CROSS TIMBERS ROYALTY TRUST - Quarter Report: 2005 September (Form 10-Q)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended September 30, 2005

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 changed 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 Exchange Act).   Yes x   No ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   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, 2005

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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, 2005, and the distributable income and changes in trust corpus for the three- and nine-month periods ended September 30, 2005 and 2004, have been included. Distributable income for such interim periods is not necessarily indicative of distributable income for the full year.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

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, 2005 and the related condensed statements of distributable income and changes in trust corpus for the three- and nine-month periods ended September 30, 2005 and 2004. These condensed financial statements are the responsibility of the trustee.

We conducted our review in accordance with standards established by the Public Company Accounting Oversight Board (United States). 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 the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

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 the standards of the Public Company Accounting Oversight Board (United States), the statement of assets, liabilities and trust corpus of the Cross Timbers Royalty Trust as of December 31, 2004, 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 2004 Annual Report on Form 10-K, and in our report dated March 14, 2005, 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, 2004 is fairly stated, in all material respects, in relation to the statement of assets, liabilities and trust corpus included in the trust’s 2004 Annual Report on Form 10-K from which it has been derived.

KPMG LLP

Dallas, Texas

October 21, 2005

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CROSS TIMBERS ROYALTY TRUST

Condensed Statements of Assets, Liabilities and Trust Corpus

The accompanying notes to condensed financial statements are 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 are 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 are 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 production expense or development costs. For the 75% net profits interests, costs deducted in the calculation of net proceeds include production expense, 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. This comprehensive basis of accounting other than GAAP corresponds to the accounting permitted for royalty trusts by the U.S. Securities and Exchange Commission, as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.

Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with GAAP, directing such entities to accrue or defer revenues and expenses in a period other than when such revenues were received or expenses were paid. Because the trust’s financial statements are prepared

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on the modified cash basis, as described above, most accounting pronouncements are not applicable to the trust’s financial statements.

The initial carrying value of the net profits interests of $61,100,449 represents XTO Energy Inc.’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 $39,512,729 as of September 30, 2005 and $38,252,755 as of December 31, 2004.

Several states have enacted legislation to require state income tax withholding from nonresident recipients of oil and gas proceeds. After consultation with its state tax counsel, XTO Energy Inc. has advised the trustee that it believes the trust is not subject to these withholding requirements. However, regulations are subject to change by the various states, which could change this conclusion. 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 2004 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, 2005, net profits income was $5,069,110 compared to $4,017,397 for third quarter 2004. This 26% 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 $5,578 and administration expense of $35,600, distributable income for the quarter ended September 30, 2005 was $5,039,088, or $0.839848 per unit of beneficial interest. Administration expense for the quarter decreased 61% from the prior year quarter primarily because of the timing of expenditures. For third quarter 2004, distributable income was $3,928,740, or $0.654790 per unit. Distributions to unitholders for the quarter ended September 30, 2005 were:

The September 2005 distribution, paid to unitholders on October 17, 2005, included $668,000, or $0.11 per unit, related to a purchaser’s recalculation and remittance of royalties for San Juan Basin production before February 2002. The interest payment associated with this remittance, in the amount of $880,000, or approximately $0.15 per unit, will be included in the October 2005 distribution which will be paid to unitholders on November 15, 2005.

Nine Months

For the nine months ended September 30, 2005, net profits income was $14,120,370 compared to $10,792,393 for the same 2004 period. This 31% 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 $13,399 and administration expense of $300,289, distributable income for the nine months ended September 30, 2005 was $13,833,480, or $2.305580 per unit of beneficial interest. Administration expense for the first nine months of 2005 increased 13% from the comparable 2004 period primarily because of fees related to the audit of the trust’s internal control over financial reporting for 2004 and the timing of expenditures. For the nine months ended September 30, 2004, distributable income was $10,530,516, or $1.755086 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 Inc., 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 expense 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 on the underlying properties from third quarter 2004 to third quarter 2005 and from the first nine months of 2004 to the comparable period in 2005:

Sales Volumes

Oil

Oil sales volumes decreased 4% for third quarter 2005 and decreased 2% from the first nine months of 2004 to the comparable period in 2005 primarily because of natural production decline, partially offset by the timing of cash receipts.

Gas

Gas sales volumes decreased 24% for third quarter 2005 and 13% for the nine-month period as compared with the same 2004 periods. The 2005 third quarter and nine-month period gas sales volumes were lower because of a purchaser’s gas sales adjustments related to prior periods. These lower volumes affected the September 2005 distribution to unitholders. Excluding the effect of these adjustments, gas sales volumes decreased 15% for third quarter 2005 and 10% for the nine-month period as compared with the same 2004 periods. These decreased gas sales volumes are primarily because of natural production decline, prior period volume adjustments in 2005 and the timing of cash receipts.

See “Gulf of Mexico Hurricanes” below.

Sales Prices

Oil

The average oil price increased 39% to $50.57 per Bbl for the third quarter and 41% to $46.61 per Bbl for the nine-month period. Oil prices increased for the third quarter and for the nine-month period primarily because of increasing global demand and supply shortage concerns, inadequate refining capacity, reduced production as a result of July tropical storms in the Gulf of Mexico, market speculation and political instability, and are expected to remain volatile. Oil prices increased to record levels in August 2005, exceeding $69.00 per Bbl. The average NYMEX price for August and September 2005 was $65.22 per Bbl. At October 21, 2005, the average NYMEX futures price for the following twelve months was $61.12 per Bbl. Recent trust oil prices have averaged approximately $3.90 per Bbl lower than the NYMEX price.

Gas

Gas prices for the third quarter increased 50% to $9.05 per Mcf and for the nine-month period increased 34% to $7.51 per Mcf. The 2005 third quarter and nine-month period gas prices were higher because of a purchaser’s recalculation and remittance of royalties for San Juan Basin production before February 2002. Excluding the effect of this adjustment, gas prices for the third quarter increased 25% to $7.54 per Mcf and for the nine-month period increased 26% to $7.07 per Mcf. Gas prices increased for the third quarter and for the nine-month period primarily because of increased demand and declining North American production. Prices will continue to be affected by weather, the U.S. economy, the level of North American production, crude oil prices and import levels of liquified natural gas, and are expected to remain volatile. The third quarter 2005 gas price is primarily related to production from April through June 2005, when the average NYMEX price was $6.95 per MMBtu. The average NYMEX price for July through September 2005 was

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$9.64 per MMBtu. At October 21, 2005, the average NYMEX futures price for the following twelve months was $11.58 per MMBtu. Recent trust gas prices have been approximately $0.50 per Mcf higher than the NYMEX price. Because of regional differences in supply and demand, however, trust gas prices are generally expected to decline in relationship to the NYMEX price as the NYMEX price increases.

See “Gulf of Mexico Hurricanes” below.

Costs

Taxes

Taxes generally vary in relation to revenues, with oil taxed at a lower rate than gas revenue. Taxes, transportation and other decreased 6% for the third quarter and increased 8% for the nine-month period as compared with increased revenues of 21% for the quarter and 25% for the nine-month period. Decreased taxes, transportation and other for the third quarter and the lower percentage increase in taxes for the nine-month period are primarily because of a higher proportion of oil revenue to total revenue in 2005 and a purchaser adjustment related to prior periods.

Production Expense

Production expense was 8% higher for the third quarter and nine-month period primarily because of the timing of maintenance projects as well as the timing of cash disbursements.

Development

Development costs increased 417% for the third quarter and 10% for the nine-month period primarily because of the timing of projects and disbursements primarily related to two properties underlying the 75% net profits interests.

Gulf of Mexico Hurricanes

In late August and September 2005, hurricanes in the Gulf of Mexico disrupted a significant portion of U.S. oil and gas production, leading to higher prices. These increased prices will affect distributions to unitholders beginning with the November 2005 distribution to be paid in December 2005. The underlying properties to the trust are not located near the Gulf and related production was not significantly affected. However, because of greater supply and weaker demand in areas where trust related oil and gas is produced, the price received for such production is expected to be lower than the price received for Gulf production or NYMEX prices. As a result of storm damages and related supply shortages, production expense and development costs are expected to increase throughout the industry. The duration of these higher prices and costs cannot be predicted.

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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 and expenses, oil and gas prices and differentials to NYMEX prices, supply shortages, distributions to unitholders 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, 2004, which is incorporated by this reference as though fully set forth herein. Although XTO Energy Inc. and the trustee believe that the expectations reflected in such forward-looking statements are reasonable, neither XTO Energy Inc. nor the trustee can give any assurance that such expectations will prove to be correct.

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, 2004.

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 Inc. 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.

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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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