HUGOTON ROYALTY TRUST - Quarter Report: 2016 June (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 June 30, 2016

OR

Commission File Number: 1-10476

Hugoton Royalty Trust

(Exact name of registrant as specified in its charter)

(855) 588-7839

(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, 2016

40,000,000

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HUGOTON ROYALTY TRUST

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016

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HUGOTON ROYALTY TRUST

GLOSSARY OF TERMS

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

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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 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 for a fair statement of the assets, liabilities and trust corpus of the Hugoton Royalty Trust at June 30, 2016 and the distributable income and changes in trust corpus for the three- and six-month periods ended June 30, 2016 and 2015 have been included. Distributable income for such interim periods is not necessarily indicative of the distributable income for the full year. The condensed financial statements as of June 30, 2016, and for the three-month and six-month periods ended June 30, 2016 and 2015 have been subjected to a review by PricewaterhouseCoopers LLP, the Trust’s independent registered public accounting firm, whose report is included herein.

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Report of Independent Registered Public Accounting Firm

To the Unitholders of Hugoton Royalty Trust and

Southwest Bank, Trustee:

We have reviewed the accompanying condensed statement of assets, liabilities and trust corpus of Hugoton Royalty Trust (the “Trust”) as of June 30, 2016, and the related condensed statements of distributable income and changes in trust corpus for the three-month and six-month periods ended June 30, 2016 and 2015. These interim financial statements are the responsibility of the Trustee.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures 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.

As described in Note 1, these financial statements were prepared on the modified cash basis of accounting, 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 accompanying condensed interim financial statements for them to be in conformity with the basis of accounting described in Note 1.

We previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the statement of assets, liabilities and trust corpus as of December 31, 2015, and the related statements of distributable income and changes in trust corpus for the year then ended (not presented herein), and in our report dated March 11, 2016, 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, 2015 is fairly stated in all material respects in relation to the statement of assets, liabilities and trust corpus from which it has been derived.

/s/ PricewaterhouseCoopers LLP

Dallas, TX

August 4, 2016

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HUGOTON ROYALTY TRUST

Condensed Statements of Assets, Liabilities and Trust Corpus (Unaudited)

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)

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)

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)

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 U.S. generally accepted accounting principles (“GAAP”):

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

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

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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.

Impairment of Net Profits Interest

The trustee reviews the Trust’s net profits interests (“NPI”) in oil and gas properties for impairment whenever events or circumstances indicate that the carrying value of the NPI may not be recoverable. In general, the trustee does not view temporarily low prices as a trigger event for conducting an impairment test. The markets for crude oil and natural gas have a history of significant price volatility and though prices will occasionally drop significantly, industry prices over the long term will continue to be driven by market supply and demand. If a trigger event occurred, the trustee would use the estimated undiscounted future net cash flows from the NPI to evaluate the recoverability of the Trust assets. If the undiscounted future net cash flows from the NPI are less than the NPI carrying value, the Trust would recognize an impairment loss for the difference between the NPI carrying value and the estimated fair value of the NPI. The determination as to whether the NPI is impaired requires a significant amount of judgment by the trustee and is based on the best information available to the trustee at the time of the evaluation.

In light of lower long term prices used to develop projections of future cash flows, continued excess costs on two conveyances and zero distributions to unitholders for the six months ended June 30, 2016, the trustee concluded that an impairment trigger event had occurred in the second quarter of 2016. An assessment of the forecasted net cash flows was performed for the NPI. The result of the assessment indicated that the estimated undiscounted future net cash flows from the NPI were below the carrying value of the NPI. During the second quarter of 2016, the NPI was written down to its fair value of $ 28.8 million, resulting in a $ 57.3 million impairment charged directly to Trust corpus, which does not affect distributable income. The fair value of the NPI was developed using estimates for future oil and gas production attributable to the Trust, future crude oil and natural gas commodity prices published by third-party industry experts (adjusted for basis differentials), estimated taxes, development and operating expenses, and a risk-adjusted discount rate.

Net profits interests in oil and gas properties

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. For the quarter ended June 30, 2016, the carrying value of the NPI was written down to its fair value, resulting in an impairment of $57,306,527 charged directly to Trust corpus. Amortization of the net profits interests is calculated on a unit-of-production basis and charged directly to Trust corpus. Accumulated amortization was $160,959,424 as of June 30, 2016 and $160,166,720 as of December 31, 2015.

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The following summarizes actual development costs, budgeted development costs deducted in the calculation of net profits income, and the cumulative actual costs compared to the amount deducted:

The monthly development cost deduction was $200,000 from the January 2015 distribution through the August 2015 distribution. Due to the anticipated level of actual costs and the 2015 development budget, the development cost deduction was increased to $300,000 beginning with the September 2015 distribution and was maintained at that level through January 2016. Due to the level of actual development costs, the monthly development cost deduction was decreased from $300,000 to $187,500 beginning in February 2016 and was maintained at that level through the March 2016 distribution. Due to the revised 2016 budget, the monthly development cost deduction was decreased to $100,000 beginning with the April 2016 distribution and due to the level of actual development costs the monthly development cost deduction was further decreased to $50,000 beginning with the June 2016 distribution. The monthly deduction is based on the current level of development expenditures, budgeted future development costs and the cumulative actual costs under (over) previous deductions. Changes in oil or natural gas prices could impact future development plans on the underlying properties. XTO Energy has advised the trustee that this monthly deduction will continue to be evaluated and revised as necessary.

For federal income tax purposes, the Trust constitutes a fixed investment trust that is taxed as a grantor trust. A grantor trust is not subject to tax at the trust level. Accordingly, no provision for income taxes has been made in the financial statements. The unitholders are considered to own the Trust’s income and principal as though no trust were in existence. The income of the Trust is deemed to have been received or accrued by each unitholder at the time such income is received or accrued by the Trust and not when distributed by the Trust. If the Trust borrows against the net profits interest of the Trust, as contemplated in “Administration Expense Reserve,” unrelated business taxable income could result to tax-exempt unitholders. Impairment for book purposes will not result in a loss for tax purposes for the unitholders until the loss is recognized.

All revenues from the Trust are from sources within Kansas, Oklahoma or Wyoming. Because it distributes all of its net income to unitholders, the Trust has not been taxed at the trust level in Kansas or Oklahoma. While the Trust has not owed tax, the trustee is required to file a return with Kansas and Oklahoma reflecting the income and deductions of the Trust attributable to properties located in each state, along with a schedule that includes information regarding distributions to unitholders.

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Wyoming does not have a state income tax.

Each unitholder should consult his or her own tax advisor regarding income tax requirements, if any, applicable to such person’s ownership of Trust units.

Unitholders should consult the Trust’s latest annual report on Form 10-K for a complete discussion of federal and state tax matters.

In September 2008, a royalty class action lawsuit was filed against XTO Energy styled Wallace B. Roderick Revocable Living Trust, et al. v. XTO Energy Inc. in the District Court of Kearny County, Kansas. The case was removed to federal court in Wichita, Kansas. The plaintiffs allege that XTO Energy has improperly taken post production costs from royalties paid to the plaintiffs from wells located in Kansas, Oklahoma, and Colorado; later reduced to Kansas. The case was certified as a class action in March 2012. XTO Energy filed an appeal of the class certification to the 10th Circuit Court of Appeals on April 11, 2012, which was granted on June 26, 2012. The court reversed the certification of the class and remanded the case back to the trial court for further proceedings. The case was previously stayed pending a final decision from the Kansas Supreme Court on the Fawcett v. OPIK appeal. Following the decision in Fawcett, the Judge in Roderick ordered new briefing on the pending motions. In its pleadings, the plaintiff has alleged damages in excess of $40 million. On June 22, 2016, plaintiffs’ Second Motion for Class Certification was denied.

In December 2010, a royalty class action lawsuit was filed against XTO Energy styled Chieftain Royalty Company v. XTO Energy Inc. in Coal County District Court, Oklahoma. XTO Energy removed the case to federal court in the Eastern District of Oklahoma. The plaintiffs allege that XTO Energy wrongfully deducted fees from royalty payments on Oklahoma wells, failed to make diligent efforts to secure the best terms available for the sale of gas and its constituents, and demand an accounting to determine whether they have been fully and fairly paid gas royalty interests. The case was certified as a class action in April 2012. XTO Energy filed an appeal of the class certification to the 10th Circuit Court of Appeals on April 26, 2012, which was granted on June 26, 2012. The court reversed the certification of the class and remanded the case back to the trial court for further proceedings. A non-binding mediation is scheduled for September 1, 2016.

XTO Energy has informed the trustee that it believes that XTO Energy has strong defenses to these lawsuits and intends to vigorously defend its position. However, XTO Energy has informed the trustee that it is cognizant of other, similar litigation. As these cases develop, XTO Energy will assess its legal position accordingly. If XTO Energy ultimately makes any settlement payments or receives a judgment against it in Chieftain or Roderick, XTO Energy has advised the trustee that the Trust should bear its 80% share of such settlement or judgment, including any future royalty adjustments that would reduce net proceeds. The trustee intends to review any claimed reductions in payment to the Trust based on the facts and circumstances of such settlement or judgment. In light of a 2014 arbitration decision in which a three panel tribunal decided that the settlement in Fankhouser v. XTO Energy, Inc, including a new royalty calculation for future royalty payments, could not be charged to the Trust, to the extent that the claims in Chieftain or Roderick are similar to those in Fankhouser the trustee would likely object to such claimed reductions. XTO Energy has informed the trustee that, although the amount of any reduction in net proceeds is not presently determinable, in its management’s opinion, the amount is not currently expected to be material to the Trust’s financial position or liquidity though it could be material to the Trust’s annual distributable income. Additionally, XTO Energy has advised

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the trustee that any reductions would result in costs exceeding revenues on the properties underlying the net profit interests of the cases named above, as applicable, for several monthly distributions, depending on the size of the judgment or settlement, if any, and the net proceeds being paid at that time, which would result in the net profits interest being limited until such time that the revenues exceed the costs for those net profit interests. If there is a settlement or judgment and should XTO Energy and the trustee disagree concerning the amount of the settlement or judgment to be charged, if any, against the Trust’s net profits interests, the matter will be resolved by binding arbitration through the American Arbitration Association under the terms of the Indenture creating the Trust.

Certain of the underlying properties are involved in various other lawsuits and 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 the financial position or liquidity of the Trust, but may have an effect on annual distributable income.

Other

Several states have enacted legislation requiring state income tax withholding from nonresident recipients of oil and gas proceeds. After consultation with its tax counsel, the trustee believes that it is not required to withhold on payments made to the unitholders. However, regulations are subject to change by the various states, which could change this conclusion. Should amounts be withheld on payments made to the Trust or the unitholders, distributions to the unitholders would be reduced by the required amount, subject to the filing of a claim for refund by the Trust or unitholders for such amount.

If monthly costs exceed revenues for any of the three conveyances (one for each of the states of Kansas, Oklahoma and Wyoming), such excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from other conveyances.

XTO Energy advised the trustee that a one-time reimbursement for overhead corrections, led to the partial recovery of excess costs of $71,807 ($57,446 net to the Trust) on properties underlying the Kansas net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $255,605 ($204,484 net to the Trust) on properties underlying the Kansas net profits interest for the quarter ended March 31, 2016.

XTO Energy advised the trustee that a one-time reimbursement for overhead corrections led to full recovery of excess costs, plus accrued interest of $1,059 ($847 net to the Trust), on properties underlying the Oklahoma net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $97,457 ($77,966 net to the Trust) on properties underlying the Oklahoma net profits interest for the quarter ended March 31, 2016.

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XTO Energy advised the trustee that lower gas prices, partially offset by a one-time reimbursement for overhead corrections caused costs to exceed revenues by a total of $570,141 ($456,113 net to the Trust) on properties underlying the Wyoming net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $472,481 ($377,985 net to the Trust) on properties underlying the Wyoming net profits interest for the quarter ended March 31, 2016.

XTO Energy advised the trustee that increased costs, decreased gas production and lower gas prices caused costs to exceed revenues by a total of $367,814 ($294,251 net to the Trust) for the quarter ended June 30, 2015 and $338,668 ($270,934 net to the Trust) for the quarter ended March 31, 2015 on properties underlying the Kansas net profits interest.

XTO Energy advised the trustee that lower gas prices and increased costs caused costs to exceed revenues by a total of $125,832 ($100,666 net to the Trust) for the quarter ended June 30, 2015 and $87,082 ($69,666 net to the Trust) for the quarter ended March 31, 2015 on properties underlying the Wyoming net profits interest.

Cumulative excess costs for the Kansas, Oklahoma and Wyoming conveyances remaining as of June 30, 2016 totaled $2,846,607 ($2,277,286 net to the Trust).

Due to the current level of commodity prices, the Trust is receiving reduced cash distributions and excess costs have accumulated within two of the three conveyances of the Trust. As a result, administrative expenses have exceeded cash disbursements received during the first half of 2016 in all months except May. The May 2016 distribution included a one-time reimbursement related to operated overhead, which allowed the trustee to cover administrative expenses and partially replenish the expense reserve. With the increase in natural gas and oil prices, there was sufficient net profits income for the July distribution to replenish the expense reserve to $1,000,000 after paying administrative expenses and providing a distribution to unitholders. The trustee believes that the current reserve will be sufficient to pay the Trust’s obligations for the next year.

The trustee is exploring its options with regards to the payment of the Trust’s obligations if and when the administrative expense reserve is depleted. This may include but is not limited to borrowing against the net profits interest of the Trust. Such borrowing may result in unrelated business taxable income to unitholders who are exempt organizations.

XTO Energy advised the trustee that the May 2016 distribution included a one-time reimbursement of $788,000 related to operated overhead corrections for the period of January 2014 through February 2016. The reimbursement affected the net profits income under the Kansas, Oklahoma and Wyoming conveyances by approximately $186,000, $320,000 and $282,000 respectively.

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XTO Energy advised the trustee that the February 2015 distribution included a one-time prior period adjustment for the recoupment of natural gas liquids revenue from the Trust in the amount of $353,069 ($282,455 net to the Trust) which was deducted from net proceeds for the first quarter of 2015.

XTO Energy has advised the trustee that net profits income for August 2016 will include an additional reimbursement of approximately $450,000 related to operated overhead corrections for the period of January 2014 through May 2016. The reimbursement will affect the net profits income under the Oklahoma conveyance.

XTO Energy has advised the trustee that net profits income for August 2016 will include approximately $500,000 in additional gathering fees for the period of December 2015 through May 2016 related to a gas purchase contract change subsequent to June 30, 2016 that includes production from properties underlying the Oklahoma conveyance.

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 2015 Annual Report on Form 10-K, 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.hgt-hugoton.com.

Distributable Income

Quarter

For the quarter ended June 30, 2016, net profits income was $199,545, as compared to $1,463,774 for second quarter 2015. This 86% decrease in net profits income is primarily the result of lower oil and gas prices ($3.2 million), partially offset by decreased production expense ($1.4 million), lower development costs ($0.3 million), and decreased taxes, transportation, and other costs ($0.3 million). See “Net Profits Income” on following page.

After adding interest income of $173, deducting administration expense of $193,490, and increasing the cash reserve $6,228 for the payment of Trust expenses, distributable income for the quarter ended June 30, 2016 was $0, or $0.000000 per unit of beneficial interest. Administration expense for the quarter increased $15,385 as compared to the prior year quarter. Changes in interest income are attributable to fluctuations in net profits income and interest rates. For second quarter 2015, distributable income was $1,185,720 or $0.029643 per unit.

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Distributions to unitholders for the quarter ended June 30, 2016 were:

Six Months

For the six months ended June 30, 2016, net profits income was $263,107 compared with $5,600,616 for the same 2015 period. This 95% decrease in net profits income is primarily the result of lower oil and gas prices ($8.8 million), partially offset by decreased production expense ($2.1 million), lower taxes, transportation, and other costs ($1.0 million), decreased development costs ($0.2 million), and net excess costs in 2016 ($0.2 million). See “Net Profits Income” below.

After adding interest income of $255, deducting administration expense of $537,337, and reducing the cash reserve $273,975 for the payment of Trust expenses, distributable income for the six months ended June 30, 2016 was $0, or $0.000000 per unit of beneficial interest. Administration expense for the six months ended June 30, 2016 increased $88,321 as compared to the same 2015 period. Changes in interest income are attributable to fluctuations in net profits income and interest rates. For the six months ended June 30, 2015, distributable income was $4,951,720, or $0.123793 per unit.

Net Profits Income

Net profits income is recorded when received by the Trust, which is the month following receipt by XTO Energy, and generally two months after oil and gas production. Net profits income is generally affected by three major factors:

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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 second quarter 2015 to second quarter 2016 and from the first six months of 2015 to the comparable period in 2016:

Sales Volumes

Gas

Gas sales volumes were relatively flat from second quarter 2015 to second quarter 2016 as natural production decline was offset by completion of repairs at a third party gas processing system in the Hugoton area following a force majeure incident and the timing of cash receipts.

Gas sales volumes increased 1% for the six-month period as compared with the same 2015 period primarily due to timing of cash receipts and the completion of repairs at a third party gas processing system in the Hugoton area following a force majeure incident, partially offset by natural production decline.

XTO Energy advised the trustee that repairs and maintenance in the first half of 2015 at a third party gas processing system in the Hugoton area following a force majeure incident resulted in decreased underlying gas volumes of approximately 5,000 Mcf per day. After being advised by the third party processor that the repairs were completed, XTO Energy then received notice that the force majeure event was being extended to the processing portion of the third party plant due to an equipment malfunction. The processor was able to bypass the plant and take gas; however, the plant was not able to process gas for NGLs or helium for a period of time. XTO Energy received notice that the plant returned to full capacity at the end of October 2015, including the processing of gas for NGLs and helium.

Oil

Oil sales volumes decreased 3% for second quarter and 3% for the six-month period as compared with the same 2015 periods primarily due to natural production decline.

The estimated rate of natural production decline on the underlying oil and gas properties is approximately 6% to 8% a year.

Sales Prices

Gas

The second quarter 2016 average gas price was $1.61 per Mcf, a 36% decrease from the second quarter 2015 average gas price of $2.50 per Mcf. For the six-month period, the average gas price decreased 41% to $1.76 per Mcf in 2016 from $2.99 per Mcf in 2015. Natural gas prices are affected by the level of North American production, weather, crude oil and natural gas liquids prices, the U.S. economy, storage levels and import levels of liquefied natural gas. Natural gas prices are expected to remain volatile. The second quarter 2016 gas price is primarily related to production from February through April 2016, when the average NYMEX price was $1.93 per MMBtu. The average NYMEX price for May and June 2016 was $1.98 per MMBtu. On July 18, 2016, the average NYMEX futures price for the following twelve months was $3.03 per MMBtu.

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Oil

The second quarter 2016 average oil price was $32.28 per Bbl, a 31% decrease from the second quarter 2015 average oil price of $46.84 per Bbl. The year-to-date average oil price decreased 38% to $32.75 per Bbl in 2016 from $52.46 per Bbl in 2015. Oil prices are expected to remain volatile. The second quarter 2016 oil price is primarily related to production from February through April 2016, when the average NYMEX price was $36.57 per Bbl. The average NYMEX price for May and June 2016 was $47.81 per Bbl. On July 18, 2016, the average NYMEX futures price for the following twelve months was $48.19 per Bbl.

Costs

Taxes, Transportation and Other

Taxes, transportation and other costs decreased 23% for the second quarter and 35% for the six-month period primarily because of decreased oil and gas production taxes and other deductions related to lower oil and gas revenues and decreased property taxes related to lower valuations.

Production Expense

Production expense decreased 14% for the second quarter and 15% for the six-month period primarily because of decreased repairs and maintenance, field, compressor rental, fuel and labor costs.

Development Costs

Development costs deducted in the calculation of net profits income are based primarily on the current level of development expenditures and the development budget. These development costs decreased 58% for the second quarter and 23% for the six-month period.

At December 31, 2015, cumulative budgeted costs deducted exceeded cumulative actual costs by approximately $0.2 million. In calculating net profits income for the quarter ended June 30, 2016, XTO Energy deducted budgeted development costs of $0.3 million for the quarter and $0.9 million for the six-month period. After considering actual development costs of $0.2 million for the quarter and $0.7 million for the six-month period, cumulative budgeted costs deducted exceeded actual costs deducted by approximately $0.4 million at June 30, 2016.

XTO Energy has advised the trustee that revised 2016 budgeted development costs for the underlying properties are between $2 million and $4 million. The 2016 budget year generally coincides with the Trust distribution months from April 2016 through March 2017. The monthly development cost deduction will be reevaluated by XTO Energy and revised as necessary, based on the 2016 budget and the timing and amount of actual expenditures. See Note 2 to Condensed Financial Statements.

Overhead

Overhead decreased 35% for the quarter and 16% for the six-month period primarily because of a one-time reimbursement of approximately $788,000 related to operated overhead corrections for the period of January 2014 through February 2016, and the annual rate adjustment based on an industry index. See Note 7 to Condensed Financial Statements.

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Excess Costs

If monthly costs exceed revenues for any of the three conveyances (one for each of the states of Kansas, Oklahoma and Wyoming), such excess costs must be recovered, with accrued interest, from future net proceeds of that conveyance and cannot reduce net proceeds from other conveyances.

XTO Energy advised the trustee that a one-time reimbursement for overhead corrections, led to the partial recovery of excess costs of $71,807 ($57,446 net to the Trust) on properties underlying the Kansas net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $255,605 ($204,484 net to the Trust) on properties underlying the Kansas net profits interest for the quarter ended March 31, 2016.

XTO Energy advised the trustee that a one-time reimbursement for overhead corrections led to full recovery of excess costs, plus accrued interest of $1,059 ($847 net to the Trust), on properties underlying the Oklahoma net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $97,457 ($77,966 net to the Trust) on properties underlying the Oklahoma net profits interest for the quarter ended March 31, 2016.

XTO Energy advised the trustee that lower gas prices, partially offset by a one-time reimbursement for overhead corrections caused costs to exceed revenues by a total of $570,141 ($456,113 net to the Trust) on properties underlying the Wyoming net profits interest for the quarter ended June 30, 2016. XTO Energy advised the trustee that lower gas prices caused costs to exceed revenues by a total of $472,481 ($377,985 net to the Trust) on properties underlying the Wyoming net profits interest for the quarter ended March 31, 2016.

XTO Energy advised the trustee that increased costs, decreased gas production and lower gas prices caused costs to exceed revenues by a total of $367,814 ($294,251 net to the Trust) for the quarter ended June 30, 2015 and $338,668 ($270,934 net to the Trust) for the quarter ended March 31, 2015 on properties underlying the Kansas net profits interest.

XTO Energy advised the trustee that lower gas prices and increased costs caused costs to exceed revenues by a total of $125,832 ($100,666 net to the Trust) for the quarter ended June 30, 2015 and $87,082 ($69,666 net to the Trust) for the quarter ended March 31, 2015 on properties underlying the Wyoming net profits interest.

Cumulative excess costs for the Kansas, Oklahoma and Wyoming conveyances remaining as of June 30, 2016 totaled $2,846,607 ($2,277,286 net to the Trust).

Impairment of Net Profits Interest

In light of lower long term prices used to develop projections of future cash flows, continued excess costs on two conveyances and zero distributions to unitholders for the six months ended June 30, 2016, the trustee concluded that an impairment trigger event had occurred in the second quarter of 2016. An assessment of the forecasted net cash flows was performed for the NPI. The result of the assessment indicated that the estimated undiscounted future net cash flows from the NPI were below the carrying value of the NPI. During the second quarter of 2016, the NPI was written down to its fair value of $28.8 million, resulting in a $57.3 million impairment charged directly to Trust corpus, which does not affect distributable income. The fair value of the NPI was developed using estimates for future oil and gas production attributable to the Trust, future crude oil and natural gas commodity prices published by third-party industry experts (adjusted for basis differentials), estimated taxes, development and operating expenses, and a risk-adjusted discount rate.

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Administration Expense Reserve

Due to the current level of commodity prices, the Trust is receiving reduced cash distributions and excess costs have accumulated within two of the three conveyances of the Trust. As a result, administrative expenses have exceeded cash disbursements received during the first half of 2016 in all months except May. The May 2016 distribution included a one-time reimbursement related to operated overhead, which allowed the trustee to cover administrative expenses and partially replenish the expense reserve. With the increase in natural gas and oil prices, there was sufficient net profits income for the July distribution to replenish the expense reserve to $1,000,000 after paying administrative expenses and providing a distribution to unitholders. The trustee believes that the current reserve will be sufficient to pay the Trust’s obligations for the next year.

The trustee is exploring its options with regards to the payment of the Trust’s obligations if and when the administrative expense reserve is depleted. This may include but is not limited to borrowing against the net profits interest of the Trust. Such borrowing may result in unrelated business taxable income to unitholders who are exempt organizations.

Other

XTO Energy advised the trustee that the February 2015 distribution included a one-time prior period adjustment for the recoupment of natural gas liquids revenue from the Trust in the amount of $353,069 ($282,455 net to the Trust) which was deducted from net proceeds for the first quarter of 2015.

Contingencies

XTO Energy is a party to certain litigation affecting the underlying properties. See Note 4 to Condensed Financial Statements.

Several states have enacted legislation requiring state income tax withholding from nonresident recipients of oil and gas proceeds. After consultation with its tax counsel, the trustee believes that it is not required to withhold on payments made to the unitholders. However, regulations are subject to change by the various states, which could change this conclusion. Should amounts be withheld on payments made to the Trust or the unitholders, distributions to the unitholders would be reduced by the required amount, subject to the filing of a claim for refund by the Trust or unitholders for such amount.

Forward-Looking Statements

Statements in this report relating to future plans, predictions, events or conditions are forward-looking statements. All statements other than statements of historical fact included in this Form 10-Q, including, without limitation, statements regarding the net profits interests, underlying properties, development activities, annual and monthly development, production and other costs and expenses, monthly development cost deductions, oil and gas prices and differentials to NYMEX prices, supply levels, future drilling, workover and restimulation plans, the outcome of litigation and impact on Trust proceeds, 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, 2015, which is incorporated by this reference as though fully set forth herein. XTO Energy and the trustee assume no duty to update these statements as of any future date.

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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 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, 2015.

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.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

Refer to Note 4 of this Quarterly Report on Form 10-Q for information on legal proceedings.

Item 1A. Risk Factors.

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, 2015.

Items 2 through 5.

Not applicable.

Item 6. Exhibits.

(a) Exhibits.

Exhibit Number

and Description

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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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