CROSS TIMBERS ROYALTY TRUST - Quarter Report: 2003 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

OR

Commission File Number: 1-10982

Cross Timbers Royalty Trust

(Exact name of registrant as specified in its charter)

(877) 228-5084

(Registrant’s telephone number, including area code)

NONE

(Former name, former address and former fiscal year, if change since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct).

Yes  ¨  No  x

Indicate the number of units of beneficial interest outstanding, as of the latest practicable date:

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CROSS TIMBERS ROYALTY TRUST

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003

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CROSS TIMBERS ROYALTY TRUST

GLOSSARY OF TERMS

The following are definitions of significant terms used in this Form 10-Q:

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CROSS TIMBERS ROYALTY TRUST

PART I - FINANCIAL INFORMATION

The condensed financial statements included herein are presented, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted pursuant to such rules and regulations, although the trustee believes that the disclosures are adequate to make the information presented not misleading. These condensed financial statements should be read in conjunction with the financial statements and the notes thereto included in the trust’s latest Annual Report on Form 10-K. In the opinion of the trustee, all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the assets, liabilities and trust corpus of the Cross Timbers Royalty Trust at September 30, 2003, and the distributable income and changes in trust corpus for the three- and nine-month periods ended September 30, 2003 and 2002, have been included. Distributable income for such interim periods is not necessarily indicative of distributable income for the full year.

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INDEPENDENT ACCOUNTANTS’ REVIEW REPORT

Bank of America, N.A., as Trustee

for the Cross Timbers Royalty Trust:

We have reviewed the accompanying condensed statement of assets, liabilities and trust corpus of the Cross Timbers Royalty Trust as of September 30, 2003 and the related condensed statements of distributable income and changes in trust corpus for the three- and nine-month periods ended September 30, 2003 and 2002. These condensed financial statements are the responsibility of the trustee.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States of America, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

The accompanying condensed financial statements are prepared on a modified cash basis as described in Note 1 which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States of America.

Based on our review, we are not aware of any material modifications that should be made to the condensed financial statements referred to above for them to be in conformity with the basis of accounting described in Note 1.

We have previously audited, in accordance with auditing standards generally accepted in the United States of America, the statement of assets, liabilities and trust corpus of the Cross Timbers Royalty Trust as of December 31, 2002, and the related statements of distributable income and changes in trust corpus for the year then ended (not presented herein), included in the trust’s 2002 Annual Report on Form 10-K, and in our report dated March 14, 2003, we expressed an unqualified opinion on those financial statements. In our opinion, the information set forth in the accompanying condensed statement of assets, liabilities and trust corpus as of December 31, 2002 is fairly stated, in all material respects, in relation to the statement of assets, liabilities and trust corpus included in the trust’s 2002 Annual Report on Form 10-K from which it has been derived.

KPMG LLP

Dallas, Texas

October 15, 2003

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CROSS TIMBERS ROYALTY TRUST

Condensed Statements of Assets, Liabilities and Trust Corpus

The accompanying notes to condensed financial statements is an integral part of these statements.

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CROSS TIMBERS ROYALTY TRUST

Condensed Statements of Distributable Income (Unaudited)

The accompanying notes to condensed financial statements is an integral part of these statements.

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CROSS TIMBERS ROYALTY TRUST

Condensed Statements of Changes in Trust Corpus (Unaudited)

The accompanying notes to condensed financial statements is an integral part of these statements.

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CROSS TIMBERS ROYALTY TRUST

Notes to Condensed Financial Statements (Unaudited)

The financial statements of Cross Timbers Royalty Trust are prepared on the following basis and are not intended to present financial position and results of operations in conformity with generally accepted accounting principles (“GAAP”):

Costs deducted in the calculation of net proceeds for the 90% net profits interests generally include applicable taxes, transportation, marketing and legal costs, and do not include other production and development costs. For the 75% net profits interests, costs deducted in the calculation of net proceeds include production expenses, development costs, applicable taxes, operating charges and other costs.

The financial statements of the trust differ from those prepared in conformity with GAAP because revenues are recognized when received rather than accrued in the month of production, expenses are recognized when paid rather than when incurred, and certain cash reserves may be established for contingencies which would not be accrued under GAAP.

The initial carrying value of the net profits interests of $61,100,449 represents XTO Energy’s historical net book value on February 12, 1991, the creation date of the trust. Amortization of the net profits interests is calculated on a unit-of-production basis and is charged directly to trust corpus. Accumulated amortization was $35,903,847 as of September 30, 2003 and $34,543,916 as of December 31, 2002.

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On September 18, 2003, XTO Energy distributed all of the 1,360,000 trust units it owned as a dividend to its common stockholders. As of this date, XTO Energy is not a unitholder of the trust.

Several states have enacted legislation to require state income tax withholding from nonresident royalty owners. After consultation with legal counsel, XTO Energy has advised the trustee that it believes the trust is not subject to these withholding requirements. However, final regulations have not been issued. In the event it is determined that the trust is required to withhold state taxes, distributions to the unitholders would be reduced by the required amount, subject to the unitholder’s right to file a state tax return to claim any refund due.

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The following discussion should be read in conjunction with the trustee’s discussion and analysis contained in the trust’s 2002 annual report, as well as the condensed financial statements and notes thereto included in this quarterly report on Form 10-Q. The trust’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 trust’s web site at www.crosstimberstrust.com.

Distributable Income

Quarter

For the quarter ended September 30, 2003, net profits income was $3,122,116 compared to $2,526,363 for third quarter 2002. This 24% increase in net profits income is the result of higher gas prices. See “Net Profits Income” on the following page.

After considering interest income of $953 and administration expense of $53,457, distributable income for the quarter ended September 30, 2003 was $3,069,612, or $0.511602 per unit of beneficial interest. Administration expense for the quarter increased 60% from the prior year quarter primarily because of the timing of expenditures. For third quarter 2002, distributable income was $2,494,434, or $0.415739 per unit. Distributions to unitholders for the quarter ended September 30, 2003 were:

Nine Months

For the nine months ended September 30, 2003, net profits income was $9,539,904 compared to $6,222,032 for the same 2002 period. This 53% increase in net profits income is the result of higher oil and gas prices. See “Net Profits Income” on the following page.

After considering interest income of $3,347 and administration expense of $210,275, distributable income for the nine months ended September 30, 2003 was $9,332,976, or $1.555496 per unit of beneficial interest. Administration expense for the first nine months of 2003 increased 4% from the comparable 2002 period. For the nine months ended September 30, 2002, distributable income was $6,022,728, or $1.003788 per unit.

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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 production and three months after gas production. Net profits income is generally affected by three major factors:

Because properties underlying the 90% net profits interests are royalty and overriding royalty interests, they generally bear no costs other than production and property taxes, related legal costs, and marketing and transportation charges. In addition to these costs, the 75% net profits interests are subject to production and development costs, since the properties underlying the 75% net profits interests are working interests.

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The following is a summary of the calculation of net profits income received by the trust:

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The following are explanations of significant variances from third quarter 2002 to third quarter 2003 and from the first nine months of 2002 to the comparable period in 2003:

Sales Volumes

Oil

Oil sales volumes decreased 16% for third quarter 2003 and 12% for the nine-month period as compared with the same 2002 periods. Decreased oil sales volumes are primarily because of natural production decline and timing of cash receipts.

Gas

Gas sales volumes decreased 16% for third quarter 2003 and 11% for the nine-month period as compared with the same 2002 periods. Decreased gas sales volumes for the quarter are primarily because of natural production decline and timing of cash receipts. Decreased gas sales volumes for the nine-month period are primarily because of natural production decline, partially offset by timing of cash receipts.

Sales Prices

Oil

The average oil price increased 13% to $27.96 per Bbl for the third quarter and 35% to $28.16 per Bbl for the nine-month period. Because of lower prices, OPEC members agreed to cut daily production by 1.5 million barrels in 2002 to support oil prices affected by weak demand and excess supply. Oil prices increased during 2002 largely because of OPEC production discipline and rising uncertainty surrounding the Middle East. OPEC members agreed to increase daily oil production 1.5 million barrels beginning February 1, 2003, to help stabilize a volatile world market. Oil prices have remained relatively high in 2003, however, because of the war in Iraq, slower than anticipated resumption of Iraqi oil exports and unusually low storage levels. OPEC reduced daily oil production by 2 million barrels beginning June 1, 2003 and, because of the recent fall in oil prices and the concern of increasing production from non-OPEC suppliers, agreed to cut daily oil production by 900,000 barrels beginning November 1, 2003. The average NYMEX price for August and September 2003 was $30.01 per Bbl. At October 15, 2003, the average NYMEX futures price for the following twelve months was $29.78 per Bbl. Recent trust oil prices have averaged approximately $2.20 per Bbl lower than the NYMEX price.

Gas

Gas prices for the third quarter increased 66% to $5.05 per Mcf and for the nine-month period increased 76% to $4.79 per Mcf. The winter of 2001-2002 was one of the warmest on record, resulting in higher than average gas storage levels and lower gas prices in the first nine months of 2002. Prices climbed in fourth quarter 2002 as a result of low levels of drilling activity, increased industrial demand, colder weather and international instability. With colder than normal weather, record low gas storage levels and continued increasing demand, gas prices were relatively high during the first five months of 2003. Since May, higher than normal levels of gas have been injected into storage due to diminished demand related to higher prices, resulting in lower natural gas prices. Prices for the remainder of 2003 will be influenced by weather, possible

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revived demand due to lower prices, the pace of recovery of the domestic economy and increases in North American production. In any case, natural gas prices are expected to remain volatile. The third quarter 2003 gas price is primarily related to production from April through June 2003, when the average NYMEX price was $5.73. The average NYMEX price for July through September 2003 was $4.89 per MMBtu. At October 15, 2003, the average NYMEX futures price for the following twelve months was $5.19 per MMBtu. Recent trust gas prices have averaged approximately $0.20 per MMBtu lower than the NYMEX price.

Costs

Taxes

Taxes, transportation and other increased 13% for the third quarter and 53% for the nine-month period. The third quarter increase is because of higher production taxes and other deductions related to higher product prices, partially offset by lower property taxes related to the timing of disbursements. The nine-month increase is because of higher production taxes and other deductions related to higher product prices and increased Texas property taxes related to the timing of disbursements.

Production Expenses

Production expenses were 12% higher for the third quarter and for the nine-month period primarily because of increased fuel costs related to higher gas prices and timing of maintenance projects.

Development

Development costs decreased 65% for the third quarter and 75% for the nine-month period primarily because of reduced drilling activity on properties underlying the Texas 75% net profits interests.

Excess Costs

During first quarter 2002, costs exceeded revenues by $66,867 ($50,150 net to the trust) for the Texas 75% net profits interests as a result of lower oil prices. Total excess costs and accrued interest of $67,484 ($50,613 net to the trust) were fully recovered during the third quarter of 2002. There were no excess costs during the remainder of 2002 or in the first nine months of 2003.

Other

On September 18, 2003, XTO Energy distributed all of the 1,360,000 trust units it owned as a dividend to its common stockholders. As of this date, XTO Energy is not a unitholder of the trust.

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Forward-Looking Statements

This report on Form 10-Q includes “forward-looking statements” 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, development, production and other costs, oil and gas prices, and industry and market conditions, are forward-looking statements that are subject to risks and uncertainties which are detailed in Part II, Item 7 of the trust’s Annual Report on Form 10-K for the year ended December 31, 2002, 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.

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There have been no material changes in the trust’s market risks, as disclosed in Part II, Item 7a of the trust’s Annual Report on Form 10-K for the year ended December 31, 2002.

As of the end of the period covered by this report, the trustee carried out an evaluation of the effectiveness of the design and operation of the trust’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15. Based upon that evaluation, the trustee concluded that the trust’s disclosure controls and procedures are effective in timely alerting the trustee to material information relating to the trust required to be included in the trust’s periodic filings with the Securities and Exchange Commission. In its evaluation of disclosure controls and procedures, the trustee has relied, to the extent considered reasonable, on information provided by XTO Energy. There has not been any change in the trust’s internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the trust’s internal control over financial reporting.

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PART II - OTHER INFORMATION

Items 1 through 5. Not Applicable.

(a) Exhibits.

(b) Reports on Form 8-K.

No reports on Form 8-K were filed during the quarter. The trust furnished two reports on Form 8-K under Item 12 for this period.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.

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