The Daily Magic Formula Stock for 01/25/2009 is Hugoton Royalty Trust. According to the Magic Formula Investing Web Site, the ebit yield is 18% and the EBIT ROIC is 75-100%.
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Hugoton Royalty Trust is an express trust created under the laws of Texas pursuant to the Hugoton Royalty Trust Indenture entered into on December 1, 1998 between XTO Energy Inc. (formerly known as Cross Timbers Oil Company), as grantor, and NationsBank, N.A., as trustee. Bank of America, N.A., successor to NationsBank, N.A., is now the trustee of the trust. In 2007 the Bank of America private wealth management group officially became known as â€śU.S. Trust, Bank of America Private Wealth Management.â€ť The legal entity that serves as the trustee of the trust did not change, and references in this Form 10-K to U.S. Trust, Bank of America Private Wealth Management shall describe the legal entity Bank of America, N.A. The principal office of the trust is located at 901 Main Street, Dallas, Texas 75202 (telephone number 877-228-5083).
The trustâ€™s internet web site is www.hugotontrust.com. We make available free of charge, through our web site, our Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. These reports are accessible through our internet web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.
Effective December 1, 1998, XTO Energy conveyed to the trust 80% net profits interests in certain predominantly natural gas producing working interest properties in Kansas, Oklahoma and Wyoming under three separate conveyances. In exchange for these net profits interest conveyances to the trust, 40 million units of beneficial interest were issued to XTO Energy. In April and May 1999, XTO Energy sold a total of 17 million units in the trustâ€™s initial public offering. In 1999 and 2000, XTO Energy also sold 1.3 million trust units to certain of its officers. The trust did not receive the proceeds from these sales of trust units. Units are listed and traded on the New York Stock Exchange under the symbol â€śHGT.â€ť
In May 2006, XTO Energy distributed all of its remaining 21.7 million trust units as a dividend to its common stockholders. XTO Energy currently is not a unitholder of the trust.
The net profits interests entitle the trust to receive 80% of the net proceeds from the sale of oil and gas from the underlying properties. Each month XTO Energy determines the amount of cash received from the sale of production and deducts property and production taxes, production expense, development costs and overhead.
Net proceeds payable to the trust depend upon production quantities, sales prices of oil and gas and costs to develop and produce oil and gas in the prior month. If monthly costs exceed revenues for any of the three conveyances (one for each of the states of Kansas, Oklahoma and Wyoming), such excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from other conveyances.
In November and December 2007, costs exceeded revenues on properties underlying the Wyoming net profits interests. For further information on excess costs, see â€śTrusteeâ€™s Discussion and Analysisâ€ť of financial condition and results of operations for the three-year period ended December 31, 2007 in the trustâ€™s annual report to unitholders for the year ended December 31, 2007.
The trust is not liable for any production costs or liabilities attributable to the underlying properties. If at any time the trust receives net profits income in excess of the amount due, the trust is not obligated to return such overpayment, but net profits income payable to the trust for the next month will be reduced by the overpayment, plus interest at the prime rate.
As a working interest owner, XTO Energy can generally decline participation in any operation and allow consenting parties to conduct such operations, as provided under the operating agreements. XTO Energy also can assign, sell, or otherwise transfer its interest in the underlying properties, subject to the net profits interests, or can abandon an underlying property if it is incapable of producing in paying quantities, as determined by XTO Energy.
To the extent allowed, XTO Energy is responsible for marketing its production from the underlying properties under existing sales contracts or new arrangements on the best terms reasonably obtainable in the circumstances. See Item 2., â€śPricing and Sales Information.â€ť
Net profits income received by the trust on or before the last business day of the month is related to net proceeds received by XTO Energy in the preceding month, and is generally attributable to oil and gas production two months prior. The amount to be distributed to unitholders each month by the trustee is determined by:
(1) net profits income received,
(2) interest income and any other cash receipts and
(3) cash available as a result of reduction of cash reserves, then
(1) liabilities paid and
(2) the reduction in cash available related to establishment of or increase in any cash reserve.
The monthly distribution amount is distributed to unitholders of record within ten business days after the monthly record date. The monthly record date is generally the last business day of the month. The trustee calculates the monthly distribution amount and announces the distribution per unit at least ten days prior to the monthly record date.
The trustee may establish cash reserves for contingencies. Cash held for such reserves, as well as for pending payment of the monthly distribution amount, may be invested in federal obligations or certificates of deposit of major banks.
The trusteeâ€™s function is to collect the net profits income from the net profits interests, to pay all trust expenses, and pay the monthly distribution amount to unitholders. The trusteeâ€™s powers are specified by the terms of the trust indenture. The trust cannot engage in any business activity or acquire any assets other than the net profits interests and specific short-term cash investments. The trust has no employees since all administrative functions are performed by the trustee.
Approximately 88% of the net profits income received by the trust during 2007, as well as 89% of the estimated proved reserves of the net profits interests at December 31, 2007 (based on estimated future net cash flows using year-end oil and gas prices), is attributable to natural gas. There has historically been a greater demand for gas during the winter months than the rest of the year. Otherwise, trust income generally is not subject to seasonal factors, nor dependent upon patents, licenses, franchises or concessions. The trust conducts no research activities.
Item 1A. Risk Factors
The following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements made in this report and presented elsewhere by the trustee from time to time. Such factors, among others, may have a material adverse effect upon the trustâ€™s financial condition, distributable income and changes in trust corpus.
The following discussion of risk factors should be read in conjunction with the financial statements and related notes included in the trustâ€™s annual report to unitholders for the year ended December 31, 2007. Because of these and other factors, past financial performance should not be considered an indication of future performance.
The market price for the trust units may not reflect the value of the net profits interests held by the trust.
The public trading price for the trust units tends to be tied to the recent and expected levels of cash distributions on the trust units. The amounts available for distribution by the trust vary in response to numerous factors outside the control of the trust or XTO Energy, including prevailing prices for oil and natural gas produced from the underlying properties. The market price of the trust units is not necessarily indicative of the value that the trust would realize if the net profits interests were sold to a third party buyer. In addition,
MANAGEMENT DISCUSSION FROM LATEST 10K
The â€śTrusteeâ€™s Discussion and Analysisâ€ť of financial condition and results of operations for the three-year period ended December 31, 2007 in the trustâ€™s annual report to unitholders for the year ended December 31, 2007 is incorporated herein by reference.
Liquidity and Capital Resources
The trustâ€™s only cash requirement is the monthly distribution of its income to unitholders, which is funded by the monthly receipt of net profits income after payment of trust administration expenses. The trust is not liable for any production costs or liabilities attributable to the net profits interests. If at any time the trust receives net profits income in excess of the amount due, the trust is not obligated to return such overpayment, but future net profits income payable to the trust will be reduced by the overpayment, plus interest at the prime rate.
The trust does not have any transactions, arrangements or other relationships with unconsolidated entities or persons that could materially affect the trustâ€™s liquidity or the availability of capital resources.
Off-Balance Sheet Arrangements
The trust has no off-balance sheet financing arrangements. The trust has not guaranteed the debt of any other party, nor does the trust have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt, losses or contingent obligations.
As shown below, the trust had no obligations and commitments to make future contractual payments as of December 31, 2007, other than the December distribution payable to unitholders in January 2008, as reflected in the statement of assets, liabilities and trust corpus.
Related Party Transactions
The underlying properties from which the net profits interests were carved are currently owned by XTO Energy, which operates approximately 94% of the underlying properties. In computing net proceeds, XTO Energy deducts a monthly overhead charge for reimbursement of administrative expenses on the underlying properties it operates. As of December 31, 2007, the monthly overhead charge, based on the number of operated wells, was approximately $770,000 ($616,000 net to the trust) and is subject to annual adjustment based on an oil and gas industry index.
In May 2006, XTO Energy distributed all of its remaining 21.7 million trust units as a dividend to its common stockholders. XTO Energy currently is not a unitholder of the trust.
XTO Energy sells a significant portion of natural gas production from the underlying properties to certain of XTO Energyâ€™s wholly owned subsidiaries under contracts in existence when the trust was created, generally at amounts approximating monthly published market prices. For further information regarding natural gas sales from the underlying properties to affiliates of XTO Energy, see Item 2, Properties, and Note 7 to Financial Statements in the trustâ€™s annual report to unitholders for the year ended December 31, 2007. Total gas sales from the underlying properties to XTO Energyâ€™s wholly owned subsidiaries were $76.6 million for 2007, or 48% of total gas sales, $103.2 million for 2006, or 53% of total gas sales and $107.9 million for 2005, or 54% of total gas sales.
Critical Accounting Policies
The financial statements of the trust are significantly affected by its basis of accounting and estimates related to its oil and gas properties and proved reserves, as summarized below.
Basis of Accounting
The trustâ€™s financial statements are prepared on a modified cash basis, which is a comprehensive basis of accounting other than U.S. generally accepted accounting principles. This method of accounting is consistent with reporting of taxable income to trust unitholders. The most significant differences between the trustâ€™s financial statements and those prepared in accordance with U.S. generally accepted accounting principles are:
â€˘ Net profits income is recognized in the month received rather than accrued in the month of production.
â€˘ Expenses are recognized when paid rather than when incurred.
â€˘ Cash reserves may be established by the trustee for certain contingencies that would not be recorded under U.S. generally accepted accounting principles.
This comprehensive basis of accounting other than U.S. generally accepted accounting principles corresponds to the accounting permitted for royalty trusts by the U.S. Securities and Exchange Commission, as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts. For further information regarding the trustâ€™s basis of accounting, see Note 2 to Financial Statements in the trustâ€™s annual report to unitholders for the year ended December 31, 2007.
All amounts included in the trustâ€™s financial statements are based on cash amounts received or disbursed, or on the carrying value of the net profits interests, which was derived from the historical cost of the interests at the date of their transfer from XTO Energy, less accumulated amortization to date. Accordingly, there are no fair value estimates included in the financial statements based on either exchange or nonexchange trade values.
Oil and Gas Reserves
The proved oil and gas reserves for the underlying properties are estimated by independent petroleum engineers. The estimated reserves for the underlying properties are then used by XTO Energy to calculate the estimated oil and gas reserves attributable to the net profits interests. Reserve engineering is a subjective process that is dependent upon the quality of available data and the interpretation thereof. Estimates by different engineers often vary, sometimes significantly. In addition, physical factors such as the results of drilling, testing and production subsequent to the date of an estimate, as well as economic factors such as changes in product prices, may justify revision of such estimates. Because proved reserves are required to be estimated using prices at the date of the evaluation, estimated reserve quantities can be significantly impacted by changes in product prices. Accordingly, oil and gas quantities ultimately recovered and the timing of production may be substantially different from original estimates.
The standardized measure of discounted future net cash flows and changes in such cash flows, as reported in Item 2, is prepared using assumptions required by the Financial Accounting Standards Board and the Securities and Exchange Commission. Such assumptions include using year-end oil and gas prices and year-end costs for estimated future development and production expenditures. Discounted future net cash flows are calculated using a 10% rate. Changes in any of these assumptions, including consideration of other factors, could have a significant impact on the standardized measure. Accordingly, the standardized measure does not represent XTO Energyâ€™s or the trusteeâ€™s estimated current market value of proved reserves.
Certain information included in this annual report and other materials filed, or to be filed, by the trust with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by XTO Energy or the trustee) contain forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended, relating to the trust, operations of the underlying properties and the oil and gas industry. Such forward-looking statements may concern, among other things, development activities, future development plans, increased density drilling, maintenance projects, development, production and other costs, oil and gas prices, pricing differentials, proved reserves, production levels, litigation, regulatory matters and competition. Such forward-looking statements are based on XTO Energyâ€™s current plans, expectations, assumptions, projections and estimates and are identified by words such as â€śexpects,â€ť â€śintends,â€ť â€śplans,â€ť â€śprojects,â€ť â€śanticipates,â€ť â€śpredicts,â€ť â€śbelieves,â€ť â€śgoals,â€ť â€śestimates,â€ť â€śshould,â€ť â€ścould,â€ť and similar words that convey the uncertainty of future events. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from expectations, estimates or assumptions expressed in, implied in, or forecasted in such forward-looking statements. Some of the risk factors that could cause actual results to differ materially are explained in Item 1A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The only assets of and sources of income to the trust are the net profits interests, which generally entitle the trust to receive a share of the net profits from oil and gas production from the underlying properties. Consequently, the trust is exposed to market risk from fluctuations in oil and gas prices. The trust is a passive entity and, other than the trustâ€™s ability to periodically borrow money as necessary to pay expenses, liabilities and obligations of the trust that cannot be paid out of cash held by the trust, the trust is prohibited from engaging in borrowing transactions. The amount of any such borrowings is unlikely to be material to the trust. In addition, the trustee is prohibited by the trust indenture from engaging in any business activity or causing the trust to enter into any investments other than investing cash on hand in specific short-term cash investments. Therefore, the trust cannot hold any derivative financial instruments. As a result of the limited nature of the trustâ€™s borrowing and investing activities, the trust is not subject to any material interest rate market risk. Additionally, any gains or losses from any hedging activities conducted by XTO Energy are specifically excluded from the calculation of net proceeds due the trust under the forms of the conveyances. The trust does not engage in transactions in foreign currencies which could expose the trust to any foreign currency related market risk.
Item 8. Financial Statements and Supplementary Data
The financial statements of the trust and the notes thereto, together with the related reports of KPMG LLP dated February 25, 2008, appearing in the trustâ€™s annual report to unitholders for the year ended December 31, 2007, are incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
There have been no changes in accountants and no disagreements with the trustâ€™s independent registered public accountants on any matter of accounting principles or practices or financial statement disclosures during the two years ended December 31, 2007.
Item 9A. Controls and Procedures
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
The trustee conducted an evaluation of the trustâ€™s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, the trustee has concluded that the trustâ€™s disclosure controls and procedures were effective as.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
The following discussion should be read in conjunction with the trusteeâ€™s discussion and analysis contained in the trustâ€™s 2007 annual report, as well as the condensed financial statements and notes thereto included in this Quarterly report on Form 10-Q. The trustâ€™s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports are available on the trustâ€™s web site at www.hugotontrust.com.
For the quarter ended September 30, 2008, net profits income was $43,741,409, as compared to $17,870,756 for third quarter 2007. This 145% increase in net profits income is primarily the result of higher oil and gas prices and higher oil and gas production, partially offset by higher taxes, transportation and other costs and increased production expense. See â€śNet Profits Incomeâ€ť on the following page.
After adding interest income of $31,050 and deducting administration expense of $83,819, distributable income for the quarter ended September 30, 2008 was $43,688,640, or $1.092216 per unit of beneficial interest. Administration expense for the quarter was lower than the prior year quarter primarily because of the timing of expenditures. For third quarter 2007, distributable income was $17,734,680, or $0.443367 per unit. Distributions to unitholders for the quarter ended September 30, 2008 were:
For the nine months ended September 30, 2008, net profits income was $99,676,511 compared with $55,857,387 for the same 2007 period. This 78% increase in net profits income is primarily the result of higher oil and gas prices and higher oil and gas production, partially offset by higher taxes, transportation and other costs, increased production expense and higher development costs. See â€śNet Profits Incomeâ€ť on the following page.
After adding interest income of $73,801 and deducting administration expense of $737,592, distributable income for the nine months ended September 30, 2008 was $99,012,720, or $2.475318 per unit of beneficial interest. Administration expense for the first nine months of 2008 was lower than in the first nine months of 2007 primarily because of lower costs related to unitholder tax reporting, as a result of a decrease in the number of unitholders, and the timing of expenditures. For the nine months ended September 30, 2007, distributable income was $54,822,960, or $1.370574 per unit.
Net Profits Income
Net profits income is recorded when received by the trust, which is the month following receipt by XTO Energy, and generally two months after oil and gas production. Net profits income is generally affected by three major factors:
oil and gas sales volumes,
oil and gas sales prices, and
costs deducted in the calculation of net profits income.
Because of the two-month interval between time of production and receipt of net profits income by the trust, (1) oil and gas sales for the quarter ended September 30 generally represent production for the period May through July and (2) oil and gas sales for the nine months ended September 30 generally represent production for the period November through July.
Oil and gas sales volumes are allocated to the net profits interests based upon a formula that considers oil and gas prices and the total amount of production expense and development costs. Changes in any of these factors may result in disproportionate fluctuations in volumes allocated to the net profits interests. Therefore, comparative discussion of oil and gas sales volumes is based on the underlying properties.
See Note 2 to Condensed Financial Statements.
See Note 4 to Condensed Financial Statements.
The following are explanations of significant variances on the underlying properties from third quarter 2007 to third quarter 2008 and from the first nine months of 2007 to the comparable period in 2008:
Gas sales volumes increased 2% for the third quarter and 3% for the nine-month period. Increased gas sales volumes are primarily because of increased production from new wells and workovers, partially offset by natural production decline.
Oil sales volumes increased 23% for the third quarter and 18% for the nine-month period primarily because of increased production from new wells and workovers, partially offset by natural production decline. In addition, oil sales volumes increased in the third quarter because of the timing of cash receipts, and increased for the nine-month period because of prior period volume adjustments in 2007.
The third quarter 2008 average gas price was $10.15 per Mcf, a 71% increase from the third quarter 2007 average gas price of $5.93 per Mcf. For the nine-month period, the average gas price increased 38% to $8.29 per Mcf in 2008 from $6.02 per Mcf in 2007. Although the U.S. entered the winter with above average gas storage, a normal winter and lower liquefied natural gas imports led to normal storage levels. As a result of tighter storage levels and higher oil prices, gas prices reached as high as $13.00 per MMBtu. Due to concerns of oversupply from shale gas development, falling oil prices and a mild summer which led to increased gas in storage, recent gas prices have declined. Prices will continue to be affected by weather, oil prices, the U.S. economy, the level of North American production and import levels of liquified natural gas. Natural gas prices are expected to remain volatile. The third quarter 2008 gas price is primarily related to production from May through July 2008, when the average NYMEX price was $12.10 per MMBtu. The average NYMEX price for August and September 2008 was $8.81 per MMBtu. At October 15, 2008, the average NYMEX futures price for the following twelve months was $7.09 per MMBtu. Recent trust gas prices have averaged approximately 16% lower than the NYMEX price.
Scheduled pipeline maintenance on a major pipeline transporting gas from the Rocky Mountain region has led to lower realized gas prices in September 2008 for the trustâ€™s Wyoming gas production. Realized gas prices for September 2008 Wyoming gas production are expected to be approximately 78% lower than the NYMEX price compared to recent prices which have averaged approximately 18% lower than the NYMEX price. The downward pressure on realized prices is expected to result in lower monthly trust distributions over the near term. At October 15, 2008, the average futures price for the following three months is expected to be approximately 33% lower than the NYMEX price. Wyoming gas production was approximately 27% of total trust gas production for the nine-month period ended September 30, 2008.
The third quarter 2008 average oil price was $125.74 per Bbl, a 93% increase from the third quarter 2007 average oil price of $65.14 per Bbl. The year-to-date average oil price increased 79% to $108.41 per Bbl in 2008 from $60.41 per Bbl in 2007. In the last few months of 2007 and the first half of 2008, continued tension in the Middle East, weakness in the U.S. dollar and strong demand caused prices to reach record levels of above $147.00 per Bbl. However, rising crude oil supplies, the tightened credit markets and the potential for lower demand in slowing U.S. and global economies have caused recent oil prices to decline. Oil prices are expected to remain volatile. The third quarter 2008 oil price is primarily related to production from May through July 2008, when the average NYMEX price was $131.56 per Bbl. The average NYMEX price for August and September 2008 was $110.57 per Bbl. At October 15, 2008, the average NYMEX futures price for the following twelve months was $76.66 per Bbl. Recent trust oil prices have averaged approximately 1% lower than the NYMEX price.
Taxes, Transportation and Other
Taxes, transportation and other increased 55% for the quarter and 32% for the nine-month period primarily because of increased production taxes related to higher oil and gas revenues.
Production expense increased 37% for the quarter and 21% for the nine-month period primarily because of increased maintenance, compressor rental, plugging and abandonment, fuel and labor costs. In addition, increased production expense for the nine-month period was partially offset by mechanical and marketing rebates.
Development costs deducted in the calculation of net profits income are based on the development budget. These development costs increased 2% for the third quarter and 8% for the nine-month period primarily because of the timing of expenditures. During the first nine months of 2008, 28 wells were completed on the underlying properties and 10 wells were pending completion at September 30.
As of December 31, 2007, cumulative actual costs exceeded cumulative budgeted costs deducted by approximately $0.7 million. In calculating net profits income, XTO Energy deducted budgeted development costs of $11.5 million for the quarter and $34.0 million for the nine-month period. After considering actual development costs of $19.9 million for the quarter and $37.0 million for the nine-month period, actual costs exceeded cumulative budgeted costs by approximately $3.7 million at September 30, 2008.
XTO Energy has advised the trustee that total 2008 budgeted development costs for the underlying properties are approximately $46.0 million. The 2008 budget year generally coincides with the trust distribution months from April 2008 through March 2009. The monthly development cost deduction will be reevaluated by XTO Energy and revised as necessary, based on the 2008 budget and the timing and amount of actual expenditures. See Note 2 to Condensed Financial Statements.
Overhead increased 12% for the quarter and 8% for the nine-month period primarily because of the annual rate adjustment based on an industry index.
Costs exceeded revenues by $853,468 ($682,774 net to the trust) on properties underlying the Wyoming net profits interests in November and December 2007. Limited pipeline capacity for shipping from the Rocky Mountain region and excess regional supply led to significantly lower realized regional gas prices for production. These lower gas prices caused costs to exceed revenues on properties underlying the Wyoming net profits interests, however, these excess costs did not reduce net proceeds from the remaining conveyances.
XTO Energy advised the trustee that with the onset of winter demand and the completion of the first phase of a major pipeline expansion in January 2008, Rocky Mountain gas prices increased and the excess costs, plus accrued interest of $10,090 ($8,072 net to the trust), were fully recovered by February 2008.
This Form 10-Q includes â€śforward-looking statementsâ€ť within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact included in this Form 10-Q, including, without limitation, statements regarding the net profits interests, underlying properties, development activities, annual and monthly development, production and other costs and expenses, monthly development cost deductions, oil and gas prices and differentials to NYMEX prices, supply shortages, future drilling, workover and restimulation plans, future distributions to unitholders and industry and market conditions, are forward-looking statements that are subject to risks and uncertainties which are detailed in Part I, Item 1A of the trustâ€™s Annual Report on Form 10-K for the year ended December 31, 2007, which is incorporated by this reference as though fully set forth herein. Although XTO Energy and the trustee believe that the expectations reflected in such forward-looking statements are reasonable, neither XTO Energy nor the trustee can give any assurance that such expectations will prove to be correct.