HUGOTON ROYALTY TRUST - Quarter Report: 2004 March (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

ý  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2004

 

OR

 

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number:  1-10476

 

Hugoton Royalty Trust

(Exact name of registrant as specified in its charter)

 

 

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  ý No  o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yes ý No o

 

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

 

 

 

HUGOTON ROYALTY TRUST

 

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004

 

		TABLE OF CONTENTS
		Glossary of Terms
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements
		Independent Accountants’ Review Report
		Condensed Statements of Assets, Liabilities and Trust Corpus at March 31, 2004 and December 31, 2003
		Condensed Statements of Distributable Income for the Three Months Ended March 31, 2004 and 2003
		Condensed Statements of Changes in Trust Corpus for the Three Months Ended March 31, 2004 and 2003
		Notes to Condensed Financial Statements
Item 2.		Trustee’s Discussion and Analysis
Item 3.		Quantitative and Qualitative Disclosures about Market Risk
Item 4.		Controls and Procedures
PART II.		OTHER INFORMATION
Item 6.		Exhibits and Reports on Form 8-K
		Signatures

 

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HUGOTON ROYALTY TRUST

 

GLOSSARY OF TERMS

 

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

 

Bbl		Barrel (of oil)
Mcf		Thousand cubic feet (of natural gas)
MMBtu		One million British Thermal Units, a common energy measurement
net proceeds		Gross proceeds received by XTO Energy from sale of production from the underlying properties, less applicable costs, as defined in the net profits interest conveyances
net profits income		Net proceeds multiplied by the net profits percentage of 80% and paid to the trust by XTO Energy.  “Net profits income” is referred to as “royalty income” for income tax purposes.
net profits interest		An interest in an oil and gas property measured by net profits from the sale of production, rather than a specific portion of production.  The following defined net profits interests were conveyed to the trust from the underlying properties:
		80% net profits interests - interests that entitle the trust to receive 80% of the net proceeds from the underlying properties that are working interests in Kansas, Oklahoma and Wyoming
underlying properties		XTO Energy’s interest in certain oil and gas properties from which the net profits interests were conveyed.  The underlying properties include working interests in predominantly gas-producing properties located in Kansas, Oklahoma and Wyoming.
working interest		An operating interest in an oil and gas property that provides the owner a specified share of production that is subject to all production and development costs

 

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HUGOTON 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 trust’s financial statements and the notes thereto included in the trust’s 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 Hugoton Royalty Trust at March 31, 2004 and the distributable income and changes in trust corpus for the three-month periods ended March 31, 2004 and 2003 have been included.  Distributable income for such interim periods is not necessarily indicative of the distributable income for the full year.

 

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INDEPENDENT ACCOUNTANTS’ REVIEW REPORT

 

 

Bank of America, N.A., as Trustee
for the Hugoton Royalty Trust:

 

We have reviewed the accompanying condensed statement of assets, liabilities and trust corpus of the Hugoton Royalty Trust as of March 31, 2004 and the related condensed statements of distributable income and changes in trust corpus for the three-month periods ended March 31, 2004 and 2003.  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 Hugoton Royalty Trust as of December 31, 2003, 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 2003 Annual Report on Form 10-K, and in our report dated March 5, 2004, 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, 2003 is fairly stated, in all material respects, in relation to the statement of assets, liabilities and trust corpus included in the trust’s 2003 Annual Report on Form 10-K from which it has been derived.

 

 

KPMG LLP

Dallas, Texas

April 28, 2004

 

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HUGOTON ROYALTY TRUST

 

Condensed Statements of Assets, Liabilities and Trust Corpus

 

		March 31, 2004			December 31, 2003
		(Unaudited)
ASSETS
Cash and short-term investments		$	7,601,200		$	5,706,240
Net profits interests in oil and gas properties - net		190,517,602			193,245,847
		$	198,118,802		$	198,952,087
LIABILITIES AND TRUST CORPUS
Distribution payable to unitholders		$	7,601,200		$	5,706,240
Trust corpus (40,000,000 units of beneficial interest authorized and outstanding)		190,517,602			193,245,847
		$	198,118,802		$	198,952,087

 

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

 

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HUGOTON ROYALTY TRUST

 

Condensed Statements of Distributable Income (Unaudited)

 

		Three Months Ended March 31
		2004			2003
Net profits income		$	19,057,231		$	16,412,178
Interest income		4,102			5,578
Total income		19,061,333			16,417,756
Administration expense		84,573			52,196
Distributable income		$	18,976,760		$	16,365,560
Distributable income per unit (40,000,000 units)		$	0.474419		$	0.409139

 

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

 

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HUGOTON ROYALTY TRUST

 

Condensed Statements of Changes in Trust Corpus (Unaudited)

 

		Three Months Ended March 31
		2004			2003
Trust corpus, beginning of period		$	193,245,847		$	205,493,243
Amortization of net profits interests		(2,728,245		)	(2,973,282		)
Distributable income		18,976,760			16,365,560
Distributions declared		(18,976,760		)	(16,365,560		)
Trust corpus, end of period		$	190,517,602		$	202,519,961

 

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

 

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HUGOTON ROYALTY TRUST

 

Notes to Condensed Financial Statements (Unaudited)

 

1.              Basis of Accounting

 

The financial statements of Hugoton 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”):

 

•                  Net profits income recorded for a month is the amount computed and paid by XTO Energy Inc., the owner of the underlying properties, to Bank of America, N.A., as trustee for the trust.  Net profits income consists of net proceeds received by XTO Energy from the underlying properties in the prior month, multiplied by a net profits percentage of 80%.

 

Costs deducted in the calculation of net proceeds for the 80% net profits interests generally include applicable taxes, transportation, marketing and legal costs, production expenses, development costs, operating charges and other costs.

 

•                  Net profits income is computed separately for each of three conveyances under which the net profits interests were conveyed to the trust.  If monthly costs exceed revenues for any conveyance, such excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from the other conveyances.

 

•                  Trust expenses are recorded based on liabilities paid and cash reserves established by the trustee for liabilities and contingencies.

 

•                  Distributions to unitholders are recorded when declared by the trustee.

 

The trust’s financial statements 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 by the trustee for contingencies which would not be recorded under GAAP.

 

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 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 $247,066,951 represents XTO Energy’s historical net book value for the interests on December 1, 1998, the date of the transfer to the trust.  Amortization of the net profits interests is calculated on a unit-of-production basis and charged directly to trust corpus.  Accumulated amortization was $56,549,349 as of March 31, 2004 and $53,821,104 as of December 31, 2003.

 

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2.              Development Costs

 

The following summarizes actual development costs, the amount of development costs deducted in the calculation of net profits income and the cumulative actual development costs (over) under the amount deducted:

 

		Three Months Ended March 31
		2004			2003
Cumulative development costs (over) under the amount deducted - beginning of period		$	(1,583,988	)	$	3,089,563
Actual development costs		(4,713,576		)	(2,639,695		)
Development costs deducted		5,100,000			3,799,343
Cumulative development costs (over) under the amount deducted - end of period		$	(1,197,564	)	$	4,249,211

 

The monthly development cost deduction is $1.7 million, which is expected to be maintained through the March 2005 distribution.  The development cost deduction will be evaluated and revised as necessary.  As of April 2004, actual costs exceeded development costs deducted by approximately $200,000.

 

3.              Contingencies

 

Litigation

 

XTO Energy is a defendant in lawsuits related to the underlying properties that could, if adversely determined, decrease future trust distributable income attributable to production on or after December 1, 1998, the creation date of the trust.  Any damages relating to production prior to December 1, 1998 will be borne by XTO Energy.

 

On October 17, 1997, an action, styled United States of America ex rel. Grynberg v. Cross Timbers Oil Company, et al., was filed in the United States District Court for the Western District of Oklahoma.  This lawsuit alleges that XTO Energy underpaid royalties on natural gas produced from federal leases and lands owned by Native Americans in amounts in excess of 20% as a result of mismeasuring the volume of natural gas and wrongfully analyzing its heating content during at least the past ten years.  The suit, which was brought under the qui tam provisions of the U.S. False Claims Act, seeks treble damages for the unpaid royalties (with interest), civil penalties between $5,000 and $10,000 for each violation of the U.S. False Claims Act, and an order for XTO Energy to cease the allegedly improper measuring practices.  The cases against XTO Energy and other defendants have been consolidated in the United States District Court for Wyoming.  While XTO Energy is unable to predict the outcome of this case or estimate the amount of any possible loss, it has informed the trustee that it believes that the allegations of this lawsuit are without merit and intends to vigorously defend the action.  However, an order to change measuring practices or a related settlement could adversely affect the trust by reducing net proceeds in the future by an amount that is presently not determinable, but, in XTO Energy management’s opinion, is not currently expected to be material to the trust’s annual distributable income, financial position or liquidity.

 

10

 

Certain of the trust properties are involved in various other 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.

 

Other

 

Several states have enacted legislation to require state income tax withholding from nonresident recipients of oil and gas proceeds.  After consultation with legal counsel, XTO Energy has advised the trustee that it believes the trust is not subject to these withholding requirements.  However, regulations are being developed or 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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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 2003 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.hugotontrust.com.

 

Distributable Income

 

For the quarter ended March 31, 2004, net profits income was $19,057,231, as compared to $16,412,178 for first quarter 2003.  Increased net profits income is primarily the result of higher gas prices.  See “Net Profits Income” below.

 

After adding interest income of $4,102 and deducting administration expense of $84,573, distributable income for the quarter ended March 31, 2004 was $18,976,760, or $0.474419 per unit of beneficial interest.  Administration expense for the quarter increased 62% from the prior year quarter primarily because of the timing of expenditures.  Decreased interest income over these periods was because of lower interest rates.  For first quarter 2003, distributable income was $16,365,560, or $0.409139 per unit.  Distributions to unitholders for the quarter ended March 31, 2004 were:

 

Record Date		Payment Date		Distribution per Unit
January 30, 2004		February 13, 2004		$	0.134306
February 27, 2004		March 12, 2004		0.150083
March 31, 2004		April 14, 2004		0.190030
				$	0.474419

 

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.

 

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

 

		Three Months Ended March 31 (a )						Increase
		2004			2003			(Decrease)
Sales Volumes
Gas (Mcf) (b)
Underlying properties		7,760,866			8,168,421			(5	)%
Average per day		84,357			88,787			(5	)%
Net profits interests		4,199,638			4,329,031			(3	)%
Oil (Bbls) (b)
Underlying properties		78,176			86,159			(9	)%
Average per day		850			937			(9	)%
Net profits interests		47,811			47,447			1	%
Average Sales Prices
Gas (per Mcf)		$	4.60		$	3.80		21	%
Oil (per Bbl)		$	31.52		$	28.76		10	%
Revenues
Gas sales		$	35,666,582		$	31,039,748		15	%
Oil sales		2,463,949			2,477,575			(1	)%
		38,130,531			33,517,323			14	%
Costs
Taxes, transportation and other		3,010,934			3,261,979			(8	)%
Production expense		4,414,667			3,999,585			10	%
Development costs (c)		5,100,000			3,799,343			34	%
Overhead		1,783,391			1,941,676			(8	)%
Total Costs		14,308,992			13,002,583			10	%
Other Proceeds
Property sales		—			482			(100	)%
Net Proceeds		23,821,539			20,515,222			16	%
Net Profits Percentage		80		%	80		%
Net Profits Income		$	19,057,231		$	16,412,178		16	%

 

(a)          Because of the two-month interval between time of production and receipt of net profits income by the trust, oil and gas sales for the quarter ended March 31 generally represent production for the period November through January.

 

(b)         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 expenses 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.

 

(c)          See Note 2 to Condensed Financial Statements.

 

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The following are explanations of significant variances from first quarter 2003 to first quarter 2004:

 

Sales Volumes

 

First quarter gas sales volumes decreased 5% and oil sales volumes decreased 9% primarily because of natural production decline, partially offset by increased production from new wells and workovers.

 

Sales Prices

 

Gas

 

The first quarter 2004 average gas price was $4.60 per Mcf, a 21% increase from the first quarter 2003 average gas price of $3.80.  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.  With diminished demand related to higher prices, natural gas prices were lower during the summer months, then rose with cooler weather in the fall and early winter.  Forecasts for continued production declines, increasing natural gas demand and larger than projected storage withdrawals have supported higher prices in early 2004.  Prices in 2004 will continue to be affected by weather, the pace of recovery of the domestic economy and fluctuations in North American production.  In any case, natural gas prices are expected to remain volatile.  The average NYMEX price for February and March 2004 was $5.45 per MMBtu.  At April 26, 2004, the average NYMEX futures price for the following twelve months was $6.03 per MMBtu.  Recent trust gas prices have averaged approximately $0.70 per MMBtu lower than the NYMEX price.

 

Oil

 

The first quarter 2004 average oil price was $31.52 per Bbl, a 10% increase from the first quarter 2003 average oil price of $28.76.  OPEC members agreed to increase daily oil production 1.5 million barrels beginning February 2003, to help stabilize a volatile world market.  Oil prices 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 reiterated its intent to maintain oil prices by reducing daily oil production by 2 million barrels beginning June  2003 and by an additional 900,000 barrels beginning November 2003.  In March 2004, an unexpected drop in gasoline stocks led oil prices to 13-year highs, reaching $38 per Bbl.  OPEC members agreed to reduce daily oil production by 1 million barrels beginning April 2004 to maintain market balance in the second quarter when there is seasonally low demand.  The average NYMEX price for February and March 2004 was $35.63 per Bbl.  At April 26, 2004, the average NYMEX futures price for the following twelve months was $34.78 per Bbl.  Recent trust oil prices have averaged approximately $0.60 per Bbl lower than the NYMEX price.

 

Costs

 

Taxes

 

Taxes, transportation and other decreased 8% for the first quarter primarily because of decreased property taxes related to the timing of cash disbursements, partially offset by increased production taxes related to higher revenues.

 

Production

 

Production expense increased 10% primarily because of increased labor and fuel costs.

 

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Development

 

Development costs deducted in the calculation of net profits income are based on the 2004 budget.  These development costs increased 34% for first quarter 2004 from the prior year quarter because of the timing of development projects and related disbursements.  First quarter actual development costs primarily relate to disbursements for development activity in fourth quarter 2003.  During the first three months of 2004, one well was started on the underlying properties and was pending completion at March 31.  XTO Energy has informed the trustee that it plans to drill approximately 19 wells during 2004.  All 2004 drilling is expected to be in western Oklahoma and southwestern Wyoming.

 

As of December 31, 2003, actual costs exceeded cumulative development costs deducted by $1.6 million.  In calculating net profits income for the quarter ended March 31, 2004, XTO Energy deducted budgeted development costs of $5.1 million.  After considering actual development costs of $4.7 million for the quarter, actual costs exceeded cumulative development costs deducted by $1.2 million.  See Note 2 to Condensed Financial Statements.

 

Overhead

 

Overhead decreased 8% primarily because of the annual rate adjustment based on an industry index.

 

Forward-Looking Statements

 

This 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, future drilling plans 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, 2003, 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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Item 3.  Quantitative and Qualitative Disclosures about Market Risk.

 

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, 2003.

 

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 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.

 

Item 6.            Exhibits and Reports on Form 8-K.

 

(a)		Exhibits.
		Exhibit Number
		and Description
		(15)	Awareness letter of KPMG LLP
		(31)	Rule 13a-14(a)/15d-14(a) Certification
		(32)	Section 1350 Certification
		(99)	Items 7 and 7a to the Annual Report on Form 10-K for Hugoton Royalty Trust filed with the Securities and Exchange Commission on March 11, 2004 (incorporated herein by reference)
(b)		Reports on Form 8-K.
		No reports on Form 8-K were filed during the quarter.  The trust furnished three 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.

 

	HUGOTON ROYALTY TRUST
	By BANK OF AMERICA, N.A., TRUSTEE
	By	/S/ NANCY G.  WILLIS
		Nancy G. Willis
		Vice President
	XTO ENERGY INC.
Date: April 29, 2004	By	/S/ LOUIS G. BALDWIN
		Louis G. Baldwin
		Executive Vice President
		and Chief Financial Officer

 

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