
Section 3.14. Timing of Trust Income and Expenses........................ 9
Section 3.15. Divestiture of Units....................................... 9
Section 3.16. Filing of Registration Statements, Listing of Units....... 10
Section 3.17. Reserve Reports........................................... 12
Section 3.18. Miscellaneous............................................. 13
ARTICLE IV. BENEFICIAL SHARES AND CERTIFICATES................................... 13
Section 4.01. Creation and Distribution.................................. 13
Section 4.02. Beneficial Interest of Unitholders......................... 13
Section 4.03. Execution of Certificates.................................. 14
Section 4.04. Registration and Transfer of Unit.......................... 14
Section 4.05. Mutilated, Lost, Stolen and Destroyed Certificates......... 15
Section 4.06. Protection of Trustee...................................... 15
Section 4.07. Determination of Ownership of Certificates................. 15
ARTICLE V. ACCOUNTING AND DISTRIBUTION; REPORTS................................. 16
Section 5.01. Fiscal Year and Accounting Method.......................... 16
Section 5.02. Distributions.............................................. 16
Section 5.03. Income Tax Reporting....................................... 16
Section 5.04 Reports to Unitholders..................................... 16
Section 5.05. Filings.................................................... 17
Section 5.06. Information to be Supplied by Grantor and Trustee.......... 17
Section 5.07. Reliance on Information.................................... 17
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ARTICLE VI. LIABILITY OF TRUSTEE,
INDEMNIFICATION AND METHOD OF SUCCESSION......................................... 18
Section 6.01. Liability of Trustee....................................... 18
Section 6.02. Indemnification of Trustee................................. 18
Section 6.03. Guaranty................................................... 19
Section 6.04. Contribution............................................... 19
Section 6.05. Indemnification Procedures................................. 19
Section 6.06. Resignation of Trustee..................................... 20
Section 6.07. Removal of Trustee......................................... 20
Section 6.08. Appointment of Successor Trustee........................... 20
Section 6.09. Laws of Other Jurisdictions................................ 21
Section 6.10. Force Majeure.............................................. 21
ARTICLE VII. COMPENSATION OF THE TRUSTEE........................................ 22
Section 7.01. Compensation of Trustee.................................... 22
Section 7.02. Expenses................................................... 22
Section 7.03. Other Services............................................. 22
Section 7.04. Source of Funds............................................ 22
ARTICLE VIII. MEETINGS OF UNITHOLDERS........................................... 22
Section 8.01. Purpose of Meetings........................................ 22
Section 8.02. Call and Notice of Meetings................................ 22
Section 8.03. Voting..................................................... 23
Section 8.04. Conduct of Meetings........................................ 23
Section 8.05. Unitholder Proposals....................................... 23
ARTICLE IX. DURATION, REVOCATION AND TERMINATION OF TRUST....................... 24
Section 9.01. Revocation................................................. 24
Section 9.02. Termination................................................ 24
Section 9.03. Disposition and Distribution of Properties................. 24
ARTICLE X. AMENDMENTS........................................................... 25
Section 10.01. Prohibited................................................ 25
Section 10.02. Permitted................................................. 25
ARTICLE XI. ARBITRATION......................................................... 25
XII. MISCELLANEOUS.............................................................. 28
Section 12.01. Inspection of Trustee's Books............................. 28
Section 12.02. Trustee's Employment of Experts........................... 28
Section 12.03. Merger or Consolidation of Trustee........................ 28
Section 12.04. Filing of this Indenture.................................. 29
Section 12.05. Severability.............................................. 29
Section 12.06. Notices................................................... 29
Section 12.07. Counterparts.............................................. 30
Section 12.08. Successors................................................ 30
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HUGOTON ROYALTY TRUST INDENTURE
This Royalty Trust Indenture ("Indenture") of Hugoton Royalty Trust (the "Trust") is entered into as of December 1, 1998, between Cross Timbers Oil Company, a Delaware corporation ("Grantor"), as Grantor, and NationsBank, N.A., a banking association organized under the laws of the United States (the "Bank"), as trustee.
WHEREAS, Grantor is engaged in the business of developing and producing oil and gas and owns various mineral interests in properties that contain proved reserves of oil and gas and are currently producing oil and gas; and
WHEREAS, Grantor has determined to convey to the Trust the Royalties (hereinafter defined) pursuant to the Conveyances (hereinafter defined) in consideration for the issuance by the Trust to Grantor of 40,000,000 Units (hereinafter defined) representing the ownership of undivided Beneficial Interest (hereinafter defined) in the assets of the Trust;
NOW, THEREFORE, in furtherance of forming the Trust, Grantor has delivered to the Bank, on behalf of the Trust, One Thousand Dollars ($1,000.00) upon execution of this Indenture, which Bank accepts and agrees to hold in trust, together with the Royalties to be received hereunder, for the purposes, and in accordance with the duties, terms and conditions hereof.
ARTICLE I. DEFINITIONS
Section 1.01. Defined Terms. As used herein, the following terms are used with the meanings indicated:
"Affiliate" of a Person means another Person controlled by, controlling or under common control with such Person. As used herein, "control" (including the terms "controlling", "controlled by" and "under common control with") means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise.
"Beneficial Interest" means the aggregate equitable interest of the Unitholders in the Trust Estate as expressly set out in this Trust Indenture and all other rights of beneficiaries of express trusts created under the Texas Trust Code, subject to the limitations set forth in this Trust Indenture.
"Business Day" means any day that is not a Saturday, Sunday or other day on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law or a holiday determined by the New York Stock Exchange as "affecting 'ex' dates."
"Certificate" means a certificate issued by the Trustee pursuant to Article IV evidencing the ownership of one or more Units.
"Code" means the Internal Revenue Code of 1986, as amended.
"Closing" means the closing of the initial public offering of Units contemplated by the Securities Act Registration Statement.
"Conveyances" means the Net Overriding Royalty Conveyances effective as of December 1, 1998 between Grantor and the Trust pursuant to which the Royalties are to be conveyed to the Trust.
"Distribution Date" means the date of a distribution, which shall be on or before ten Business Days after the Monthly Record Date.
"Effective Time" means 12:01 A.M. on December 1, 1998.
"Environmental Laws" means all applicable federal, state and local laws, regulations, ordinances, rules, orders, permits and governmental restrictions relating to the environment, the effect of the environment on human health or safety, pollutants, contaminants, hazardous substances, or hazardous waste, in effect on the date of this Indenture, and all binding judicial and administrative interpretations thereof.
"Exchange Act" means the Securities Exchange Act of 1934, as amended.
"Exchange Act Registration Statement" means the registration statement by which the Units may be registered under Section 12 of the Exchange Act.
"Indenture" means this instrument, as originally executed, or, if amended or supplemented, as so amended or supplemented.
"Monthly Distribution Amount" means for each Monthly Period an amount determined by the Trustee (pursuant to Section 5.02 hereof) to be equal to the excess, if any, of (a) the cash received by the Trustee during the Monthly Period attributable to the Royalties, plus any cash available for distribution as a result of the reduction or elimination during the Monthly Period of any existing cash reserve created pursuant to Section 3.08 hereof to provide for the payment of liabilities of the Trust, plus any other cash receipts of the Trust during the Monthly Period including any cash received from interest earned pursuant to Section 3.04, other than interest earned on deposits of the Monthly Distribution Amount for any prior Monthly Period pending distribution of such amount, over (b) the liabilities of the Trust paid during the Monthly Period, plus the amount of any cash used pursuant to Section 3.08 hereof in the Monthly Period to establish or increase a cash reserve for the payment of any accrued, future or contingent liabilities of the Trust. Without limiting the foregoing, the liabilities of the Trust to be paid during the first Monthly Period shall include liabilities incurred prior to the Effective Time that relate to the formation of the Trust or for which the Trust or Trustee is otherwise responsible for payment. If the Monthly
Distribution Amount determined in accordance with the preceding sentence shall for any Monthly Period be a negative amount, then the Monthly Distribution Amount shall be zero, and such negative amount shall reduce the next Monthly Distribution Amount. Notwithstanding the foregoing, the Monthly Distribution Amount for any Monthly Period shall not include any amount which would have been required to be reported to any securities exchange or quotation system on which the Units are listed or admitted in connection with the establishment of an 'ex' date in order to be distributed to Unitholders who were such on the Monthly Record Date for such Monthly Period but was not so reported unless the securities exchange or quotation system agrees to such amount being a part of that Monthly Period's Monthly Distribution Amount or the Trustee receives an opinion of counsel, in a form reasonably satisfactory to the Trustee, stating that none of the Trust, the Trustee or any owner of Units will be adversely affected by such inclusion. An amount which pursuant to the preceding sentence is not included in the Monthly Distribution Amount for that Monthly Period shall be included in the Monthly Distribution Amount for the next Monthly Period (unless it is reserved pursuant to Section 3.08 hereof).
"Monthly Period" means, for the initial period, the period which commences on the Effective Time and continues through and includes the Monthly Record Date occurring in March 1999, and for succeeding periods the period which commences on the day following a Monthly Record Date and continues through and includes the next succeeding Monthly Record Date.
"Monthly Record Date" for each month means the close of business on the last Business Day of such month unless the Trustee determines that a different date is required to comply with applicable law or the rules of any exchange or quotation system on which the Units may be listed or admitted for trading, in which event it means such different date.
"NASD" means the National Association of Securities Dealers, Inc.
"NASDAQ" means the National Association of Securities Dealers Automated Quotation System.
"NYSE" means the New York Stock Exchange.
"Person" means an individual, a corporation, partnership, limited liability company, trust, estate or other organization.
"Reserve Report" means a report of estimated proved reserves attributable to the Royalties and the present value thereof prepared on the basis required by the SEC for inclusion in financial statements filed with the SEC.
"Royalties" means the net overriding royalty interests conveyed to the Trustee pursuant to the Conveyances.
"SEC" means the Securities and Exchange Commission and any agency which may succeed to its responsibilities and functions after the date hereof.
"Securities Act" means the Securities Act of 1933, as amended.
"Securities Act Registration Statement" means a registration statement filed under and complying with the requirements of the Securities Act, and the rules and regulations promulgated thereunder, in respect of the offering and sale of all or a fraction of the Units to the public and the transactions related thereto.
"Subject Interests" has the meaning set forth in the Conveyances.
"Transferee", as to any Unitholder or former Unitholder, means any Person succeeding to the interest of such Unitholder or former Unitholder in one or more Units of the Trust, whether as purchaser, donee, legatee or otherwise.
"Trust" means the express trust created hereby which shall be held and administered as provided herein and in accordance with the terms and provisions (not inconsistent with any terms and provisions hereof) of the Texas Trust Code.
"Trust Estate" means the assets held by the Trustee under this Indenture, and shall include both income and principal if separate accounts or records are kept therefor.
"Trustee" means the initial trustee under this instrument, or any successor, during the period it is so serving in such capacity.
"Unit" means an undivided fractional interest in the Beneficial Interest, determined as hereinafter provided.
"Unitholder" means the owner of one or more Units as reflected on the books of the Trustee pursuant to Article IV.
ARTICLE II. NAME AND PURPOSE OF THE TRUST
Section 2.01. Name. The Trust shall be known as the Hugoton Royalty Trust, and the Trustee may transact the affairs of the Trust in that name.
Section 2.02. Purposes. The purposes of the Trust are:
(a) to receive, hold, protect and conserve, for the benefit of the Unitholders, the Trust Estate;
(b) to convert the Royalties to cash either (1) by retaining them and collecting the proceeds from production payable with respect thereto until production has ceased or the Royalties have otherwise terminated or (2) by selling or otherwise disposing of all or a part of the Royalties in accordance with and subject to the terms of this Indenture;
(c) to pay, or provide for the payment of, any costs and liabilities incurred in carrying out the purposes of the Trust, and thereafter to distribute the remaining amounts of
cash received by the Trust to the Unitholders pro rata based on the number of Units owned; and
(d) subject to Section 3.03 of this Indenture, to engage in such other activities as are necessary or convenient for the attainment of any of the foregoing or are incident thereto and which may be engaged in or carried out by a trust under the Texas Trust Code.
Section 2.03. Nature of the Trust. It is the intention and agreement of Grantor and the Trustee to create an express trust within the meaning of Section 111.004(4) of the Texas Trust Code, for the benefit of the owners of Units, and a grantor trust for federal income tax purposes of which the owners of Units are the grantors. As set forth above and amplified herein, the Trust is intended to be limited to the receipt of revenues attributable to the Royalties and the distribution of such revenues, after payment of or provision for Trust expenses and liabilities, to the Unitholders. It is neither the purpose nor the intention of the parties hereto to create, and nothing in this Trust Indenture shall be construed as creating, a partnership, joint venture, joint stock company or business association between or among Unitholders, present or future, or among or between Unitholders, or any of them, and the Trustee or Grantor.
Section 2.04. Transfer of Trust Property to the Trust; Closing Matters.
Upon the execution of this Indenture, Grantor has paid to the Trustee, in trust,
and the Trustee has accepted, for the uses and purposes provided herein, the sum
of One Thousand Dollars ($1,000.00) in consideration for 40,000,000 Units to be
issued by the Trust to Grantor, which Units shall collectively represent the
entire Beneficial Interest in accordance with Section 4.01 of this Indenture.
At or before the Closing, Grantor shall grant, bargain, sell, convey and assign
the Royalties to the Trust for the uses and purposes provided herein and for the
benefit of the Unitholders, pursuant to the Conveyances. The Units to be issued
by the Trust to Grantor in accordance with the first sentence of this Section
2.04 shall be evidenced by one or more Certificates (which may be temporary
Certificates) issued in such denominations and otherwise in accordance with
written instructions furnished to the Trustee. Upon receipt of written transfer
instructions from Grantor, the Trustee shall prepare Certificates (which may be
temporary Certificates) in proper form duly executed and countersigned in
accordance with Section 4.03 of this Indenture in such names and in such
denominations as Grantor may request in writing not less than two full Business
Days before the Closing. For the purpose of expediting the checking and
packaging of the Certificates so prepared by the Trustee pursuant to the
preceding sentence, the Trustee shall make such Certificates available for
inspection by the representatives of the several underwriters named in the
Securities Act Registration Statement. The Trustee shall deliver such
Certificates to such location and at such time as is stated in the written
transfer instructions from Grantor and shall release such Certificates (a) upon
the receipt from Grantor of one or more Certificates, duly endorsed for
transfer, that evidence a number of Units equal to or not less than the number
of Units evidenced by the Certificates to be so released and (b) in accordance
with the instructions of Grantor. At the Closing, the Trustee shall receive the
following documents dated as of the date of the Closing: (i) local counsel
opinions and opinions of Kelly, Hart & Hallman, P.C. and Butler & Binion, L.L.P.
addressed to the Trustee substantially in the forms of the opinions to be
delivered by such counsel at the Closing pursuant to the underwriting agreement
referred to in the Securities Act Registration Statement (the "Underwriting
Agreement"), (ii) a certificate of Grantor signed by an executive officer
certifying that the representations and warranties of Grantor contained in the
Underwriting Agreement are true and correct as of the date of the Closing and
(iii) such other
documents or certificates as the Trustee may reasonably request; provided, that the certificate regarding Grantor's representations and warranties set forth in said Underwriting Agreement may be to the best knowledge of the officer certifying as to such representations and warranties, and shall exclude information furnished to Grantor in writing by or on behalf of the Trustee.
ARTICLE III. ADMINISTRATION OF THE TRUST
Section 3.01. General. The Trustee accepts the Trust created by this Indenture and agrees to perform its duties in accordance with the terms of this Indenture. Subject to the limitations set forth in this Indenture, the Trustee is authorized to take such action as in its judgment is necessary or advisable best to achieve the purposes of the Trust, including the authority to enter into the Conveyances, to agree to modifications or settlements of the terms of the Conveyances or to settle disputes with respect thereto, so long as such modifications or settlements do not alter the nature of the Royalties as rights to receive a share of the proceeds of oil and gas produced from the properties presently burdened by such Royalties which are free of any obligation for operating expenses and as rights which do not possess any operating rights or obligations. The Trustee may not dispose of all or any portion of the Royalties except as provided in Sections 3.02, 3.05, 3.09 and 9.03 of this Indenture.
Section 3.02. Limited Power to Dispose of Royalties.
(a) In the event the Trustee determines it to be in the best interest of the Unitholders the Trustee may sell, at any time and from time to time, all or any part of any of the Royalties for cash in such a manner as it deems in the best interest of the Unitholders if approved by the Unitholders present or represented at a meeting held in accordance with the requirements of Article VIII. This Section 3.02(a) shall not be construed to require approval of the Unitholders for any sale or other disposition of all or any part of the Royalties pursuant to Sections 3.02(b), 3.05, 3.09 or 9.03. The Trustee is authorized to retain any of the Royalties in the form in which such property was transferred to the Trustee, without regard to any requirement to diversify investments or other requirements.
(b) Grantor may at any time and from time to time notify the Trustee
that it desires to sell for cash any of the Subject Interests to any Person
not an Affiliate of Grantor free of and unburdened by the Royalties, and
upon receipt of such notice the Trustee shall be required to join in such
sale and execute and deliver a partial release, assignment or such other
instrument as Grantor may reasonably request to evidence that such Subject
Interest is being sold free and unburdened by the Royalties; provided,
however, that the Trustee shall not be required to join in such sale if the
value of the Royalties (determined as provided below) associated with the
Subject Interests to be so sold in any calendar year pursuant to this
Section 3.02(b) exceeds one percent (1%) of the value of all the Royalties
before such sale. The net proceeds from any sale pursuant to this Section
3.02(b) shall be allocated twenty percent (20%) to Grantor and eighty
percent (80%) to the Trust. For purposes of this Section 3.02(b), the
value of the Royalties associated with the Subject Interests to be sold and
of all the Royalties shall be the discounted present value of the future
net revenue attributable to the proved reserves attributable to such
Royalties, respectively, as determined by reference to the Reserve Report
as of December 31 of the year preceding the closing of the sale. The
use of such values is solely for the purpose of determining compliance with this Section 3.02(b) and it is recognized that the proceeds of sale may be greater or lesser than the value so determined.
Section 3.03. No Power to Engage in Business or Make Investments. The Trustee shall not, in its capacity as Trustee under the Trust, engage in any business or commercial activity of any kind whatsoever and shall not, under any circumstances, use any portion of the Trust Estate to acquire any oil and gas lease, royalty or other mineral interest other than the Royalties, or, except as permitted in Sections 3.04 and 3.15, acquire any other asset. The Trustee shall have no right or duty to operate the Subject Interests burdened by the Royalties or to market any production therefrom. The Trustee shall not accept contributions to the Trust other than the Royalties and the initial cash deposit.
Section 3.04. Interest on Cash on Hand. Cash being held by the Trustee as a reserve for liabilities or for distribution at the next Distribution Date shall be invested (in the Trustee's discretion) in: (a) obligations issued (or unconditionally guaranteed) by the United States of America or any agency or instrumentality thereof (provided such agency or instrumentality obligations are secured by the full faith and credit of the United States of America), (b) repurchase agreements secured by obligations qualifying under subparagraph (a) above, or (c) certificates of deposit of any bank having capital, surplus and undivided profits in excess of $100,000,000; provided such repurchase agreements or certificates of deposit shall bear interest at a rate that is not less than the greater of (i) the interest rate that the Bank or its successor pays in the normal course of business on amounts placed with it, taking into account the amounts involved, the period held and other relevant factors, or (ii) the rate of interest paid on obligations qualifying under subparagraph (a) above. Any such obligations, repurchase agreements or certificates representing funds to be distributed at the next Distribution Date must mature on or before the next succeeding Distribution Date and must be held to maturity. To the extent not prohibited by Section 113.057 of the Texas Trust Code, any such cash may be placed with the Bank or any successor bank serving as Trustee.
Section 3.05. Power to Settle Claims. Subject to the limitations specified in Article XI, the Trustee is authorized to prosecute or defend, or to settle by arbitration or otherwise, any claim of or against the Trustee, the Trust or the Trust Estate, to waive or release rights of any kind and to pay or satisfy any debt, tax or claim upon any evidence by it deemed sufficient, without the joinder or consent of any Unitholder. Such authority shall include, but not be limited to, the authority to dispose of or relinquish title to any of the Royalties that are the subject of such a dispute upon receipt of such evidence. The Trustee agrees to respond definitively to, and within a commercially reasonable time period following its receipt of, any written request by Grantor relating to any such claim and complying with the last sentence of this Section 3.05, and the failure of the Trustee so to respond definitively and timely shall conclusively estop the Trustee from thereafter claiming a right that is inconsistent with the stated intent as set forth in the notice and materially detrimental to Grantor or its Affiliates with respect to such requested matter. Any request made by Grantor intended to be governed by this Section 3.05 shall specifically reference this Section.
Section 3.06. Power to Contract for Services. In the administration of the Trust, the Trustee is empowered to employ oil and gas consultants, independent reservoir engineers, accountants (who may be the same accounting firm who are engaged as outside auditors for Grantor), attorneys (who
may be counsel to Grantor unless Grantor otherwise notifies the Trustee in writing), transfer agents and other professional and expert persons and to employ or contract for clerical and other administrative assistance (including assistance from Grantor or its Affiliates) and to make payments of all fees for services or expenses in any manner thus incurred out of the Trust Estate.
Section 3.07. Payment of Liabilities of Trust. The Trustee shall, to the extent that funds of the Trust are available therefor (which shall not include funds previously set aside for payment of a Monthly Distribution Amount), make payment of all liabilities of the Trust, including, but without limiting the generality of the foregoing, all expenses, taxes, liabilities of all kinds, including compensation to it for its services hereunder, and compensation to such parties as may be employed as provided for in Section 3.06 hereof.
Section 3.08. Establishment of Reserves. With respect to any liability which is contingent or uncertain in amount or which otherwise is not currently due and payable, the Trustee in its sole discretion may, but is not obligated to, establish a cash reserve for the payment of such liability.
Section 3.09. Limited Power to Borrow. If at any time the cash on hand and to be received by the Trust and available to pay liabilities is not, or will not be, in the judgment of the Trustee, sufficient to pay liabilities of the Trust as they become due or to purchase Units if required under Section 3.15(b), the Trustee is authorized to borrow the funds required to pay such liabilities or make such purchases. In such event, no further distributions will be made to Unitholders (except in respect of previously determined Monthly Distribution Amounts) until the indebtedness created by such borrowing has been paid in full. Such funds may be borrowed from any Person, including, without limitation, the Bank or any other fiduciary hereunder. To secure payment of such indebtedness, the Trustee is authorized to mortgage, pledge, grant security interests in or otherwise encumber (and to include as a part thereof any and all terms, powers. remedies, covenants and provisions deemed necessary or advisable in the Trustee's discretion, including, without limitation, the power of sale with or without judicial proceedings) the Trust Estate, or any portion thereof, including the Royalties, and to carve out and convey production payments.
Section 3.10. Income and Principal. The Trustee shall not be required to keep separate accounts or records for income and principal or maintain any reserves for depletion of the Royalties. However, if the Trustee does keep such separate accounts or records, then the Trustee is authorized to treat all or any part of the receipts from the Royalties as income or principal, and in general to determine all questions as between income and principal and to credit or charge to income or principal or to apportion between them any receipt or gain and any charge, disbursement or loss as is deemed advisable under the circumstances of each case. Regardless of any such characterization, however, the Trustee shall not make any distribution, accumulate any funds, or maintain any reserve except as expressly provided in this Indenture.
Section 3.11. Term of Contracts. In exercising the rights and powers granted hereunder, the Trustee is authorized to make the term of any transaction or contract or other instrument extend beyond the term of the Trust.
Section 3.12. Transactions between Related Parties. The Trustee shall not be prohibited in any way in exercising its powers from making contracts or having dealings with itself in any other capacity (fiduciary or otherwise) or with Grantor.
Section 3.13. No Bond Required. The Trustee shall not be required to furnish any bond or security of any kind.
Section 3.14. Timing of Trust Income and Expenses. The Trustee will use all reasonable efforts to cause the Trust and the Unitholders to recognize income and expenses on Monthly Record Dates. The Trustee will invoice the Trust for services rendered by the Trustee only on a Monthly Record Date and shall cause the Trust to pay any such invoices only on the Monthly Record Date on which an invoice is rendered and will use all reasonable efforts to cause all Persons to whom the Trust becomes liable to invoice the Trust for such liability on a Monthly Record Date and to cause the Trust to pay any such liabilities on the Monthly Record Date on which such liability is invoiced. In connection with the requirements of any securities exchange on which the Units are listed or market system through which Units are traded, the Trustee will, if required by such securities exchange or market system, use all reasonable efforts to determine the Monthly Distribution Amount and report such amount to the exchange or market system at such time as may be required by such securities exchange or market system. Nothing in this Section 3.14 shall be construed as requiring the Trustee to cause payment to be made for Trust liabilities on any date other than on such date as in its sole discretion it shall deem to be in the best interest of the Unitholders.
Section 3.15. Divestiture of Units. If at any time the Trust or the Trustee is named a party in any judicial or administrative proceeding which seeks the cancellation or forfeiture of any property in which the Trust has an interest because of the nationality, or any other status, of any one or more Unitholders, the following procedures will be applicable:
(a) The Trustee will promptly give written notice ("Notice") to each Unitholder ("Ineligible Holder") whose nationality or other status is an issue in the proceeding as to the existence of such controversy related to the Royalties, the Trust or the Trust Units. The Notice will contain a reasonable summary of such controversy and will constitute a demand to each Ineligible Holder that he dispose of his Units to a party which would not be an Ineligible Holder within 30 days after the date of the Notice.
(b) If any Ineligible Holder fails to dispose of his Units as required by the Notice, the Trustee will have the right to purchase, and will purchase, any such Units at any time during the 90 days after the expiration of the 30-day period specified in the Notice. The purchase price on a per Unit basis will be determined as of the last Business Day ("determination day") preceding the end of the 30-day period specified in the Notice and will equal the following per Unit amount: (i) if the Units are then listed on a securities exchange the price will equal the closing price of the Units on such exchange (or, if the Units are then listed on more than one exchange, on the largest such exchange in terms of the volume of Units traded thereon during the preceding twelve months) on the determination day if any Units were sold on such exchange on such day or, if not, on the last preceding day on which any Units were sold on such exchange or (ii) if the Units are not then listed on any securities exchange, but are traded through a market system, the price will equal the mean between the
closing bid and asked prices for the Units in such market system on the determination day if quotations for such prices on such day are available or, if not, on the last preceding day for which such quotations are available or (iii) if the Units are not then listed on any stock exchange or traded through any market system, the price will be determined by multiplying the present value of the estimated future net revenues attributable to proved reserves of the Royalties as reflected in the latest Reserve Report prepared for the Trust (minus all liabilities of the Trust) by 1.4 and by then dividing such amount by the number of Units (including the Units to be purchased) then outstanding. Such purchase will be accomplished by tender of the above cash price to the Ineligible Holder at his address as shown on the records of the Trustee, either in person or by mail as provided in Section 12.06, accompanied by notice of cancellation. Concurrently with such tender the Trustee shall cancel or cause to be cancelled all Certificates representing Units then owned by such Ineligible Holder and for which tender has been made, and the Trustee shall issue or cause to be issued to itself a Certificate or Certificates representing the same number of Units as were so cancelled. Upon such cancellation, the Ineligible Holder shall part with the Beneficial Interest attributable to the Units theretofore owned by him and all interests, rights and benefits of the Ineligible Holder as a Unitholder shall terminate. In the event the tender is refused by the Ineligible Holder or if he cannot be located after reasonable efforts to do so, the tendered sum shall be held by the Trustee in an interest bearing account for the benefit of such Ineligible Holder, until proper claim for same (together with interest accrued thereon) has been made by such Holder, but subject to applicable laws concerning unclaimed property.
(c) The Trustee may, in its sole discretion, cancel any Units acquired in accordance with the foregoing procedures or may sell such Units, either publicly or privately, in accordance with all applicable laws. The proceeds of any such sale of Units, less the expenses of such sale, will constitute revenues of the Trust.
Section 3.16. Filing of Registration Statements, Listing of Units.
(a) The Trustee shall, in connection with the initial public offering of the Units and otherwise, upon the request of Grantor, on behalf of the Trust, cooperate with Grantor and otherwise use its best efforts to cause:
(i) one or more Securities Act Registration Statements to be prepared, signed, filed and declared effective by the SEC;
(ii) an Exchange Act Registration Statement to be prepared, signed, filed and become effective;
(iii) the Units to be qualified or exempted from qualification under the securities or Blue Sky laws of the several states; and
(iv) the Units to be listed for trading on the NYSE or another national securities exchange, as it shall select, or, if listing on a national securities exchange is not feasible or is undesirable, to cause the Units to be admitted for quotation on the NASDAQ.
(b) Grantor shall be obligated and entitled, at its own expense except as otherwise herein provided, to take or cause to be taken all steps customary or appropriate to the accomplishment of the objectives set forth above including, without limitation, engaging counsel for itself and approving special counsel for the Trust, engaging accountants for the Trust, contracting for all printing and engraving services, making all filings and applications necessary to the foregoing and paying all filing and application fees associated therewith. The Trustee shall execute, by and on behalf of the Trust, any documents incidental or related to the foregoing as reasonably requested by Grantor. Notwithstanding anything in this Section 3.16 to the contrary, unless required by the SEC, the Trustee shall not be required to sign any Securities Act Registration Statement or Exchange Act Registration Statement in connection with the initial public offering or any subsequent offering of the Units. If the Trustee does not sign any Securities Act Registration Statement or Exchange Act Registration Statement on behalf of the Trust in connection with the initial public offering or any subsequent offering of the Units by Grantor, then Grantor may sign on behalf of the Trust.
(c) Except as precluded in Article VI, the reasonable fees, charges, expenses, disbursements and other costs incurred by the Trustee in connection with the discharge of its duties under this Section 3.16 shall be paid by Grantor.
(d) The Trustee shall cooperate with and assist Grantor in every
reasonable way and in good faith in accomplishing the foregoing. Among
other things, the Trustee shall permit counsel, special counsel and
accountants engaged by Grantor and other representatives of Grantor
reasonable access to information responsive to the requirements of the
Securities Act, the Exchange Act, the securities or Blue Sky laws of the
several states, the rules of any securities exchange upon which listing is
to be sought and the rules of the NASD, and to Trustee personnel having
such information, as fully and to the same extent as if the Trustee were
proceeding for its own purposes to accomplish such objectives. The Trustee
agrees to provide Grantor with the authority and, if required pursuant to
Section 3.16(b) above, the signatures required for the filing of the
Securities Act Registration Statements, the Exchange Act Registration
Statement, and registration statements, notices of exemption, applications
for exemption, consents to service of process and all other documents
necessary to comply with the Blue Sky laws of the several states, a listing
application with the NYSE or any other national securities exchange or an
application for quotation on the NASDAQ. The Trustee shall also provide
Grantor upon request with a Unitholders' list as of the latest Monthly
Record Date in such form as Grantor may reasonably request.
(e) After the registration of the Units pursuant to the Exchange Act and/or the listing of the Units on the NYSE or another national securities exchange or the admission for quotation of the Units on the NASDAQ, the Trustee, on behalf of the Trust, shall cause the Trust to comply with all of the rules, orders and regulations of the SEC, such exchange or the NASDAQ, and take all such other actions necessary for the Units to remain so registered, listed or admitted for quotation until the Trust is terminated.
(f) The Trustee shall be empowered to, in connection with the initial public offering of the Units or such other public offering of Units, upon request of Grantor, in the
name and on behalf of the Trust, enter into any underwriting or similar securities purchase agreement for the purpose of causing the Trust to provide certain warranties and agreements, including, without limitation, providing, jointly and severally with the Grantor, indemnification in favor of the underwriters and their control persons for material misstatements and omissions made in connection with the public offering (and related contribution agreements), and in connection therewith the Trustee shall, upon request of Grantor, provide certificates and other documents (provided that in no event shall the Trustee be required to sign any registration statement under the Securities Act or Exchange Act unless required to do so by the SEC) and engage legal counsel to provide opinions of counsel reasonably requested by the underwriters under such agreements; provided that the warranties and agreements or obligations of the Trust under this paragraph (f) shall be limited soley to the assets of the Trust and shall not result in the incurrence of any liability by the Trustee or any Unitholder.
(g) To the fullest extent permitted by law, Grantor agrees to defend,
indemnify and hold the Trust and the Trustee harmless from and against any
loss, cost, claim, damage, expense or liability, joint or several, or any
action in respect thereof, to which the Trust or the Trustee or the
officers, employees or agents of the Trustee or any controlling person of
the Trustee becomes subject, under the Securities Act or the Exchange Act,
or otherwise, insofar as such loss, cost, claim, damage, expense or
liability or action arises out of, or is based upon, (i) any untrue
statement or alleged untrue statement of a material fact contained in any
Securities Act Registration Statement or Exchange Act Registration
Statement, or any other document filed by or on behalf of Grantor with the
SEC, or any other statement publicly made by or on behalf of Grantor, or
(ii) the omission or alleged omission to state in any Securities Act
Registration Statement or Exchange Act Registration Statement, or any other
document, or any other statement publicly made by or on behalf of Grantor,
any material fact required to be stated therein or necessary to make the
statements therein not misleading; provided, however, that Grantor shall
not be liable in any case to the extent that any such loss, cost, claim,
damage, expense, liability or action arises out of, or is based upon, (A)
any fraudulent misrepresentation, gross negligence or willful misconduct of
the Trustee or (B) any untrue statement or alleged untrue statement or
omission or alleged omission included in any such Securities Act
Registration Statement or Exchange Act Registration Statement, or any other
document filed by or on behalf of Grantor, the Trust or the Trustee with
the SEC, or any other statement publicly made by or on behalf of Grantor,
the Trust or the Trustee in reliance upon and in conformity with written
information furnished by or on behalf of the Trustee specifically for
inclusion therein. This provision shall in no way limit the general rights
to indemnification and contribution and limitations on liability of the
Trust and Trustee set forth in Article VI of this Indenture or elsewhere
herein.
Section 3.17. Reserve Reports. If a Reserve Report for the Royalties is not provided by Grantor pursuant to Section 4.08 of the Conveyances, the Trustee shall cause a Reserve Report for the Royalties to be prepared as of December 31 of each year, in accordance with criteria established by the SEC showing estimated proved oil and gas reserves attributable to the Royalties as of December 31 of such year and other reserve information required in order for the Trustee to furnish the information required in Sections 5.03 and 5.04 of this Indenture. The Reserve Reports shall be prepared by a firm of independent petroleum engineers selected by the Trustee. Such Reserve Report
shall also show estimated future net revenues and the net present value (discounted at 10 percent or such other rate required by the SEC) of the estimated future net revenues (calculated in accordance with criteria established by the SEC) of proved reserves attributable to the Royalties. The costs of such Reserve Reports, whether provided by Grantor or obtained by the Trustee, shall constitute an administrative expense of the Trust payable out of the Trust Estate pursuant to Section 3.07. Grantor shall assist the Trustee in the preparation of the Reserve Reports by furnishing all current and existing reserve, production and geophysical data in its possession relating to the Royalties reasonably requested by or on behalf of the independent petroleum engineers selected by the Trustee as necessary to prepare such Reserve Reports; provided, that Grantor shall not be required to disclose or produce any information, documents or other materials which (a) were generated for analysis or discussion purposes or contain interpretative data or (b) are subject to the attorney-client or attorney-work product privileges, or any other privileges to which Grantor may be entitled pursuant to applicable law.
Section 3.18. Miscellaneous. Except as otherwise provided in this Indenture, this Indenture and the Trust shall be governed, construed, administered and controlled by and under the laws of the State of Texas, and the rights, powers, duties and liabilities of the Trustee shall be in accordance with and governed by the terms and provisions of the Texas Trust Code and other applicable laws of the State of Texas as in effect at any applicable time.
ARTICLE IV. BENEFICIAL SHARES AND CERTIFICATES
Section 4.01. Creation and Distribution. The entire Beneficial Interest shall be divided into 40,000,000 Units. The ownership of the Units shall be evidenced by Certificates in substantially the form of Schedule 1 attached to this Indenture, containing such changes or alterations of form, but not substance, as the Trustee shall from time to time, in its discretion, deem necessary or desirable.
Section 4.02. Beneficial Interest of Unitholders. Each Unit shall
represent pro rata undivided ownership of the Beneficial Interest and shall
entitle its holder to participate pro rata in the rights and benefits of the
Unitholders under this Indenture. A Unitholder (by assignment or otherwise)
shall take and hold each Unit subject to all the terms and provisions of this
Indenture and the Conveyances, which shall be binding upon and inure to the
benefit of the heirs, personal representatives, successors and assigns of the
Unitholder. By an assignment or transfer of one or more Units represented by a
Certificate, the assignor thereby shall, effective as of the close of business
on the date of transfer and with respect to such assigned or transferred Unit or
Units, part with, except as provided in Section 4.04 in the case of a transfer
after a Monthly Record Date and prior to the corresponding monthly payment date,
(i) all his Beneficial Interest attributable thereto; (ii) all his rights in, to
and under such Certificate; and (iii) all interests, rights and benefits under
this Trust of a Unitholder which are attributable to such Unit or Units as
against all other Unitholders and the Trustee. The Certificates, the Units and
the rights, benefits and interests evidenced by either or both (including,
without limiting the foregoing, the entire Beneficial Interest) are and shall be
held and construed to be in all respects intangible personal property, and the
Certificates and Units evidenced thereby shall be bequeathed, assigned, disposed
of and distributed as intangible personal property. No Unitholder as such shall
have any legal or equitable title in or to any real or personal property
interest which is a part of the Trust Estate, including, without limiting the
foregoing, the
Royalties or any part thereof, but the sole interest of each Unitholder shall be such Unitholder's Beneficial Interest and the obligation of the Trustee to hold, manage and dispose of the Trust Estate and to account for the proceeds thereof as herein provided. No Unitholder shall have the right to call for or demand or secure any partition or distribution of the Royalties during the continuance of the Trust or during the period of liquidation and winding up under Section 9.03 of this Indenture.
Section 4.03. Execution of Certificates.
(a) All Certificates shall be signed by a duly authorized officer of the Trustee. Certificates may be signed on behalf of the Trustee by such persons as at the actual date of the signing of such Certificates shall be the proper officers of the Trustee, although at the nominal date of such Certificates any such person shall not have been such officer of the Trustee. Any such signature may be the manual or facsimile signature (to the extent permitted by law or the rules or regulations of any stock exchange or quotation system on which the Units are listed or traded) of such officers and may be affixed, imprinted or otherwise reproduced on the Certificate.
(b) Pending the preparation of definitive Certificates, the Trustee shall execute, and the transfer agent and registrar for the Units appointed in accordance with Section 3.06 of this Indenture shall countersign and register, temporary Certificates, as directed in a certificate of an officer of Grantor. Temporary Certificates may contain such references to any provisions of this Indenture as may be appropriate. Each temporary Certificate shall be executed by the Trustee and signed and registered upon the same conditions and in substantially the same manner, and with like effect as the definitive Certificates.
(c) As promptly as practicable, the Trustee shall execute and furnish definitive Certificates and thereupon temporary Certificates may be surrendered in exchange therefor without charge to the Unitholders at the principal office of the transfer agent at which Certificates may be presented for transfer pursuant to Section 4.04 hereof, and the Trustee (or the transfer agent and registrar if the Trustee is not serving in such capacities) shall sign and register in exchange for such temporary Certificates a like aggregate amount of definitive Certificates. Until so exchanged, the temporary Certificates shall be entitled to the same benefits under this Indenture as definitive Certificates.
Section 4.04. Registration and Transfer of Units. The Units shall be transferable as against the Trustee as provided herein, and then only on the records of the Trustee and, except as provided in Section 3.15 hereof, upon the surrender of Certificates, if any, and compliance with such reasonable regulations as it may prescribe. No service charge shall be made to Unitholders or Transferees for any transfer of a Unit, but the Trustee may require payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto. Until any such transfer is completed, the Trustee may treat the owner of any Unit as shown by its records as the owner of the Unit for all purposes and shall not be charged with notice of any claim or demand respecting such Unit or the Beneficial Interest represented thereby by any other party. Any such transfer of a Unit shall, as to the Trustee, transfer to the Transferee as of the close of business on the date of transfer all of the Beneficial Interest of the transferor; provided that a transfer of a Unit after any Monthly Record Date shall not transfer to the Transferee the right of the transferor to any sum
payable to such transferor as title holder of the Certificate of record on said Monthly Record Date. As to matters affecting the title, ownership, warranty or transfer of Units and Certificates, except as provided to the contrary herein, Article 8 of the Uniform Commercial Code, the Texas Uniform Act for Simplification of Fiduciary Security Transfers under Chapter 33 of the Texas Business and Commerce Code and other statutes and rules with respect to the transfer of securities, each as adopted and then in force in the State of Texas, shall govern and apply. The death of any Unitholder shall not entitle the Transferee to an accounting or valuation for any purpose, but such Transferee shall succeed to all rights of the deceased Unitholder under this Indenture upon proper proof of title satisfactory to the Trustee.
Section 4.05. Mutilated, Lost, Stolen and Destroyed Certificates. If any Certificate is lost, stolen, destroyed or mutilated, the Trustee, in its discretion and upon proof satisfactory to the Trustee, together with receipt by the Trustee of a surety bond sufficient in the opinion of the Trustee to indemnify the Trustee and the Trust against all losses and expenses that may reasonably be expected to be incurred in connection therewith (if deemed advisable by the Trustee), and surrender of the mutilated Certificate, will issue a new Certificate to the holder of such lost, stolen, destroyed or mutilated Certificate as shown by the records of the Trustee, upon payment of a reasonable charge of the Trustee and any reasonable expenses incurred by it in connection therewith.
Section 4.06. Protection of Trustee. The Trustee shall be protected in acting or relying upon any notice, certificate, assignment or other document or instrument believed by the Trustee to be genuine and to be signed by the proper party or parties, including, without limitation, any instructions or documents received from Grantor in connection with this Indenture. Except as provided herein to the contrary, the Trustee is specifically authorized to rely upon the application of Article 8 of the Uniform Commercial Code, the application of the Texas Uniform Act for Simplification of Fiduciary Security Transfers under Chapter 33 of the Texas Business and Commerce Code and the application of other statutes and rules with respect to the transfer of securities, each as adopted and then in force in the State of Texas, as to all matters affecting title, ownership, warranty or transfer of the Certificates and the Units represented thereby, without any personal liability for such reliance, and the indemnity granted under Section 6.02 of this Indenture shall specifically extend to any matters arising as a result thereof.
Section 4.07. Determination of Ownership of Certificates. In the event of any disagreement between persons claiming to be Transferees of any Unit, and in addition to any other rights it may have under applicable law, the Trustee shall be entitled, at its option, to refuse to recognize any such claim so long as such disagreement shall continue. In so refusing, the Trustee may elect to make no delivery or other disposition of the interest represented by the Certificate involved, or any part thereof, or of any sum or sums of money, accrued or accruing thereunder, and, in so doing, the Trustee shall not be or become liable to any Person for the failure or refusal of the Trustee to comply with such conflicting claims, and the Trustee shall be entitled to continue so to refrain and refuse so to act, until
(a) the rights of the adverse claimants have been adjudicated by arbitration (pursuant to Article XI) or by a final nonappealable judgment of a court assuming and having jurisdiction of the parties and the interest and money involved, or
(b) all differences have been resolved by valid agreement between said parties and the Trustee shall have been notified thereof in writing signed by all of the interested parties.
ARTICLE V. ACCOUNTING AND DISTRIBUTION; REPORTS
Section 5.01. Fiscal Year and Accounting Method. The fiscal year of the Trust shall be the calendar year. The Trustee shall maintain its books in accordance with generally accepted accounting principles or such other method as will provide appropriate financial data responsive to the needs of the Unitholders and which shall comply with Sections 5.03 and 5.04.
Section 5.02. Distributions. The Trustee shall determine the Monthly Distribution Amount for each month and shall establish a cash reserve equal to such amount on the Monthly Record Date for such month. On the Distribution Date for such Monthly Distribution Amount, the Trustee will distribute pro rata to the Unitholders of record on such Monthly Record Date such Monthly Distribution Amount.
Section 5.03. Income Tax Reporting. For federal or state income tax purposes, the Trustee shall file for the Trust such returns and statements as in its judgment are required to comply with applicable provisions of the Code and regulations and any applicable state laws and regulations, in either case to permit each Unitholder to report such Unitholder's share of the income and deductions of the Trust. The Trustee will treat all income and deductions of the Trust for each month as having been realized on the Monthly Record Date for such month unless otherwise advised by its counsel or the Internal Revenue Service. The Trustee will report as a grantor trust until and unless it receives an opinion of tax counsel that such reporting is no longer proper. Within 75 days following the end of each fiscal year, the Trustee shall mail, to each Unitholder of record on a Monthly Record Date during such fiscal year, a report which shall show in reasonable detail such information as is necessary to permit all holders of record of Units on a Monthly Record Date during such fiscal year to make calculations necessary for tax purposes, including depletion.
Section 5.04 Reports to Unitholders. As promptly as practicable
following the end of each calendar quarter except the fourth calendar quarter,
(a) the Trustee shall mail to each Person who was a Unitholder of record on a
Monthly Record Date during such quarter a report which shall show in reasonable
detail such information as is necessary to permit holders of Units to make all
calculations necessary for tax purposes including depletion, and (b) the Trustee
shall mail to each Person who was a Unitholder of record on the last Monthly
Record Date during such calendar quarter a report, which may be a copy of the
Trust's report on Form 10Q under the Exchange Act, which shall show the assets
and liabilities of the Trust at the end of such quarter and distributable income
of the Trust for such quarter. Within 120 days following the end of each fiscal
year, the Trustee shall mail, to each Unitholder of record on a date to be
selected by the Trustee, an annual report containing financial statements
audited by a nationally recognized firm of public accountants selected by the
Trustee. Notwithstanding the foregoing, the Trustee will furnish to the
Unitholders such reports, in such manner and at such times, as are at any time
required by law or by rules or regulations of any securities exchange or
quotation system on which the Units are listed or admitted for trading.
Section 5.05. Filings. The Trustee is authorized to make all Exchange Act filings on behalf of the Trust required by applicable law or regulation. It is the intention of Grantor that the Units be listed on the NYSE, and, in this regard, Grantor shall advise the Trustee of any actions (consistent with the purposes of the Trust) that the Trustee should take in connection with the effectuation of such listing. If listing is accomplished, the Trustee shall take all reasonable actions necessary to maintain such listing, including compliance with the stock exchange's rules and the filing of any reports required by the stock exchange. Grantor shall prepare and file all filings and reports required under the Securities Act or state securities or Blue Sky laws. The Trustee is authorized to and shall take all reasonable actions to prepare and mail to Unitholders, any reports, press releases or statements, financial or otherwise, that Grantor notifies the Trustee in writing are required to be provided by the Trust to Unitholders by law or governmental regulation or the requirements of any securities exchange or quotation system on which the Units are listed or admitted for trading, subject to receipt by the Trustee of a satisfactory opinion of counsel confirming the necessity of such reports, if such an opinion is deemed necessary by the Trustee.
Section 5.06. Information to be Supplied by Grantor and Trustee. Grantor
shall provide, or cause to be provided, to the Trustee on a timely basis (a) an
annual audited statement of revenues and direct operating expenses of the
Subject Interests and quarterly statements of revenues and direct operating
expenses of the Subject Interests, which quarterly statements may be on a
condensed basis and need not be audited by a firm of independent accountants and
(b) such other information as is not known to the Trustee or is otherwise more
easily available to Grantor than to the Trustee concerning the Royalties
(including information with respect to the properties burdened by the Royalties)
and related matters as shall be necessary for Trustee to comply with the
reporting obligations of the Trust pursuant to the Exchange Act, the
requirements of any securities exchange or quotation system on which the Units
are listed or admitted for trading and this Indenture, including, without
limitation, Sections 5.03, 5.04 and 5.05 hereof. For purposes of this Section
5.06, the phrase "timely basis" shall mean not less than 10 days prior to the
date on which the Trustee is required to comply with such reporting obligations
of the Trust. In addition, Grantor shall provide to the Trustee on a timely
basis, for use in connection with the Trust's Form 10-K annual report, a
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" relating to such financial statements. Notwithstanding any
provision to the contrary in this Indenture or the Conveyances, Grantor and its
Affiliates shall not be required to disclose, produce or prepare any
information, documents or other materials which (i) were generated for analysis
or discussion purposes or contain interpretative data or (ii) are subject to the
attorney-client or attorney-work-product privileges, or any other privileges to
which they may be entitled pursuant to applicable law. At least one Business Day
prior to reporting the Monthly Distribution Amount to the securities exchange or
market system in accordance with Section 3.14, the Trustee shall provide to
Grantor a written and reasonably detailed report showing such Monthly
Distribution Amount and each administrative cost of the Trust paid or payable
for such Monthly Period, including, but not limited to, each out-of-pocket
expenditure, and all Trustee compensation. The Trustee will respond promptly to
Grantor's reasonable questions regarding such report.
Section 5.07. Reliance on Information. The Trustee, so long as acting in
good faith, shall be entitled to rely, without investigation, on all information
provided to it by Grantor for purposes of complying with the reporting
obligations of the Trust as contemplated by Section 5.06, including, without
limitation, information regarding depletion and entitlement to tax credits under
Section 29
of the Code. Notwithstanding any time limit imposed by applicable laws or regulations or by the provisions of this Indenture, if, due to the unavailability prior to the expiration of any such time limit of information necessary, or a delay in receipt by the Trustee of information necessary, for preparation of a report required to be filed, made or delivered by the Trustee, the Trustee shall be unable to prepare and file or mail such report within such time limit, the Trustee shall prepare and file or mail such report as soon as practicable after such information is received.
ARTICLE VI. LIABILITY OF TRUSTEE,
INDEMNIFICATION AND METHOD OF SUCCESSION
Section 6.01. Liability of Trustee.
(a) Except as otherwise provided herein and specifically except as provided in subparagraph (b) below, the Trustee, in carrying out its powers and performing its duties, may act in its discretion directly, or at the expense of the Trust, through agents or attorneys pursuant to agreements entered into with any of them, and shall be personally or individually liable only for fraud or gross negligence or for acts or omissions in bad faith as adjudicated by final, nonappealable judgment of a court of competent jurisdiction and shall not individually or personally be liable for any act or omission of any agent or employee of the Trustee unless the Trustee has acted in bad faith or with gross negligence in the selection and retention of such agent or employee.
(b) If the Trustee enters into a contract on behalf of the Trust Estate without ensuring that any liability arising out of such contract shall be satisfiable only out of the Trust Estate and shall not in any event, including the exhaustion of the Trust Estate, be satisfiable out of amounts at any time distributed to any Unitholder or out of any other assets owned by any Unitholder, then Trustee, vis-a-vis the Unitholders, shall be fully and exclusively liable for such liability, but shall have the right to be indemnified and reimbursed from the Trust Estate to the extent provided in Section 6.02.
Section 6.02. Indemnification of Trustee. The Trustee and its officers,
agents and employees when acting in such capacity shall be indemnified by, and
receive reimbursement from, the Trust Estate against and from any and all
liability, expense, claims, damages or loss incurred by it individually or as
Trustee in the administration of the Trust and the Trust Estate or any part or
parts thereof, including, without limitation, any liability, expense, claims,
damages or loss arising out of or in connection with any liability under
Environmental Laws, or in the doing of any act done or performed or omission
occurring on account of its being Trustee or acting in such capacity, except
such liability, expense, claims, damages or loss as to which it is liable under
Section 6.01. Trustee shall have a lien upon the Trust Estate to secure it for
such indemnification and reimbursement and for compensation to be paid to
Trustee. Except as provided in Section 4.05, neither the Trustee nor any
officer, agent or employee of the Trustee shall be entitled to any reimbursement
or indemnification from any Unitholder for any liability, expense, claims,
damages or loss incurred by the Trustee or any such officer, agent or employee,
their right of reimbursement and indemnification, if any, being limited solely
to the Trust Estate (and Grantor pursuant to Section 6.03), whether or not the
Trust Estate is exhausted without full reimbursement or indemnification of the
Trustee or any such officer, agent or employee.
Section 6.03. Guaranty. If the Trust Estate is exhausted without the Trustee (or any officer, agent or employee of the Trustee) being fully reimbursed as provided in Section 6.02 above, then Grantor shall fulfill the remaining indemnity obligation to the Trustee.
Section 6.04. Contribution. If the indemnification provided for in this Indenture shall for any reason (including, without limitation, due to violation of public policy) be unavailable to or insufficient to hold harmless the Trustee in respect of any liability, expense, claims, damages or loss as to which the Trustee would otherwise be entitled to indemnification pursuant to Section 3.16(f), 6.02 or 6.03, then Grantor and the Trust shall, in lieu of indemnifying the Trustee, contribute to the amount paid or payable by the Trustee as a result of such liability, expense, claims, damages or loss, in such proportion as shall be appropriate to reflect the relative fault of Grantor (with respect to contribution by the Trust or Grantor) or the Trustee with respect to the events, acts or circumstances giving rise to the liability, expense, claims, damages or loss, as well as any other relevant equitable considerations. For purposes of determining contribution liability with respect to claims based upon the Securities Act or Exchange Act, relative fault shall be determined by reference to whether the untrue or alleged untrue statement of a material fact or omission or alleged omission to state a material fact relates to information supplied by Grantor or by the Trustee. The Trustee shall look first to the Trust Estate for contribution under this Section 6.04, and then to Grantor to the extent the assets of the Trust Estate are not sufficient to reimburse the Trustee fully for all such liability, expense, claims, damages or loss.
Section 6.05. Indemnification Procedures. If any action or proceeding shall be brought or asserted against the Trust, or the Trustee or any officer, agent or employee thereof (each referred to as an "Indemnified Party" and, collectively, the "Indemnified Parties") in respect of which indemnity may be sought from Grantor or the Trust (the "Indemnifying Party") pursuant to Sections 6.02 or 6.03 of this Indenture, of which the Indemnified Party shall have received notice, the Indemnified Party shall promptly notify the Indemnifying Party in writing, and the Indemnifying Party shall assume the defense thereof, including the employment of counsel reasonably satisfactory to the Indemnified party and the payment of all costs and expenses; provided, however, that the failure so to notify the Indemnifying Party of the commencement of any such action or proceeding shall not relieve the Indemnifying Party from any liability that it may have to any Indemnified Party unless the Indemnifying Party or Grantor is prejudiced or damaged by the failure to receive prompt notice. The Indemnified Party shall have the right to employ separate counsel in any such action and to participate in the defense thereof, but the fees and expenses of such counsel shall be at the expense of the Indemnified Party unless (i) the Indemnifying Party has agreed to pay such fees and expenses, (ii) the Indemnifying Party shall have failed to assume the defense of such action or proceeding and employ counsel reasonably satisfactory (including the qualifications of such counsel) to the Indemnified Party on any such action or proceeding or (iii) the named parties to any such action or proceeding include both the Indemnified Party and the Indemnifying Party and the Indemnified Party shall have been advised by counsel that there may be one or more legal defenses available to such Indemnified Party that are different from or in addition to those available to the Indemnifying Party or any other Indemnified Party (in which case, if the Indemnified Party notifies the Indemnifying Party in writing that it elects to employ separate counsel at the expense of the Indemnifying Party, the Indemnifying Party shall not have the right to assume the defense of such action or proceeding on behalf of the Indemnified Party and the Indemnified Party may employ such counsel for the
defense of such action or proceeding as is reasonably satisfactory to the Indemnifying Party; it being understood, however, that except in the case of the addition of counsel caused by the existence or development of a conflict rendering unified representation impermissible or unadvisable, the Indemnifying Party shall not, in connection with any one such action or proceeding or separate but substantially similar or related actions or proceedings in the same jurisdiction arising out of the same general allegations or circumstances, be liable for the fees and expenses of more than one separate firm of attorneys for the Indemnified Parties at any time). The Indemnifying Party shall not be liable for any settlement of any such action or proceeding effected without the written consent of the Indemnifying Party, but, if settled with such written consent, or if there be a final judgment for the plaintiff in any such action or proceeding, the Indemnifying Party agrees (to the extent stated above) to indemnify and hold harmless the Indemnified Party from and against any liability, expense, claims, damages or loss by reason of such settlement or judgment. The Indemnified Party and the Indemnifying Party (if not Grantor) shall, if so requested by Grantor, provide reports to Grantor on the status of such actions or proceedings.
Section 6.06. Resignation of Trustee. The Trustee may resign, with or without cause, at any time by notice to Grantor and each of the then Unitholders of record. Such notice shall specify a date when such resignation shall take effect, which shall be a Business Day not less than ninety days after the date such notice is mailed; provided, however, that in no event shall any resignation of the Trustee be effective until a qualified successor Trustee has accepted appointment as successor Trustee. In case of such resignation, the Trustee will use its best efforts to nominate a successor, and will call a meeting of Unitholders for the purpose of appointing a successor, and will solicit proxies for such meeting. If the Trustee has given notice of resignation in accordance with this Section 6.06 and a successor has not accepted its appointment as successor Trustee during the 180-day period following the receipt by Grantor of such notice of resignation, the annual fee payable to the Trustee as set forth on Schedule 2 attached hereto shall be increased as of the end of such 180-day period by ten percent and shall further be increased by ten percent for each month to a maximum of three times the fee payable at the time the notice of resignation was received by Grantor until a successor has accepted its appointment as successor Trustee.
Section 6.07. Removal of Trustee. The Trustee may be removed, with or without cause, at a meeting held in accordance with the requirements of Article VIII by the affirmative vote of the holders of a majority of all the Units then outstanding; provided, however, that any removal of the Trustee shall be effective only at such time as a qualified successor Trustee has accepted appointment as successor Trustee.
Section 6.08. Appointment of Successor Trustee. In the event of a vacancy in the position of Trustee or if the Trustee has given notice of its intention to resign, the Unitholders present or represented at a meeting held in accordance with the requirements of Article VIII may appoint a successor Trustee. Nominees for appointment may be made by (i) the resigned or resigning Trustee, (ii) any Unitholder or Unitholders owning of record at least 15% of the Units then outstanding, or (iii) Grantor. Any such successor Trustee shall be a bank or trust company having a capital, surplus and undivided profits (as of the end of its last fiscal year prior to its appointment) of at least $100,000,000. In the event that a vacancy in the position of Trustee continues for sixty days, a successor Trustee may be appointed by any State or Federal District Court having jurisdiction in Tarrant County, Texas, upon the application of Grantor or any Unitholder, and in the event any such
application is filed, such court may appoint a temporary trustee at any time after such application is filed, which shall, pending the final appointment of a Trustee, have such powers and duties as the court appointing such temporary trustee shall provide in its order of appointment, consistent with the provisions of this Indenture.
Immediately upon the appointment of any successor Trustee, all rights, titles, duties, powers and authority of the predecessor Trustee hereunder shall be vested in and undertaken by the successor Trustee which shall be entitled to receive from the predecessor Trustee all of the Trust Estate held by it hereunder and all records and files in connection therewith. Any resigning or removed Trustee shall account to its successor for its administration of the Trust. No successor Trustee shall be obligated to examine or seek alteration of any account of any preceding Trustee, nor shall any successor Trustee be liable personally for failing to do so or for any act or omission of any preceding Trustee. The preceding sentence shall not prevent any successor Trustee or anyone else from taking any action otherwise permissible in connection with any such account.
Section 6.09. Laws of Other Jurisdictions. If, notwithstanding the other provisions of this Indenture, the laws of jurisdictions other than Texas (each being referred to below as "such jurisdiction") apply to the administration of properties under this Indenture, the following provisions shall apply. If it is necessary or advisable for a trustee to serve in such jurisdiction and if the Trustee is disqualified from serving in such jurisdiction or for any other reason fails or ceases to serve there, an ancillary trustee meeting the requirements set forth in the third sentence of Section 6.08 shall be designated in writing by the Trustee. To the extent permitted under the laws of such jurisdiction, the Trustee may remove the ancillary trustee in such jurisdiction, without cause and without necessity of court proceeding or Unitholder approval, and may or may not appoint a successor ancillary trustee in such jurisdiction from time to time. The ancillary trustee serving in such jurisdiction is requested and authorized, to the extent not prohibited under the laws of such jurisdiction, to appoint the Trustee to handle the details of administration in such jurisdiction. The ancillary trustee in such jurisdiction shall have all rights, powers, discretions, responsibilities and duties as are delegated in writing by the Trustee, subject to such limitations and directions as shall be specified by the Trustee in the instrument evidencing such appointment. Any ancillary trustee in such jurisdiction shall be responsible for all assets with respect to which such trustee is empowered to act. To the extent the provisions of this Indenture and Texas law cannot be applicable to the administration in such jurisdiction, the rights, powers, duties and liabilities of the ancillary trustee in such jurisdiction shall be the same (or as near the same as permitted under the laws of such jurisdiction if applicable) as if governed by Texas law. In all events, the administration in such jurisdiction shall be as free and independent of court control and supervision as permitted under the laws of such jurisdiction. Whenever the term "Trustee" is applied in this Indenture to the administration in such jurisdiction, it shall refer only to the trustee then serving in such jurisdiction.
Section 6.10. Force Majeure. No party to this Indenture (or its Affiliates) shall incur any liability to any other party to this Indenture or to any Unitholder if, by reason of any current or future law or regulation thereunder of the federal government or any other governmental authority, or by reason of any act of God, war or other circumstance beyond its control, such party is prevented or forbidden from doing or performing any act or thing required by the terms hereof to be done or performed; nor shall any party to this Indenture incur any liability to any other party to this Indenture or any Unitholder by reason of any nonperformance or delay caused as aforesaid in the performance
of any act or thing required by the terms hereof to be done or performed, or by reason of any exercise of, or failure to exercise, any discretion provided for herein caused as set forth above.
ARTICLE VII. COMPENSATION OF THE TRUSTEE
Section 7.01. Compensation of Trustee. The Trustee shall receive compensation for its services as Trustee hereunder and as transfer agent as set forth in Schedule 2 attached hereto.
Section 7.02. Expenses. The reasonable out-of-pocket costs incurred by the Trustee, including, but not limited to, charges for SEC, NYSE and other fees, Reserve Reports (including those contemplated by Section 4.08 of each of the Conveyances), the audit contemplated by Section 4.07 of each of the Conveyances, long distance telephone calls, overtime necessitated by rush orders, travel, legal, accounting and other professional services, printing, stationery, binders, envelopes, ledger sheets, transfer sheets, checks, Certificate list sheets, postage and insurance will be reimbursed to the Trustee at actual cost.
Section 7.03. Other Services. The Trustee shall be reimbursed for actual reasonable expenditures made on account of any unusual duties in connection with matters pertaining to the Trust. In the event of litigation involving the Trust, audits or inspection of the records of the Trust pertaining to the transactions affecting the Trust or any other unusual or extraordinary services rendered in connection with the administration of the Trust, Trustee shall be entitled to receive reasonable compensation for the services rendered; provided, however, the Trustee shall not be entitled to reimbursement or compensation for services that unreasonably duplicate services provided by or through Grantor.
Section 7.04. Source of Funds. All compensation, reimbursements and other charges owing to the Trustee will be payable by the Trust out of the Trust Estate.
ARTICLE VIII. MEETINGS OF UNITHOLDERS
Section 8.01. Purpose of Meetings. A meeting of the Unitholders may be called at any time and from time to time pursuant to the provisions of this Article VIII to transact any matter that the Unitholders may be authorized to transact.
Section 8.02. Call and Notice of Meetings. Any such meeting of the Unitholders may be called by the Trustee in its discretion and will be called by the Trustee at the written request of Grantor or Unitholders owning of record not less than 15% in number of the Units then outstanding. All such meetings shall be held at such time and at such place in Tarrant County, Texas, as the notice of any such meeting may designate. Except as may otherwise be required by applicable law or by any securities exchange or market system on which the Units are admitted for trading, written notice of every meeting of the Unitholders signed by the Trustee setting forth the time and place of the meeting and in general terms the matters proposed to be acted upon at such meeting shall be given in person or by mail not more than sixty nor less than twenty days before such meeting is to be held to all of the Unitholders of record as of a record date set by the Trustee (the "Record Date
Unitholders") which shall be not more than sixty days before the date of such mailing. No matter other than that stated in the notice shall be acted upon at any meeting. If such notice is given to any Unitholder by mail, it shall be directed to him at his last address as shown by the ownership ledger of the Trustee and shall be deemed duly given when so addressed and deposited in the United States mail, postage paid. Only Record Date Unitholders shall be entitled to notice of and to exercise rights at or in connection with the meeting. Any action required by this Indenture to be taken at a meeting of the Unitholders, or any action which may be taken at a meeting of the Unitholders, may not be taken and shall not be effective without an actual meeting of the Unitholders, prior written notice to the Unitholders thereof and a vote by the Unitholders with respect thereto.
Section 8.03. Voting. Each Record Date Unitholder shall be entitled to one vote for each Unit owned by him, and any Record Date Unitholder may vote in person or by duly executed written proxy. At any such meeting the presence in person or by proxy of Record Date Unitholders holding a majority of the Units outstanding at the record date shall constitute a quorum, and, except as otherwise specifically provided herein, any matter shall be deemed to have been approved by the Unitholders if it is approved by the vote of a majority in interest of such Record Date Unitholders constituting a quorum, although less than a majority of all of the Units at the time outstanding, except that the affirmative vote by the Record Date Unitholders of 80% or more of all the Units outstanding at the record date shall be required to:
(a) approve or authorize any sale of all or any material part of the assets of the Trust (excluding sales or dispositions authorized under Sections 3.02(b), 3.05, 3.09 or 9.03), or
(b) terminate the Trust pursuant to Section 9.02(c), or
(c) approve any amendment to or affecting this Indenture, except that amendments prohibited by Section 10.01 shall not be effected in any event and amendments authorized by Section 10.02 shall not require the approval of any Unitholder.
Section 8.04. Conduct of Meetings. The Trustee may make such reasonable regulations consistent with the provisions hereof as it may deem advisable for any meeting of the Unitholders, including regulations covering the closing of the transfer books of the Trustee for purposes of determining Unitholders entitled to notice of or to vote at any meeting, the appointment of proxies, the appointment and duties of inspectors of votes, the submission and examination of proxies, Certificates and other evidence of the right to vote, the preparation and use at the meeting of a list authenticated by or on behalf of the Trustee of the Unitholders entitled to vote at the meeting and such other matters concerning the calling and conduct of the meeting as it shall deem advisable.
Section 8.05. Unitholder Proposals. In the event a meeting of Unitholders is called for any purpose at the request of any Unitholder or Unitholders pursuant to the provisions of this Article VIII, the Unitholder or Unitholders requesting such meeting shall be required to prepare and file a proxy statement with the SEC and the NYSE regarding such meeting in satisfaction of all applicable SEC and NYSE rules and regulations and at the expense of such requesting Unitholder or Unitholders. The Unitholder or Unitholders requesting such meeting shall bear the expense of distributing to Unitholders the notice of meeting and the proxy statement related thereto. The
Trustee shall cooperate in the preparation of any such proxy statement and any related materials and shall provide such information for inclusion therein as and to the extent reasonably necessary at the expense of the Trust.
ARTICLE IX. DURATION, REVOCATION AND TERMINATION OF TRUST
Section 9.01. Revocation. The Trust is and shall be irrevocable and Grantor, as such, retains no power to alter, amend or terminate the Trust. The Trust shall be terminable only as provided in Section 9.02, and shall continue until so terminated.
Section 9.02. Termination. The Trust shall terminate upon the first to occur of the following events:
(a) the disposition of all of the Royalties pursuant to the terms of this Indenture;
(b) at such time as the aggregate Gross Proceeds (as defined in the Conveyances) with respect to the Subject Interests for each of two successive years after the year 1999 is less than $1,000,000 per year;
(c) a vote in favor of termination by the Unitholders present or represented at a meeting held in accordance with the requirements of Article VIII; or
(d) the expiration of twenty-one years after the death of the last survivor of the lawful descendants of any degree of the signers of the Declaration of Independence in being on the date of execution hereof.
Section 9.03. Disposition and Distribution of Properties. For the purpose
of liquidating and winding up the affairs of the Trust at its termination, the
Trustee shall continue to act as such and exercise each power until its duties
have been fully performed and the Trust Estate finally distributed. Upon the
termination of the Trust, the Trustee shall sell for cash in one or more sales
all the properties other than cash then constituting the Trust Estate. The
Trustee shall as promptly as possible distribute the proceeds of any such sales
and any other cash in the Trust Estate according to the respective interests and
rights of the Unitholders, after paying, satisfying and discharging all of the
liabilities of the Trust, or, when necessary, setting up reserves in such
amounts as the Trustee in its discretion deems appropriate for contingent
liabilities. In the event that any property which the Trustee is required to
sell is not sold by the Trustee within two years after the termination of the
Trust, the Trustee shall cause such property to be sold at public auction to the
highest cash bidder. Notice of such sale by auction shall be mailed at least
thirty days prior to such sale to each Unitholder of record as of a date set by
the Trustee at such Unitholder's address as it appears upon the books of the
Trustee. Grantor may purchase all or any portion of the Trust Estate properties
at any sale pursuant to this Section. The Trustee shall not be required to
obtain approval of the Unitholders prior to selling property pursuant to this
Section 9.03. In connection with sales pursuant to this Section 9.03, the
Trustee may accept any offer to purchase the properties constituting the Trust
Estate that it deems reasonable in its discretion and shall have no liability in
connection with any such sales except under the circumstances described in
Section 6.01(a). The Trustee may engage the services of one or more investment
advisers or other parties deemed by the Trustee to be
qualified as experts on such matters to assist with such sales and shall be
entitled to rely on the advice of such professionals as contemplated by Section
12.02. Upon making final distribution to the Unitholders, the Trustee shall be
under no further liability except as provided in Section 6.01(b).
ARTICLE X. AMENDMENTS
Section 10.01. Prohibited. After the Closing, no amendment may be made to any provision of the Indenture which would
(a) alter the purposes of the Trust or permit the Trustee to engage in any business or investment activities or any activity substantially different from that specified herein;
(b) alter the rights of the Unitholders vis-a-vis each other; or
(c) permit the Trustee to distribute the Royalties in kind either during the continuation of the Trust or during the period of liquidation or winding up under Section 9.03.
Section 10.02. Permitted. Prior to the Closing, this Indenture may be amended by Grantor and the Trustee, jointly, and no party shall have any liability to any Unitholder therefor, including for any amendment that increases or decreases any right, benefit or liability of any present or future Unitholder. After the Closing, Grantor and the Trustee may, jointly, from time to time, supplement or amend this Indenture, without the approval of the Unitholders, in order to cure any ambiguity, to correct or supplement any provision herein which may be defective or inconsistent with any other provision hereof, or to change the name of the Trust, provided that such supplement or amendment does not adversely affect the interests of the Unitholders. All other amendments to the provisions of the Indenture shall be made only by a vote of the Unitholders present or represented at a meeting held in accordance with the requirements of Article VIII. The Trustee shall approve all amendments permitted under this Section 10.02, provided all prior conditions are satisfied and there is no adverse effect on the Trust or the Trustee. In connection with any request by Grantor to supplement or amend this Indenture to cure any ambiguity, defect or inconsistency, Grantor shall provide to the Trustee, and it shall be a condition to the Trustee's approval thereof, an officer's certificate and an opinion of counsel deemed satisfactory to the Trustee to support a determination of the existence of an ambiguity, defect or inconsistency that may properly be cured under this Section 10.01 and applicable law. The Trustee shall be entitled to rely on such officers' certificate and opinion, and such officers' certificate and opinion shall be full and complete authorization and protection in respect of any action taken or suffered by it hereunder in good faith and in accordance therewith.
ARTICLE XI. ARBITRATION
THE PARTIES TO THIS INDENTURE AGREE THAT ANY DISPUTE, CONTROVERSY OR CLAIM THAT MAY ARISE BETWEEN OR AMONG GRANTOR (ON THE ONE HAND) AND THE TRUST OR THE TRUSTEE (ON THE OTHER HAND) IN CONNECTION WITH OR OTHERWISE RELATING TO THIS INDENTURE OR THE CONVEYANCES OR THE APPLICATION, IMPLEMENTATION, VALIDITY OR BREACH OF THIS INDENTURE OR THE CONVEYANCES OR ANY PROVISION OF THIS INDENTURE OR
THE CONVEYANCES (INCLUDING, WITHOUT LIMITATION, CLAIMS BASED ON CONTRACT, TORT OR STATUTE), SHALL BE FINALLY, CONCLUSIVELY AND EXCLUSIVELY SETTLED BY BINDING ARBITRATION IN FORT WORTH, TEXAS IN ACCORDANCE WITH THE COMMERCIAL ARBITRATION RULES (THE "RULES") OF THE AMERICAN ARBITRATION ASSOCIATION OR ANY SUCCESSOR THERETO ("AAA") THEN IN EFFECT. THE PARTIES TO THIS INDENTURE (AND ON BEHALF OF THE TRUST) HEREBY EXPRESSLY WAIVE THEIR RIGHT TO SEEK REMEDIES IN COURT, INCLUDING, WITHOUT LIMITATION, THE RIGHT TO TRIAL BY JURY, WITH RESPECT TO ANY MATTER SUBJECT TO ARBITRATION PURSUANT TO THIS ARTICLE XI. ANY PARTY TO THIS INDENTURE MAY BRING AN ACTION, INCLUDING, WITHOUT LIMITATION, A SUMMARY OR EXPEDITED PROCEEDING, IN ANY COURT HAVING JURISDICTION, TO COMPEL ARBITRATION OF ANY DISPUTE, CONTROVERSY OR CLAIM TO WHICH THIS ARTICLE XI APPLIES. EXCEPT WITH RESPECT TO THE FOLLOWING PROVISIONS (THE "SPECIAL PROVISIONS") WHICH SHALL APPLY WITH RESPECT TO ANY ARBITRATION PURSUANT TO THIS ARTICLE XI, THE INITIATION AND CONDUCT OF ARBITRATION SHALL BE AS SET FORTH IN THE RULES, WHICH RULES ARE INCORPORATED IN THIS INDENTURE BY REFERENCE WITH THE SAME EFFECT AS IF THEY WERE SET FORTH IN THIS INDENTURE.
(a) In the event of any inconsistency between the Rules and the Special Provisions, the Special Provisions shall control. References in the Rules to a sole arbitrator shall be deemed to refer to the tribunal of arbitrators provided for under subparagraph (c) below in this Article XI.
(b) The arbitration shall be administered by AAA.
(c) The arbitration shall be conducted by a tribunal of three arbitrators. Within ten days after arbitration is initiated pursuant to the Rules, the initiating party or parties (the "Claimant") shall send written notice to the other party or parties (the "Respondent"), with a copy to the Dallas office of AAA, designating the first arbitrator (who shall not be a representative or agent of any party but may or may not be an AAA panel member and, in any case, shall be reasonably believed by the Claimant to possess the requisite experience, education and expertise in respect of the matters to which the claim relates to enable such person to completely perform arbitral duties). Within ten days after receipt of such notice, the Respondent shall send written notice to the Claimant, with a copy to the Dallas office of AAA and to the first arbitrator, designating the second arbitrator (who shall not be a representative or agent of any party, but may or may not be an AAA panel member and, in any case, shall be reasonably believed by the Respondent to possess the requisite experience, education and expertise in respect of the matters to which the claim relates to enable such person to competently perform arbitral duties). Within ten days after such notice from the Respondent is received by the Claimant, the Respondent and the Claimant shall cause their respective designated arbitrators to select any mutually agreeable AAA panel member as the third arbitrator. If the respective designated arbitrators of the Respondent and the Claimant cannot so agree within said ten day period, then the third arbitrator will be determined pursuant to the Rules. For purposes of this Article XI, Grantor (on the one hand) and the
Trust and the Trustee (on the other hand) shall each be entitled to the selection of one arbitrator. Prior to commencement of the arbitration proceeding, each arbitrator shall have provided the parties with a resume outlining such arbitrator's background and qualifications and shall certify that such arbitrator is not a representative or agent of any of the parties. If any arbitrator shall die, fail to act, resign, become disqualified or otherwise cease to act, then the arbitration proceeding shall be delayed for fifteen days and the party by or on behalf of whom such arbitrator was appointed shall be entitled to appoint a substitute arbitrator (meeting the qualifications set forth in this Article XI) within such fifteen day period; provided, however, that if the party by or on behalf of whom such arbitrator was appointed shall fail to appoint a substitute arbitrator within such fifteen day period, the substitute arbitrator shall be a neutral arbitrator appointed by the AAA arbitrator within fifteen days thereafter.
(d) All arbitration hearings shall be commenced within one hundred twenty days after arbitration is initiated pursuant to the Rules, unless, upon a showing of good cause by a party to the arbitration, the tribunal of arbitrators permits the extension of the commencement of such hearing; provided, however, that any such extension shall not be longer than sixty days.
(e) All claims presented for arbitration shall be particularly identified and the parties to the arbitration shall each prepare a statement of their position with recommended courses of action. These statements of position and recommended courses of action shall be submitted to the tribunal of arbitrators chosen as provided hereinabove for binding decision. The tribunal of arbitrators shall not be empowered to make decisions beyond the scope of the position papers.
(f) The arbitration proceeding will be governed by the substantive laws of the State of Texas and will be conducted in accordance with such procedures as shall be fixed for such purpose by the tribunal of arbitrators, except that (i) discovery in connection with any arbitration proceeding shall be conducted in accordance with the Federal Rules of Civil Procedure and applicable case law, (ii) the tribunal of arbitrators shall have the power to compel discovery and (iii) unless the parties otherwise agree and except as may be provided in this Article XI, the arbitration shall be governed by the United States Arbitration Act, 9 U.S.C. (S)(S) 1- 16, to the exclusion of any provision of state law or other applicable law or procedure inconsistent therewith or which would produce a different result. The parties shall preserve their right to assert and to avail themselves of the attorney-client and attorney-work-product privileges, and any other privileges to which they may be entitled pursuant to applicable law. No party to the arbitration or any arbitrator may compel or require mediation and/or settlement conferences without the prior written consent of all such parties and the tribunal of arbitrators.
(g) The tribunal of arbitrators shall make an arbitration award as soon as possible after the later of the close of evidence or the submission of final briefs, and in all cases the award shall be made not later than thirty days following submission of the matter. The finding and decision of a majority of the arbitrators shall be final and shall be binding upon the parties. Judgment upon the arbitration award or decision may be entered in any court
having jurisdiction thereof or application may be made to any such court for a judicial acceptance of the award and an order of enforcement, as the case may be. The tribunal of arbitrators shall have the authority to assess liability for pre-award and post-award interest on the claims, attorneys' fees, expert witness fees and all other expenses of arbitration as such arbitrators shall deem appropriate based on the outcome of the claims arbitrated. Unless otherwise agreed by the parties to the arbitration in writing, the arbitration award shall include findings of fact and conclusions of law.
(h) Nothing in this Article XI shall be deemed to (i) limit the
applicability of any otherwise applicable statute of limitations or repose
or any waivers contained in this Indenture, (ii) constitute a waiver by any
party hereto of the protections afforded by 12 U.S.C. (S) 91 or any
successor statute thereto or any substantially equivalent state law, or
(iii) restrict the right of the Trustee to make application to any state or
federal district court having jurisdiction in Tarrant County, Texas, to
appoint a successor Trustee or to request instructions with regard to any
provision in this Indenture when the Trustee is unsure of its obligations
thereunder.
(i) This Article XI shall preclude participation by the Trust in any class action brought against Grantor by any Person who is not a Unitholder and the Trustee shall opt out of any such class action in which the Trust is a purported class member.
ARTICLE XII. MISCELLANEOUS
Section 12.01. Inspection of Trustee's Books. Each Unitholder and such Unitholder's duly authorized agents, attorneys and auditors shall have the right, at such Unitholder's own expense and during reasonable business hours, to examine and inspect the records of the Trust and the Trustee, including lists of Unitholders, for any proper purpose in reference thereto. For purposes of determining whether a purpose asserted by a Unitholder is a "proper purpose," the Trustee, in the absence of controlling precedent applicable to trusts organized under the Texas Trust Code, may rely on any reasonably analogous precedent, including laws and court decisions relating to corporations of the State of Texas or other jurisdictions.
Section 12.02. Trustee's Employment of Experts. The Trustee may, but shall not be required to, consult with counsel, who may be its own counsel, accountants, geologists, engineers and other parties deemed by the Trustee to be qualified as experts on the matters submitted to them, and the opinion or advice of any such parties on any matter submitted to them by the Trustee shall be full and complete authorization and protection in respect of any action taken or suffered by it hereunder in good faith and in accordance with the opinion of any such party. The Trustee is authorized to make payments of all reasonable and necessary fees billed by third parties for services or expenses thus incurred out of the Trust Estate.
Section 12.03. Merger or Consolidation of Trustee. Neither a change of name of the Trustee nor any merger or consolidation of it or of its corporate powers with another bank or with a trust company shall affect its right or capacity to act hereunder. Upon any merger, consolidation, sale of assets or other transaction involving the Trustee in which the Trustee is not the surviving entity, the surviving entity in such transaction shall automatically become Trustee of the Trust and succeed to
all rights, titles, duties, powers and authority of the predecessor Trustee hereunder, without the requirement of Unitholder approval or any other action, provided such surviving entity has succeeded to the rights and obligations of the predecessor Trustee in accordance with applicable law and is a bank or trust company having capital, surplus and undivided profits (as of the end of its last fiscal year prior to the consummation of such transaction) of at least $100,000,000.
Section 12.04. Filing of this Indenture. Neither this Indenture nor any executed copy hereof need be filed in any county in which any of the Trust Estate is located, but the same may be filed for record in any county by the Trustee. In order to avoid the necessity of filing this Indenture for record, the Trustee agrees that for the purpose of vesting the record title to the Royalties in any successor Trustee, the succeeded Trustee will, upon appointment of any successor Trustee, execute and deliver to such successor Trustee appropriate assignments or conveyances.
Section 12.05. Severability. If any provision of this Indenture or the application thereof to any Person or circumstances shall be finally determined by a court of proper jurisdiction to be illegal, invalid or unenforceable to any extent, the remainder of this Indenture or the application of such provision to Persons or circumstances, other than those as to which it is held illegal, invalid or unenforceable, shall not be affected thereby, and every provision of this Indenture shall be valid and enforced to the fullest extent permitted by law.
Section 12.06. Notices. Any and all notices or demands permitted or required to be given under this Indenture shall be in writing and shall be validly given or made if (a) personally delivered, (b) delivered and confirmed by telecopier or like instantaneous transmission service, or by Federal Express or other overnight courier delivery service, which shall be effective as of confirmation of receipt by the courier at the address for notice hereinafter stated, (c) solely in the case of notice to any Unitholder, by press release in a nationally recognized and distributed media, or (d) deposited in the United States mail, first class, postage prepaid, certified or registered, return receipt requested, addressed as follows:
If to the Trustee, to:
NationsBank, N.A.
901 Main Street, 17th Floor
Dallas, Texas 75202
Attention: Ron E. Hooper, Vice President
Telecopier No.: (214) 508-2431
If to Grantor, to:
Cross Timbers Oil Company
810 Houston Street, Suite 2000
Fort Worth, Texas 76102-6298
Attention: Corporate Secretary
Telecopier No. (817) 870-1671
If to a Unitholder, to:
the Unitholder
at its last address as shown on the
ownership records maintained by the Trustee.
Notice which is mailed in the manner specified shall be conclusively deemed given three days after the date postmarked or upon receipt, whichever is sooner. Any party to this Indenture may change its address for the purpose of receiving notices or demands by notice given as provided in this Section 12.06.
Section 12.07. Counterparts. This Indenture may be executed in a number of counterparts, each of which shall constitute an original, but such counterparts shall together constitute but one and the same instrument.
Section 12.08. Successors. This Indenture shall inure to the benefit of and be binding upon the parties hereto and their respective successors and assigns.
IN WITNESS WHEREOF, Grantor and Trustee have caused this Indenture to be duly executed the day and year first above written at Fort Worth, Tarrant County, Texas.
CROSS TIMBERS OIL COMPANY
ATTEST:
By:
------------------------------- ----------------------------------
Name: Frank G. McDonald Name: Louis G. Baldwin
Title: Assistant Secretary Title: Senior Vice President
- GRANTOR -
ATTEST: NATIONSBANK, N.A.
By:
------------------------------- ----------------------------------
Name: Name: Ron E. Hooper
-------------------------- Title: Vice President
Title:
-------------------------
- TRUSTEE -
|
SCHEDULE 2
TRUSTEE COMPENSATION
A. Administrative Fee
1. For all administrative and other services to be provided by the Trustee under the Indenture including, but not limited to, costs of Trustee's personnel, the Trustee will be paid, from the Trust Estate, the sum of $35,000 per year, with such fee to be paid in equal monthly installments.
2. The Administrative Fee provided above will be adjusted annually, beginning April 1, 2000. The adjustment shall be computed by multiplying the current Administrative Fee by the percentage increase or decrease in the average weekly earnings of Crude Petroleum and Gas Production Workers for the last calendar year compared to the calendar year preceding as shown by the index of average weekly earnings of Crude Petroleum and Gas Production Workers as published by the United States Department of Labor, Bureau of Labor Statistics. The adjusted Administrative Fee shall be the Administrative Fee currently in use, plus or minus the computed adjustment.
B. Termination Fee
Upon termination of the Trust, the Trustee shall be paid a Termination Fee of $15,000.
C. The fees provided above are in addition to out-of-pocket cost reimbursements permitted under the Indenture.
EXHIBIT 15.1
AWARENESS LETTER--UNAUDITED INTERIM FINANCIAL INFORMATION
Cross Timbers Oil Company
Fort Worth, Texas
We are aware that our reports dated April 20, 1998, July 22, 1998, and October 21, 1998, which were included in the Cross Timbers Oil Company's Quarterly Report on Form 10-Q for the quarters ended March 31, 1998, June 30, 1998, and September 30, 1998, are being incorporated by reference in the Company's Registration Statement on Form S-3.
We also are aware that the aforementioned reports, pursuant to Regulation C under the Securities Act of 1933, are not considered a part of the Registration Statement prepared or certified by our firm within the meaning of Sections 7 and 11 of that Act.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
December 4, 1998
EXHIBIT 23.1
INDEPENDENT PUBLIC ACCOUNTANTS' CONSENT
As independent public accountants, we hereby consent to the use in this Registration Statement on Form S-1 of Hugoton Royalty Trust and on Form S-3 of Cross Timbers Oil Company (the Company) of our reports dated December 3, 1998 and December 4, 1998, and to the incorporation by reference of our report dated March 18, 1998 included in the Company's Form 10-K for the year ended December 31, 1997, our report dated February 11, 1998 included in the Company's Form 8-K/A Amendment No. 1 dated December 1, 1997 and our report dated April 17, 1998 included in the Company's Form 8-K and Form 8-K/A Amendment No.1 dated April 24, 1998, and to all references to our firm included in this Registration Statement.
ARTHUR ANDERSEN LLP
Fort Worth, Texas
December 4, 1998
| ARTICLE 5 |
| CIK: 0000862022 |
| NAME: HUGOTON ROYALTY TRUST |
| PERIOD TYPE | OTHER |
| FISCAL YEAR END | DEC 31 1998 |
| PERIOD END | DEC 04 1998 |
| CASH | 1,000 |
| SECURITIES | 0 |
| RECEIVABLES | 0 |
| ALLOWANCES | 0 |
| INVENTORY | 0 |
| CURRENT ASSETS | 0 |
| PP&E | 0 |
| DEPRECIATION | 0 |
| TOTAL ASSETS | 1,000 |
| CURRENT LIABILITIES | 0 |
| BONDS | 0 |
| PREFERRED MANDATORY | 0 |
| PREFERRED | 0 |
| COMMON | 0 |
| OTHER SE | 1,000 |
| TOTAL LIABILITY AND EQUITY | 1,000 |
| SALES | 0 |
| TOTAL REVENUES | 0 |
| CGS | 0 |
| TOTAL COSTS | 0 |
| OTHER EXPENSES | 0 |
| LOSS PROVISION | 0 |
| INTEREST EXPENSE | 0 |
| INCOME PRETAX | 0 |
| INCOME TAX | 0 |
| INCOME CONTINUING | 0 |
| DISCONTINUED | 0 |
| EXTRAORDINARY | 0 |
| CHANGES | 0 |
| NET INCOME | 0 |
| EPS PRIMARY | 0 |
| EPS DILUTED | 0 |