SAN JUAN BASIN ROYALTY TRUST - Quarter Report: 2004 March (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

For the Quarterly Period Ended March 31, 2004
or

For the transition period from                      to                     

Commission File No. 1-8032

SAN JUAN BASIN ROYALTY TRUST

TexasBank, Trust Department
2525 Ridgmar Boulevard, Suite 100
Fort Worth, Texas 76116
(Address of principal executive offices)
(Zip Code)

Telephone Number: (866) 809-4553
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last report)

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

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

Number of Units of beneficial interest outstanding at May 10, 2004: 46,608,796

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Table of Contents

SAN JUAN BASIN ROYALTY TRUST

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements.

     The condensed financial statements included herein have been prepared by the independent accountants for the San Juan Basin Royalty Trust (the “Trust”), at the request of TexasBank, the Trustee of the Trust, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 47, released September 16, 1982, the Trust continues to prepare its financial statements in a manner that differs from accounting principals generally accepted in the United States of America (“GAAP”); such presentation is customary to other royalty trusts. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted pursuant to Rule 10-01 of Regulation S-X promulgated under the Securities and Exchange Act of 1934, 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 Annual Report for the year ended December 31, 2003. 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 San Juan Basin 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. The distributable income for such interim periods is not necessarily indicative of the distributable income for the full year.

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SAN JUAN BASIN ROYALTY TRUST

CONDENSED STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS

CONDENSED STATEMENTS OF DISTRIBUTABLE INCOME (UNAUDITED)

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

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SAN JUAN BASIN 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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SAN JUAN BASIN ROYALTY TRUST

NOTES TO CONDENSED FINANCIAL STATEMENTS (UNAUDITED)

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Item 2. Trustee’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Information

     Certain information included in this Quarterly Report on Form 10-Q contains, and other materials filed or to be filed by the Trust with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Trust) may contain or include, forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, and Section 27A of the Securities Act of 1933. Such forward-looking statements may be or may concern, among other things, capital expenditures, drilling activity, development activities, production efforts and volumes, hydrocarbon prices and the results thereof, and regulatory matters. Such forward-looking statements generally are accompanied by words such as “may,” “will,” “estimate,” “expect,” “predict,” “project,” “anticipate,” “goal,” “should,” “assume,” “believe,” “plan,” “intend,” or other words that convey the uncertainty of future events or outcomes. Such statements reflect BROG’s current view with respect to future events; are based on an assessment of, and are subject to, a variety of factors deemed relevant by the Trustee and BROG and involve risks and uncertainties. Should one or more of these risks or uncertainties occur, actual results may vary materially and adversely from those anticipated.

Business Overview

     The Trust is an express trust created under the laws of the state of Texas by the San Juan Basin Royalty Trust Indenture (the “Original Indenture”) entered into on November 3, 1980, between Southland Royalty Company (“Southland Royalty”) and The Fort Worth National Bank. Effective as of September 30, 2002, the Original Indenture was amended and restated (the Original Indenture, as amended and restated, the “Indenture”). The Trustee of the Trust is TexasBank.

     On October 23, 1980, the stockholders of Southland Royalty approved and authorized that company’s conveyance of a 75% net overriding royalty interest (equivalent to a net profits interest) to the Trust for the benefit of the stockholders of Southland Royalty of record at the close of business on the date of the conveyance (the “Royalty”) carved out of that company’s oil and gas leasehold and royalty interests in properties located in the San Juan Basin of northwestern New Mexico (the “Underlying Properties”). Pursuant to the Net Overriding Royalty Conveyance (the “Conveyance”) the Royalty was transferred to the Trust on November 3, 1980, effect as to production from and after November 1, 1980 at 7:00 A.M.

     The Royalty constitutes the principal asset of the Trust and the beneficial interests in the Royalty are divided into that number of Units of Beneficial Interest (the “Units”) of the Trust equal to the number of shares of the common stock of Southland Royalty outstanding as of the close of business on November 3, 1980. Holders of Units are referred to herein as “Unit Holders.” Subsequent to the conveyance of the Royalty, through a series of assignments and mergers, Southland Royalty’s successor became BROG.

     The function of the Trustee is to collect the income attributable to the Royalty, to pay all expenses and charges of the Trust, and then distribute the remaining available income to the Unit Holders. The Trust is not empowered to carry on any business activity and has no employees, all administrative functions being performed by the Trustee.

Three Months Ended March 31, 2004 and 2003

     The Trust received Royalty income of $21,196,352 and interest income of $8,692 during the first quarter of 2004. There was no change in cash reserves. After deducting administrative expenses of $513,163, distributable income for the quarter was $20,691,881 ($.443948 per Unit). In the first quarter

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of 2003, Royalty income was $19,911,068, interest income was $7,453, there was no change in cash reserves, administrative expenses were $420,374 and distributable income was $19,498,147 ($.418337 per Unit). The tax credit relating to production from coal seam and tight sand wells sold before January 1, 2003, totaled approximately $.03 per Unit for the first quarter of 2003. For further information concerning this tax credit, Unit Holders should refer to the Trust’s Annual Report for 2003. Based on 46,608,796 Units outstanding, the per Unit distributions during the first quarter of 2004 were as follows:

     The Royalty income distributed in the first quarter of 2004 was higher than that distributed in the first quarter of 2003, primarily due to an increase in the average gas price from $3.51 per Mcf for the first quarter of 2003 to $4.17 per Mcf for the first quarter of 2004. Interest earnings for the quarter ended March 31, 2004, as compared to the quarter ended March 31, 2003, were higher, primarily due to an increase in funds available for investment. Administrative expenses were higher primarily as a result of differences in timing in the receipt and payment of these expenses.

     BROG has informed the Trustee that the New Mexico Oil and Gas Proceeds Withholding Tax Act (the “Withholding Tax Act”) requires remitters who pay certain oil and gas proceeds from production on New Mexico properties on or after October 1, 2003, to withhold income taxes from such proceeds in the case of certain nonresident recipients. The Trustee, on advice of counsel, has observed that “net profits interests,” such as the Royalty, and other types of interests, the extent of which cannot be determined with respect to a specific share of the oil and gas production, are excluded from the withholding requirements of the Withholding Tax Act. Unit Holders are reminded to consult with their tax advisors regarding the applicability of New Mexico income tax to distributions received from the Trust by a Unit Holder.

     The capital costs attributable to the Underlying Properties for the first quarter of 2004 were reported by BROG as approximately $9.45 million. BROG’s capital expenditure budget for the Underlying Properties for 2004 is estimated at $18.5 million of which approximately $383,000 has been spent; however, BROG reports that based on its actual capital requirements, its mix of projects and swings in the price of natural gas, the actual capital expenditures for 2004 could range from $15 million to $25 million. Capital expenditures were approximately $6.6 million for the first quarter of 2003. In 2003, approximately $20.6 million in capital expenditures were deducted in calculating Royalty income. In February 2004, BROG informed the Trustee that for 2004 it anticipates 441 projects, including the drilling of 103 new wells to be operated by BROG and 29 wells to be operated by third parties. Of the new BROG operated wells, 30 are projected to be conventional wells completed in the Pictured Cliffs, Mesaverde and/or Dakota formations, and the remaining 73 are projected as coal seam wells completed in the Fruitland Coal formation. A total of 22 of the wells operated by third parties are projected to be conventional wells and the remaining seven are projected to be coal seam wells. BROG projects approximately $11.7 million to be spent on the new wells, and $6.8 million is to be expended in working over existing wells and in the maintenance and improvement of production facilities. BROG has indicated that, principally as a result of the New Mexico Oil Conservation Division’s approval of reduced, 160-acre spacing in the Fruitland Coal formation, BROG’s budget for 2004 reflects a continued focus on that formation.

     BROG indicates its budget for 2004 reflects continued, significant development of conventional formations, including infill drilling to the Mesaverde and Dakota formations, development of the

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Fruitland Coal formation and multiple formation completions. A majority of the new wells for 2004 are projected to be drilled on Underlying Properties in which the fractional working interest included in the Underlying Properties is relatively low, but many of the recompletions and restimulations are scheduled on properties in which such working interest is relatively high.

     BROG has informed the Trustee that lease operating expenses and property taxes were $3,998,055 and $126,800, respectively, for the first quarter of 2004, as compared to $3,921,567 and $136,250, respectively, for the first quarter of 2003.

     BROG has reported to the Trustee that during the first quarter of 2004, five gross (0.17 net) coal seam wells, one gross (0.82 net) coal seam recompletion, ten gross (6.33 net) conventional wells, three gross (0.007 net) payadds, one gross (0.44 net) recompletion, and four gross (3.37 net) restimulations were completed on the Underlying Properties.

     Three gross (0.12 net) coal seam miscellaneous projects, 78 gross (11.97 net) coal seam wells, ten gross (0.27 net) conventional wells, five gross (1.77 net) payadds, eight gross (5.86 net) recompletions, and 12 gross (8.06 net) restimulations were in progress at March 31, 2004.

     There were two gross (0.88 net) coal seam miscellaneous projects, seven gross (0.87 net) coal seam wells, three gross (0.94 net) miscellaneous capital projects, nine gross (6.56 net) conventional wells, 19 gross (0.92 net) payadds and five gross (3.21 net) restimulations completed on the Underlying Properties as of March 31, 2003. Twenty-seven gross (9.53 net) coal seam wells, one gross (0.002 net) recavitation, four gross (0.14 net) recompletions, 25 gross (13.02 net) conventional wells, 27 gross (2.52 net) payadds, 14 gross (4.55 net) recompletions and 26 gross (17.56 net) restimulations were in progress at March 31, 2003.

     “Gross” acres or wells, for purposes of this discussion, means the entire ownership interest of all parties in such properties, and BROG’s interest therein is referred to as the “net” acres or wells. A “payadd” is the completion of an additional production interval in an existing completed zone in a well.

     Royalty income for the quarter ended March 31, 2004, is associated with actual gas and oil production during November 2003 through January 2004 from the Underlying Properties. Gas and oil sales from the Underlying Properties for the quarters ended March 31, 2004 and 2003 were as follows:

     Sales volumes attributable to the Royalty are determined by dividing the net profits received by the Trust and attributable to oil and gas, respectively, by the prices received for sales volumes from the

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Underlying Properties, taking into consideration production taxes attributable to the Underlying Properties. Since the oil and gas sales attributable to the Royalty are based on an allocation formula that is dependent on such factors as price and cost, including capital expenditures, the aggregate production volumes from the Underlying Properties may not provide a meaningful comparison to volumes attributable to the Royalty.

     During the first quarter of 2004, average gas prices were $.66 higher than the average prices reported during the first quarter of 2003. The average price per barrel of oil during the first quarter of 2004 was $3.62 per barrel higher than that received for the first quarter of 2003 due to increases in oil prices in world markets generally, including the posted prices applicable to oil sales attributable to the Royalty.

     BROG has entered into two contracts for the sale of all volumes of gas produced from the Underlying Properties. These contracts provide for (i) the sale of such gas to Duke Energy and Marketing, L.L.C. and PNM Gas Services, respectively, (ii) the delivery of such gas at various delivery points through March 31, 2005, and from year-to-year thereafter until terminated by either party on twelve months notice, and (iii) for the sale of such gas at prices which fluctuate in accordance with published indices for gas sold in the San Juan Basin of New Mexico. Effective January 1, 2004, the rights and obligations of Duke Energy and Marketing L.L.C. were assumed by ConocoPhillips Company (“ConocoPhillips”) pursuant to an Assignment and Novation Agreement. By correspondence dated March 25, 2004, BROG notified ConocoPhillips of BROG’s election to terminate such contract as of March 31, 2005. BROG is preparing a form of request for proposal that will be circulated to a number of potential purchasers, including ConocoPhillips, inviting them to bid for the purchase of the gas currently sold under the contract expiring March 31, 2005. Unit Holders are referred to Note 6 of the Notes to Financial Statements in the Trust’s 2003 Annual Report for further information concerning the marketing of gas produced from the Underlying Properties.

     Confidentiality agreements with purchasers of gas produced from the Underlying Properties prohibit public disclosure of certain terms and conditions of gas sales contracts with those entities, including specific pricing terms and gas receipt points. Such disclosure could compromise the ability to compete effectively in the marketplace for the sale of gas produced from the Underlying Properties.

Calculation of Royalty Income

     Royalty income received by the Trust for the three months ended March 31, 2004 and 2003, respectively, was computed as shown in the following table:

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Contractual Obligations

     Under the Indenture governing the Trust, the Trustee is entitled to an administrative fee for its administrative services and the preparation of quarterly and annual statements of: (i) 1/20 of 1% of the first $100 million of the annual gross revenue of the Trust, and 1/30 of 1% of the annual gross revenue of the Trust in excess of $100 million and (ii) the Trustee’s standard hourly rates for time in excess of 300 hours annually. As of January 1, 2003, the administrative fee due under items (i) and (ii) above will not be less than $36,000 per year (as adjusted annually to reflect the increase (if any) in the Producers Price Index as published by the U.S. Department of Labor, Bureau of Labor Statistics).

Effects of Securities Regulation

     As a publicly-traded trust listed on the New York Stock Exchange (the “NYSE”), the Trust is and will continue to be subject to extensive regulation under, among others, the Securities Act of 1933, the Securities Exchange Act of 1934, the rules and regulations of the NYSE and the Sarbanes-Oxley Act of 2002. Issuers failing to comply with such authorities risk serious consequences, including criminal as well as civil and administrative penalties. In most instances, these laws, rules and regulations do not specifically address their applicability to publicly-traded trusts, such as the Trust. In particular, the Sarbanes-Oxley Act of 2002 provides for the adoption by the Securities and Exchange Commission (the “Commission”) and NYSE of certain rules and regulations that may be impossible for the Trust to literally satisfy because of its nature as a pass-through trust. For example, the Commission is required to adopt rules and regulations pursuant to the Sarbanes-Oxley Act of 2002 that would require a publicly-traded company’s board of directors, audit committee or executive directors (or similar body) to act with respect to certain corporate governance matters. The Trust does not have, nor does the Indenture governing the Trust provide for, a board of directors, an audit committee or any executive officers. Accordingly, the Trust could not literally comply with such rules and regulations. It is the Trustee’s intention to follow the Commission’s and NYSE’s rulemaking closely, attempt to comply with such rules and regulations and, where appropriate, request relief from these rules and regulations. However, if the Trust is unable to comply with such rules and regulations or to obtain appropriate relief, the Trust may be required to expend as yet unknown but potentially material costs to amend the Indenture that governs the Trust to allow for compliance with such rules and regulations.

     During 2003, the Commission adopted rules implementing legislation concerning governance matters for publicly-held entities that was passed as part of the Sarbanes-Oxley Act of 2002. In addition, the NYSE adopted additional corporate governance rules. Not all of the governance requirements are applicable to passive entities such as the Trust.

Critical Accounting Policies

     In accordance with the Commission’s staff accounting bulletins and consistent with other royalty trusts, the financial statements of the Trust are prepared on the following basis:

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     The financial statements of the Trust differ from financial statements prepared in accordance with GAAP because revenues are not accrued in the month of production; certain cash reserves may be established for contingencies which would not be accrued in financial statements prepared in accordance with GAAP; and amortization of the Royalty calculated on a unit-of-production basis is charged directly to trust corpus instead of an expense.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

     The Trust invests in no derivative financial instruments, and has no foreign operations or long-term debt instruments. The Trust is a passive entity and other than the Trust’s ability to periodically borrow money as necessary to pay expenses, liabilities and obligations of the Trust that cannot be paid out of cash held by the Trust, the Trust is prohibited from engaging in borrowing transactions. The amount of any such borrowings is unlikely to be material to the Trust. The Trust periodically holds short-term investments acquired with funds held by the Trust pending distribution to Unit Holders and funds held in reserve for the payment of Trust expenses and liabilities. Because of the short-term nature of these borrowings and investments and certain limitations upon the types of such investments which may be held by the Trust, the Trustee believes that the Trust is not subject to any material interest rate risk. The Trust does not engage in transactions in foreign currencies which could expose the Trust or Unit Holders to any foreign currency related market risk. The Trust does not market the gas, oil and/or natural gas liquids from the Underlying Properties. BROG is responsible for such marketing.

Item 4. Controls and Procedures.

     The Trust maintains a system of disclosure controls and procedures that is designed to provide reasonable assurance that information required to be disclosed in the Trust’s filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Commission’s rules and forms. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by the Trust is accumulated and communicated by BROG to the Trustee and its employees who participate in the preparation of the Trust’s periodic reports to allow timely decisions regarding disclosure. Due to the pass-through nature of the Trust, BROG provides much of the information disclosed in this Form 10-Q and the other periodic reports filed by the Trust with the Commission.

     The Indenture does not require BROG to update or provide information to the Trust. Under the Conveyance transferring the Royalty to the Trust, BROG is obligated to provide the Trust with certain information concerning calculations of net proceeds owed to the Trust, among other information. Pursuant to the settlement of litigation in 1996 between the Trust and BROG, BROG agreed to new, more formal financial reporting and audit procedures as compared to those provided in the Conveyance.

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     The Trustee receives periodic updates from BROG regarding activities related to the Trust. Accordingly, the Trust’s ability to timely report certain information required to be disclosed in the Trust’s periodic reports is dependent on BROG’s timely delivery of such information to the Trust. In order to help ensure the accuracy and completeness of the information required to be disclosed in the Trust’s periodic reports, the Trust employs independent public accountants, joint interest auditors, marketing consultants, attorneys and petroleum engineers. These outside professionals assist the Trustee in reviewing and compiling this information for inclusion in this Form 10-Q and the other periodic reports provided by the Trust to the Commission.

     The Trustee has evaluated the Trust’s disclosure controls and procedures as of March 31, 2004, and has determined that, subject to BROG’s delivery of timely and accurate information to the Trust, such disclosure controls and procedures are effective. The Trustee has not reviewed the Trust’s disclosure controls and procedures in concert with management, a board of directors or an independent audit committee. The Trust does not have, nor does the Indenture provide for, officers, a board of directors or an independent audit committee.

     During the quarter ended March 31, 2004, there were no changes in the Trust’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934) that materially affected or are reasonably likely to materially affect the Trust’s internal control over financial reporting.

PART II
OTHER INFORMATION

Item 1. Legal Proceedings.

     As discussed above under Part I, Item 4 (Controls and Procedures), due to the pass-through nature of the Trust, BROG provides much of the information disclosed in this Form 10-Q and the other periodic reports filed by the Trust with the Commission. Although the Trustee receives periodic updates from BROG regarding activities which may relate to the Trust, the Trust’s ability to timely report certain information required to be disclosed in the Trust’s periodic reports is dependent on BROG’s timely delivery of the information to the Trust.

      The Trust is not aware of any material developments in, or the termination of, any of the legal proceedings disclosed under Part I, Item 3 of the Trust’s Annual Report on Form 10-K for the year ended December 31, 2003, filed with the Commission on March 15, 2004 (the “Annual Report”). The Trust is not named as a party, nor are its assets subject, to any legal proceedings including, without limitation, those legal proceedings disclosed in the Annual Report. Should any such legal proceeding be decided in a manner adverse to BROG, the amount of Royalty income received by the Trust could materially decrease. The Trust has not received from BROG any estimate of the amount of any potential loss in such proceedings, or the portion of any such potential loss that might be allocated to the Royalty.

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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.

(The Trust has no directors or executive officers.)

INDEX TO EXHIBITS