CROSS TIMBERS ROYALTY TRUST - Quarter Report: 2009 June (Form 10-Q)

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the quarterly period ended June 30, 2009

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2).    Yes  ¨    No  x

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

Outstanding as of July 1, 2009

6,000,000

Table of Contents

CROSS TIMBERS ROYALTY TRUST

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2009

TABLE OF CONTENTS

2

Table of Contents

CROSS TIMBERS ROYALTY TRUST

GLOSSARY OF TERMS

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

3

Table of Contents

CROSS TIMBERS ROYALTY TRUST

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

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 June 30, 2009, and the distributable income and changes in trust corpus for the three- and six-month periods ended June 30, 2009 and 2008, have been included. Distributable income for such interim periods is not necessarily indicative of distributable income for the full year.

4

Table of Contents

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 June 30, 2009 and the related condensed statements of distributable income and changes in trust corpus for the three- and six-month periods ended June 30, 2009 and 2008. 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, 2008, 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 2008 Annual Report on Form 10-K, and in our report dated February 25, 2009, 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, 2008 is fairly stated, in all material respects, in relation to the statement of assets, liabilities and trust corpus included in the trust’s 2008 Annual Report on Form 10-K from which it has been derived.

KPMG LLP

Fort Worth, Texas

July 20, 2009

5

Table of Contents

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.

6

Table of Contents

CROSS TIMBERS ROYALTY TRUST

Condensed Statements of Distributable Income (Unaudited)

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

7

Table of Contents

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.

8

Table of Contents

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 U.S. 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, transportation, marketing and legal costs, operating charges and other costs.

The financial statements of the trust differ from those prepared in conformity with U.S. GAAP because revenues are recognized when received rather than accrued in the month of production, expenses are recognized when paid rather than when incurred, and certain cash reserves may be established for contingencies which would not be accrued under U.S. GAAP. This comprehensive basis of accounting other than U.S. GAAP corresponds to the accounting permitted for royalty trusts by the U.S. Securities and Exchange Commission, as specified by Staff Accounting Bulletin Topic 12:E, Financial Statements of Royalty Trusts.

9

Table of Contents

Most accounting pronouncements apply to entities whose financial statements are prepared in accordance with U.S. GAAP, directing such entities to accrue or defer revenues and expenses in a period other than when such revenues were received or expenses were paid. Because the trust’s financial statements are prepared on the modified cash basis, as described above, most accounting pronouncements are not applicable to the trust’s financial statements.

In December 2008, the Securities and Exchange Commission (SEC) released Final Rule, Modernization of Oil and Gas Reporting. The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. In addition, the new disclosure requirements require companies to: (a) report the independence and qualifications of its reserves preparer or auditor; (b) file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and (c) report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. The new disclosure requirements are effective for financial statements for fiscal years ending on or after December 31, 2009. The effect of adopting the SEC rule has not been determined, but it is not expected to have a significant effect on the trust’s reported financial position or distributable income.

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 $44,177,921 as of June 30, 2009 and $43,844,688 as of December 31, 2008.

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 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. Should the trust be 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.

Certain of the underlying properties are involved in various lawsuits and certain governmental proceedings arising in the ordinary course of business. XTO Energy has advised the trustee that it does not believe that the ultimate resolution of these claims will have a material effect on trust annual distributable income, financial position or liquidity.

In first quarter 2008, the calculation of net profits income included a lawsuit settlement of $827,446 related to underpayment of royalties on underlying properties in the San Juan Basin. Included in this settlement was interest of $212,654 and additional gas revenue of $614,792. The total settlement, net to the trust, was $744,702, or $0.12 per unit. Based on additional information received by XTO Energy in April 2008, the amount allocated to interest income was increased by $136,262 in second quarter 2008. This reallocation did not change the total lawsuit settlement.

10

Table of Contents

In second quarter 2008, the calculation of net profits income included another lawsuit settlement of $1,602,880 related to underpayment of royalties on underlying properties in the San Juan Basin. Included in this settlement was interest of $675,899 and additional gas revenue of $926,981. The total settlement, net to the trust, was $1,442,592, or $0.24 per unit.

Significantly lower oil prices and elevated costs caused costs to exceed revenues on properties underlying the Texas working interest for January through April 2009 and on properties underlying the Oklahoma working interest for February through April 2009. However, these excess costs did not reduce net proceeds from the remaining conveyances. XTO Energy advised the trustee that increased oil prices and decreased costs led to the partial recovery of excess costs, plus accrued interest, on the properties underlying the Texas and Oklahoma working interests during second quarter 2009. Remaining excess costs totaled $125,672 ($94,254 net to the trust) on properties underlying the Texas working interest and $274,363 ($205,772 net to the trust) on properties underlying the Oklahoma working interest at the end of second quarter 2009.

Item 2. Trustee’s Discussion and Analysis.

The following discussion should be read in conjunction with the trustee’s discussion and analysis contained in the trust’s 2008 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 June 30, 2009, net profits income was $2,389,205 compared to $8,528,354 for second quarter 2008. This 72% decrease in net profits income is the result of lower oil and gas prices, lawsuit settlement proceeds included in second quarter 2008 and lower oil and gas production. See “Net Profits Income” and “Other Proceeds” below.

After considering interest income of $82 and administration expense of $100,593, distributable income for the quarter ended June 30, 2009 was $2,288,694, or $0.381449 per unit of beneficial interest. Changes in interest income are attributable to fluctuations in net profits income and interest rates. Administrative expense for the quarter decreased 34% from the prior year quarter primarily because of the timing of expenditures. For second quarter 2008, distributable income was $8,380,314, or $1.396719 per unit. Distributions to unitholders for the quarter ended June 30, 2009 were:

11

Table of Contents

Six Months

For the six months ended June 30, 2009, net profits income was $5,194,504 compared to $15,414,208 for the same 2008 period. This 66% decrease in net profits income is the result of lower oil and gas prices, lawsuit settlement proceeds included in the first six months of 2008 and lower oil and gas production. See “Net Profits Income” and “Other Proceeds” below.

After considering interest income of $154 and administration expense of $236,174, distributable income for the six months ended June 30, 2009 was $4,958,484, or $0.826414 per unit of beneficial interest. Changes in interest income are attributable to fluctuations in net profits income and interest rates. Administrative expense for the six months ended June 30, 2009 decreased 15% from the prior year six-month period primarily because of the timing of expenditures. For the six months ended June 30, 2008, distributable income was $15,146,592, or $2.524432 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 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.

12

Table of Contents

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

13

Table of Contents

The following are explanations of significant variances on the underlying properties from second quarter 2008 to second quarter 2009 and from the first six months of 2008 to the comparable period in 2009:

Sales Volumes

Oil

Oil sales volumes decreased 8% for second quarter 2009 and 5% for the first six months of 2009 as compared with the same 2008 periods primarily because of natural production decline and the timing of cash receipts, partially offset by increased production from new wells and workovers.

Gas

Gas sales volumes decreased 14% for second quarter 2009 and 7% for the first six months of 2009 as compared with the same 2008 periods primarily because of the timing of cash receipts and natural production decline, partially offset by increased production from new wells and workovers.

Sales Prices

Oil

The average oil price decreased 57% to $40.08 per Bbl for the second quarter and 55% to $40.81 per Bbl for the six-month period. Lower demand as a result of the global economic situation and rising crude oil supplies caused oil prices to decline in the first quarter of 2009. However, signs of possible economic improvement have resulted in higher recent oil prices. Oil prices are expected to remain volatile. The second quarter 2009 oil price is primarily related to production from February through April 2009, when the average NYMEX price was $46.01 per Bbl. The average NYMEX price for May and June 2009 was $64.51 per Bbl. At July 14, 2009, the average NYMEX futures price for the following twelve months was $63.91 per Bbl. Recent trust oil prices have averaged approximately 16% lower than the NYMEX price.

Gas

Gas prices for the second quarter decreased 54% to $5.37 per Mcf and for the six-month period decreased 48% to $5.76 per Mcf. Excluding the effects of the lawsuit settlement in first and second quarters 2008, the average gas price was $10.23 per Mcf in second quarter 2008 and $9.80 per Mcf for the first six months of 2008. See “Other Proceeds” below. Due to concerns of oversupply from shale gas development, declining demand due to the U.S. recession and increased gas storage, gas prices have declined. Prices will continue to be affected by the level of North American production, weather, oil prices, the U.S. economy, storage levels and import levels of liquified natural gas. Natural gas prices are expected to remain volatile. The second quarter 2009 gas price is primarily related to production from January through March 2009, when the average NYMEX price was $4.89 per MMBtu. The average NYMEX price for May and June 2009 was $3.43 per MMBtu. At July 14, 2009, the average NYMEX futures price for the following twelve months was $4.86 per MMBtu. Recent trust gas prices have been approximately 10% higher than the NYMEX price.

14

Table of Contents

Costs

Taxes, Transportation and Other

Taxes, transportation and other decreased 38% for the second quarter and 30% for the six-month period primarily because of decreased production taxes related to lower oil and gas revenues, partially offset by increased other deductions. In addition, decreased taxes, transportation and other costs for the six-month period was partially offset by higher property taxes.

Production Expense

Production expense was 14% lower for the second quarter primarily because of the timing of expenditures and decreased power and fuel costs, partially offset by increased repairs and maintenance, carbon dioxide injection and overhead costs on nonoperated properties. Production expense was 17% higher for the six-month period primarily because of increased overhead, repairs and maintenance and carbon dioxide injection costs, partially offset by the timing of expenditures.

Development

Development costs decreased 75% for the second quarter and 46% for the six-month period primarily because of decreased activity and costs related to Texas and Oklahoma properties underlying the 75% net profits interests.

Excess Costs

Significantly lower oil prices and elevated costs caused costs to exceed revenues on properties underlying the Texas working interest for January through April 2009 and on properties underlying the Oklahoma working interest for February through April 2009. However, these excess costs did not reduce net proceeds from the remaining conveyances. XTO Energy advised the trustee that increased oil prices and decreased costs led to the partial recovery of excess costs, plus accrued interest, on the properties underlying the Texas and Oklahoma working interests during second quarter 2009. Remaining excess costs totaled $125,672 ($94,254 net to the trust) on properties underlying the Texas working interest and $274,363 ($205,772 net to the trust) on properties underlying the Oklahoma working interest at the end of second quarter 2009.

Contingencies

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 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. Should the trust be 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.

Other Proceeds

In first quarter 2008, the calculation of net profits income included a lawsuit settlement of $827,446 related to underpayment of royalties on underlying properties in the San Juan Basin. Included in this settlement was interest of $212,654 and additional gas revenue of $614,792. The total settlement, net to the trust, was $744,702, or $0.12 per unit. Based on additional information received by XTO Energy in April 2008, the

15

Table of Contents

amount allocated to interest income was increased by $136,262 in second quarter 2008. This reallocation did not change the total lawsuit settlement.

In second quarter 2008, the calculation of net profits income included another lawsuit settlement of $1,602,880 related to underpayment of royalties on underlying properties in the San Juan Basin. Included in this settlement was interest of $675,899 and additional gas revenue of $926,981. The total settlement, net to the trust, was $1,442,592, or $0.24 per unit.

Pending Securities and Exchange Commission Rule

In December 2008, the Securities and Exchange Commission (SEC) released Final Rule, Modernization of Oil and Gas Reporting. The new disclosure requirements include provisions that permit the use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes. The new requirements also will allow companies to disclose their probable and possible reserves to investors. In addition, the new disclosure requirements require companies to: (a) report the independence and qualifications of its reserves preparer or auditor; (b) file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and (c) report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. The new disclosure requirements are effective for financial statements for fiscal years ending on or after December 31, 2009. The effect of adopting the SEC rule has not been determined, but it is not expected to have a significant effect on the trust’s reported financial position or distributable income.

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, 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 trust’s Annual Report on Form 10-K for the year ended December 31, 2008, 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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

There have been no material changes in the trust’s market risks from the information disclosed in Part II, Item 7A of the trust’s annual report on Form 10-K for the year ended December 31, 2008 other than the addition of the market risk described below:

Currently, cash held by the trustee as a reserve for liabilities and for the payment of expenses and distributions to unitholders is invested in Bank of America, N.A. certificates of deposit which are backed by the good faith and credit of Bank of America, N.A., but are only insured by the Federal Deposit Insurance Corporation up to $250,000. Each unitholder should independently assess the creditworthiness of Bank of America, N.A. For more information about the credit rating of Bank of America, N.A., please refer to its periodic filings with the SEC. The trust does not lend money and has limited ability to borrow money, which the trustee believes limits the trust’s risk from the current tightening of credit markets. The trust’s future royalty income, however, may be subject to risks relating to the creditworthiness of the operators of the underlying properties and other purchasers

16

Table of Contents

of crude oil and natural gas produced from the underlying properties, as well as risks associated with fluctuations in the price of crude oil and natural gas. See “Item 1A — Risk Factors — Cash held by the trustee is not fully insured by the Federal Deposit Insurance Corporation, and future royalty income may be subject to risks relating to the creditworthiness of third parties.” Information contained in Bank of America, N.A.’s periodic filings with the SEC is not incorporated by reference into this quarterly report on Form 10-Q and should not be considered part of this report or any other filing that the trust makes with the SEC.

Item 4. Controls and Procedures.

As of the end of the period covered by this report, the trustee carried out an evaluation of the effectiveness 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 recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the trust in the reports that it files or submits under the Securities Exchange Act of 1934 and are effective in ensuring that information required to be disclosed by the trust in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to the trustee to allow timely decisions regarding required disclosure. 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.

17

Table of Contents

PART II - OTHER INFORMATION

Item 1.

Not applicable.

Item 1A. Risk Factors.

Except as set forth below, there have been no material changes in the risk factors disclosed under Part I, Item 1A of the trust’s annual report on Form 10-K for the year ended December 31, 2008.

Cash held by the trustee is not fully insured by the Federal Deposit Insurance Corporation, and future royalty income may be subject to risks relating to the creditworthiness of third parties.

Currently, cash held by the trustee as a reserve for liabilities and for the payment of expenses and distributions to unitholders is invested in Bank of America, N.A. certificates of deposit which are backed by the good faith and credit of Bank of America, N.A., but are only insured by the Federal Deposit Insurance Corporation up to $250,000. Each unitholder should independently assess the creditworthiness of Bank of America, N.A. For more information about the credit rating of Bank of America, N.A., please refer to its periodic filings with the SEC. The trust does not lend money and has limited ability to borrow money, which the trustee believes limits the trust’s risk from the current tightening of credit markets. The trust’s future royalty income, however, may be subject to risks relating to the creditworthiness of the operators of the underlying properties and other purchasers of crude oil and natural gas produced from the underlying properties, as well as risks associated with fluctuations in the price of crude oil and natural gas. Information contained in Bank of America, N.A.’s periodic filings with the SEC is not incorporated by reference into this quarterly report on Form 10-Q and should not be considered part of this report or any other filing that the trust makes with the SEC.

Items 2 through 5.

Not applicable.

Item 6. Exhibits.

18

Table of Contents

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.

19