-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ro5FFgyAeC9yTqqvak2YQRqy09U4kEoxWpv0QKXxsrBCyovVXa8XkScLV7FdB5y5 t2WLiQmo7YYRaPugq6UuGw== 0000950109-99-000215.txt : 19990126 0000950109-99-000215.hdr.sgml : 19990126 ACCESSION NUMBER: 0000950109-99-000215 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 12 FILED AS OF DATE: 19990125 FILER: COMPANY DATA: COMPANY CONFORMED NAME: HUGOTON ROYALTY TRUST CENTRAL INDEX KEY: 0000862022 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 586379215 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-68441 FILM NUMBER: 99512355 BUSINESS ADDRESS: STREET 1: C/O NATIONS BANK, N.A. TRUSTEE STREET 2: 901 MAIN ST., 17TH FLOOR CITY: DALLAS STATE: TX ZIP: 75202 BUSINESS PHONE: 2145082400 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CROSS TIMBERS OIL CO CENTRAL INDEX KEY: 0000868809 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 752347769 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-3/A SEC ACT: SEC FILE NUMBER: 333-68441-01 FILM NUMBER: 99512356 BUSINESS ADDRESS: STREET 1: 810 HOUSTON ST STREET 2: STE 2000 CITY: FORT WORTH STATE: TX ZIP: 76102 BUSINESS PHONE: 8178702800 MAIL ADDRESS: STREET 1: 810 HOUSTON STREET STREET 2: STE 2000 CITY: FORT WORTH STATE: TX ZIP: 76102 S-1/A 1 AMENDMENT NO. 1 TO FORM S-1 As filed with the Securities and Exchange Commission on January 25, 1999. Registration No. 333-68441 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------- AMENDMENT NO. 1 TO REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 on Form S-1 -------------- Form S-3 HUGOTON ROYALTY TRUST CROSS TIMBERS OIL COMPANY (Exact name of co-registrant as (Exact name of co-registrant as specified in its charter) specified in its charter) Delaware Texas (State or other jurisdiction of (State or other jurisdiction of incorporation or organization) incorporation or organization) 58-6379215 75-2347769 (I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.) 901 Main St., 17th Floor 810 Houston Street, Suite 2000 Dallas, Texas 75202 Fort Worth, Texas 76102 (214) 508-2440 (817) 870-2800 (Address, including zip code, and (Address, including zip code, and telephone telephone number, including area code, of number, including area code, of registrant's principal executive registrant's principal executive offices) offices) Frank G. McDonald, Esq. Bob R. Simpson 901 Main St., 17th Floor 810 Houston Street, Suite 2000 Dallas, Texas 75202 Fort Worth, Texas 76102 (214) 508-2400 (817) 870-2800 (Name, address, including zip code, (Name, address, including zip code, and and telephone number, including area code, telephone number, including area code, of of agent for service) agent for service) -------------- Copies to: F. Richard Bernasek, Esq. James M. Prince, Esq. Kelly, Hart & Hallman, P.C. Andrews & Kurth L.L.P. 201 Main Street, Suite 2500 600 Travis, Suite 4200 Fort Worth, Texas 76102 Houston, Texas 77002 (817) 332-2500 (713) 220-4300 -------------- Approximate date of commencement of proposed sale to the public: As soon as practicable after this Registration Statement becomes effective. If the only securities being registered on this form are being offered pursuant to dividend or interest reinvestment plans, please check the following box. [_] If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] -------------- CALCULATION OF REGISTRATION FEE - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Title of Each Class of Proposed Maximum Amount of Securities to Be Registered Aggregate Offering Price(1) Registration Fee(2) - ------------------------------------------------------------------------------ Units of Beneficial Interest.................... $172,500,000 $47,955 - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o). (2) $24,936.60 was paid previously. The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +The information in this prospectus is not complete and may be changed. We may + +not sell these securities until the registration statement filed with the + +Securities and Exchange Commission is effective. This prospectus is not an + +offer to sell these securities and we are not soliciting offers to buy these + +securities in any state where the offer or sale is not permitted. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Subject to Completion. Dated January 25, 1999. Hugoton Royalty Trust 15,000,000 Trust Units ----------- This is an initial public offering of units of beneficial interest in the Hugoton Royalty Trust. Cross Timbers Oil Company has formed the trust and is offering all of the trust units to be sold in this offering, and Cross Timbers will receive all proceeds from the offering. The trust will not receive any proceeds from the offering. There is currently no public market for the trust units. Cross Timbers expects that the public offering price will be between $8.00 and $10.00 per trust unit. The trust units have been approved for listing on the New York Stock Exchange under the symbol "HGT". The Trust Units. Trust units are units of beneficial ownership of the trust and represent undivided interests in the trust. They do not represent any interest in Cross Timbers. The Trust. The trust owns net profits interests in principally natural gas producing properties located in the Hugoton area of Kansas and Oklahoma, the Anadarko Basin of Oklahoma and the Green River Basin of Wyoming. The net profits interests entitle the trust to receive 80% of the net proceeds from the sale of production from these oil and natural gas properties owned by Cross Timbers. The Trust Unitholders. As a trust unitholder, you will receive monthly distributions of cash that the trust receives for its net profits interests from the sale of oil and natural gas produced from the underlying properties. See "Risk Factors" beginning on page 10 to read about certain information you should consider before purchasing trust units. ----------- Neither the Securities and Exchange Commission nor any other regulatory body has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense. -----------
Per Trust Unit Total ----- ----- Initial public offering price....................................... $ $ Underwriting discounts.............................................. $ $ Proceeds, before expenses, to Cross Timbers......................... $ $
The underwriters may, under certain circumstances, purchase from Cross Timbers up to an additional 2,250,000 trust units at the initial public offering price less the underwriting discount. ----------- The underwriters expect to deliver the trust units against payment in New York, New York on , 1999. Goldman, Sachs & Co. Lehman Brothers Bear, Stearns & Co. Inc. Dain Rauscher Wessels a division of Dain Rauscher Incorporated Donaldson, Lufkin & Jenrette A.G. Edwards & Sons, Inc. ----------- Prospectus dated , 1999. [MAP OF UNDERLYING PROPERTIES APPEARS HERE] 2 PROSPECTUS SUMMARY This summary may not contain all of the information that is important to you. To understand this offering fully, you should read the entire prospectus carefully, including the risk factors and the financial statements and notes to those statements. You will find definitions for terms relating to the oil and natural gas business in "Glossary of Certain Oil and Natural Gas Terms." Miller & Lents, Ltd., an independent engineering firm ("Miller & Lents"), provided the estimates of proved oil and natural gas reserves at December 31, 1998 included in this prospectus. These estimates are contained in summaries by Miller & Lents of the reserve reports as of December 31, 1998, for the underlying properties described below and for the net profits interests in the underlying properties held by the trust. These summaries are located at the back of this prospectus as Exhibits A and B and are referred to in the prospectus as the "Reserve Report." Hugoton Royalty Trust Hugoton Royalty Trust was formed in December 1998 by Cross Timbers Oil Company. Cross Timbers conveyed to the trust net profits interests in certain oil and natural gas producing properties, referred to in this prospectus as the "underlying properties." The net profits interests entitle the trust to receive 80% of net proceeds from the sale of oil and natural gas from these properties. The underlying properties are located in the Hugoton area of Kansas and Oklahoma, the Anadarko Basin of Oklahoma and the Green River Basin of Wyoming. The trust will make monthly distributions of substantially all of its income to holders of its trust units. On your federal income tax returns, you will be required to include your proportionate share of trust net income. In addition, you will be entitled to claim a depletion deduction and a small tax credit relating to production from the underlying properties. The deductions and credits will permit you to defer or reduce taxes on a significant portion of the income you receive from the trust. Cross Timbers will determine net proceeds monthly on a state-by-state basis. It will collect cash received from the sale of production and deduct property and production taxes, development and production costs and overhead. Cross Timbers will pay to the trust 80% of the net profits remaining after deducting those costs. Net proceeds payable to the trust depend upon production quantities, sales prices of oil and natural gas and costs to develop and produce the oil and natural gas. If at any time development and production costs should exceed gross proceeds, neither the trust nor the trust unitholders would be liable for the excess costs. However, the trust would not receive any net proceeds until future net proceeds exceed the total of those excess costs, plus interest at the prime rate. Cross Timbers does not expect future production costs for the underlying properties to change significantly as compared to recent historical costs. It expects the level of development costs to decline significantly as compared to recent historical amounts. 3 Cross Timbers' Ownership Interest The underlying properties include Cross Timbers' undivided interests in oil and natural gas leases and the production from existing and future wells on those leases. Accordingly, if Cross Timbers successfully drills additional wells on acreage covered by these leases or successfully conducts other development activities, those activities will enhance production from the underlying properties. The trust will benefit from increased production, net of related development costs. Cross Timbers' interests in the underlying properties are predominantly "working interests," which require it to bear the costs of exploration, production and development. Cross Timbers' retained interest in the underlying properties entitles it to 20% of the net proceeds from production. Cross Timbers believes that a 20% ownership interest will provide incentive to operate and develop the underlying properties in an efficient and cost effective manner. Cross Timbers is under no obligation to continue to own the underlying properties, but currently intends to do so. The following chart shows the relationship of Cross Timbers, the trust and the public trust unitholders, assuming no exercise of the underwriters' over- allotment option. [CHART SHOWING RELATIONSHIP OF TRUST TO CROSS TIMBERS APPEARS HERE] The Underlying Properties The underlying properties are located in three of the best known and most prolific natural gas producing areas in the United States. As of December 31, 1998, proved reserves of the underlying properties were estimated at 539 Bcfe in the Reserve Report. Approximately 30% of the proved reserves were located in the Hugoton area of Kansas and Oklahoma, 37% were located in the Anadarko Basin of Oklahoma and 33% were located in the Green River Basin of Wyoming. These areas are characterized by wells with low rates of annual decline in production and low production costs. Wells in these areas have been producing for many years, in some cases since the 1920s. Reserve estimates for properties with long production histories are generally more reliable than estimates for properties with short histories. 4 Long Life of Properties The productive lives of producing oil and natural gas properties are often compared using their reserve-to-production index. This index is calculated by dividing total estimated proved reserves of the property by annual production for the prior 12 months. The reserve-to-production index for the underlying properties at December 31, 1998 was 13.0 years. An index of 13.0 years shows a long producing life for an oil and natural gas property. This compares favorably to an average index of 9.2 years for U.S. oil and natural gas properties of publicly reporting companies at year-end 1997. Because production rates naturally decline over time, the reserve-to-production index is not a useful estimate of how long properties should economically produce. Based on the Reserve Report, economic production from the underlying properties is expected for at least 40 more years. High Percentage of Proved Developed Reserves Proved developed reserves are the most valuable and lowest risk category of reserves because their production requires no significant future development costs. Proved developed reserves represent approximately 93% of the discounted present value of estimated future net revenues from the underlying properties. Control of Operations The right to operate an oil and natural gas lease is important because the operator controls the timing and amount of discretionary expenditures for operational and development activities. Cross Timbers operates approximately 90% of the underlying properties, based on the discounted present value of estimated future net revenues. History of Low Cost Reserve Additions Cross Timbers has a record of successfully adding reserves to the underlying properties through development at costs substantially below the industry average. Over the last three years Cross Timbers added 187 Bcfe of proved reserves, or 156% of production, at a cost of $0.47 per Mcfe. For publicly reporting companies in the United States, the average industry cost of adding oil and natural gas reserves from 1995 through 1997 was $0.96 per Mcfe. Over the last three years proved reserve additions on existing wells on the underlying properties included upward revisions of 23 Bcfe. These upward revisions were due to better than projected production performance and development results, reduced production costs, increased oil and natural gas prices in some years, gathering system improvements and improved technology. Cross Timbers believes that the underlying properties will experience reserve additions in the future, but cannot assure you that this will occur. Effect of Planned Development Program Without development projects, the underlying properties would typically experience a 6% to 10% annual decline in production. Cross Timbers plans development expenditures on the underlying properties of $12 million per year for the next four years. The Reserve Report projects that these development expenditures will reduce the natural rate of decline in production to approximately 4% per year. Additional Development Opportunities Cross Timbers believes that the underlying properties will offer economic development projects that are not included in the Reserve Report. These additional development opportunities could significantly increase production and proved reserves above those projected in the Reserve Report. Additional development opportunities could include: . adding pipeline compression and pumps to improve production flow; . opening new producing zones in existing wells; 5 . deepening existing wells to new producing zones; . performing mechanical and chemical treatments to stimulate production rates; and . drilling additional wells. Cross Timbers may face conflicts of interest in allocating its resources between additional development of the underlying properties and development of other oil and natural gas properties that it now owns or may own in the future. Cross Timbers allocates resources for development based on expected rates of return. The underlying properties have historically provided attractive rates of return on development projects compared to Cross Timbers' other properties, and are expected to continue to do so in the future. Substantial Operating Margins The underlying properties have historically generated substantial operating margins. Production expenses, production and property taxes, transportation costs and overhead on the underlying properties averaged $0.68 per Mcfe during 1998. During the same period, the sales price for oil and natural gas produced from the underlying properties averaged $2.03 per Mcfe, providing an operating margin of $1.35 per Mcfe. Control of Natural Gas Gathering Systems Cross Timbers and its affiliates operate natural gas gathering systems for approximately 70% of the production from the underlying properties. This allows Cross Timbers to manage gathering operations to maintain optimum natural gas production. Proved Reserves Estimated proved reserves of the underlying properties are approximately 95% natural gas and 5% oil, based on the Reserve Report. The following table provides, as of December 31, 1998, estimated proved oil and natural gas reserves, and undiscounted and discounted estimated future net revenues, for the underlying properties and the net profits interests. Proved reserves in the table are based on oil and natural gas prices realized by Cross Timbers as of December 31, 1998, which were $11.24 per Bbl of oil and $2.01 per Mcf of natural gas. The amounts of estimated future net revenues from proved reserves shown in the table are before income taxes. Discounted future net revenues are based on a discount rate of 10%, which is the rate required by the Securities and Exchange Commission. Reserve estimates are subject to revision.
Proved Reserves --------------------------- Estimated Future Net Revenues from Gas Proved Reserves Gas Oil Equivalents ------------------------ (MMcf) (MBbls) (MMcfe) Undiscounted Discounted ------- ------- ----------- ------------ ----------- (in thousands, except per Unit data) Underlying properties (100%): Anadarko Basin......... 174,433 3,621 196,159 $258,416 $150,711 Green River Basin...... 178,970 270 180,590 242,897 104,193 Hugoton Area........... 161,670 139 162,504 173,205 92,273 ------- ----- ------- -------- -------- Total................ 515,073 4,030 539,253 $674,518 $347,177 ======= ===== ======= ======== ======== Underlying properties (80%)................... 412,058 3,224 431,402 $539,615 $277,742 Net profits interests (a)..................... 282,297 2,193 295,455 $539,615 $277,742 Per trust unit........... -- -- -- $ 13.49 $ 6.94
- -------- (a) Proved reserves for the net profits interests are calculated by subtracting from 80% of proved reserves of the underlying properties, reserve quantities of a sufficient value to pay 80% of the 6 future estimated costs, before overhead and trust administrative expenses, that are deducted in calculating net proceeds. Accordingly, proved reserves for the net profits interests reflect quantities that are calculated after reductions for future costs and expenses based on price and cost assumptions used in the reserve estimates. Producing Areas The underlying properties consist of predominantly natural gas producing leases located in the States of Kansas, Oklahoma and Wyoming. These productive areas include: . Hugoton Area. The largest natural gas producing region in North America, the Hugoton area covers an estimated five million acres in parts of Oklahoma, Kansas and Texas. The area has produced more than 64 trillion cubic feet of natural gas since 1922. Wells in this area produce primarily from formations less than 3,000 feet in depth. Wells also produce from deeper formations at depths ranging from 3,000 to 7,000 feet. The average 1999 net daily production for the underlying properties in this area estimated in the Reserve Report is approximately 36,700 Mcf of natural gas and 40 Bbls of oil per day. . Anadarko Basin. Cross Timbers properties in this area are concentrated in Major County, Oklahoma as well as the Elk City Field and other areas in western Oklahoma. Oil and natural gas were first discovered in Major County and the Elk City Field in the 1940s. Natural gas wells in this region produce from a variety of productive zones and geological structures. Principal productive zones range in depth from 6,500 to 9,400 feet. The average 1999 net daily production for the underlying properties in this area estimated in the Reserve Report is approximately 45,000 Mcf of natural gas and 1,100 Bbls of oil per day. . Green River Basin. Located in southwestern Wyoming, this area includes Cross Timbers properties in the Fontenelle area. Wells in this area have produced since the early 1970s from formations ranging in depth from 7,500 to 10,000 feet. The average 1999 net daily production for the underlying properties in this area estimated in the Reserve Report is approximately 30,500 Mcf of natural gas and 50 Bbls of oil per day. 7 Pro Forma Trust Distributions and Related Data The following table contains oil and natural gas sales volumes and average sales prices for production from the underlying properties and the calculation of trust distributable income: . for 1996, 1997 and 1998, based on historical net proceeds from the underlying properties. See the audited statements of revenues and direct operating expenses for the years ended December 31, 1996, 1997 and 1998 and the pro forma statement of distributable income for the year ended December 31, 1998 included in this prospectus. . for 1998, on an adjusted basis using the reduced development costs budgeted for 1999. Cross Timbers aggressively developed the underlying properties during 1996, 1997 and 1998, but intends to reduce development costs to approximately $12 million per year for the next four years. The "Adjusted 1998" data in the table are the same as the actual 1998 data, except for the effects of reducing development costs to $12 million. The "Adjusted 1998" data allow a comparison between the "Hypothetical 1999" data and the 1998 data, adjusted to show the effect of the expected reduced development expenditures during 1999. . for 1999, on a hypothetical basis using the assumptions and methods of calculation described under "Hypothetical Annual Cash Distributions." These calculations were made using hypothetical realized prices of $2.00 for natural gas and $11.75 for oil, which equates to a $10.00 posted oil price. The "Hypothetical 1999" data in the table are not a projection or forecast of the actual or estimated results from an investment in the trust units. They are intended only to demonstrate the calculation of distributable income based on assumed production levels, prices and costs. See "Hypothetical Annual Cash Distributions." "Trust distributable income per trust unit" for each year is a pro forma amount, assuming the net profits interests were conveyed to the trust prior to January 1, 1996 and that trust administrative expense was $300,000 annually.
Year Ended December 31, ------------------------- Adjusted Hypothetical 1996 1997 1998 1998 1999 ------- ------- ------- -------- ------------ (in thousands, except per unit data) Underlying Properties Sales Volumes: Natural gas (Mcf).......... 36,143 37,172 38,535 38,535 41,027 Oil (Bbls)................. 455 470 479 479 434 Average Price: Natural gas (per Mcf)...... $ 1.67 $ 2.21 $ 2.00 $ 2.00 $ 2.00 Oil (per Bbl).............. $ 19.95 $ 20.63 $ 14.78 $ 14.78 $ 11.75 Calculation of Distributable Income Revenues: Natural gas sales.......... $60,502 $82,192 $77,124 $77,124 $82,054 Oil sales.................. 9,075 9,704 7,083 7,083 5,100 ------- ------- ------- ------- ------- Total.................... 69,577 91,896 84,207 84,207 87,154 ------- ------- ------- ------- ------- Costs: Production and property taxes and transportation.. 5,919 9,173 9,170 9,170 9,310 Production expenses........ 11,359 12,837 13,031 13,031 11,937 Development costs.......... 14,392 40,027 33,019 12,000 12,000 Overhead................... 4,557 5,354 6,198 6,198 6,200 ------- ------- ------- ------- ------- Total................... 36,227 67,391 61,418 40,399 39,447 ------- ------- ------- ------- ------- Net proceeds................. 33,350 24,505 22,789 43,808 47,707 Net profits percentage....... 80% 80% 80% 80% 80% ------- ------- ------- ------- ------- Trust royalty income......... 26,680 19,604 18,231 35,046 38,166 Trust administrative expense..................... 300 300 300 300 300 ------- ------- ------- ------- ------- Trust distributable income... $26,380 $19,304 $17,931 $34,746 $37,866 ======= ======= ======= ======= ======= Trust distributable income per trust unit.............. $ 0.66 $ 0.48 $ 0.45 $ 0.87 $ 0.95 ======= ======= ======= ======= =======
8 The Offering Trust units offered by Cross Timbers................... 15,000,000 Trust units outstanding... 40,000,000 Use of proceeds........... Cross Timbers will receive all net proceeds from this offering, which will be used to repay indebtedness under its revolving credit facility. NYSE symbol............... HGT Investing in Trust Units Investing in these trust units differs from investing in corporate stock in the following ways: . trust unitholders have limited voting rights; . trust unitholders are taxed directly on their proportionate share of trust net income; . trust unitholders are entitled to federal income tax depletion deductions and tax credits; . substantially all trust income must be distributed to trust unitholders; and . trust assets are limited to the net profits interests which have a finite economic life. 9 RISK FACTORS Trust Distributions Will Be Sensitive to Changing Oil and Natural Gas Prices The trust's monthly cash distributions are highly dependent upon the prices realized from the sale of oil and, in particular, natural gas. Oil and natural gas prices can fluctuate widely on a month-to-month basis in response to a variety of factors that are beyond the control of the trust and Cross Timbers. These factors include, among others: . weather conditions; . the supply and price of foreign oil and natural gas; . the level of consumer product demand; . worldwide economic conditions; . political conditions in the Middle East; . government regulations; . the price and availability of alternative fuels; . the proximity to, and capacity of, transportation facilities; and . worldwide energy conservation measures. Lower oil and natural gas prices may reduce the amount of oil and natural gas that is economic to produce and reduce net profits available to the trust. The volatility of energy prices reduces the accuracy of estimates of future cash distributions to trust unitholders. Trust Distributions Are Affected by Production and Development Costs Production and development costs on the underlying properties are deducted in the calculation of the trust's share of net proceeds. Accordingly, higher or lower production and development costs will directly decrease or increase the amount received by the trust for its net profits interests. For a summary of these costs for the last three years, see "The Net Profits Interests and the Underlying Properties--Pro Forma Distributable Income and Oil and Natural Gas Sales Volumes." If development and production costs of underlying properties located in a particular state exceed the proceeds of production from the properties, the trust will not receive net proceeds for those properties until future proceeds from production in that state exceed the total of the excess costs plus accrued interest during the deficit period. Development activities may not generate sufficient additional revenue to repay the costs. Trust Reserve Estimates Are Uncertain The value of the trust units will depend upon, among other things, the reserves attributable to the trust's net profits interests. Estimating reserves is inherently uncertain. Ultimately, actual production, revenues and expenditures for the underlying properties will vary from estimates and those variations could be material. Petroleum engineers consider many factors and make assumptions in estimating reserves. Those factors and assumptions include: . historical production from the area compared with production rates from other producing areas; . the assumed effect of governmental regulation; and . assumptions about future commodity prices, production and development costs, severance and excise taxes, and capital expenditures. 10 Changes in these assumptions can materially change reserve estimates. The trust's reserve quantities and revenues are based on estimates of reserves and revenues for the underlying properties. The method of allocating a portion of those reserves to the trust is complicated because the trust holds an interest in net profits and does not own a specific percentage of the oil and natural gas reserves. See "The Net Profits Interests and the Underlying Properties--Oil and Natural Gas Reserves--Proved Reserves" for a discussion of the method of allocating proved reserves to the trust. Production Risks Can Adversely Affect Trust Distributions The occurrence of drilling, production or transportation accidents at any of the underlying properties will reduce trust distributions by the amount of uninsured costs. These accidents may result in personal injuries, property damage, damage to productive formations or equipment and environmental damages. The Trust Does Not Control Operations and Development Neither the trustee nor the trust unitholders can influence or control the operation or future development of the underlying properties. Cross Timbers is unable to significantly influence the operations or future development of the underlying properties that it does not operate, which contain about 10% of the proved reserve value of all underlying properties. The current operators of the underlying properties, including Cross Timbers, are under no obligation to continue operating the properties. Cross Timbers can sell any of the underlying properties that it operates and relinquish the ability to control or influence operations. Neither the trustee nor trust unitholders have the right to replace an operator. Cross Timbers May Transfer or Abandon Underlying Properties Although it has no current intention of selling any of the underlying properties, Cross Timbers may at any time transfer all or part of the underlying properties. You will not be entitled to vote on any transfer, and the trust will not receive any proceeds of the transfer. Following any material transfer, the underlying properties will continue to be subject to the net profits interests of the trust, but the net proceeds from the transferred property would be calculated separately and paid by the transferee. The transferee would be responsible for all of Cross Timbers' obligations relating to the net profits interests on the portion of the underlying properties transferred, and Cross Timbers would have no continuing obligation to the trust for those properties. Cross Timbers and any transferee may abandon any well or property if it believes that the well or property can no longer produce in commercially economic quantities. This could result in termination of the net profits interest relating to the abandoned well. Net Profits Interest Can Be Sold or the Trust May Be Terminated The trustee must sell the net profits interests if the holders of 80% or more of the trust units approve the sale or vote to terminate the trust. The trustee must also sell the net profits interests if the annual gross proceeds from the underlying properties are less than $1 million for each of two consecutive years after 1999. Sale of all the net profits interests will terminate the trust. The net proceeds of any sale will be distributed to the trust unitholders. 11 Cross Timbers May Dispose of Remaining Trust Units Cross Timbers currently owns 100% of the trust units and will sell 37.5% of the trust units in this offering, or 43% if the underwriters' over-allotment option is exercised in full. Cross Timbers has granted options to its executive officers to purchase $12 million of its retained trust units at the initial public offering price. It may use some or all of the remaining trust units it owns for a number of corporate purposes, including: . selling them for cash; and . exchanging them for interests in oil and natural gas properties or securities of oil and natural gas companies. If Cross Timbers sells additional trust units or exchanges trust units in connection with acquisitions or if Cross Timbers executives acquire trust units upon exercise of options, then additional trust units will be available for sale in the market. Cross Timbers expects these additional trust units to increase market liquidity, but cannot presently determine whether they will impact the market price for trust units. The release of these additional trust units into the public market may cause the market price to decrease. See "Selling Trust Unitholder." Cross Timbers Will Receive Payments Deducted from Net Proceeds Cross Timbers and some of its affiliates receive payments under existing contracts for services relating to the underlying properties. Payments to Cross Timbers and its affiliates will be deducted in determining net proceeds payable to the trust. This will reduce the amounts available for distribution to the trust unitholders. These payments will include: . payments to Cross Timbers for production and development costs to operate wells; . payments to Cross Timbers affiliates for marketing, gathering, processing and transportation services; and . overhead fees to operate the underlying properties, which include accounting and other administrative functions. In addition to providing services, Cross Timbers affiliates purchase production from the underlying properties. Approximately two-thirds of 1998 oil and natural gas sales from the underlying properties were made to Cross Timbers affiliates. Cross Timbers believes that the terms of these contracts are competitive with those that could be obtained from unrelated third parties. Cross Timbers is permitted under the conveyance agreements creating the net profits interests to enter into new contracts without any negotiations or other involvement by independent third parties. Provisions in the conveyance agreements, however, require that . future contracts with affiliates relating to transportation, processing or marketing of oil and natural gas cannot materially exceed charges prevailing in the area for similar services; and . future oil and natural gas sales contracts with affiliates must provide that the affiliates retain not more than 2% of the proceeds from the sale of production by the affiliates. Cross Timbers Will Have Potential Conflicts of Interest Because Cross Timbers has interests in oil and natural gas properties not included in the trust, the interests of Cross Timbers and the trust unitholders may not always be in common. For example, . in setting budgets for development and production expenditures for Cross Timbers' properties, including the underlying properties, Cross Timbers may make decisions that could adversely affect future production from the underlying properties; 12 . Cross Timbers could continue to operate an underlying property and earn an overhead fee even though abandonment of the property might be more beneficial to trust unitholders; and . Cross Timbers could decide to sell or abandon some or all of the underlying properties, and that decision may not be in the best interests of the trust unitholders. Except for specified matters that require approval of the trust unitholders described in "Description of the Trust Indenture," the documents governing the trust do not provide a mechanism for resolving these conflicting interests. Trust Unitholders Will Have Limited Voting Rights Your voting rights as a trust unitholder are more limited than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of trust unitholders or for an annual or other periodic re-election of the trustee. Additionally, trust unitholders have no voting rights in Cross Timbers and therefore will have no ability to influence its operations of the underlying properties. Trust Unitholders Will Have Limited Ability to Enforce Rights The trust indenture does not provide you with any right to compel the trustee to take action against Cross Timbers or any other future owner of the underlying properties to honor the net profits interests. Rather, the trust indenture and related trust law permit the trustee and the trust to bring those claims. If the trustee does not take appropriate action to enforce provisions of the net profits interests, your recourse as a trust unitholder would likely be limited to bringing a lawsuit against the trustee to compel the trustee to take specified actions. Limited Liability of Trust Unitholders Is Uncertain Texas law is not clear whether a trust unitholder could be held personally liable for the trust's liabilities if those liabilities exceeded the value of the trust's assets. Cross Timbers believes it is highly unlikely the trust could incur such excess liabilities. As a royalty interest, the trust's net profit interest is generally not subject to operational and environmental liabilities and obligations. The trust conducts no active business that would give rise to other business liabilities. The trustee has limited ability to incur obligations on behalf of the trust. The trustee must ensure that all contractual liabilities of the trust are limited to claims against the assets of the trust. The trustee will be liable for its failure to do so. Cross Timbers' Liability to the Trust Is Limited The net profits interest conveyance provides that Cross Timbers will not be liable to the trust for performing its duties in operating the underlying properties as long as it acts in good faith. Cross Timbers has no fiduciary duty to protect the interests of the trust. Amendment of the Trust Indenture Requires Supermajority Vote Trust unitholders may amend the trust indenture by a vote of the holders of 80% or more of the outstanding trust units. Any amendment will be binding on you, regardless of whether you voted for or against the amendment. Some provisions of the trust indenture cannot be amended without the consent of all trust unitholders. See "Description of the Trust Indenture--Creation and Organization of the Trust; Amendments." 13 Trust Assets Are Depleting Assets The net proceeds payable to the trust are derived from the sale of depleting assets. Accordingly, the portion of the distributions to trust unitholders attributable to depletion may be considered a return of capital. The reduction in proved reserve quantities is a common measure of the depletion. Future maintenance and development projects on the underlying properties will affect the quantity of proved reserves. The timing and size of these projects will depend on the market prices of oil and natural gas. If operators of the properties do not implement additional maintenance and development projects, the future rate of production decline of proved reserves may be higher than the rate currently expected by Cross Timbers. For federal income tax purposes, depletion is reflected as a deduction, which is anticipated to be $0.73 per trust unit in 1999, based on a trust unit purchase price of $9.00. See "Federal Income Tax Consequences--Royalty Income and Depletion." Tax Considerations The trust has received an opinion of tax counsel that the trust is a "grantor trust" for federal income tax purposes. This means that: . you will be taxed directly on your pro rata share of the net income of the trust, regardless of whether all of that net income is distributed to you; . you will be allowed (1) depletion deductions equal to the greater of percentage depletion or cost depletion, computed on the tax basis of your trust units and (2) your pro rata share of other deductions of the trust; and . you will be allowed the tax credit for your share of qualifying natural gas production from tight sands provided under Section 29 of the Internal Revenue Code, subject to limitations described in this prospectus. See "Federal Income Tax Consequences." Tax counsel believes that its opinion is in accordance with the present position of the Internal Revenue Service (the "IRS") regarding grantor trusts. Neither Cross Timbers nor the trustee has requested a ruling from the IRS regarding these tax questions. Neither Cross Timbers nor the trust can assure you that they would be granted such a ruling if requested or that the IRS will continue this position in the future. Trust unitholders should be aware of possible state tax implications of owning trust units. See "State Tax Considerations." 14 FORWARD-LOOKING STATEMENTS Some statements made by Cross Timbers in this prospectus under "Hypothetical Annual Cash Distributions," statements pertaining to future development activities and costs, and other statements contained in this prospectus are prospective and constitute forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from future results expressed or implied by the forward-looking statements. The most significant risks, uncertainties and other factors are discussed under "Risk Factors" above. USE OF PROCEEDS The trust will not receive any proceeds from the sale of the trust units. Cross Timbers will receive all proceeds from the sale of trust units after deducting underwriting discounts and costs of the offering paid by Cross Timbers. The estimated net proceeds will be approximately $ , and will increase to $ if the underwriters exercise their over-allotment option in full. Cross Timbers intends to apply the net proceeds from the offering to repay outstanding indebtedness under its bank revolving credit facility. The facility bears interest at a floating rate based on LIBOR, currently 6.5%, and matures on June 30, 2003. Cross Timbers incurred its bank debt to finance recent acquisitions of oil and natural gas producing properties, purchases of equity securities of other energy companies, repurchases of Cross Timbers common stock, and development expenditures. CROSS TIMBERS Cross Timbers Oil Company is a leading United States independent energy company. It engages in the acquisition, development and exploration of oil and natural gas properties, and in the production, processing, marketing and transportation of oil and natural gas in the United States. Cross Timbers organized the trust in December 1998 and conveyed the net profits interests to the trust in exchange for all of the trust units. Cross Timbers continues to own the underlying properties from which the net profits interests were conveyed. Cross Timbers has granted to its executive officers options to purchase up to $12 million of its retained trust units at the initial public offering price. The executive officers will not receive any trust distributions until their options are exercised. Cross Timbers may form additional royalty trusts with other properties. It may in the future dispose of some or all of the trust units of the Hugoton Royalty Trust or any of the other royalty trusts. See "Risk Factors--Cross Timbers May Dispose of Remaining Trust Units." THE TRUST The trust was formed in December 1998 by execution of the trust indenture between NationsBank, N.A., as trustee, and Cross Timbers. In connection with the formation of the trust, Cross Timbers carved the net profits interests from the underlying properties and conveyed the net profits interests to the trust in exchange for all 40,000,000 of the trust units. The trustee can authorize the trust to borrow money to pay trust administrative or incidental expenses that exceed cash held by the trust. The trustee may authorize the trust to borrow from the trustee as a lender. Because the trustee is a fiduciary, the terms of the loan must be fair to the trust unitholders. The trustee may also deposit funds awaiting distribution in an account with itself, if the interest paid to the trust at least equals amounts paid by the trustee on similar deposits. 15 The trust will pay the trustee a fee of $35,000 per year and a fee of $15,000 for services to terminate the trust. The trust will also incur legal, accounting and engineering fees, printing costs and other expenses that are deducted from the 80% of net proceeds received by the trust before distributions are made to trust unitholders. HYPOTHETICAL ANNUAL CASH DISTRIBUTIONS The amount of trust revenues and cash distributions to trust unitholders will depend on (1) natural gas prices, (2) oil prices to a lesser extent, (3) the volume of oil and natural gas produced and sold and (4) production, development and other costs. Cross Timbers prepared the following unaudited tables, which demonstrate the hypothetical effect that changes in the prices for oil and natural gas could have on trust distributions. The following tables show: . the hypothetical cash distributions per trust unit for calendar year 1999 on the accrual or production basis; . the resulting hypothetical cash distributions per trust unit as a percentage of the purchase price of the trust unit ("Hypothetical Pre- Tax Cash Returns"); and . the resulting hypothetical cash return following payment of all federal income tax, net of available deductions and credits, at the highest individual tax rate of 39.6% ("Hypothetical After-Tax Cash Returns"). The tables are based on: . an assumed purchase price of $9.00 per trust unit; . various hypothetical oil and natural gas sales prices, which were chosen solely for illustrative purposes and without reference to any historical prices; . 1999 production, as estimated in the Reserve Report; and . the other assumptions described below under "How the Hypothetical Tables Were Prepared." The tables are not a projection or forecast of the actual or estimated results from an investment in the trust units. The purpose of the tables is to illustrate the sensitivity of cash distributions and hypothetical cash returns to changes in the prices of oil and natural gas. There is no assurance that the assumptions described below will actually occur or that the prices of oil or natural gas will not decline or increase by amounts different from those shown in the tables. Due to the seasonal demand for natural gas, the amount of monthly cash distributions from the trust is expected to vary during the year. Month-to- month distributions will also vary based on the timing of development expenditures and the net proceeds, if any, generated by development projects. As a result of typical production declines for oil and natural gas properties, production estimates generally decrease from year to year. Accordingly, the hypothetical cash distributions for 1999 production do not indicate the amount of distributions for future years. Because payments to the trust will be generated by depleting assets, a portion of each distribution may represent a return of your original investment. 16 Hypothetical Cash Distributions Per Trust Unit For Estimated 1999 Production
Hypothetical Wellhead Hypothetical Posted Gas Oil Price per Bbl Price per Mcf ------------------- -------------------------- $1.50 $2.00 $2.50 $3.00 ----- ----- ----- ----- $10.00........................................... $0.57 $0.95 $1.32 $1.70 15.00........................................... 0.61 0.99 1.36 1.74 20.00........................................... 0.65 1.03 1.40 1.78 25.00........................................... 0.69 1.07 1.44 1.82 Hypothetical Pre-Tax Cash Returns at a Trust Unit Price of $9.00 For Estimated 1999 Production Hypothetical Wellhead Hypothetical Posted Gas Oil Price per Bbl Price per Mcf ------------------- -------------------------- $1.50 $2.00 $2.50 $3.00 ----- ----- ----- ----- $10.00........................................... 6.3% 10.6% 14.7% 18.9% 15.00........................................... 6.8 11.0 15.1 19.3 20.00........................................... 7.2 11.4 15.6 19.8 25.00........................................... 7.7 11.9 16.0 20.2 Hypothetical After-Tax Cash Returns at a Trust Unit Price of $9.00 For Estimated 1999 Production Hypothetical Wellhead Hypothetical Posted Gas Oil Price per Bbl Price per Mcf ------------------- -------------------------- $1.50 $2.00 $2.50 $3.00 ----- ----- ----- ----- $10.00........................................... 7.2% 9.8% 12.3% 14.9% 15.00........................................... 7.6 10.1 12.6 15.1 20.00........................................... 7.8 10.3 12.8 15.3 25.00........................................... 8.1 10.7 13.1 15.7
17 The following table shows the calculation of hypothetical 1999 cash distributions per trust unit, pre-tax and after-tax cash returns, based on the assumptions described below under "How the Hypothetical Tables Were Prepared" and assuming a $10.00 per Bbl posted West Texas Intermediate crude oil price ($11.75 realized), a $2.00 per Mcf wellhead natural gas price and a $9.00 trust unit purchase price: Hypothetical 1999 Cash Distributions
(in thousands) Trust Distributable Income: Natural gas (41,027 MMcf).................................. $82,054 Oil (434 MBbls)............................................ 5,100 ------- Total revenues........................................... 87,154 ------- Production and property taxes and transportation........... 9,310 Production expenses........................................ 11,937 Development costs.......................................... 12,000 Overhead................................................... 6,200 ------- Total expenses........................................... 39,447 ------- Net Proceeds............................................... 47,707 Net profits percentage..................................... 80% ------- Trust royalty income....................................... 38,166 Trust administrative expense............................... 300 ------- Trust distributable income................................. $37,866 =======
Annual Cash Amount Return ------ ------ Per Trust Unit (40,000,000 Trust Units): Total cash distributions....................................... $0.95 10.6% Cost depletion tax deduction................................... (0.73) ----- Taxable income................................................. 0.22 Income tax rate................................................ 39.6% ----- Income tax expense............................................. 0.09 Section 29 tax credit.......................................... (0.02) ----- Net tax........................................................ 0.07 ----- Total cash distributions after tax............................. $0.88 9.8% =====
How the Hypothetical Tables Were Prepared Timing of Actual Distributions. In preparing the tables above, the revenues and expenses of the trust were calculated based on the terms of the conveyances creating the trust's net profits interests. These calculations are described under "Computation of Net Proceeds," except that amounts for the tables were calculated on an accrual or production basis rather than the cash basis prescribed by the conveyances. As a result, the proceeds for production for the final one or two months of 1999, and reflected in the tables above, will actually enter into the calculation of net proceeds to be received by the trust in 2000. Net proceeds from production during December 1998 will in fact be distributed from the trust in 1999. Accordingly, the hypothetical cash distributions attributable to 1999 production represent hypothetical cash distributions from the trust from February or March 1999 through January or February 2000. 18 Production Estimates. Production estimates for 1999 are based on the Reserve Report. The Reserve Report assumed constant prices at December 31, 1998, based on a West Texas Intermediate crude oil price of $9.50 ($11.24 realized) per Bbl and the weighted average wellhead natural gas price at December 31, 1998 of $2.01 per Mcf. Production from the underlying properties for 1999 is estimated to be 434,000 Bbls of oil and 41,027,000 Mcf of natural gas. See "--Oil and Natural Gas Prices" below for a description of changes in production due to price variations. Sales for 1998 were 479,000 Bbls of oil and 38,535,000 Mcf of natural gas. For purposes of computing the amount of Section 29 tax credit, natural gas production from the underlying properties that qualify for the tight sands natural gas credit is estimated to be 2,752,000 Mcf during 1999 (1,376,000 Mcf net to the trust). Differing levels of production will result in different levels of distributions and cash returns. Oil and Natural Gas Prices. Oil prices shown in the above tables are hypothetical posted oil prices. Posted price is the price paid for oil at a specific point, unadjusted for gravity, quality and transportation and marketing costs. Published benchmark prices are typically based upon West Texas Intermediate crude, a light, sweet oil of a particular gravity. These prices differ from the average or actual price received for production from the underlying properties, which takes into account those factors. Differentials between posted oil prices and the prices actually received for the oil production may vary significantly due to market conditions. In the above tables, $1.75 per barrel is added to the hypothetical posted oil price to reflect these adjustments. This addition is based on the average difference between the posted price of West Texas Intermediate crude and the price received for production from the underlying properties during 1998. Pro forma average oil prices appearing in this prospectus have been adjusted for these differentials. Natural gas prices shown in the above tables are hypothetical wellhead prices for natural gas. Wellhead price is the net price received for natural gas and natural gas liquids after all deductions for transportation, marketing and gathering. The weighted average price of natural gas production from the underlying properties during 1998 was $2.00 per Mcf. This was approximately $0.25 below the average of the monthly closing NYMEX natural gas futures contract prices for the same period. However, if previously occurring location, quality and other differentials continue in the future, there may be more significant differences between the natural gas price received and the NYMEX price. The adjustments to posted oil prices and wellhead natural gas prices applied in the hypothetical distribution and cash return tables are based upon an analysis by Cross Timbers of the historic price differentials for production from the underlying properties with consideration given to gravity, quality and transportation and marketing costs that may affect these differentials in 1999. There is no assurance that these assumed differentials will recur in 1999. When oil and natural gas prices decline, the operators of the underlying properties may elect to reduce or completely suspend production. No adjustments have been made to estimated 1999 production to reflect potential reductions or suspensions of production. Production Expenses, Development Costs and Overhead. For 1999, Cross Timbers estimates production expenses to be $11.9 million, development costs to be $12 million and overhead to be $6.2 million. Overhead is the estimated fee for all properties operated by Cross Timbers that is deducted by Cross Timbers in calculating net proceeds. For a description of production expenses and development costs, see "Computation of Net Proceeds." Administrative Expense. Trust administrative expense for 1999 is assumed to be $300,000 ($0.0075 per trust unit). See "The Trust." Hypothetical After-Tax Cash Return. Because the net profits interests are a depleting asset, a portion of this return may be considered a return of your original investment. The portion that would 19 be considered a return of original investment is not currently determinable. For a discussion of alternative ways of measuring the depletion of oil and natural gas assets, see "Risk Factors--Trust Assets Are Depleting Assets." The Hypothetical After-Tax Cash Returns on annual hypothetical cash distributions were computed by: . determining the amount of federal income tax that would be paid on the cash distributions at the highest individual marginal tax rate for 1999 of 39.6%, taking into account: -- a cost depletion tax deduction of $0.73 per trust unit; and -- a Section 29 tax credit of $0.02 per trust unit; . subtracting this income tax amount from the annual cash distributions; and . dividing the result by $9.00 per trust unit. Cost depletion is calculated by multiplying the assumed trust unit purchase price of $9.00 by the cost depletion rate of 8.1%. This rate was estimated by dividing estimated 1999 production by December 31, 1998 proved reserves estimated in the Reserve Report. Cost depletion is recaptured upon sale of the trust units, which results in the taxation of any gain on sale as ordinary income, as opposed to capital gain, up to the amount of cost depletion previously deducted. The Section 29 tax credit was based on estimated tight sands natural gas production of 1,376,000 Mcf for the net profits interests at $0.52 per MMBtu. The Section 29 tax credit will expire January 1, 2003. When the hypothetical distributions are less than $0.77 per trust unit, the Hypothetical After-Tax Cash Return would be the same or greater than the Hypothetical Pre-Tax Cash Return because of cost depletion and the Section 29 tax credit. In all instances, each trust unitholder is assumed to have a regular federal income tax liability sufficient to utilize the depletion deduction and the Section 29 tax credit. Alternative minimum tax implications have not been considered. The Section 29 tax credit cannot be used to reduce a trust unitholder's regular tax below his tentative minimum tax, calculated as provided in the alternative minimum tax computation rules. See "Federal Income Tax Consequences--Section 29 Tight Sands Natural Gas Tax Credit." The effect of state income taxes has not been taken into account in computing the Hypothetical After-Tax Cash Return. See "State Tax Considerations." THE NET PROFITS INTERESTS AND THE UNDERLYING PROPERTIES General Cross Timbers created the net profits interests through three conveyances to the trust of 80% net profits interests carved from Cross Timbers' interests in properties in Kansas, Oklahoma and Wyoming. The net profits interests entitle the trust to receive 80% of the net proceeds from the sale of oil and natural gas attributable to the underlying properties. Net proceeds equal the gross proceeds received by Cross Timbers from the sale of production less property and production taxes, overhead fees and production and development costs. The small number of interests in underlying properties that are royalty and overriding royalty interests are not subject to production and development costs or overhead fees. For a more detailed description of net proceeds, see "Computation of Net Proceeds." Cross Timbers owns the underlying properties, subject to the net profits interests conveyed to the trust. Cross Timbers may, at any time, sell all or any portion of the underlying properties, subject to the net profits interests. It has no present intention to do so. 20 Cross Timbers' interests in the underlying properties include its undivided interests in oil and natural gas leases and the production from existing and future wells on those leases. Cross Timbers' interests cover the leased acreage and wells drilled on that acreage. When Cross Timbers drills additional wells on the leased acreage covered by its interests, or when it deepens or opens new producing zones in existing wells, any production from those activities is attributable to the underlying properties. Accordingly, those activities, if successful, will increase or replace production from the underlying properties and increase revenues subject to the trust's net profits interest. Cross Timbers' interest in substantially all of the underlying properties is referred to in the oil and natural gas industry as a "working interest." A working interest is an interest of an oil and natural gas lease entitling its owner to receive a specified percentage of production, but requiring the owner to bear the cost of exploring for, developing and producing oil and natural gas from the property. Where the working interest is held by a number of persons on a single lease, a working interest owner is designated the lease operator by agreement. Cross Timbers operates approximately 90% of the underlying properties based on relative value, and major oil companies and established independent producers operate the rest. A lease operator controls operations on the lease, including the timing and amount of discretionary expenditures for operational and development activities. For that reason it is desirable to operate properties, and it is important that the operator be qualified and experienced. 21 Pro Forma Distributable Income and Oil and Natural Gas Sales Volumes The following table provides oil and natural gas sales volumes and average sales prices for production from the underlying properties and the calculation of distributable income (1) for the years ended December 31, 1996, 1997 and 1998, based on historical net proceeds from the underlying properties, (2) for the year ended December 31, 1998, adjusting development costs to $12 million as is budgeted for 1999, and (3) for the year ended December 31, 1999, on a hypothetical basis, as described under "Hypothetical Annual Cash Distributions."
Year Ended December 31, ------------------------- Adjusted Hypothetical 1996 1997 1998 1998(a) 1999(b) ------- ------- ------- -------- ------------ (in thousands, except per unit data) Underlying Properties Sales Volumes: Natural gas (Mcf).......... 36,143 37,172 38,535 38,535 41,027 Oil (Bbls)................. 455 470 479 479 434 Average Price: Natural gas (per Mcf)...... $ 1.67 $ 2.21 $ 2.00 $ 2.00 $ 2.00 Oil (per Bbl).............. $ 19.95 $ 20.63 $ 14.78 $ 14.78 $ 11.75 Calculation of Distributable Income Revenues: Natural gas sales.......... $60,502 $82,192 $77,124 $77,124 $82,054 Oil sales.................. 9,075 9,704 7,083 7,083 5,100 ------- ------- ------- ------- ------- Total.................... 69,577 91,896 84,207 84,207 87,154 ------- ------- ------- ------- ------- Costs: Production and property taxes and transportation.. 5,919 9,173 9,170 9,170 9,310 Production expenses........ 11,359 12,837 13,031 13,031 11,937 Development costs.......... 14,392 40,027 33,019 12,000 12,000 Overhead................... 4,557 5,354 6,198 6,198 6,200 ------- ------- ------- ------- ------- Total.................... 36,227 67,391 61,418 40,399 39,447 ------- ------- ------- ------- ------- Net proceeds................. 33,350 24,505 22,789 43,808 47,707 Net profits percentage....... 80% 80% 80% 80% 80% ------- ------- ------- ------- ------- Trust royalty income......... 26,680 19,604 18,231 35,046 38,166 Trust administrative expense..................... 300 300 300 300 300 ------- ------- ------- ------- ------- Trust distributable income(c)................... $26,380 $19,304 $17,931 $34,746 $37,866 ======= ======= ======= ======= ======= Trust distributable income per trust unit(c)........... $ 0.66 $ 0.48 $ 0.45 $ 0.87 $ 0.95 ======= ======= ======= ======= =======
- -------- (a) Based on the statement of revenues and direct operating expenses for the underlying properties for the year ended December 31, 1998, with the exception that development costs are assumed to be $12 million, as is budgeted for 1999. (b) Based on the assumptions and methods of calculation described under "Hypothetical Annual Cash Distributions" and using hypothetical prices of $2.00 for natural gas and $10.00 ($11.75 realized) for oil. The hypothetical amounts are not a projection or forecast of the actual or estimated results from an investment in the trust units. They are intended only to demonstrate distributable income based on assumed prices and costs. (c) On a pro forma basis, assuming the net profits interests were conveyed to the trust prior to January 1, 1996 and that trust administration expenses were $300,000 annually. Discussion and Analysis of Pro Forma Distributable Income Trust royalty income from the net profits interests was $26,680,000 for 1996, $19,604,000 for 1997 and $18,231,000 for 1998. The changes in royalty income were primarily related to changes in volumes, prices and development costs. Natural gas sales were 89% of total revenues for the three-year period ended December 31, 1998. Trust royalty income is recorded when received by the trust, which is the month following receipt by Cross Timbers, and generally two months after the related oil and natural gas production. 22 Volumes. Natural gas sales volumes from the underlying properties increased 3% from 1996 to 1997, and 4% from 1997 to 1998. Oil sales volumes from the underlying properties increased 4% from 1996 to 1997, and 2% from 1997 to 1998. The increases were primarily attributable to development projects. Prices. The average natural gas price increased 32% from $1.67 per Mcf in 1996 to $2.21 in 1997, and decreased 10% from 1997 to $2.00 in 1998. The 1996 prices were at the beginning of an upturn in natural gas prices that lasted through the summer of 1998. The average oil price increased 3% from $19.95 per Bbl in 1996 to $20.63 in 1997, and decreased 28% from 1997 to $14.78 in 1998. The lower 1998 oil prices were caused by increased global production without a corresponding increase in consumption. Costs. Total costs deducted in the calculation of royalty income increased 86% from $36,227,000 in 1996 to $67,391,000 in 1997, followed by a 9% decrease to $61,418,000 in 1998. The primary reason for the fluctuation among the three years was the timing of development projects. Many of the underlying properties were purchased by Cross Timbers in 1995 and 1996, leading to large development expenditures in 1997 and 1998. Development costs rose 178% from $14,392,000 in 1996 to $40,027,000 in 1997, and decreased 18% to $33,019,000 in 1998 as development projects were completed. Cross Timbers expects development costs to be $12,000,000 per year for the next four years. Production expense rose 13% from $11,359,000 in 1996 to $12,837,000 in 1997, and increased 2% to $13,031,000 from 1997 to 1998. Most of the increase was related to the timing of major remedial projects such as workovers and subsurface maintenance and to increases in production volumes. On a per Mcfe basis, production costs declined from $0.32 in 1997 to $0.31 in 1998. Production and property taxes and transportation costs have generally fluctuated in relation to revenue levels. Overhead expenses charged to the underlying properties by Cross Timbers were $4,557,000 for 1996, $5,354,000 for 1997 and $6,198,000 for 1998. Fluctuations resulted from changes in the number of active operated wells and the increase in overhead rates per well. Producing Acreage and Well Counts For the following data, "gross" refers to the total wells or acres in which Cross Timbers owns a working interest and "net" refers to gross wells or acres multiplied by the percentage working interest owned by Cross Timbers. Although many of Cross Timbers' wells produce both oil and natural gas, a well is categorized as an oil well or a natural gas well based upon the ratio of oil to natural gas production. The underlying properties are interests in developed properties located primarily in natural gas producing regions of Kansas, Oklahoma and Wyoming. The following is a summary of the approximate producing acreage of the underlying properties at December 31, 1998. Undeveloped acreage is not significant.
Gross Net ------- ------- Hugoton Area.................................................... 217,590 200,390 Anadarko Basin.................................................. 152,042 113,946 Green River Basin............................................... 42,654 28,841 ------- ------- Total........................................................... 412,286 343,177 ======= =======
23 The following is a summary of the producing wells on the underlying properties as of December 31, 1998:
Operated Non-Operated Wells Wells Total ------------- ------------- ------------- Gross Net Gross Net Gross Net ----- ------- ------------- ----- ------- Natural gas........................... 1,005 913.5 253 59.8 1,258 973.3 Oil................................... 140 124.1 7 1.5 147 125.6 ----- ------- ----- ------ ----- ------- Total................................. 1,145 1,037.6 260 61.3 1,405 1,098.9 ===== ======= ===== ====== ===== =======
The following is a summary of the number of development wells drilled by Cross Timbers on the underlying properties during the years indicated:
Year Ended December 31 -------------------------------- 1996 1997 1998 ---------- ---------- ---------- Gross Net Gross Net Gross Net ----- ---- ----- ---- ----- ---- Completed: Natural gas wells (a)......................... 39 30.9 79 68.8 64 43.7 Oil wells..................................... 2 2.0 1 1.0 -- -- Non-productive................................. -- -- 2 1.5 1 1.0 --- ---- --- ---- --- ---- Total (b)...................................... 41 32.9 82 71.3 65 44.7 === ==== === ==== === ====
- -------- (a) One gross (0.5 net) natural gas well drilled in 1997 was an exploratory well. (b) Included in totals are 9 gross (3.2 net) in 1996, 8 gross (1.5 net) in 1997 and 25 gross (8.8 net) in 1998 wells drilled on non-operated interests. Oil and Natural Gas Sales Prices and Production Costs The following table shows the average sales prices per Bbl of oil and Mcf of natural gas produced and the production costs, production and property taxes and transportation costs per Mcfe for the underlying properties:
Year Ended December 31 ----------------------- 1996 1997 1998 ------- ------- ------- Sales prices: Natural gas (per Mcf)................................ $ 1.67 $ 2.21 $ 2.00 Oil (per Bbl)........................................ 19.95 20.63 14.78 Production costs per Mcfe............................. 0.29 0.32 0.31 Production and property taxes and transportation costs per Mcfe............................................. 0.15 0.23 0.22
Major Producing Areas Hugoton Area Natural gas was discovered in 1922 in the Hugoton area, the largest natural gas producing area in North America, covering parts of Texas, Oklahoma and Kansas with an estimated five million productive acres. The Permian-aged Chase formation is the major productive formation in the Hugoton area, ranging in depth from 2,700 to 2,900 feet. There are more than 7,200 Chase wells currently producing. More than 64 trillion cubic feet of natural gas have been produced from the Hugoton area. 24 Additional productive formations in the Hugoton area include the Council Grove between 2,950 and 3,400 feet, the Chester between 6,350 and 6,700 feet and the Morrow between 6,000 and 6,300 feet. Cross Timbers is actively exploring and developing these additional formations on the underlying properties. Cross Timbers' projected 1999 net production from the underlying properties in the Hugoton area averages approximately 36,700 Mcf of natural gas per day and 40 Bbls of oil per day. Cross Timbers delivers approximately 70% of its Hugoton natural gas production to a gathering and processing system operated by a subsidiary. This system collects 71% of its throughput from underlying properties, which, in recent months, has been approximately 26,000 Mcf per day net to Cross Timbers' interest from 243 wells. The subsidiary purchases the natural gas from Cross Timbers at the wellhead, gathers and transports the natural gas to its plant, treats and processes the natural gas at the plant, and then transports it to the marketing pipelines. Cross Timbers sells the natural gas to the subsidiary under long-term contracts at a price equal to 80% to 85% of the price received by the subsidiary for the natural gas. The price is adjusted based upon the Btu content of the natural gas. The subsidiary sells the natural gas to a marketing affiliate of Cross Timbers based upon the average price of several published indices, but does not pay a marketing fee. The price paid by the marketing affiliate includes a deduction for any pipeline access fees incurred by the marketing subsidiary. Pipeline access fees currently are approximately $0.02 per Mcf. Other Hugoton natural gas production is delivered under a third party contract. Under the contract, Cross Timbers receives 74.5% of the net proceeds received from the sale of the residue natural gas and liquids. In the Hugoton area, Cross Timbers' development plans include: . additional compression to lower line pressures; . pumping unit installations; . opening new producing zones of existing wells; . drilling additional wells; and . deeper drilling of existing wells to new producing zones. Cross Timbers plans to develop the Chase formation primarily through infill drilling of up to 40 wells in Kansas. If new legislation is enacted in Oklahoma allowing for reduced spacing and Cross Timbers receives regulatory approval, it will have approximately 200 potential infill well locations in Oklahoma. Cross Timbers also plans to develop the other formations, including the Council Grove, Chester, Morrow and St Louis formations that underlie the 79,500 net acres held by production by the Chase formation wells. Cross Timbers has participated in 3-D seismic shoots covering 30,000 acres of Cross Timbers' net acreage position beneath the Chase formation. Cross Timbers drilled 12 gross (10.9 net) wells in 1997, and 17 gross (10.5 net) wells in 1998, to the Chester, Council Grove and Chase formations, all of which were successfully completed. Anadarko Basin Cross Timbers' projected average 1999 daily production from the underlying properties in the Anadarko Basin is 45,000 Mcf of natural gas and 1,100 Bbls of oil. Two of the principal areas within this basin are the Major County area and the Elk City Field. 25 Major County Area. Cross Timbers is one of the largest producers in the Ringwood, Northwest Okeene and Cheyenne Valley fields in Major County, Oklahoma. Projected average 1999 net daily natural gas production from the underlying properties is approximately 33,800 Mcf and oil production is approximately 920 Bbls. Oil and natural gas were first discovered in the Major County area in 1945. The fields in the Major County area are characterized by oil and natural gas production from a variety of structural and stratigraphic traps. Productive zones range from 6,500 to 9,400 feet and include the Oswego, Red Fork, Chester, Manning, Mississippian, Hunton and Arbuckle formations. A gathering subsidiary of the Company operates a 300-mile gathering system and pipeline in the Major County area. The gathering subsidiary and a third- party processor purchase natural gas produced at the wellhead from Cross Timbers and other producers in the area under life of production contracts. The gathering subsidiary gathers and transports the natural gas to a third-party processor, which processes the natural gas and pays Cross Timbers and other producers for at least 50% of the liquids processed. After the natural gas is processed, the gathering subsidiary transports the natural gas via a 26-mile pipeline to a connection with other pipelines. The gathering subsidiary sells the residue natural gas to the marketing subsidiary of Cross Timbers based upon the average price of several published indices. The gathering subsidiary pays this price to Cross Timbers less a gathering fee of $.313 per Mcf of residue natural gas. This gathering fee was previously approved by the Federal Energy Regulatory Commission when the gathering subsidiary was regulated. In recent months, the gathering system has been collecting approximately 25,500 Mcf per day from over 400 wells, 70% of which Cross Timbers operates. Estimated capacity of the gathering system is 40,000 Mcf per day. The gathering subsidiary also provides contract operating services to properties in Woodward County, collecting approximately 80,000 Mcf per month from 25 wells, for a historical average fee of approximately $.125 per Mcf. Cross Timbers also sells natural gas to its marketing subsidiary, which then sells the natural gas to third parties. The price paid to Cross Timbers is based upon the average price of several published indices, but does not include a deduction for any marketing fees. The price paid by the marketing affiliate includes a deduction for any transportation fees charged by the third party. Cross Timbers plans to develop the Major County area primarily through: . mechanical treatments to stimulate production rates; . opening new producing zones in existing wells; . deepening existing wells to new producing zones; and . drilling additional wells. Cross Timbers drilled 25 gross (20.3 net) wells in 1997, and 23 gross (16.3 net) wells in 1998, in the western portion of Major County, targeted at the Mississippian and Chester formations. All of these wells were successfully completed. Elk City Field. The Elk City Field is located in Beckham and Washita counties of Western Oklahoma. Projected average 1999 net production of underlying properties in the Elk City Field is approximately 4,200 Mcf of natural gas and 130 Bbls of oil per day. The Elk City Field was discovered in 1947 and has been extensively developed. Production is from the Hoxbar (9,500 feet), Atoka (13,100 feet) and Morrow (15,500 feet) zones. Cross Timbers has increased production primarily by adding mechanical treatments to stimulate production rates and opening new producing zones in existing wells. Opportunities remain for additional development in the field. Cross Timbers added significant additional reserves through recent recompletions to the Atoka Formation. 26 A third party processes natural gas from the Elk City Field and pays Cross Timbers 80% of the proceeds received from the sale of the liquids. Cross Timbers sells the residue natural gas to its marketing subsidiary, which pays Cross Timbers the average price of several published indices. Green River Basin The Green River Basin is located in southwestern Wyoming. Cross Timbers' projected 1999 average net daily production from the underlying properties in the Fontenelle field is approximately 30,500 Mcf of natural gas and 50 Bbls of oil. Natural gas was discovered in the Fontenelle area in the early 1970s. The producing reservoirs are the Cretaceous-aged Frontier and Dakota sandstones at depths ranging from 7,500 to 10,000 feet. Cross Timbers markets the natural gas produced from the Fontenelle Unit and nearby properties, under three different marketing arrangements. Under the agreement covering 70% of the natural gas sold, Cross Timbers compresses the natural gas on the lease, transports it off the lease and compresses the natural gas again prior to entry into the natural gas plant pipeline. The pipeline transports the natural gas 35 miles to the natural gas plant, where the natural gas is processed, then redelivered to Cross Timbers and sold to Cross Timbers' marketing subsidiary. The owner of the natural gas plant and related pipeline charges Cross Timbers for operational fuel and processing. In 1998 the fuel charge was about 4% per MMBtu delivered and the processing fee was $0.0792 per MMBtu. In 1999 Cross Timbers anticipates the fuel charge to be 2.5% to 3% and the processing fee to be $0.05 per MMBtu. The marketing subsidiary then sells the residue natural gas based upon a spot sales price, and pays Cross Timbers the net proceeds that the marketing subsidiary receives. The marketing subsidiary does not receive a marketing fee. Condensate is sold at the lease to an independent third party at market rates. The natural gas not sold under the above arrangement is sold either under a similar arrangement where the fee is $.145 per MMBtu, or under a contract where Cross Timbers directly sells the natural gas to a third party on the lease at an adjusted index price. Cross Timbers drilled 35 gross (34 net) wells in 1997 and 16 gross (16 net) wells in 1998 in the Fontenelle Unit, all of which were successfully completed. During 1997, Cross Timbers installed additional pipeline compression to lower overall field operating pressures and improve overall field performance. Cross Timbers also completed an interconnect to another pipeline in the southeastern part of the Fontenelle field that added an additional market for natural gas. Potential development activities for the fields in this area include: . additional compression to lower line pressures; . opening new producing zones of existing wells; . deepening existing wells to new producing zones; and . drilling additional wells. Oil and Natural Gas Reserves Miller & Lents estimated oil and natural gas reserves attributable to the net profits interests as of December 31, 1998. Numerous uncertainties are inherent in estimating reserve volumes and values, and the estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production of the reserves may vary significantly from the original estimates. Miller & Lents calculated reserve quantities and revenues for the net profits interests from projections of reserves and revenues attributable to the combined interests of the trust and Cross Timbers in the underlying properties. Because the trust owns net profits interests and not a specific 27 ownership percentage of the oil and natural gas reserve quantities, proved reserves for the trust's net profits interests are calculated by subtracting from 80% of proved reserves of the underlying properties, reserve quantities of a sufficient value to pay 80% of the future estimated production and development costs, excluding overhead. Accordingly, proved reserves for the net profits interests reflect quantities that are calculated after reductions for future costs and expenses based on the price and cost assumptions used in the reserve estimates. The standardized measure of discounted future net cash flows and changes in discounted cash flows presented below were prepared using assumptions required by the Financial Accounting Standards Board. These assumptions include the use of year-end prices for oil and natural gas and year-end costs for estimated future development and production expenditures to produce the proved reserves. Because natural gas prices are influenced by seasonal demand, use of year- end prices, as required by the Financial Accounting Standards Board, may not be the most accurate basis for estimating future revenues or reserve data. Future net cash flows are discounted at an annual rate of 10%. There is no provision for federal income taxes because future net revenues are not subject to taxation at the trust level. Oil prices used to determine the standardized measure at December 31, 1998 were based on West Texas Intermediate crude prices of $9.50 ($11.24 realized) per Bbl. The weighted average December 31, 1998 wellhead natural gas price used to determine the standardized measure was $2.01 per Mcf. Proved Reserves The following table shows proved reserves, proved developed reserves, future net revenues and discounted present value of future net revenues at December 31, 1998 for the underlying properties, 80% of the underlying properties and the net profits interests.
80% of Net Underlying Underlying Profits Properties Properties Interests ---------- ---------- --------- (in thousands) Proved reserves Natural gas (Mcf)............................ 515,073 412,058 282,297 Oil (Bbls)................................... 4,030 3,224 2,193 Natural gas Equivalents (Mcfe)............... 539,253 431,402 295,455 Proved developed reserves Natural gas (Mcf)............................ 435,328 348,262 249,215 Oil (Bbls)................................... 3,368 2,694 1,934 Natural gas Equivalents (Mcfe)............... 455,536 364,429 260,819 Future net revenues............................ $674,518 $539,615 $539,615 Present value discounted at 10% per annum...... $347,177 $277,742 $277,742
The following table summarizes the changes in estimated pro forma proved reserves attributable to the net profits interests and the changes in estimated proved reserves of the underlying properties for the periods indicated. The data is presented assuming the underlying properties were acquired and the net profits interests were created prior to December 31, 1995 and the trust was formed at that date. Reserve estimates for underlying properties that Cross Timbers acquired between 1996 and 1998 are not available prior to the date acquired. For purposes of calculating quantities of estimated proved reserves of these properties as of December 31, 1995, 1996 and 1997, proved 28 reserves are assumed to equal reserves at the acquisition date plus production between December 31, 1995, 1996 or 1997 and the acquisition date.
Net Profits Interests Underlying Properties (Pro Forma) ---------------------------- ---------------------------- Gas Gas Gas Oil Equivalents Gas Oil Equivalents (Mcf) (Bbls) (Mcfe) (Mcf) (Bbls) (Mcfe) ------- ------ ----------- ------- ------ ----------- (in thousands) Balance, December 31, 1995................... 445,836 4,442 472,488 251,306 2,481 266,192 Revisions, extensions, discoveries and additions............ 47,432 577 50,894 53,978 608 57,626 Production............ (36,143) (455) (38,873) (15,148) (191) (16,294) ------- ----- ------- ------- ----- ------- Balance, December 31, 1996................... 457,125 4,564 484,509 290,136 2,898 307,524 Revisions, extensions, discoveries and additions............ 68,837 180 69,917 (2,303) (356) (4,439) Production............ (37,172) (470) (39,992) (8,809) (111) (9,475) ------- ----- ------- ------- ----- ------- Balance, December 31, 1997................... 488,790 4,274 514,434 279,024 2,431 293,610 Revisions, extensions, discoveries and additions............ 64,818 235 66,228 12,636 (122) 11,904 Production............ (38,535) (479) (41,409) (9,363) (116) (10,059) ------- ----- ------- ------- ----- ------- Balance, December 31, 1998................... 515,073 4,030 539,253 282,297 2,193 295,455 ======= ===== ======= ======= ===== ======= Proved Developed Reserves Balance, December 31, 1995................... 384,588 3,633 406,386 222,155 2,096 234,731 Balance, December 31, 1996................... 401,784 3,966 425,580 259,281 2,564 274,665 Balance, December 31, 1997................... 417,912 3,574 439,356 249,148 2,136 261,964 Balance, December 31, 1998................... 435,328 3,368 455,536 249,215 1,934 260,819
Cross Timbers expects to spend $12 million per year for the next four years to develop the underlying properties and expects that development activities will moderate the rate of decline of proved reserves. Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves The following table provides the summary calculation of the standardized measure of discounted future net cash flows of the underlying properties and net profits interests as of December 31, 1998:
Net Underlying Profits Properties Interests ---------- --------- (in thousands) Future cash flows.......................................... $1,087,660 $595,301 Future costs: Production............................................... 364,930 55,686 Development.............................................. 48,212 -- ---------- -------- Future net cash flows...................................... 674,518 539,615 10% discount factor........................................ 327,341 261,873 ---------- -------- Standardized measure....................................... $ 347,177 $277,742 ========== ========
29 Regulation Natural Gas Regulation. The availability, terms and cost of transportation significantly affect sales of natural gas. The interstate transportation and sale for resale of natural gas is subject to federal regulation, including transportation rates, storage tariffs and various other matters, primarily by the Federal Energy Regulatory Commission ("FERC"). Federal and state regulations govern the price and terms for access to natural gas pipeline transportation. The FERC's regulations for interstate natural gas transmission in some circumstances may also affect the intrastate transportation of natural gas. While natural gas prices are currently unregulated, Congress historically has been active in the area of natural gas regulation. Cross Timbers cannot predict whether new legislation to regulate natural gas might be proposed, what proposals, if any, might actually be enacted by Congress or the various state legislatures, and what effect, if any, the proposals might have on the operations of the underlying properties. Sales of crude oil, condensate and natural gas liquids are not currently regulated and are made at market prices. The FERC implemented regulations on January 1, 1995, to establish an indexing system for transportation rates for oil that could increase the cost of transporting oil to the purchaser. Cross Timbers is not able to predict what effect, if any, these regulations might have. Environmental Regulation. Companies that are engaged in the oil and gas industry are affected by federal, state and local laws regulating the discharge of materials into the environment. Those laws may impact operations of the underlying properties. Cross Timbers believes that it is in substantial compliance with the environmental laws and regulations that apply to the operations of the underlying properties. Cross Timbers has not previously incurred material expenses in complying with environmental laws and regulations that affect its operations of the underlying properties. It does not currently expect that future compliance will have a material adverse effect on the trust or the monthly distributions. State Regulation. The various states regulate the production and sale of oil and natural gas, including imposing requirements for obtaining drilling permits, the method of developing new fields, the spacing and operation of wells and the prevention of waste of oil and gas resources. States may regulate rates of production and may establish maximum daily production allowables from both oil and gas wells based on market demand or resource conservation, or both. Other Regulation. The Mineral Management Service of the United States Department of Interior is evaluating existing methods of settling royalties on federal and Native American oil and gas leases. A portion of the underlying properties, primarily those located in Wyoming, involve federal leases. Although the final rules could cause an increase in the federal royalties to be paid on these properties and, correspondingly, decrease the revenue to Cross Timbers and the trust from these properties, Cross Timbers does not believe that the proposed rule changes will have a significant detrimental effect on the distributions from the trust. The petroleum industry is also subject to compliance with various other federal, state and local regulations and laws. Some of those laws relate to occupational safety, resource conservation and equal employment opportunity. Cross Timbers does not believe that compliance with these laws will have a material adverse effect upon the trust unitholders. 30 Title to Properties Cross Timbers believes that its title to the underlying properties is, and the trust's title to the net profits interest will be, good and defensible in accordance with standards generally accepted in the oil and gas industry. The underlying properties are typically subject, in one degree or another, to one or more of the following: . royalties, overriding royalties and other burdens, under oil and gas leases; . contractual obligations (including, in some cases, development obligations) arising under operating agreements, farmout agreements, production sales contracts and other agreements that may affect the properties or their titles; . liens that arise in the normal course of operations, such as those for unpaid taxes, statutory liens securing unpaid suppliers and contractors and contractual liens under operating agreements; . pooling, unitization and commutation agreements, declarations and orders; and . easements, restrictions, rights-of-way and other matters that commonly affect property. To the extent that these burdens and obligations affect Cross Timbers' rights to production and the value of production from the underlying properties, they have been taken into account in calculating the trust's interests and in estimating the size and the value of the reserves attributable to the net profits interests. Cross Timbers believes that the burdens and obligations affecting the underlying properties and the net profits interests are conventional in the industry for similar properties. Cross Timbers also believes that the burdens and obligations do not in the aggregate materially interfere with the use of the underlying properties and will not materially adversely affect the value of the net profits interests. Although the matter is not entirely free from doubt, Cross Timbers believes that the net profits interests should constitute real property interests under Oklahoma and Wyoming law, but not under Kansas law. Cross Timbers will record the conveyances in the appropriate real property records of Kansas, Oklahoma and Wyoming, the states in which the underlying properties are located. If during the term of the trust Cross Timbers should become a debtor in a bankruptcy proceeding, it is not entirely clear that the net profits interests would be treated as real property interests under the laws of Oklahoma and Wyoming, and they would not be so treated under Kansas law. If a determination were made in a bankruptcy proceeding that a net profits interest did not constitute a real property interest under applicable state law, it could be designated an executory contract. An executory contract is a term used, but not defined, in the federal bankruptcy code to refer to a contract under which the obligations of both the debtor and the other party are so unsatisfied that the failure of either to complete performance would constitute a material breach excusing performance by the other. If a net profits interest were designated an executory contract and rejected in the bankruptcy proceeding, Cross Timbers would not be required to perform its obligations under the net profits interest and the trust would seek damages as one of Cross Timbers' unsecured creditors. Although no assurance can be given, Cross Timbers does not believe that the net profits interests should be subject to rejection in a bankruptcy proceeding as executory contracts. Marketing A subsidiary of Cross Timbers markets Cross Timbers' natural gas production and the natural gas output of the gathering and processing systems operated by other Cross Timbers subsidiaries. The natural gas is sold on a monthly basis to third parties for the best available price, although Cross Timbers occasionally enters into forward contracts for future deliveries. Oil production is generally marketed at the 31 wellhead to third parties at the best available price. The marketing subsidiary may arrange to accumulate oil from a number of different locations and transport it to a central point where the greater volume will provide a higher price, net of the transportation costs. Cross Timbers arranges for some of its natural gas to be processed by unaffiliated third parties and markets the natural gas liquids from that processing in a similar manner as it markets its oil. The natural gas attributable to the underlying properties will be marketed under the existing sales contracts. Contracts covering production from the Major County area are for the life of the lease, and the contract for the majority of production from the Hugoton area expires in 2004. If new contracts are entered into with unaffiliated third parties, the proceeds from sales under those new contracts will be included in gross proceeds from the underlying properties. If new contracts are entered into with the marketing subsidiary, it may charge Cross Timbers a fee that may not exceed 2% of the sales price of the oil and natural gas received from unaffiliated third parties. The sales price is net of any deductions for transportation from the wellhead to the unaffiliated third parties and any gravity or quality adjustments. Year 2000 "Year 2000," or the ability of computer systems to process dates with years beyond 1999, affects almost all companies and organizations. Computer systems that are not Year 2000 compliant by January 1, 2000 may cause material adverse effects to companies and organizations that rely upon those systems. The trust's timely receipt of royalty income and disbursement of distributable income to trust unitholders will largely depend upon performance of computer systems of Cross Timbers, the trust's transfer agent and other third parties. These third parties include oil and natural gas purchasers and significant service providers such as natural gas plant and gathering system operators. Because the trust will not use the trustee's computer systems to any significant degree, the trustee's Year 2000 compliance should not significantly affect the trust. Cross Timbers is in the process of reviewing its computer systems and computer-controlled field equipment and making the necessary modifications for Year 2000 compliance. Cross Timbers has completed most of the modifications of its primary accounting and land computer programs and is currently testing these modifications. Some of Cross Timbers' critical field equipment, such as natural gas compressors, are partially controlled or regulated by embedded computer chips. Cross Timbers is in the process of reviewing this equipment. Remediation and testing of all Cross Timbers' computer systems and equipment is expected to be completed by June 1999. Based on its review, remediation efforts and the results of testing to date, Cross Timbers does not believe that timely modification of its computer systems for Year 2000 compliance represents a material risk to the trust. Cross Timbers' costs related to Year 2000 compliance efforts to date have not been material, and it expects that future costs will not be material. The trust will not incur any of Cross Timbers' Year 2000 costs. Cross Timbers has identified significant third parties whose Year 2000 compliance could affect Cross Timbers, and is in the process of formally inquiring about their Year 2000 status. Despite its efforts to assure that such third parties are Year 2000 compliant, Cross Timbers cannot provide assurance that all significant third parties will achieve compliance in a timely manner. A third party's failure to achieve Year 2000 compliance could have a material adverse effect on Cross Timbers' operations and cash flow, and therefore have a material adverse impact on timely trust distributions to trust unitholders. For example a third party might fail to deliver revenue related to the trust's net profits interest to Cross Timbers, or Cross Timbers might fail to deliver the income of the net profits interest to the trust. In these situations, the trustee would be unable to make distributions of those amounts to trust unitholders on a timely basis.The potential effect of Year 2000 non-compliance by third parties is currently unknown. Cross Timbers is currently developing contingency plans in the event of potential problems resulting from failure of Cross Timbers' or significant third parties' computer systems on January 1, 32 2000. No contingency plans have been completed to date. Cross Timbers expects these contingency plans to be completed by September 1999. Litigation Cross Timbers is a defendant in two lawsuits that could, if adversely determined, decrease the net proceeds from certain of the underlying properties. A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 Cross Timbers has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling natural gas through affiliated companies at prices less favorable than those paid by third parties. Cross Timbers believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, the trust would bear its proportionate share of the increased royalties through reduced net proceeds. The amount of any reduction in net proceeds is not presently determinable, but is not expected to be material. A second lawsuit, 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 action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, Cross Timbers has mismeasured the volume of natural gas and wrongfully analyzed its heating content. 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 and an order for Cross Timbers to cease the allegedly improper measuring practices. This lawsuit is one of more than 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by Cross Timbers for production from underlying properties on federal and Native American lands during 1998 totalled approximately $2.8 million. Cross Timbers believes that the allegations of this lawsuit are without merit. 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 indeterminable amount. Damages relating to production prior to the formation of the trust will be borne by Cross Timbers. COMPUTATION OF NET PROCEEDS The provisions governing the computation of the net proceeds are detailed and extensive. The following description of the net profits interests and the computation of net proceeds is subject to and qualified by the more detailed provisions of the conveyances of the net profits interests that are filed as exhibits to the registration statement. See "Available Information." Net Profits Interests The net profits interests are defined net profits interests carved from the underlying properties. Each net profits interest entitles the trust to receive 80% of the net proceeds from the sale of oil and natural gas produced from the underlying properties. The amounts paid to the trust for the net profits interests are based on the definitions of "gross proceeds" and "net proceeds" set forth in the conveyances and described below. Under the conveyances, net proceeds are computed monthly (a "Computation Period"). Cross Timbers pays 80% of the aggregate net proceeds attributable to a Computation Period to the trust on or before the 33 last business day of the month following the Computation Period. Cross Timbers will not pay to the trust interest on the net proceeds held by Cross Timbers prior to payment to the trust. The trustee makes distributions to trust unitholders monthly. See "Description of the Trust Units--Distributions and Income Computations." Net proceeds equal the excess of gross proceeds over production costs and excess production costs attributable to a prior Computation Period. For royalty and overriding royalty interests, production costs are zero. Gross proceeds means the amounts received by Cross Timbers from sales of oil and natural gas produced from the underlying properties, after deducting: . all general property (ad valorem), production, severance, sales, gathering, excise and other taxes and gathering costs if they are deducted or excluded from the proceeds of sales; and . any payment made to the owner of an underlying property for -- natural gas not taken, but to the extent payments are allocated to natural gas taken in the future, payments are included, without interest, in gross proceeds when such natural gas is taken; -- damages, other than drainage or reservoir injury; -- rental for reservoir use; and -- payments in connection with the drilling of any well. Gross proceeds does not include (1) consideration for the transfer or sale of any underlying property by Cross Timbers or any subsequent owner to any new owner or (2) any amount for oil and natural gas lost in production or marketing or used by the owner of the underlying properties in drilling, production and plant operations. Gross proceeds includes payments for future production if they are not subject to repayment in the event of insufficient subsequent production. Production costs means, on a cash basis, generally the sum of: . all payments to mineral or landowners, such as royalties or other burdens against production, delay rentals, shut-in natural gas payments, minimum royalty or other payments for drilling or deferring drilling; . any taxes paid by the owner of an underlying property to the extent not deducted in calculating gross proceeds, including estimated and accrued ad valorem and other property taxes; . costs paid by the owner of an underlying property under any joint operating agreement; . all other costs, expenses and liabilities of exploring for, drilling, operating and producing oil and natural gas, including allocated expenses such as labor, vehicle and travel costs and materials; . costs or charges associated with gathering, treating and processing natural gas; . certain interest costs; . any overhead charge; . amounts previously included in gross proceeds but subsequently paid as a refund, interest or penalty; . costs and expenses for renewals or extensions of leases; and . at the option of the owner of an underlying property, accruals for costs approved under authorizations for expenditure. 34 As is customary in the oil and natural gas industry, Cross Timbers charges an overhead fee to operate the underlying properties. The operating activities include various engineering, accounting and administrative functions. The fee is based on a monthly charge per active operated well, and it totalled $6.2 million in 1998 for all underlying properties operated by Cross Timbers. The fee is adjusted annually and will increase or decrease each year based on changes in the year-end index of average weekly earnings of crude petroleum and natural gas workers. Excess production costs are the excess of production costs over gross proceeds, plus interest accrued at the prime rate. Therefore, if production costs exceed gross proceeds for a Computation Period, the trust will receive no payment for that period, and excess production costs will be carried over to the following month as a production cost in determining the excess of gross proceeds over production costs for that following month. Gross proceeds and production costs are calculated on a cash basis, except that certain costs, primarily ad valorem taxes and expenditures of a material amount, may be determined on an accrual basis. For convenience in complying with state tax laws, the net profits interests were created by three separate conveyances, one for each of Kansas, Oklahoma and Wyoming, the three states in which the underlying properties are located. Net proceeds are calculated separately for the underlying properties covered by each conveyance, so excess production costs in one state do not reduce net proceeds from the others. Cash distributions generally will include one month's net proceeds less related trustee expenses and administrative charges. However, the first distribution, which will be made in April 1999 to record holders as of March 31, 1999, will include net proceeds received, less trustee's expenses, during the period December 1, 1998 through February 28, 1999. This initial distribution will also be adjusted to exclude any development charges on the underlying properties incurred through December 31, 1998, which Cross Timbers will bear. Additional Provisions If a controversy arises as to the sales price of any oil or natural gas, then for purposes of determining gross proceeds: . amounts withheld or placed in escrow by a purchaser are not considered to be received by the owner of the underlying property until actually collected; . amounts received by the owner of the underlying property and promptly deposited with a nonaffiliated escrow agent will not be considered to have been received until disbursed to it by the escrow agent; and . amounts received by the owner of the underlying property and not deposited with an escrow agent will be considered to have been received. The trust is not liable to the owner of the underlying properties or the operators for any operating, capital or other costs or liabilities attributable to the underlying properties. The trustee is not obligated to return any income received from the net profits interests. Any overpayments made to the trust due to adjustments to prior calculations of net proceeds or otherwise will reduce future amounts payable to the trust until Cross Timbers recovers the overpayments plus interest at the prime rate. The conveyances permit Cross Timbers to assign without the consent or approval of the trust unitholders all or any part of the underlying properties, subject to the net profits interests. The trust unitholders are not entitled to any proceeds of a transfer. Following a transfer, the underlying properties will continue to be subject to the net profits interests, and the net proceeds attributable to the transferred property will be calculated separately and paid by the transferee. The conveyances 35 have been recorded in the appropriate real property records to give notice of the net profits interests to Cross Timbers' creditors and transferees. Upon notice from Cross Timbers, the trust is required to sell for cash net profits interests that relate to underlying properties which Cross Timbers is selling to an unaffiliated party. These types of sales may not exceed in any calendar year 1% of the discounted present value of estimated future net revenues for the proved reserves of the underlying properties allocated to the trust's net profits interests, as set forth in the most recent reserve report. The trust will receive 80% of the net proceeds from a sale. As an operator of an underlying property, Cross Timbers may enter into farmout, operating, participation, joint venture and other similar agreements covering the property if Cross Timbers believes it to be advantageous to the working interests owners of the property. The net profits interest held by the trust would then be calculated on the interest retained by Cross Timbers under the agreement and not on Cross Timbers' original interest before modification by the agreement. Cross Timbers may enter into any of these agreements without the consent or approval of the trustee or any trust unitholder. However, Cross Timbers' interest in entering into any of these types of agreements should be parallel with that of trust unitholders because of Cross Timbers' retained 20% net profits interest in the underlying properties. Cross Timbers and any transferee will have the right to abandon any well or property if it believes the well or property ceases to produce or is not capable of producing in commercially paying quantities. Upon termination of the lease, that portion of the net profits interests relating to the abandoned property will be extinguished. Cross Timbers must maintain books and records sufficient to determine the amounts payable for the net profits interests. Quarterly and annually, Cross Timbers must deliver to the trustee a statement of the computation of the net proceeds for each Computation Period. Cross Timbers will cause the annual computation of net proceeds to be audited. The audit cost will be borne by the trust. FEDERAL INCOME TAX CONSEQUENCES This section summarizes the material federal income tax consequences of the ownership and sale of trust units. Many aspects of federal income taxation that may be relevant to a particular taxpayer or to certain types of taxpayers subject to specific tax treatment are not addressed. In addition, the tax laws can and do change regularly and any future changes could have an adverse effect on the ownership or sale of trust units. The trust will not request advance rulings from the IRS dealing with the tax consequences of ownership of trust units but will rely on the opinion of Butler & Binion, L.L.P. ("Tax Counsel") regarding the classification of the trust and certain federal income tax consequences described below, which will be confirmed at the time of the closing. Tax Counsel believes that its opinion is in accordance with the present position of the IRS regarding grantor trusts. The tax opinion is not binding on the IRS or the courts, however, and no assurance can be given that the IRS or the courts will agree with the opinion. Summary of Legal Opinions Tax Counsel is of the opinion that, for federal income tax purposes, . the trust will be treated as a grantor trust and not a business entity taxable as a partnership or a corporation, 36 . the income from the net profits interests will be royalty income subject to an allowance for depletion, and . subject to the limitations described below, a trust unitholder will be allowed a Section 29 tax credit with respect to his share of qualifying natural gas production from tight sands attributable to the net profits interests. Tax Counsel advises that, unless noted otherwise, legal conclusions stated in this section constitute the opinion of Tax Counsel. No ruling is being requested from the IRS with respect to the trust or trust unitholders. Therefore, the IRS could challenge the opinions and statements set forth herein (which do not bind the IRS or the courts), and the IRS could win in court if it did challenge these matters. Classification and Taxation of the Trust In the opinion of Tax Counsel, under current law, the trust will be taxable as a grantor trust and not as a business entity. As a grantor trust, the trust will not be subject to tax at the trust level. For tax purposes, the grantors, who in this case are the trust unitholders, will be considered to own the trust's income and principal as though no trust were in existence. A grantor trust simply files an information return, reporting all items of income, credit or deductions which must be included in the tax returns of the trust unitholders based on their respective accounting methods and taxable years without regard to the accounting method and tax year of the trust. If, contrary to the opinion of Tax Counsel, the trust was determined to be an unincorporated business entity, it would be taxable as a partnership unless it elected to be taxed as a corporation. The principal tax consequence of the trust's being treated as a partnership for tax purposes would be that all trust unitholders would report their share of income from the trust on the accrual method of accounting regardless of their own method of accounting. Direct Taxation of Trust Unitholders Since the trust will be treated as a grantor trust for federal income tax purposes, each trust unitholder will be taxed directly on his share of trust income and will be entitled to claim his share of trust deductions. Each trust unitholder will recognize taxable income when the trust receives or accrues it, even if it is not distributed until later. Trust unitholders will report their trust income and expenses consistent with their method of accounting and their tax year. Reporting of Trust Income and Expenses The trustee intends to treat each royalty payment it receives as the taxable income of the trust unitholders who own trust units on the day of receipt (i.e., the last business day of each calendar month). Similarly, the trustee intends to pay expenses only on the day it receives a royalty payment and to treat all expenses paid on a royalty receipt day as the expenses of the trust unitholder to whom the royalty income received on that date is distributed. In most cases, therefore, the income and expenses of the trust for a period will be reported as belonging to the trust unitholder to whom the distribution for that period is made and the amount of the distribution for a trust unit will generally equal the net income allocated to that trust unit, determined without regard to depletion. This correlation may not exist if, for example, the trustee were to establish a cash reserve to pay estimated future expenses or pay an expense with borrowed funds. Moreover, it is possible that the IRS would attempt to impute income to persons who are trust unitholders when a royalty payment on the net profits interests accrued, to disallow the deduction of administrative expenses to persons who were not trust unitholders when the expenses were incurred, or both. If the IRS were successful, trust income might be taxed to trust unitholders other than those who received the distribution relating to that income. Also, an accrual basis trust unitholder might realize royalty income in a tax year earlier than that reported by the trustee. 37 Royalty Income and Depletion In the opinion of Tax Counsel, the income from the net profits interests will be royalty income qualifying for an allowance for depletion. The depletion allowance must be computed separately by each trust unitholder for each oil or gas property (within the meaning of Section 614 of the Internal Revenue Code of 1986, as amended (the "Code")). Tax Counsel understands that the IRS is presently taking the position that a net profits interest carved from multiple properties is a single property for depletion purposes. Accordingly, the trust intends to take the position that each net profits interest transferred to the trust by a conveyance is a single property for depletion purposes. It would change this position if a different method were established by the IRS or the courts. The deduction for depletion is determined annually and is the greater of cost depletion or, if allowable, percentage depletion. Royalty income from production attributable to trust units owned by "independent producers" will qualify for percentage depletion. An individual or entity with production of the equivalent of 1,000 barrels of oil per day or less is an "independent producer." Percentage depletion is a statutory allowance equal to 15% of the gross income from production from a property, subject to a net income limitation of 100% of the taxable income from the property, computed without regard to depletion deductions and certain loss carrybacks. The depletion deduction attributable to percentage depletion for a taxable year is limited to 65% of the taxpayer's taxable income for the year before allowance of "independent producers" percentage depletion. Unlike cost depletion, percentage depletion is not limited to the adjusted tax basis of the property, although it reduces the adjusted tax basis (but not below zero). Cross Timbers believes that trust unitholders who purchase trust units in this offering will derive a substantially greater benefit from cost depletion than from percentage depletion. In computing cost depletion for each property for any year, the adjusted tax basis of the property at the beginning of the year is divided by the estimated total units (e.g., Bbls of oil or Mcf of gas) recoverable from the property to determine the per-unit allowance for the property. The per-unit allowance is then multiplied by the number of units produced and sold from the property during the year. Cost depletion for a property cannot exceed the adjusted tax basis of the property. Since the trust will be taxed as a grantor trust, each trust unitholder will be deemed to own an undivided interest in the net profits interests and other assets, if any, of the trust and will compute cost depletion using his basis in his trust units. Information will be provided to each trust unitholder reflecting how his basis should be allocated among each property represented by his trust units. To the extent the depletion tax deduction exceeds cash distributions per trust unit, that excess can be deducted from the taxpayer's other sources of taxable income. Other Income and Expenses It is anticipated that the only other income of the trust will be interest income earned on funds held as a reserve. Other expenses of the trust will include any state and local taxes imposed on the trust and administrative expenses of the trustee. Although the issue has not been finally resolved, Tax Counsel believes that all or substantially all of those expenses are deductible in computing adjusted gross income and, therefore, are not the type of miscellaneous itemized deductions that are allowable only to the extent that they aggregate more than 2% of adjusted gross income. Alternative Minimum Tax All taxpayers are subject to an alternative minimum tax. Alternative minimum taxable income ("AMTI") is the taxpayer's taxable income recomputed with various "adjustments" plus "items of tax preference." In the case of persons other than "independent producers," tax preferences include the excess of the aggregate percentage depletion deductions for an oil or gas property over the adjusted 38 tax basis of the property. The alternative minimum tax rate for noncorporate taxpayers (other than married persons filing separately) is 26% up to $175,000 and 28% over $175,000 of AMTI exceeding an exemption amount, which varies between $45,000 and zero. Alternative minimum tax ("AMT") is the excess of a taxpayer's "tentative minimum tax" for a tax year over his "regular" tax for that year. The tentative minimum tax is determined by multiplying the excess of AMTI over the applicable exemption amount by 26% up to $175,000 and 28% over $175,000 and subtracting the AMT foreign tax credit. Reduced maximum AMT tax rates apply to net capital gains and certain other gains. Since the effect of the AMT varies depending upon each trust unitholder's personal tax and financial position, each prospective investor is advised to consult with his own tax advisor concerning the effect of the AMT on him. Section 29 Tight Sands Natural Gas Tax Credit Some of the natural gas production attributable to the net profits interests is produced from tight sands formations. Subject to certain statutory requirements, taxpayers are entitled to the Section 29 tax credit for production and sale of certain natural gas produced from tight formations ("tight sands"). The Section 29 tax credit applies to tight sands natural gas produced and sold to an unrelated party prior to January 1, 2003 from wells drilled prior to January 1, 1993 and after November 5, 1990 or after December 31, 1979 if the formation was dedicated to interstate commerce, within the meaning of the Natural Gas Policy Act of 1978, prior to April 20, 1977. The Section 29 tax credit for qualifying tight sands natural gas is equal to $3.00 per barrel of oil equivalent (i.e., 5.8 MMBtu), or approximately $.52 per MMBtu. The credit is reduced by a formula computation as the price of oil ("reference price") rises above an inflation adjusted amount. Because the calendar year 1998 reference price did not exceed the inflation adjusted amount, the credit was not reduced in 1998 and is not expected to be reduced in 1999. In the opinion of Tax Counsel, if the requisite statutory requirements are met, the trust unitholders will be eligible to claim the Section 29 tax credit for sales of qualified tight sands natural gas production included in the calculation of the net profits interests. Cross Timbers believes that all of the statutory requirements have been or will be met on substantially all of the tight sands wells. The Section 29 tax credit allowable for any taxable year cannot exceed the excess, if any, of the taxpayer's regular tax liability for that taxable year, as reduced by the taxpayer's foreign tax credits and certain nonrefundable credits, over the taxpayer's tentative minimum tax liability for that year. Any amount of Section 29 tax credit disallowed for the tax year solely because of this limitation will increase the taxpayer's credit for prior year minimum tax liability. This credit may be carried forward indefinitely as a credit against the taxpayer's regular tax liability, subject, however, to the limitation described in the preceding sentence. There is no provision for the carryback or carryforward of the Section 29 tax credit in any other circumstances. Hence, a trust unitholder may not receive the full benefit of the tax credit depending on his particular circumstances. Non-Passive Activity Income and Loss The income and expenses of the trust and the Section 29 tax credit will not be taken into account in computing the passive activity losses and income under Code Section 469 for a trust unitholder who acquires and holds trust units as an investment. Section 29 tax credits generated by an investment in the trust units, therefore, can be utilized to offset regular tax liability on income from any source, subject to the limitations discussed in "Section 29 Tight Sands Natural Gas Tax Credit" above. 39 Unrelated Business Taxable Income Certain organizations that are generally exempt from tax under Code Section 501 are subject to tax on certain types of business income defined in Code Section 512 as unrelated business income. In the opinion of Tax Counsel, the income of the trust will not be unrelated business taxable income so long as the trust units are not "debt-financed property" within the meaning of Code Section 514(b). In general, a trust unit would be debt-financed if the trust unitholder incurs debt to acquire a trust unit or otherwise incurs or maintains a debt that would not have been incurred or maintained if the trust unit had not been acquired. Sale of Trust Units; Depletable Basis Generally, a trust unitholder will realize gain or loss on the sale or exchange of his trust units measured by the difference between the amount realized on the sale or exchange and his adjusted basis for such trust units. Gain or loss on the sale of trust units by a trust unitholder who is not a dealer of the trust units will be a long-term capital gain, taxable at a maximum rate of 20%, if the trust units have been held for more than 12 months. A portion of the long-term gain will be treated as ordinary income to the extent of the depletion recapture amount explained below. A trust unitholder's basis in his trust units will be equal to the amount he paid for the trust units, reduced by deductions for depletion claimed by the trust unitholder, but not below zero. Upon the sale of the trust units, a trust unitholder must treat as ordinary income his depletion recapture amount, which is an amount equal to the lesser of (1) the gain on such sale or (2) the sum of the prior depletion deductions taken on the trust units, but not in excess of the initial basis of the trust units. It is possible that the IRS would take the position that a portion of the sales proceeds is ordinary income to the extent of any accrued income at the time of sale allocable to the trust units sold, but which has not been distributed to the selling trust unitholder. Taxation of Foreign Holders Unless the election described below is made, a nonresident alien individual, foreign corporation, or foreign estate or trust (a "Foreign holder") will be subject to federal income withholding tax on his share of gross royalty income from the net profits interests at a 30% rate, or lower treaty rate if applicable and proper evidence is supplied to the withholding agent, without any deductions. Gain realized on a sale of a trust unit by a Foreign holder will be subject to federal income tax only if: . the gain is otherwise effectively connected with business conducted by the Foreign holder in the United States; . the Foreign holder is an individual who is present in the United States for at least 183 days in the year of the sale; . the Foreign holder owns more than a 5% interest in the trust; or . the trust units cease to be regularly traded on an established securities exchange. Gain realized by a Foreign holder upon the sale by the trust of all or any part of the net profits interests would be subject to federal income tax. The trust unitholders who are Foreign holders may elect under Code Section 871 or Section 882 or similar provisions of applicable treaties to treat income attributable to the net profits interests as effectively connected with the conduct of a trade or business in the United States. The Foreign holder will then be taxed at regular federal income tax rates on the net income attributable to the net profits interests, including gain recognized on the disposition of trust units. Absent a treaty exception, the net income of a corporate Foreign holder which has made such an election will also be subject to the "branch profits tax" imposed under Code Section 884. To claim the deductions allowable in computing net income, including cost depletion, an electing Foreign holder will have to file a United 40 States income tax return. To avoid withholding, an electing Foreign holder will have to provide proper certificates or other evidence to the withholding agent. Once made, the election is irrevocable unless an applicable treaty allows the election to be made annually. The election is applicable to all income and gain realized by the Foreign holder on any real property interests located in the United States, including those interests held through partnerships, fixed investment trusts, and other pass-through entities. Backup Withholding In general, distributions of trust income will not be subject to "backup withholding" unless: (1) the trust unitholder is an individual or other noncorporate taxpayer and (2) the trust unitholder fails to comply with certain reporting procedures. Tax Shelter Registration The Company does not believe that the trust will meet the requirements to register as a "tax shelter" under Code Section 6111. However, it is possible that those requirements may be met for any trust unitholders whose investment base is reduced by borrowing. To avoid any potential difficulty, the trust will be registered as a tax shelter with the IRS. The trustee will furnish the tax shelter registration number to each transferee of trust units and to each trust unitholder. Each trust unitholder must disclose this number by attaching Form 8271 to his tax return. Issuance of a tax shelter registration number does not indicate this investment or the claimed tax benefits have been reviewed, examined or approved by the IRS. Reports The trustee will furnish to trust unitholders of record quarterly and annual reports in order to permit computation of their tax liability. See "Description of the Trust Units--Periodic Reports." STATE TAX CONSIDERATIONS The following is a brief summary of information regarding state income taxes and other state tax matters affecting the trust and the trust unitholders. Trust unitholders are urged to consult their own legal and tax advisors on these matters. Income Tax Considerations Wyoming presently does not have a state income tax on resident or nonresident individuals. Kansas and Oklahoma impose income taxes on residents and, for certain types of income, nonresidents. Trust unitholders may also be subject to taxation by their state of residence on income derived from the trust. Kansas tax counsel, Morris, Laing, Evans, Brock & Kennedy, Chartered, is of the opinion that, although there is no determinative precedent and Kansas taxing authorities may adopt a different view: . the activities of the trust and the trustee, as permitted under the Indenture and the conveyance, will not subject either the trust or the trustee to income taxation by the State of Kansas; and . a trust unitholder who is not a Kansas resident will not be subject to Kansas income tax and will not be required to file a Kansas income tax return, if 41 -- the trust unitholder does not use his trust units or his indirect interest in the net profits interest in conducting a trade, business, profession or occupation in Kansas, and -- the trust unitholder is not subject to Kansas income tax for some other reason. In providing this opinion, Kansas tax counsel has assumed, among other things, that the trust: . will not own any property in Kansas other than the net profits interests; . will not conduct any activities in Kansas other than ownership of the net profits interests for the benefit of trust unitholders; and . is a grantor trust for federal income tax purposes. The income tax law of Oklahoma is based on federal income tax laws. Assuming the trust is taxed as a grantor trust for federal income tax purposes, the trust unitholders will be subject to Oklahoma income tax on their share of income from the Oklahoma net profits interests. It is uncertain whether trust unitholders who are nonresidents of Oklahoma will be taxed in that state on gains from sales of trust units. The trustee will provide information concerning the trust sufficient to identify the income of the trust allocable to each state. Trust unitholders should consult their own tax advisors to determine their income tax filing requirements for their share of income of the trust allocable to states imposing an income tax on that income. Probate and Property Considerations Kansas tax counsel is also of the opinion that under Kansas law, except as noted below, the trust units will be treated the same as other securities. They will be treated as interests in intangible personal property located where the trust unitholder resides rather than as interests in tangible property in Kansas. However, if the certificate representing a trust unit is physically located in Kansas at the time of the death of the owner who is not a Kansas resident, the Kansas courts by statute have jurisdiction to probate and administer the trust unit. In that event, unless Kansas courts determine otherwise, the estate tax and devolution of title laws of Kansas would apply to the trust unit. This could make inheritance and related matters pertaining to trust units held by Kansas non-residents more onerous than if the trust units were treated as interests in intangible personal property located in the state of the owner's residence. The trust units may constitute real property or an interest in real property under the inheritance, estate and probate laws of Oklahoma and Wyoming. If the trust units are held to be real property or an interest in real property under the laws of those states, the trust units may be subject to devolution, probate and administration and estate taxes under the laws of those states. ERISA CONSIDERATIONS The Employee Retirement Income Security Act of 1974, as amended ("ERISA"), regulates pension, profit-sharing and other employee benefit plans to which it applies. ERISA also contains standards for persons who are fiduciaries of those plans. In addition, the Code provides similar requirements and standards which are applicable to these types of plans and to individual retirement accounts, whether or not subject to ERISA (collectively, "Qualified Plans"). A fiduciary of a Qualified Plan should carefully consider fiduciary standards under ERISA regarding the Qualified Plan's particular circumstances before authorizing an investment in trust units. A fiduciary should consider 42 .whether the investment satisfies the prudence requirements of Section 404(a)(1)(B) of ERISA, . whether the investment satisfies the diversification requirements of Section 404(a)(1)(C) of ERISA, and . whether the investment is in accordance with the documents and instruments governing the Qualified Plan as required by Section 404(a)(1)(D) of ERISA. A fiduciary should also consider whether an investment in trust units might result in direct or indirect nonexempt prohibited transactions under Section 406 of ERISA and Code Section 4975. In deciding whether an investment involves a prohibited transaction, a fiduciary must determine whether there are "plan assets" in the transaction. On November 13, 1986, the Department of Labor published final regulations concerning whether or not a Qualified Plan's assets would be deemed to include an interest in the underlying assets of an entity for purposes of the reporting, disclosure and fiduciary responsibility provisions of ERISA and analogous provisions of the Code. These regulations provide that the underlying assets of an entity will not be considered "plan assets" if the equity interests in the entity are a publicly offered security. Cross Timbers expects that at the time of the sale of the trust units in this offering, they will be publicly offered securities. Fiduciaries, however, will need to determine whether the acquisition of trust units is a nonexempt prohibited transaction under the general requirements of ERISA Section 406 and Code Section 4975. The prohibited transaction rules are complex, and persons involved in prohibited transactions are subject to penalties. For that reason, potential Qualified Plan investors should consult with their counsel to determine the consequences under ERISA and the Code of their acquisition and ownership of trust units. DESCRIPTION OF THE TRUST INDENTURE The following information and the information included under "Description of the Trust Units" summarize information contained in the trust indenture. This summary may not contain all the information that is important to you. For more detailed provisions concerning the Trust, you should read the trust indenture. A copy of the trust indenture was filed as an exhibit to the Registration Statement. See "Available Information." Creation and Organization of the Trust; Amendments Cross Timbers created the net profits interests and conveyed them to the trust in exchange for 40,000,000 trust units. Cross Timbers organized the trust under Texas law to acquire and hold the net profits interests for the benefit of the trust unitholders. Neither the trust nor the trustee has any control over or responsibility for costs relating to the operation of the underlying properties. Neither Cross Timbers nor other operators of the underlying properties have any contractual commitments to the trust to conduct further drilling on or to maintain their ownership interest in any of these properties. For a description of the underlying properties and other information relating to them, see "The Net Profits Interests and the Underlying Properties." The beneficial interest in the trust is divided into 40,000,000 trust units. Each of the trust units represents an equal undivided portion of the trust. You will find additional information concerning the trust units in "Description of the Trust Units." Amendment of the trust indenture requires a vote of holders of 80% or more of the outstanding trust units. However, no amendment may-- 43 . increase the power of the trustee to engage in business or investment activities; . alter the rights of the trust unitholders as among themselves; and . permit the trustee to distribute the net profits interests in kind. Assets of the Trust The assets of the trust consist of net profits interests and cash and temporary investments being held for the payment of expenses and liabilities and for distribution to the trust unitholders. You will find information relating to the assets of the trust in "The Net Profits Interests and the Underlying Properties." Duties and Limited Powers of the Trustee The duties of the trustee are specified in the trust indenture and by the laws of the State of Texas. The trustee's principal duties consist of: . collecting income attributable to the net profits interests; . paying expenses, charges and obligations of the trust from the trust's income and assets; . distributing distributable income to the trust unitholders; and . taking any action it deems necessary and advisable to best achieve the purposes of the trust. If a trust liability is contingent or uncertain in amount or not yet currently due and payable, the trustee may create a cash reserve to pay for the liability. If the trustee determines that the cash on hand and the cash to be received is insufficient to cover the trust's liability, the trustee may borrow funds required to pay the liabilities. The trustee may borrow the funds from any person, including itself. The trustee may also mortgage the assets of the trust to secure payment of the indebtedness. If the trustee borrows funds, the trust unitholders will not receive distributions until the borrowed funds are repaid. Each month, the trustee will pay trust obligations and expenses and distribute to the trust unitholders the remaining proceeds received from the net profits interests. The cash held by the trustee as a reserve against future liabilities or for distribution at the next distribution date must be invested in: . interest bearing obligations of the United States government; . repurchase agreements secured by interest-bearing obligations of the United States government; or . bank certificates of deposit. The trust may not acquire any asset except the net profits interests and cash, and it may not engage in any investment activity except investing cash on hand. At the request of Cross Timbers, the trustee must sell net profits interests relating to the underlying properties sold by Cross Timbers to an unaffiliated third party if in any calendar year the net profits interests sold do not exceed 1% of the discounted present value of estimated future net revenues for the proved reserves of the trust's net profits interests, as set forth in the most recent reserve report. The trustee may sell the net profits interests in any of the following circumstances: . the sale does not involve a material part of the trust's assets and is in the best interests of the trust unitholders. A majority of the trust units represented at a meeting of the trust unitholders where a quorum is present must approve the sale; or 44 . the sale is in the best interests of the trust unitholders, constitutes a material part of the trust's assets and holders representing 80% of the outstanding trust units approve the sale; Upon termination of the trust the trustee must sell the net profits interests. No trust unitholder approval is required. The trustee will distribute the net proceeds from any sale of the net profits interests to the trust unitholders. The trustee may require any trust unitholder to dispose of his trust units if an administrative or judicial proceeding seeks to cancel or forfeit any of the property in which the trust holds an interest because of the nationality or any other status of that trust unitholder. If a trust unitholder fails to dispose of his trust units, the trustee has the right to purchase them and to borrow funds to make that purchase. The trustee may agree to modifications of the terms of the Conveyances or to settle disputes involving the Conveyances. The trustee may not agree to modifications or settle disputes involving the royalty part of the conveyances if these actions would change the character of the net profits interests in such a way that (1) the net profits interests become working interests, or (2) the trust becomes an operating business. Liabilities of the Trust Because the trust does not conduct an active business and the trustee has little power to incur obligations, Cross Timbers expects that the trust will only incur liabilities for routine administrative expenses. These might include the trustee's fees and accounting, engineering, legal and other professional fees. Fiduciary Responsibility and Liability of the Trustee The trustee is a fiduciary for the trust unitholders and is required to act in the best interests of the trust unitholders at all times. The trustee must exercise the same judgment and care in supervising and managing the trust's assets as persons of ordinary prudence, discretion and intelligence would exercise. Under Texas law, the trustee's duties to the trust unitholders are similar to the duty of care owed by a corporate director to the corporation and its shareholders. The primary difference between the trustee's duties and a corporate director's duties is the absence of the legal presumption protecting the trustee's decisions from challenge. The trustee will not make business decisions affecting the assets of the trust. Therefore, substantially all of the trustee's functions under the trust indenture are expected to be ministerial in nature. See "--Duties and Limited Powers of the Trustee," above. Under Texas law, the trustee may not profit from any transaction with the trust. The trust indenture, however, provides that the trustee may: . charge for its services as trustee; . retain funds to pay for future expenses and deposit them in its own account; . lend funds at commercial rates to the trust to pay the trust's expenses; and . seek reimbursement from the trust for its out-of-pocket expenses. In discharging its fiduciary duty to trust unitholders, the trustee may act in its discretion and will be liable to the trust unitholders only for fraud, gross negligence or acts or omissions constituting bad faith. The trustee will not be liable for any act or omission of its agents or employees unless the trustee acted in bad faith or with gross negligence in their selection and retention. The trustee will be 45 indemnified for any liability or cost that it incurs in the administration of the trust, except in cases of fraud, gross negligence or bad faith. The trustee will have a lien on the assets of the trust as security for this indemnification and its compensation earned as trustee. The trustee is entitled to indemnification from trust assets or, to the extent that trust assets are insufficient, from Cross Timbers. Trust unitholders will not be liable to the trustee for any indemnification. See "Description of the Trust Units--Liability of Trust Unitholders." The trustee must ensure that all contractual liabilities of the trust are limited to the assets of the trust and will be liable for its failure to do so. Under Texas law, if the trustee acts in bad faith or with gross negligence, the trustee will be liable to the trust unitholders for damages. Texas law also permits the trust unitholders to file actions seeking other remedies, including: . removal of the trustee; . specific performance; . appointment of a receiver; . an accounting by the trustee to trust unitholders; and . punitive damages. Duration of the Trust; Sale of Net Profits Interests The trust will terminate if: . the trust sells all of the net profits interests; . annual gross proceeds attributable to the underlying properties are less than $1 million for each of two consecutive years after 1999; . the holders of 80% or more of the outstanding trust units vote in favor of termination; or . the trust violates the "rule against perpetuities." The trustee would then sell all of the trust's assets, either by private sale or public auction, and distribute the net proceeds of the sale to the trust unitholders. Dispute Resolution Any dispute, controversy or claim that may arise between Cross Timbers and the trustee relating to the trust will be submitted to binding arbitration before a tribunal of three arbitrators. Compensation of the Trustee The trustee's compensation will be paid out of the trust's assets. See "The Trust." Miscellaneous The trustee may consult with counsel, accountants, geologists and engineers and other parties the trustee believes to be qualified as experts on the matters for which advice is sought. The trustee will be protected for any action it takes in good faith reliance upon the opinion of the expert. DESCRIPTION OF THE TRUST UNITS Each trust unit is an undivided share of the beneficial interest in the trust. Each trust unitholder has the same rights with respect to each of his trust units as every other trust unitholder has with respect to his units. The trust has 40,000,000 trust units outstanding. 46 Distributions and Income Computations Each month, the trustee will determine the amount of funds available for distribution to the trust unitholders. Available funds are the excess cash received by the trust from the net profits interests and other sources that month, over the trust's liabilities for that month. Available funds will be reduced by any cash the trustee decides to hold as a reserve against future liabilities. Trust unitholders that own their trust units at the end of the last business day of the month (the "monthly record date") will receive a pro- rata distribution no later than 10 business days after the monthly record date. The first distribution will be made around April 10, 1999 to trust unitholders owning trust units on March 31, 1999. Unless otherwise advised by counsel or the IRS, the trustee will treat the income and expenses of the trust for each month as belonging to the trust unitholders of record on the monthly record date. Trust unitholders will recognize income and expenses for tax purposes in the month the trust receives or pays those amounts, rather than in the month the trust distributes them. Minor variances may occur. For example, the trustee could establish a reserve in one month that would not result in a tax deduction until a later month. The trustee could also make a payment in one month that would be amortized for tax purposes over several months. See "Federal Income Tax Consequences." Transfer of Trust Units Trust unitholders may transfer their trust units by sending their trust unit certificate to the trustee along with a transfer form that is properly completed. The trustee will not require either the transferor or transferee to pay a service charge for any transfer of a trust unit. The trustee may require payment of any tax or other governmental charge imposed for a transfer. The trustee may treat the owner of any trust unit as shown by its records as the owner of the trust unit. The trustee will not be considered to know about any claim or demand on a trust unit by any party except the record owner. A person who acquires a trust unit after any monthly record date will not be entitled to the distribution relating to that monthly record date. Texas law will govern all matters affecting the title, ownership, warranty or transfer of trust units. Periodic Reports The trustee will mail to trust unitholders quarterly reports showing the assets, liabilities, receipts and disbursements of the trust for each quarter except the fourth quarter. No later than 120 days following the end of each year, the trustee will mail to the trust unitholders an annual report containing audited financial statements of the trust. The trustee will file all required trust federal and state income tax and information returns. The trustee will prepare and mail to trust unitholders quarterly and annually reports that trust unitholders need to correctly report their share of the income and deductions of the trust. Each trust unitholder and his representatives may examine, for any proper purpose, during reasonable business hours the records of the trust and the trustee. Liability of Trust Unitholders The trustee must ensure that all contractual liabilities of the trust are limited to the assets of the trust. The trustee will be liable for its failure to do so. Texas law is unclear whether a trust unitholder would be responsible for a liability that exceeds the net assets of the trust and the trustee. Because of the value and passive nature of the trust assets and the restrictions in the Indenture on the power of the trustee to incur liabilities, Cross Timbers believes it is unlikely that a trust unitholder would incur any liability from the trust based on its ownership of trust units. 47 Voting Rights of Trust Unitholders Trust unitholders have more limited voting rights than those of stockholders of most public corporations. For example, there is no requirement for annual meetings of trust unitholders or for annual or other periodic re-election of the trustee. The trustee or trust unitholders owning at least 15% of the outstanding trust units may call meetings of trust unitholders. Meetings must be held in Fort Worth, Texas. The trustee must send written notice of the time and place of the meeting and the matters to be acted upon to all of the trust unitholders at least 20 days and not more than 60 days before the meeting. Trust unitholders representing a majority of trust units outstanding must be present or represented to have a quorum. Each trust unitholder is entitled to one vote for each trust unit owned. Unless otherwise required by the Trust Indenture, when a majority of the trust units held by the trust unitholders at a meeting where there is a quorum approve a matter, it is approved. This is true, even if a majority of the total trust units did not approve it. The affirmative vote of the holders of 80% of the outstanding trust units is required to . terminate the trust, . amend the Trust Indenture, or . approve the sale of all or any material part of the assets of the trust. The trustee must consent before all or any part of the trust assets can be sold except in connection with the termination of the trust or limited sales directed by Cross Timbers in conjunction with its sale of underlying properties. The trustee may be removed, with or without cause, by the vote of the holders of a majority of the outstanding trust units. Comparison of Trust Units and Common Stock You should be aware of the following ways in which an investment in trust units is different from an investment in common stock of a corporation. Trust Units Common Stock Voting Limited voting rights. Corporate statutes provide specific voting rights to stockholders on electing directors and major corporate transactions. Income Tax The trust is not subject to Corporations are taxed on income tax; trust unitholders their income, and their are directly subject to stockholders are taxed on income tax on their dividends. proportionate shares of trust net income, adjusted for tax deductions and credits. Distributions Substantially all trust Stockholders receive income is distributed to dividends at the discretion trust unitholders. of the board of directors. Business Interest is limited to A corporation conducts an and Assets specific assets with a finite active business for an economic life. unlimited term and can reinvest its earnings and raise additional capital to expand. Limited Texas law and the laws of Corporate laws provide that a Liability other states do not stockholder is not liable for specifically provide for the obligations and limited liability of trust liabilities of the unitholders. However, due to corporation, subject to the size and nature of the limited exceptions. trust assets, liability in excess of the trust unitholders' investment is extremely unlikely. 48 SELLING TRUST UNITHOLDER Cross Timbers currently owns 100% of the 40,000,000 outstanding trust units. It is offering 15,000,000 trust units in this offering, or 17,250,000 trust units if the underwriters exercise their over-allotment option in full. Cross Timbers has reserved $12 million of trust units for issuance in Cross Timbers' 1998 Royalty Trust Option Plan. It has granted options covering all trust units in the plan to its executive officers at an exercise price equal to the public offering price in this offering. The options are exercisable for a period of three years, beginning at the date of grant. Assuming the sale of all trust units offered in this offering and the exercise in full of the underwriters' over-allotment option, after taking into account the trust units reserved for the plan, Cross Timbers will have trust units, or % of the outstanding trust units available for future sale or distribution. Cross Timbers has announced that it may form additional royalty trusts with other properties. It may exchange trust units for oil and natural gas properties or use them for other corporate purposes. Prior to this offering there has been no public market for the trust units. Cross Timbers cannot predict the effect on future market prices, if any, of market sales of trust units or the availability of trust units for sale if it disposes of its remaining trust units. Nevertheless, sales of substantial amounts of trust units in the public market could adversely affect prevailing market prices. LEGAL MATTERS Counsel for Cross Timbers, Kelly, Hart & Hallman, P.C., Fort Worth, Texas, will give a legal opinion that the trust units are valid and fully paid without further consideration. Counsel for the underwriters, Andrews & Kurth L.L.P., Houston, Texas, will give a legal opinion to the underwriters regarding other matters related to this offering. Butler & Binion, L.L.P., Houston, Texas, will give the tax opinion set forth in the section of this prospectus captioned "Federal Income Tax Consequences." Morris, Laing, Evans, Brock & Kennedy, Chartered, Wichita, Kansas, will give the Kansas tax opinion set forth in the section of this prospectus captioned "State Tax Considerations." Certain members of Kelly, Hart & Hallman, P.C. currently own approximately 23,200 shares of common stock of Cross Timbers, and certain partners of Butler & Binion, L.L.P. own 95,985 shares of common stock of Cross Timbers. EXPERTS Certain information appearing in this prospectus regarding the December 31, 1998 estimated quantities of reserves of the underlying properties and net profits interests owned by the trust, the future net revenues from those reserves and their present value is based on estimates of the reserves and present values prepared by or derived from estimates prepared by Miller and Lents, Ltd. independent petroleum engineers. The financial statements of Cross Timbers incorporated by reference in this prospectus, and statements of revenues and direct operating expenses of the underlying properties and the statement of assets and trust corpus of Hugoton Royalty Trust included in this Prospectus and elsewhere in the registration statement, have been audited by Arthur Andersen LLP, independent public accountants, as indicated in their reports with respect thereto, and are included herein in reliance upon the authority of said firm as experts in accounting and auditing. 49 AVAILABLE INFORMATION Cross Timbers files annual, quarterly and current reports, proxy statements and other information with the SEC. You may read and copy any of these reports, statements or other information at the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549. You may request copies of these documents, upon payment of a duplicating fee, by writing to the SEC at the address in the previous sentence. To obtain information on the operation of the public reference rooms you may call the SEC at (800) SEC-0330. Cross Timbers' filings are also available to the public on the SEC Internet Web site at http://www.sec.gov. The SEC allows Cross Timbers to "incorporate by reference" information Cross Timbers files with it, which means that Cross Timbers can disclose important information to you by referring you to those documents. The information incorporated by reference is considered to be part of this prospectus. Cross Timbers incorporates by reference in this prospectus the following documents: . Its Annual Report on Form 10-K for the year ended December 31, 1997; . Its Quarterly Reports on Form 10-Q for the quarters ended March 31, 1998, June 30, 1998, and September 30, 1998, and on Form 10 Q/A dated September 30, 1998; . Its Current Reports on Form 8-K dated February 12, 1998, February 16, 1998 (Amendment No. 1 to Report dated December 1, 1997), February 18, 1998, February 25, 1998, April 13, 1998, April 17, 1998, April 21, 1998, April 24, 1998, May 19,1998, July 2, 1998 (Amendment No. 1 to Report dated April 24, 1998), August 26, 1998, and December 21, 1998; and . all other documents filed by it pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 after the date of this prospectus and prior to termination of the offering of the trust units. Information that Cross Timbers files later with the SEC will automatically update the information in this prospectus. In all cases, you should rely on the later information over different information included or incorporated by reference in this prospectus. As a recipient of this prospectus, you may request a copy of any document Cross Timbers incorporates by reference, except exhibits to the documents that are not specifically incorporated by reference, at no cost to you by writing or calling Cross Timbers at 810 Houston Street, Suite 2000, Fort Worth, Texas 76102, Attention: Investor Relations, telephone (817) 870-2800. NationsBank, N.A. is trustee of the trust. The trustee's address is 901 Main Street, 17th Floor, Dallas, Texas 75202, and its telephone number is (214) 508- 2400. 50 GLOSSARY OF CERTAIN OIL AND NATURAL GAS TERMS In this prospectus the following terms have the meanings specified below. Bbl -- One stock tank barrel, or 42 US gallons liquid volume, of crude oil or other liquid hydrocarbons. Bcf -- One billion cubic feet of natural gas. Bcfe -- One billion cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf. Btu -- A British Thermal Unit, a common unit of energy measurement. Estimated Future Net Revenues -- Also referred to as "estimated future net cash flows." The result of applying current prices of oil and natural gas to estimated future production from oil and natural gas proved reserves, reduced by estimated future expenditures, based on current costs to be incurred, in developing and producing the proved reserves, excluding overhead. Estimated future net revenues do not include the effects of the tight sands natural gas tax credit, since the trust is not a taxable entity and the credit goes directly to the trust unitholders. MBbl -- One thousand Bbl. Mcf -- One thousand cubic feet of natural gas. Mcfe -- One thousand cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf. MMBtu -- One million British Thermal Units (Btus). MMcf -- One million cubic feet of natural gas. MMcfe -- One million cubic feet of natural gas equivalent, computed on an approximate energy equivalent basis that one Bbl equals six Mcf. Natural Gas Revenue -- Includes revenue related to the sale of natural gas, natural gas liquids and plant products. Net Oil and Natural Gas Wells or Acres -- Determined by multiplying "gross" oil and natural gas wells or acres by the interest in such wells or acres represented by the underlying properties. NYMEX -- New York Mercantile Exchange, where futures and options contracts for the oil and natural gas industry and some precious metals are traded. Oil Revenue -- Includes revenue related to the sale of oil and condensate production. Proved Developed Reserves -- Proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Proved Reserves -- The estimated quantities of crude oil, natural gas and natural gas liquids which, upon analysis of geological and engineering data, appear with reasonable certainty to be recoverable in the future from known oil and natural gas reservoirs under existing economic and operating conditions. 51 Proved Undeveloped Reserves -- Proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required. Reserve-to-Production Index -- An estimate, expressed in years, of the total estimated proved reserves attributable to a producing property divided by production from the property for the 12 months preceding the date as of which the proved reserves were estimated. Royalty or Overriding Royalty Interest -- A real property interest entitling the owner to receive a specified portion of the gross proceeds of the sale of oil and natural gas production or, if the conveyance creating the interest provides, a specific portion of oil and natural gas produced, without any deduction for the costs to explore for, develop or produce the oil and natural gas. A royalty or overriding royalty interest owner has no right to consent to or approve the operation and development of the property, while the owners of the working interest have the exclusive right to exploit the mineral on the land. Standardized Measure of Discounted Future Net Cash Flows -- Also referred to herein as "standardized measure." It is the present value of estimated future net revenues computed by discounting estimated future net revenues at a rate of 10% annually. Working Interest -- A real property interest entitling the owner to receive a specified percentage of the proceeds of the sale of oil and natural gas production or a percentage of the production, but requiring the owner of the working interest to bear the cost to explore for, develop and produce such oil and natural gas. A working interest owner who owns a portion of the working interest may participate either as operator or by voting his percentage interest to approve or disapprove the appointment of an operator and certain activities in connection with the development and operation of a property. 52 INDEX TO FINANCIAL STATEMENTS Underlying Properties Report of Independent Public Accountants................................ F-2 Statements of Revenues and Direct Operating Expenses for the Years Ended December 31, 1996, 1997 and 1998....................................... F-3 Notes to Financial Statements........................................... F-4 Hugoton Royalty Trust Report of Independent Public Accountants................................ F-8 Statement of Assets and Trust Corpus as of December 31, 1998............ F-9 Note to Statement of Assets and Trust Corpus............................ F-10 Pro Forma Statement of Distributable Income for the Year Ended December 31, 1998 (Unaudited).......................................... F-11 Notes to Pro Forma Statement of Distributable Income (Unaudited)........ F-12
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS Cross Timbers Oil Company: We have audited the accompanying statements of revenues and direct operating expenses of the Underlying Properties of Cross Timbers Oil Company ("the Company") for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. The accompanying statements of revenue and direct operating expenses have been prepared on the cash basis of accounting, as described in Note 2, and are not intended to be a presentation in conformity with generally accepted accounting principles. In our opinion, the statements referred to above present fairly, in all material respects, the revenues and direct operating expenses of the Underlying Properties for each of the three years in the period ended December 31, 1998, in conformity with the basis of accounting described above and in Note 2. ARTHUR ANDERSEN LLP Fort Worth, Texas January 22, 1999 F-2 UNDERLYING PROPERTIES STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES For the Years Ended December 31, 1996, 1997 and 1998
1996 1997 1998 ------- ------- ------- (in thousands) Revenues Gas sales............................................. $60,502 $82,192 $77,124 Oil sales............................................. 9,075 9,704 7,083 ------- ------- ------- Total............................................... 69,577 91,896 84,207 ------- ------- ------- Direct Operating Expenses Production and property taxes and transportation...... 5,919 9,173 9,170 Production expenses................................... 11,359 12,837 13,031 ------- ------- ------- Total............................................... 17,278 22,010 22,201 ------- ------- ------- Excess of Revenues over Direct Operating Expenses....... $52,299 $69,886 $62,006 ======= ======= =======
See Accompanying Notes to Financial Statements. F-3 UNDERLYING PROPERTIES NOTES TO FINANCIAL STATEMENTS 1. UNDERLYING PROPERTIES The Underlying Properties are predominantly working interests in producing properties currently owned by Cross Timbers Oil Company ("Company") in the Hugoton Area of Oklahoma and Kansas, the Anadarko Basin of Oklahoma and the Green River Basin of Wyoming. The Company conveyed 80% defined net profits interests ("Net Profits Interests") in the Underlying Properties to the Hugoton Royalty Trust ("Trust") as of December 1998. Estimated proved reserves attributable to the Underlying Properties are approximately 5% oil and 95% natural gas, based on discounted present value of estimated future net revenues as of December 31, 1998. See Note 5. All of the Underlying Properties were acquired by the Company from 1986 through 1998. Significant property acquisitions were made by the Company during the three-year period presented in the accompanying financial statements. The statements include the historical revenues and direct operating expenses from these acquired properties for all years presented. 2. BASIS OF PRESENTATION The statements of revenues and direct operating expenses of the Underlying Properties were derived from the historical accounting records of the Company (and prior owners for acquisitions occurring during the three-year period presented), and are presented on the cash basis of accounting before the effects of conveyance of the Net Profits Interests. The statements do not include depreciation, depletion and amortization, general and administrative or interest expenses. Amounts are included in the accompanying financial statements in the period Net Proceeds are distributed by the Company to the Trust, which is the month subsequent to the month received by the Company. Accordingly, the financial statements for the year ended December 31 include amounts received by the Company from December through the following November. Royalty income of the Trust is determined based on the defined 80% net profits interest percentage of Net Proceeds of the Underlying Properties. The computation also includes deductions for capital development expenditures on the properties of $14,392,000 in 1996, $40,027,000 in 1997 and $33,019,000 in 1998, as well as an overhead charge totalling $4,557,000 in 1996, $5,354,000 in 1997, and $6,198,000 in 1998. Accordingly, royalty income of the Trust is materially different from the excess of revenues over direct operating expenses from the Underlying Properties. 3. RELATED PARTY TRANSACTIONS The Company sells a significant portion of natural gas production from the Underlying Properties to certain of the Company's wholly owned subsidiaries, generally at amounts approximating monthly spot market prices. Most of the production from the Hugoton area is sold under a contract to Timberland Gathering & Processing Company, Inc. ("TGPC"). Much of the natural gas production in Major County, Oklahoma is sold to Ringwood Gathering Company ("RGC") which retains a $0.313 per Mcf gathering fee. TGPC and RGC sell natural gas to Cross Timbers Energy Services, Inc. ("CTES") which markets natural gas to third parties. The Company sells directly to CTES most natural gas production not sold directly to TGPC or RGC. F-4 UNDERLYING PROPERTIES NOTES TO FINANCIAL STATEMENTS--(Continued) Sales from the Underlying Properties to the Company's wholly owned subsidiaries are as follows (in thousands):
1996 1997 1998 ------- ------- ------- TGPC................................................. $12,348 $16,429 $14,519 RGC.................................................. 6,768 8,436 6,421 CTES................................................. 12,167 32,294 33,878
4. CONTINGENCIES The Company is a defendant in two separate lawsuits that could, if adversely determined, decrease future revenues from certain of the Underlying Properties. Damages relating to production prior to the formation of the Trust will be borne by the Company. A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the Company has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling natural gas through affiliated companies at prices less favorable from those paid by third parties. The Company believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, revenues from the Underlying Properties will be reduced. The amount of any reduction in such revenues is not presently determinable, but is not expected to be material to the Trust's distributable income, financial position or liquidity. A second lawsuit, 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 action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, the Company has mismeasured the volume of natural gas and wrongfully analyzed its heating content. 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 and an order for the Company to cease the allegedly improper measuring practices. This lawsuit is one of more that 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by the Company for production from Underlying Properties on federal and Native American lands for 1998 totalled approximately $2.8 million. The Company believes that the allegations of this lawsuit are without merit. However, an order to change measuring practices or a related settlement could adversely affect future revenues from the Underlying Properties by an amount that is not presently determinable, but is not expected to be material to the Trust's distributable income, financial position or liquidity. 5. SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION (Unaudited) Proved oil and natural gas reserves of the Underlying Properties have been estimated as of December 31, 1998 by independent petroleum engineers. The reserve estimates provided for the Underlying Properties are before the effects of conveying the defined net profits interests to the Trust. In accordance with Statement of Financial Accounting Standards No. 69, estimates of future net revenues from proved reserves have been prepared using year-end oil and natural gas prices and current costs to produce and develop the proved reserves, excluding overhead. The standardized measure of future net cash flows from oil and natural gas reserves is calculated based on discounting such future net cash flows at an annual rate of 10%. F-5 UNDERLYING PROPERTIES NOTES TO FINANCIAL STATEMENTS--(Continued) Year-end posted West Texas Intermediate crude oil prices were $18.00 per barrel for 1995, $24.25 per barrel for 1996, $15.50 per barrel for 1997, and $9.50 per barrel for 1998. Year-end weighted average spot natural gas prices were $1.76 per Mcf for 1995, $2.84 per Mcf for 1996, $2.01 per Mcf for 1997, and $2.01 per Mcf for 1998. The standardized measure of future net cash flows is not intended to represent the fair value of the Underlying Properties. Numerous uncertainties are inherent in estimating volumes and values of proved reserves and in projecting future production rates and timing of development expenditures. Such reserve estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production may be substantially different from the original estimates. Also, because natural gas prices are influenced by seasonal demand, use of year-end prices, as required by the Financial Accounting Standards Board, may not be representative in estimating future revenues or reserve data. Reserve estimates for Underlying Properties that were acquired between 1996 and 1998 are not available for periods prior to the date they were acquired by the Company. Estimated proved reserves and the related standardized measure of these properties were calculated as of December 31, 1995, 1996 and 1997, by adding production prior to the date acquired to estimates as of the acquisition dates.
Gas (Mcf) Oil (Bbls) Proved Reserves --------- ---------- (in thousands) Balance, December 31, 1995.............................. 445,836 4,442 Revisions............................................. 20,301 432 Extensions, discoveries and other additions........... 27,131 145 Production............................................ (36,143) (455) ------- ----- Balance, December 31, 1996.............................. 457,125 4,564 Revisions............................................. (15,557) (305) Extensions, discoveries and other additions........... 84,394 485 Production............................................ (37,172) (470) ------- ----- Balance, December 31, 1997.............................. 488,790 4,274 Revisions............................................. 17,798 (24) Extensions, discoveries and other additions........... 47,020 259 Production............................................ (38,535) (479) ------- ----- Balance, December 31, 1998.............................. 515,073 4,030 ======= =====
Proved Developed Reserves
Gas (Mcf) Oil (Bbls) --------- ---------- (in thousands) December 31, 1995....................................... 384,588 3,633 ======= ===== December 31, 1996....................................... 401,784 3,966 ======= ===== December 31, 1997....................................... 417,912 3,574 ======= ===== December 31, 1998....................................... 435,328 3,368 ======= =====
F-6 UNDERLYING PROPERTIES NOTES TO FINANCIAL STATEMENTS--(Continued) Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Reserves
December 31, ---------------------------------- 1996 1997 1998 ---------- ---------- ---------- (in thousands) Future cash inflows.................... $1,414,852 $1,057,023 $1,087,660 Future costs: Production........................... 357,049 326,325 364,930 Development.......................... 30,894 42,460 48,212 ---------- ---------- ---------- Future net cash flows.................. 1,026,909 688,238 674,518 10% discount factor.................... 467,687 322,301 327,341 ---------- ---------- ---------- Standardized measure of discounted future net cash flows................. $ 559,222 $ 365,937 $ 347,177 ========== ========== ========== Changes in Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves December 31, ---------------------------------- 1996 1997 1998 ---------- ---------- ---------- (in thousands) Standardized measure, beginning of year.................................. $ 273,032 $ 559,222 $ 365,937 ---------- ---------- ---------- Revisions: Prices and costs..................... 241,743 (212,920) (27,206) Quantity estimates................... 47,520 5,585 11,161 Accretion of discount................ 24,457 50,574 33,464 Future development costs............. (18,620) (48,471) (33,542) Production rates and other........... (544) (1,076) (827) ---------- ---------- ---------- Net revisions...................... 294,556 (206,308) (16,950) Extensions, discoveries and other additions............................. 29,541 42,882 27,177 Production............................. (52,299) (69,886) (62,006) Development costs...................... 14,392 40,027 33,019 ---------- ---------- ---------- Net change........................... 286,190 (193,285) (18,760) ---------- ---------- ---------- Standardized measure, end of year...... $ 559,222 $ 365,937 $ 347,177 ========== ========== ==========
F-7 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS Hugoton Royalty Trust: We have audited the accompanying statement of assets and trust corpus of Hugoton Royalty Trust as of December 31, 1998. This financial statement is the responsibility of the management of Cross Timbers Oil Company. Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the statement referred to above presents fairly, in all material respects, the assets and trust corpus of Hugoton Royalty Trust as of December 31, 1998, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Fort Worth, Texas January 25, 1999 F-8 HUGOTON ROYALTY TRUST STATEMENT OF ASSETS AND TRUST CORPUS December 31, 1998
(in thousands) Cash........................................................... $ 1 Net overriding royalty interests in oil and gas properties..... 247,067 -------- Total Assets................................................. $247,068 ======== Trust Corpus (40,000,000 units of beneficial interest authorized and outstanding)................................... $247,068 ========
See Accompanying Note to Statement of Assets and Trust Corpus. F-9 HUGOTON ROYALTY TRUST NOTE TO STATEMENT OF ASSETS AND TRUST CORPUS 1. TRUST ORGANIZATION Hugoton Royalty Trust ("Trust") is a grantor trust that was created as of December 1, 1998 by Cross Timbers Oil Company ("Company"). The Trust was formed to hold net overriding royalty interests equivalent to 80% defined net profits interests in certain producing oil and gas properties in Kansas, Oklahoma and Wyoming that were conveyed by the Company effective December 1, 1998 in exchange for 40 million units of beneficial interest in the Trust ("Units"). The net overriding royalty interests are reflected in the accompanying statement of assets and trust corpus at the Company's historical net book value at the date of conveyance. The Company uses the successful efforts method of accounting. The Trust will terminate upon the first occurrence of: (a) disposition of all net overriding royalty interests pursuant to terms of the Trust Indenture, (b) when gross proceeds attributable to the Underlying Properties are less than $1 million per year for each of two successive years after 1999, or (c) a vote of at least 80% of the Trust Unitholders to terminate the Trust in accordance with provisions of the Trust Indenture. F-10 HUGOTON ROYALTY TRUST PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (Unaudited) For the Year Ended December 31, 1998 (in thousands, except for per Unit amounts) Gross Proceeds Gas revenues......................................................... $77,124 Oil revenues......................................................... 7,083 ------- Total Revenues...................................................... 84,207 Production and property taxes and transportation..................... 9,170 ------- Total.............................................................. 75,037 ------- Production and Development Costs Production........................................................... 13,031 Development (Note 2)................................................. 33,019 ------- Total.............................................................. 46,050 ------- Net proceeds before overhead........................................... 28,987 Overhead (Note 2)...................................................... 6,198 ------- Net proceeds........................................................... 22,789 Net profits percentage................................................. 80% ------- Trust royalty income................................................... 18,231 Administrative expense................................................. 300 ------- Distributable income................................................... $17,931 ======= Distributable income per Unit (40,000,000 Trust Units issued and outstanding--Note 1)................................................. $ 0.45 =======
See Accompanying Notes to Unaudited Pro Forma Statement of Distributable Income. F-11 HUGOTON ROYALTY TRUST NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (Unaudited) 1. BASIS OF PRESENTATION The pro forma statement of distributable income of the Trust for the year ended December 31, 1998 has been prepared on a cash basis of accounting from the historical results (successful efforts method of accounting) of operations of the properties out of which the Net Profits Interests were carved and the following assumptions made: a. The Trust was formed and the Net Profits Interests were conveyed to the Trust effective December 1, 1997. A significant property acquisition was made by the Company during the year ended December 31, 1998. The pro forma statement of distributable income includes the historical revenues and expenses of this acquisition. b. Net proceeds related to the Net Profits Interests are received and recorded as royalty income by the Trust in the month following their receipt by the Company from the Underlying Properties. Generally the Trust will receive and record royalty income two months after the month of production. This basis for recognizing royalty income differs from generally accepted accounting principles which requires that revenues be accrued in the month of production. c. Royalty income is calculated based on 80% of the Net Proceeds from the Underlying Properties. Net Proceeds is a defined term in the Net Profits Interests conveyance to the Trust. d. Administrative expense is estimated to be $300,000 annually. Such expense generally would include Trustee fees and costs incurred by the Trustee to administer the Trust and report Trust results to Unitholders, including the expense of attorneys, independent auditors, reservoir engineers, printing and mailing. 2. PRO FORMA ADJUSTMENTS The following pro forma adjustments were made to the historical direct operating expenses of the Underlying Properties to present pro forma distributable income for the year ended December 31, 1998: a. Historical development costs of $33,019,000 were deducted. b. An overhead charge by the Company totalling $6,198,000 was deducted. This charge, based on a monthly count of active wells operated by the Company, is specified by the terms of the Net Profits Interest conveyance to the Trust. Such charge is deducted in the computation of Net Proceeds and represents reimbursement to the Company for costs associated with monitoring the Underlying Properties. 3. FEDERAL INCOME TAXES As a grantor trust, the Trust will not be required to pay federal income taxes. Accordingly, the accompanying pro forma statement of distributable income does not include a provision for federal income taxes. F-12 HUGOTON ROYALTY TRUST NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (Unaudited)--(Continued) 4. CONTINGENCIES The Company is a defendant in two separate lawsuits that could, if adversely determined, decrease future Trust distributable income. Damages relating to production prior to the formation of the Trust will be borne by the Company. A class action lawsuit, Booth, et al. v. Cross Timbers Oil Company, was filed on April 3, 1998 in the District Court of Dewey County, Oklahoma by royalty owners of natural gas wells in Oklahoma. The plaintiffs allege that since 1991 the Company has underpaid royalty owners as a result of (1) reducing royalties for improper charges for production, marketing, gathering, processing and transportation costs and (2) selling natural gas through affiliated companies at prices less favorable from those paid by third parties. The Company believes that it has strong defenses to this lawsuit and intends to vigorously defend its position. However, if a judgment or settlement increased the amount of future royalty payments, the Trust would bear its proportionate share of the increased royalties through reduced Net Proceeds. The amount of any reduction in Net Proceeds is not presently determinable, but is not expected to be material to the Trust's distributable income, financial position or liquidity. A second lawsuit, 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 action alleges that in computing royalties payable for natural gas produced from federal leases and lands owned by Native Americans, the Company has mismeasured the volume of natural gas and wrongfully analyzed its heating content. 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 and an order for the Company to cease the allegedly improper measuring practices. This lawsuit is one of more than 75 suits filed nationwide by the same plaintiff alleging similar claims against over 300 producers and pipeline companies. Royalties paid by the Company for production from Underlying Properties on federal and Native American lands during 1998 totalled approximately $2.8 million. The Company believes that the allegations of this lawsuit are without merit. 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 is not expected to be material to the Trust's distributable income, financial position or liquidity. 5. PRO FORMA SUPPLEMENTAL OIL AND GAS RESERVE INFORMATION Proved oil and natural gas reserves of the Trust have been estimated as of December 31, 1998 by independent petroleum engineers. In accordance with Statement of Financial Accounting Standards No. 69, estimates of future net revenues from proved reserves have been prepared using year-end oil and natural gas prices and current costs to produce and develop the proved reserves. The standardized measure of future net cash flows from oil and natural gas reserves is calculated based on discounting such future net cash flows at an annual rate of 10%. Year-end posted West Texas Intermediate crude oil prices were $15.50 and $9.50 per barrel for 1997 and 1998, respectively. Year-end weighted average spot gas prices were $2.01 per Mcf for each of 1997 and 1998. As the Trust is not subject to taxation at the trust level, no provision is included for federal income taxes. Reserve quantities and revenues for the Net Profits Interests were estimated from projections of reserves and revenues attributable to the Underlying Properties. Since the Trust has a defined net profits interests, the Trust does not own a specific ownership percentage of the oil and natural gas reserve or production quantities. Accordingly, reserves and production allocated to the Trust pertaining to its 80% F-13 HUGOTON ROYALTY TRUST NOTES TO PRO FORMA STATEMENT OF DISTRIBUTABLE INCOME (Unaudited)--(Continued) net profits interest in the working interest properties have effectively been reduced to reflect recovery of the Trust's 80% portion of applicable production and development costs, excluding overhead and trust administrative expenses. Because Trust reserve quantities are determined using an allocation formula, any fluctuations in actual or assumed prices or costs will result in revisions to the estimated reserve quantities allocated to the Net Profits Interests. The standardized measure of future net cash flows is not intended to represent the fair value of the Trust. Numerous uncertainties are inherent in estimating volumes and values of proved reserves and in projecting future production rates and timing of development expenditures. Such reserve estimates are subject to change as additional information becomes available. The reserves actually recovered and the timing of production may be substantially different from the original estimates. Also, because natural gas prices are influenced by seasonal demand, use of year-end prices, as required by the Financial Accounting Standards Board, may not be representative in estimating future revenues or reserve data.
Gas (Mcf) Oil (Bbls) --------- ---------- (in thousands) Proved Reserves Balance, January 1, 1998................................ 279,024 2,431 Revisions ............................................ (11,541) (255) Extensions, discoveries and other additions........... 24,177 133 Production............................................ (9,363) (116) ------- ----- Balance, December 31, 1998.............................. 282,297 2,193 ======= ===== Proved Developed Reserves January 1, 1998......................................... 249,148 2,136 ======= ===== December 31, 1998....................................... 249,215 1,934 ======= =====
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Reserves at December 31, 1998
(in thousands) Future cash inflows.......................................... $595,301 Future production taxes and transportation................... 55,686 -------- Future net cash flows........................................ 539,615 10% discount factor.......................................... 261,873 -------- Standardized measure of discounted future net cash flows..... $277,742 ======== Changes in Standardized Measure of Discounted Future Net Cash Flows from Proved Reserves (in thousands) Standardized measure, January 1, 1998........................ $292,749 -------- Extensions, discoveries and other additions.................. 21,742 Trust royalty income ........................................ (18,231) Changes in prices and other.................................. (45,289) Accretion of discount........................................ 26,771 -------- (15,007) -------- Standardized measure, December 31, 1998...................... $277,742 ========
F-14 UNDERWRITING Cross Timbers and the underwriters named below (the "Underwriters") have entered into an underwriting agreement with respect to the trust units being offered. Subject to certain conditions, each Underwriter has severally agreed to purchase the number of trust units indicated in the following table. Goldman, Sachs & Co., Lehman Brothers Inc., Bear, Stearns & Co., Inc., Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, Donaldson, Lufkin & Jenrette Securities Corporation and A. G. Edwards & Sons, Inc. are representatives of the Underwriters.
Number of Underwriter Trust Units ----------- ----------- Goldman, Sachs & Co ........................................... Lehman Brothers Inc. .......................................... Bear, Stearns & Co. Inc........................................ Dain Rauscher Wessels, a division of Dain Rauscher Incorporated............................................ Donaldson, Lufkin & Jenrette Securities Corporation............ A.G. Edwards & Sons, Inc....................................... ---------- Total........................................................ 15,000,000 ==========
If the Underwriters sell more trust units than the total number shown in the table above, the Underwriters have an option to buy up to an additional 2,250,000 trust units from Cross Timbers to cover such sales. They may exercise that option for 30 days. If any trust units are purchased pursuant to this option, the Underwriters will severally purchase trust units in approximately the same proportion shown in the table above. The following table shows the per trust unit and total underwriting discounts and commissions to be paid to the Underwriters by Cross Timbers. These amounts are shown assuming both no exercise and full exercise of the Underwriters' option to purchase 2,250,000 additional trust units.
Paid by Cross Timbers ------------------------- No Exercise Full Exercise ----------- ------------- Per trust unit....................................... $ $ Total................................................ $ $
Trust units sold by the Underwriters to the public will initially be offered at the initial public offering price shown on the cover of this prospectus. Any trust units sold by the Underwriters to securities dealers may be sold at a discount of up to $ per trust unit from the initial public offering price. Any such securities dealers may resell any trust units purchased from the Underwriters to certain other brokers or dealers at a discount of up to $ per trust unit from the initial public offering price. If all the trust units are not sold at the initial offering price, the representatives may change the offering price and the other selling terms. Cross Timbers and its executive officers have agreed with the Underwriters not to dispose of or hedge any of their trust units or securities convertible into or exchangeable for trust units during the period from the date of this prospectus continuing through the date 180 days after the date of this prospectus, except with the prior written consent of the representatives. This agreement does not apply to any existing employee benefit plans. Prior to the Offering, there has been no public market for the trust units. The initial public offering price has been negotiated among Cross Timbers and the representatives. Among the factors to be considered in determining the initial public offering price of the trust units, in addition to prevailing market conditions, will be estimates of distributions to trust unitholders and overall quality of the underlying properties. U-1 The trust units have been approved for listing on the New York Stock Exchange under the symbol "HGT." In order to meet one of the requirements for listing the trust units on the New York Stock Exchange, the Underwriters have undertaken to sell lots of 100 or more trust units to a minimum of 2,000 beneficial holders. In connection with the Offering, the Underwriters may purchase and sell trust units in the open market. These transactions may include short sales, stabilizing transactions and purchases to cover positions created by short sales. Short sales involve the sale by the Underwriters of a greater number of trust units than they are required to purchase in the Offering. Stabilizing transactions consist of certain bids or purchases made for the purpose of preventing or retarding a decline in the market price of the trust units while the Offering is in progress. The Underwriters also may impose a penalty bid. This occurs when a particular Underwriter repays to the Underwriters a portion of the underwriting discount it received because the representatives repurchased trust units sold by or for the account of such Underwriter in stabilizing or short covering transactions. These activities by the Underwriters may stabilize, maintain or otherwise affect the marketprice of the trust units. As a result, the price of the trust units may be higher than the price that otherwise might exist in the open market. If these activities are commenced, they may be discontinued by the Underwriters at any time. These transactions may be effected on the New York Stock Exchange, in the over-the-counter market or otherwise. The Underwriters do not expect sales to discretionary accounts to exceed five percent of the total number of trust units offered. Cross Timbers estimates that total expenses of the Offering, other than underwriting discounts and commissions, will be approximately $650,000. Cross Timbers and the trust have agreed to indemnify the several Underwriters against certain liabilities, including liabilities under the Securities Act of 1933. The trust's indemnity obligations are limited to the assets of the trust, and neither the trustee nor any unitholder will have any obligation to indemnify the Underwriters. U-2 EXHIBIT A [LETTERHEAD OF MILLER & LENTS, LTD. APPEARS HERE] January 20, 1999 Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, TX 76102 Re: Underlying Properties (100%) Relating to the Hugoton Royalty Trust As of January 1, 1999 SEC Pricing Case Gentlemen: At your request, we estimated the proved reserves and future net revenue as of January 1, 1999, attributable to the Cross Timbers Oil Company interest in certain oil and gas properties prior to inclusion in the Hugoton Royalty Trust, i.e., Underlying Properties (100%). The properties consist of approximately 1,679 wells and are located primarily in Kansas, Oklahoma, and Wyoming. The aggregate results of our evaluations are as follows:
- ----------------------------------------------------------------------------------------------------------- Net Reserves as of 1/1/99 Future Net Revenue ----------------------------------------------------------------------- Oil and Condensate, Gas, Undiscounted, Discounted at Reserves Category MBbls. MMcf M$ 10% Per Year, M$ - ----------------------------------------------------------------------------------------------------------- Kansas - ----------------------------------------------------------------------------------------------------------- Proved Developed Producing 50.6 46,123.6 45,306.6 24,767.3 - ----------------------------------------------------------------------------------------------------------- Proved Nonproducing 0.0 499.1 344.5 176.3 - ----------------------------------------------------------------------------------------------------------- Proved Undeveloped 0.0 3,996.2 1,698.7 510.6 - ----------------------------------------------------------------------------------------------------------- Subtotal 50.6 50,618.9 47,349.7 25,454.1 - ----------------------------------------------------------------------------------------------------------- Oklahoma - ----------------------------------------------------------------------------------------------------------- Proved Developed Producing 2,901.2 235,076.2 328,413.8 192,126.8 - ----------------------------------------------------------------------------------------------------------- Proved Nonproducing 206.9 14,281.9 20,685.8 12,219.8 - ----------------------------------------------------------------------------------------------------------- Proved Undeveloped 601.3 36,125.9 35,171.7 13,182.5 - ----------------------------------------------------------------------------------------------------------- Subtotal 3,709.3 285,484.0 384,271.3 217,529.1 - ----------------------------------------------------------------------------------------------------------- Wyoming - ----------------------------------------------------------------------------------------------------------- Proved Developed Producing 189.2 132,662.1 186,849.2 88,540.8 - ----------------------------------------------------------------------------------------------------------- Proved Nonproducing 20.6 6,685.6 10,812.6 5,173.7 - ----------------------------------------------------------------------------------------------------------- Proved Undeveloped 60.3 39,622.6 45,235.3 10,479.0 - ----------------------------------------------------------------------------------------------------------- Subtotal 270.1 178,970.3 242,897.1 104,193.5 - ----------------------------------------------------------------------------------------------------------- Total Underlying Properties (100%) - ----------------------------------------------------------------------------------------------------------- Proved Developed Producing 3,140.9 413,861.8 560,569.6 305,434.9 - ----------------------------------------------------------------------------------------------------------- Proved Nonproducing 227.5 21,466.6 31,842.8 17,569.7 - ----------------------------------------------------------------------------------------------------------- Proved Undeveloped 661.5 79,744.7 82,105.7 24,172.1 - ----------------------------------------------------------------------------------------------------------- TOTAL 4,029.9 515,073.1 674,518.1 347,176.7 - -----------------------------------------------------------------------------------------------------------
MILLER AND LENTS, LTD. Cross Timbers Oil Company January 20, 1999 Page 2 We performed evaluations, which are designated as the SEC Pricing Case, using price, expense, and gas production curtailment premises specified by you and described in detail on Attachment 1. Proved reserves and future net revenue were estimated in accordance with the provisions contained in Securities and Exchange Commission Regulation S-X, Rule 4-10. The Securities and Exchange Commission definition of proved reserves is shown on Attachment 2. Estimates of future net revenue and discounted future net revenue are not intended and should not be interpreted to represent fair market values for the estimated reserves. Future costs of abandoning facilities and wells and of the restoration of producing properties to satisfy environmental standards were not deducted from total revenues as such estimates are beyond the scope of this assignment. Following Attachment 2 is a list of exhibits which include annual projections of future production and net revenue for each state and reserve category. Also included in the exhibits are one-line summaries for the total royalty trust and for each state showing the proved reserves and future net revenue for the individual properties. Projections of individual property future production and net revenue are included in separate volumes to this report. These exhibits and volumes should not be relied upon independently of this narrative. The proved developed producing reserves and production forecasts were estimated by production decline extrapolations, water-oil ratio trends, P/Z declines, or in a few cases, by volumetric calculations. For some properties with insufficient performance history to establish trends, we estimated future production by analogy with other properties with similar characteristics. The past performance trends of many properties were influenced by production curtailments, workovers, waterfloods, and/or infill drilling. Actual future production may require that our estimated trends be significantly altered. The estimated proved undeveloped reserves require significant capital expenditures such as drilling and completion costs. The proved undeveloped reserve estimates for infill wells are based on analogies to similar infill wells in the same field and/or the production histories of offset wells in the same field. Reserve estimates from volumetric calculations and from analogies are often less certain than reserve estimates based on well performance obtained over a period during which a substantial portion of the reserves was produced. With the exception of a few properties, the data employed in our determinations of proved reserves and future net income were provided by Cross Timbers Oil Company. We obtained pressure and production information from independent sources for some properties that had insufficient data from Cross Timbers Oil Company to employ as bases for reserve estimates. The current expenses for each lease were obtained from operating statements provided by Cross Timbers Oil Company except for certain leases where Cross Timbers Oil Company deducted items considered by Cross Timbers Oil Company to be nonrecurring expenditures. No overhead was included for those properties operated by Cross Timbers Oil Company. For some properties, such as large waterfloods, Cross Timbers Oil Company assumed a decline in variable operating costs due to depleting production which was derived by forecasting a decrease in the property well count. None of the data provided to us by Cross Timbers Oil Company, MILLER AND LENTS, LTD. Cross Timbers Oil Company January 20, 1999 Page 3 including, but not limited to, graphical representations and tabulations of past production performance, well tests and pressures, ownership interests, prices, and operating costs, were verified by us as such was not within the scope of our assignment. The evaluations presented in this report, with the exceptions of those parameters specified by others, reflect our informed judgments based on accepted standards of professional investigation but are subject to those generally recognized uncertainties associated with interpretation of geological, geophysical, and engineering information. Government policies and market conditions different from those employed in this study may cause the total quantity of oil or gas to be recovered, actual production rates, prices received, or operating and capital costs to vary from those presented in this report. Our workpapers and data are in our files and available for review upon request. If you have any questions regarding the above, or if we can be of further assistance, please call. Very truly yours, MILLER AND LENTS, LTD. By /s/ Karen F. Loving ------------------------------- Karen F. Loving Vice President KFL/hsd Attachment 1 1-1-99 Underlying Properties (100%) Relating to the Hugoton Royalty Trust SEC PRICING CASE A. Oil Price All oil/condensate prices held constant at $9.50 per barrel through the life of the property. (Adjust for gravity, transportation charges, and crude marketing arrangements.) B. Gas Price Estimated 1/1/99 price held constant through the life of the property. C. Operating Costs Current expenses held constant through the life of the property. D. Curtailment For curtailed gas wells, curtailed rates were based on the first six months of 1998 rate as a percent of 1998 capacity, then relieved over a two-year period, i.e., 100% at 1/1/01. E. Discount Rate 10% per year. Attachment 2 PROVED RESERVES DEFINITIONS IN ACCORDANCE WITH SECURITIES AND EXCHANGE COMMISSION REGULATION S-X PROVED OIL AND GAS RESERVES - --------------------------- Proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements but not on escalations based upon future conditions. 1. Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (a) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and (b) the immediately adjoining portions not yet drilled but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. 2. Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the proved classification when successful testing by a pilot project or the operation of an installed program in the reservoirs provides support for the engineering analysis on which the project or program was based. 3. Estimates of proved reserves do not include the following: a. Oil that may become available from known reservoirs but is classified separately as indicated additional reserves. b. Crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors. c. Crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects. d. Crude oil, natural gas, and natural gas liquids, that may be recovered from oil shales, coal, gilsonite, and other such sources. Depending upon their status of development, proved reserves are subdivided into proved developed reserves and proved undeveloped reserves. PROVED DEVELOPED OIL AND GAS RESERVES - ------------------------------------- Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as proved developed reserves only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. PROVED UNDEVELOPED OIL AND GAS RESERVES - --------------------------------------- Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir. EXHIBIT B [LETTERHEAD OF MILLER & LENTS, LTD. APPEARS HERE] January 20, 1999 Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, TX 76102 Re: Hugoton Royalty Trust 80% Net Profits Interests As of January 1, 1999 SEC Pricing Case Gentlemen: At your request, we estimated the proved reserves and future net revenue as of January 1, 1999, attributable to the Hugoton Royalty Trust interest in certain oil and gas properties that consist of approximately 1,679 wells located primarily in Kansas, Oklahoma, and Wyoming. The aggregate results of our evaluations are as follows:
Net Reserves as of 1/1/99 Future Net Revenue ------------------------------------------------------------------------ Oil and Condensate, Gas, Undiscounted, Discounted at Reserves Category MBbls. MMcf M$ 10% Per Year, M$ - ------------------------------------------------------------------------------------------------------- Kansas - ------------------------------------------------------------------------------------------------------- Proved Developed Producing 28.4 25,987.1 36,245.2 19,813.8 - ------------------------------------------------------------------------------------------------------- Proved Nonproducing 0.0 240.4 275.6 141.0 - ------------------------------------------------------------------------------------------------------- Proved Undeveloped 0.0 1,141.6 1,359.0 408.5 - ------------------------------------------------------------------------------------------------------- Subtotal 28.4 27,369.1 37,879.8 20,363.3 - ------------------------------------------------------------------------------------------------------- Oklahoma - ------------------------------------------------------------------------------------------------------- Proved Developed Producing 1,667.2 135,345.9 262,731.0 153,701.5 - ------------------------------------------------------------------------------------------------------- Proved Nonproducing 117.9 8,140.8 16,548.6 9,775.8 - ------------------------------------------------------------------------------------------------------- Proved Undeveloped 231.7 13,898.2 28,137.4 10,546.0 - ------------------------------------------------------------------------------------------------------- Subtotal 2,016.8 157,384.9 307,417.0 174,023.3 - ------------------------------------------------------------------------------------------------------- Wyoming - ------------------------------------------------------------------------------------------------------- Proved Developed Producing 107.4 75,219.7 149,479.4 70,832.7 - ------------------------------------------------------------------------------------------------------- Proved Nonproducing 13.2 4,280.7 8,650.1 4,139.0 - ------------------------------------------------------------------------------------------------------- Proved Undeveloped 27.5 18,042.9 36,188.2 8,383.2 - ------------------------------------------------------------------------------------------------------- Subtotal 148.1 97,543.3 194,317.7 83,354.9 - ------------------------------------------------------------------------------------------------------- Total Hugoton Royalty Trust - ------------------------------------------------------------------------------------------------------- Proved Developed Producing 1,803.0 236,552.7 448,455.6 244,348.0 - ------------------------------------------------------------------------------------------------------- Proved Nonproducing 131.1 12,661.9 25,474.3 14,055.8 - ------------------------------------------------------------------------------------------------------- Proved Undeveloped 259.2 33,082.7 65,684.6 19,337.7 - ------------------------------------------------------------------------------------------------------- TOTAL 2,193.3 282,297.3 539,614.5 277,741.5 - -------------------------------------------------------------------------------------------------------
MILLER AND LENTS, LTD. Cross Timbers Oil Company January 20, 1999 Page 2 We performed evaluations, which are designated as the SEC Pricing Case, using price, expense, and gas production curtailment premises specified by you and described in detail on Attachment 1. The Hugoton Royalty Trust interests evaluated herein are comprised of an 80 percent net overriding royalty interest of certain Cross Timbers Oil Company properties. At your instruction, the net oil and condensate reserves and the net natural gas reserves attributable to the Hugoton Royalty Trust interests were computed from 80 percent of the Cross Timbers Oil Company interests in those properties after adjustment for the estimated reserves attributable to the future operating expenses and capital costs. As a result of this procedure, a change in the future costs, or prices, or capital expenditures different from those projected herein may result in a change in the computed reserves to the net interests even if there are no revisions or additions to the gross reserves attributed to the property. Proved reserves and future net revenue were estimated in accordance with the provisions contained in Securities and Exchange Commission Regulation S-X, Rule 4-10. The Securities and Exchange Commission definition of proved reserves is shown on Attachment 2. Estimates of future net revenue and discounted future net revenue are not intended and should not be interpreted to represent fair market values for the estimated reserves. Future costs of abandoning facilities and wells and of the restoration of producing properties to satisfy environmental standards were not deducted from total revenues as such estimates are beyond the scope of this assignment. Following Attachment 2 is a list of exhibits which include annual projections of future production and net revenue for each state and reserve category. Also included in the exhibits are one-line summaries for the total royalty trust and for each state showing the proved reserves and future net revenue for the individual properties. Projections of individual property future production and net revenue are included in separate volumes to this report. These exhibits and volumes should not be relied upon independently of this narrative. The proved developed producing reserves and production forecasts were estimated by production decline extrapolations, water-oil ratio trends, P/Z declines, or in a few cases, by volumetric calculations. For some properties with insufficient performance history to establish trends, we estimated future production by analogy with other properties with similar characteristics. The past performance trends of many properties were influenced by production curtailments, workovers, waterfloods, and/or infill drilling. Actual future production may require that our estimated trends be significantly altered. The estimated proved undeveloped reserves require significant capital expenditures such as drilling and completion costs. The proved undeveloped reserve estimates for infill wells are based on analogies to similar infill wells in the same field and/or the production histories of offset wells in the same field. Reserve estimates from volumetric calculations and from analogies are often less certain than reserve estimates based on well performance obtained over a period during which a substantial portion of the reserves was produced. MILLER AND LENTS, LTD. Cross Timbers Oil Company January 20, 1999 Page 3 With the exception of a few properties, the data employed in our determinations of proved reserves and future net income were provided by Cross Timbers Oil Company. We obtained pressure and production information from independent sources for some properties that had insufficient data from Cross Timbers Oil Company to employ as bases for reserve estimates. The current expenses for each lease were obtained from operating statements provided by Cross Timbers Oil Company except for certain leases where Cross Timbers Oil Company deducted items considered by Cross Timbers Oil Company to be nonrecurring expenditures. No overhead was included for those properties operated by Cross Timbers Oil Company. For some properties, such as large waterfloods, Cross Timbers Oil Company assumed a decline in variable operating costs due to depleting production which was derived by forecasting a decrease in the property well count. None of the data provided to us by Cross Timbers Oil Company, including, but not limited to, graphical representations and tabulations of past production performance, well tests and pressures, ownership interests, prices, and operating costs, were verified by us as such was not within the scope of our assignment. The evaluations presented in this report, with the exceptions of those parameters specified by others, reflect our informed judgments based on accepted standards of professional investigation but are subject to those generally recognized uncertainties associated with interpretation of geological, geophysical, and engineering information. Government policies and market conditions different from those employed in this study may cause the total quantity of oil or gas to be recovered, actual production rates, prices received, or operating and capital costs to vary from those presented in this report. Our workpapers and data are in our files and available for review upon request. If you have any questions regarding the above, or if we can be of further assistance, please call. Very truly yours, MILLER AND LENTS, LTD. By /s/ Karen F. Loving ---------------------------- Karen F. Loving Vice President KFL/hsd Attachment 1 1-1-99 Hugoton Royalty Trust 80% Net Profits Interests SEC PRICING CASE A. Oil Price All oil/condensate prices held constant at $9.50 per barrel through the life of the property. (Adjust for gravity, transportation charges, and crude marketing arrangements.) B. Gas Price Estimated 1/1/99 price held constant through the life of the property. C. Operating Costs Current expenses held constant through the life of the property. D. Curtailment For curtailed gas wells, curtailed rates were based on the first six months of 1998 rate as a percent of 1998 capacity, then relieved over a two-year period, i.e., 100% at 1/1/01. E. Discount Rate 10% per year. Attachment 2 PROVED RESERVES DEFINITIONS IN ACCORDANCE WITH SECURITIES AND EXCHANGE COMMISSION REGULATION S-X PROVED OIL AND GAS RESERVES - --------------------------- Proved oil and gas reserves are the estimated quantities of crude oil, natural gas, and natural gas liquids which geological and engineering data demonstrate with reasonable certainty to be recoverable in future years from known reservoirs under existing economic and operating conditions, i.e., prices and costs as of the date the estimate is made. Prices include consideration of changes in existing prices provided only by contractual arrangements but not on escalations based upon future conditions. 1. Reservoirs are considered proved if economic producibility is supported by either actual production or conclusive formation test. The area of a reservoir considered proved includes (a) that portion delineated by drilling and defined by gas-oil and/or oil-water contacts, if any, and (b) the immediately adjoining portions not yet drilled but which can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of information on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. 2. Reserves which can be produced economically through application of improved recovery techniques (such as fluid injection) are included in the proved classification when successful testing by a pilot project or the operation of an installed program in the reservoirs provides support for the engineering analysis on which the project or program was based. 3. Estimates of proved reserves do not include the following: a. Oil that may become available from known reservoirs but is classified separately as indicated additional reserves. b. Crude oil, natural gas, and natural gas liquids, the recovery of which is subject to reasonable doubt because of uncertainty as to geology, reservoir characteristics, or economic factors. c. Crude oil, natural gas, and natural gas liquids, that may occur in undrilled prospects. d. Crude oil, natural gas, and natural gas liquids, that may be recovered from oil shales, coal, gilsonite, and other such sources. Depending upon their status of development, proved reserves are subdivided into proved developed reserves and proved undeveloped reserves. PROVED DEVELOPED OIL AND GAS RESERVES - ------------------------------------- Proved developed oil and gas reserves are reserves that can be expected to be recovered through existing wells with existing equipment and operating methods. Additional oil and gas expected to be obtained through the application of fluid injection or other improved recovery techniques for supplementing the natural forces and mechanisms of primary recovery should be included as proved developed reserves only after testing by a pilot project or after the operation of an installed program has confirmed through production response that increased recovery will be achieved. PROVED UNDEVELOPED OIL AND GAS RESERVES - --------------------------------------- Proved undeveloped oil and gas reserves are reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required for recompletion. Reserves on undrilled acreage shall be limited to those drilling units offsetting productive units that are reasonably certain of production when drilled. Proved reserves for other undrilled units can be claimed only where it can be demonstrated with certainty that there is continuity of production from the existing productive formation. Under no circumstances should estimates for proved undeveloped reserves be attributable to any acreage for which an application of fluid injection or other improved recovery technique is contemplated, unless such techniques have been proved effective by actual tests in the area and in the same reservoir. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell the Trust Units offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date. --------------- TABLE OF CONTENTS
Page ---- Prospectus Summary......................................................... 3 Risk Factors............................................................... 10 Forward Looking Statements................................................. 15 Use of Proceeds............................................................ 15 Cross Timbers.............................................................. 15 The Trust.................................................................. 15 Hypothetical Annual Cash Distributions..................................... 16 The Net Profits Interests and the Underlying Properties.................... 20 Computation of Net Proceeds................................................ 33 Federal Income Tax Consequences............................................ 36 State Tax Considerations................................................... 41 ERISA Considerations....................................................... 42 Description of the Trust Indenture......................................... 43 Description of the Trust Units............................................. 46 Selling Trust Unitholder................................................... 49 Legal Matters.............................................................. 49 Experts.................................................................... 49 Available Information...................................................... 50 Glossary of Certain Oil and Natural Gas Terms.............................. 51 Index to Financial Statements.............................................. F-1 Underwriting............................................................... U-1
--------------- Through and including , 1999 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer's obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 15,000,000 Trust Units Hugoton Royalty Trust --------------- PROSPECTUS --------------- Goldman, Sachs & Co. Lehman Brothers Bear, Stearns & Co. Inc. Dain Rauscher Wessels a division of Dain Rauscher Incorporated Donaldson, Lufkin & Jenrette A.G. Edwards & Sons, Inc. Representatives of the Underwriters - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PART II INFORMATION NOT REQUIRED IN PROSPECTUS All capitalized terms used and not defined in Part II of this Registration Statement shall have the meanings assigned to them in the Prospectus forming a part of this Registration Statement. Item 14. Other Expenses of Issuance and Distribution. Except for the Registration Fee and the NASD Filing Fee, the following itemized table sets forth estimates of those expenses payable by the Company in connection with the offer and sale of the securities offered hereby: Registration Fee................................................... $ 47,955 NASD Filing Fee.................................................... 17,750 Printing and Engraving Expenses.................................... 200,000 Legal Fees and Expenses............................................ 175,000 Accountants' Fees and Expenses..................................... 60,000 Miscellaneous Fees and Expenses.................................... 149,295 -------- Total.............................................................. $650,000 ========
Item 15. Indemnification of Directors and Officers. Section 6.02 of the Trust Indenture provides that the trustee will be indemnified by the trust estate or, if Trust assets are insufficient, by Cross Timbers Oil Company, a Delaware corporation (the "Company"), against any and all liability and expenses incurred by it individually or as Trustee in the administration of the trust and the trust estate, except for any liability or expense resulting from fraud or gross negligence or acts or omissions in bad faith. The Company is incorporated in Delaware. Under Section 145 of the Delaware General Corporation Law (the "DGCL"), a Delaware corporation has the power, under specified circumstances, to indemnify its directors, officers, employees and agents in connection with actions, suits or proceedings brought against them by a third party or in the right of the corporation, by reason that they were or are such directors, officers, employees or agents, against expenses and liabilities incurred in any such action, suit or proceeding so long as they acted in good faith and in a manner that they reasonably believed to be in, or not opposed to, the best interests of such corporation, and with respect to any criminal action, that they had no reasonable cause to believe their conduct was unlawful. With respect to suits by or in the right of such corporation, however, indemnification is generally limited to attorneys' fees and other expenses and is not available if such person is adjudged to be liable to such corporation unless the court determines that indemnification is appropriate. A Delaware corporation also has the power to purchase and maintain insurance for such persons. Article Nine of the Certificate of Incorporation of the Company permits indemnification of directors and officers to the fullest extent permitted by Section 145 of the DGCL. Reference is made to the Certificate of Incorporation of the Company. Section 102(b)(7) of the DGCL provides that a certificate of incorporation may contain a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, provided that such provisions may not eliminate or limit the liability of a director (i) for any breach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 (relating to liability for unauthorized acquisitions or redemptions of, or dividends on, capital stock) of the DGCL or (iv) for any transaction from which the director derived an improper personal benefit. Article Ten of the Company's Certificate of Incorporation contains such a provision. II-1 The above discussion of the Company's Certificate of Incorporation and of Sections 102(b)(7) and 145 of the DGCL is not intended to be exhaustive and is qualified in its entirety by such Certificate of Incorporation and statutes. Additionally, the Company has acquired directors' and officers' insurance in the amount of $10 million. Item 16. Exhibits.
Exhibit Number Description ------- ----------- 1.1 --Form of Underwriting Agreement. 4.1* --Hugoton Royalty Trust Indenture. 5.1 --Opinion of Kelly, Hart & Hallman, P.C. as to legality of the securities registered hereby. 8.1 --Opinion of Butler & Binion, L.L.P. regarding federal income tax matters. 8.2 --Opinion of Morris, Laing, Evans, Brock & Kennedy, Chartered as to Kansas State tax matters. 10.1 --Form of 80% Net Overriding Royalty Conveyance--Kansas. 10.2 --Form of 80% Net Overriding Royalty Conveyance--Oklahoma. 10.3 --Form of 80% Net Overriding Royalty Conveyance--Wyoming. 15.1 --Awareness letter of Arthur Andersen LLP. 23.1 --Consent of Arthur Andersen LLP. 23.2 --Consent of Kelly, Hart & Hallman, P.C. (set forth in their opinion filed as Exhibit 5.1). 23.3 --Consent of Butler & Binion, L.L.P. (set forth in their opinion filed as Exhibit 8.1). 23.4 --Consent of Morris, Laing, Evans, Brock & Kennedy, Chartered (set forth in their opinion filed as Exhibit 8.2). 23.5 --Consent of Miller & Lents. 24.1* --Powers of attorney (set forth on the signature page of the original filing). 27.1 --Financial Data Schedule.
- -------- * Previously filed. Item 17. Undertakings. The Company hereby undertakes: (a) that, for purposes of determining any liability under the Securities Act of 1933, each filing of the Company's annual reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan's annual report pursuant to Section 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in the Registration Statement shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. (b) to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser. (c) for purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed a part of this registration statement as of the time it was declared effective. II-2 (d) for the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Company has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore unenforceable. In the event that claim for indemnification against such liabilities (other than the payment by the Trust or Company of expenses incurred or paid by a director, officer or controlling person in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered the Trust or Company will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue. II-3 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Company certifies that it has reasonable grounds to believe that it meets all the requirements for filing on Form S-3 and has duly caused this Amendment to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Fort Worth, State of Texas, on January 25, 1999. CROSS TIMBERS OIL COMPANY, By /s/ J. Richard Seeds ----------------------------------- J. Richard Seeds Executive Vice President HUGOTON ROYALTY TRUST By CROSS TIMBERS OIL COMPANY, as sponsor By /s/ J. Richard Seeds ------------------------------- J. Richard Seeds Executive Vice President Pursuant to the requirements of the Securities Act of 1933, this Amendment to Registration Statement has been signed by the following persons in the capacities and on the dates indicated. /s/ Bob R. Simpson* Director, Chairman of the January 25, 1999 ______________________________________ Board and Chief Executive Bob R. Simpson Officer (Principal Executive Officer) /s/ Steffen E. Palko* Director, Vice Chairman of January 25, 1999 ______________________________________ the Board and President Steffen E. Palko /s/ J. Richard Seeds Director, Executive Vice January 25, 1999 ______________________________________ President J. Richard Seeds /s/ J. Luther King, Jr.* Director January 25, 1999 ______________________________________ J. Luther King, Jr. /s/ Jack P. Randall* Director January 25, 1999 ______________________________________ Jack P. Randall /s/ Scott G. Sherman* Director January 25, 1999 ______________________________________ Scott G. Sherman /s/ Louis G. Baldwin Senior Vice President and January 25, 1999 ______________________________________ Chief Financial Officer Louis G. Baldwin (Principal Financial Officer) /s/ Bennie G. Kniffen Senior Vice President and January 25, 1999 ______________________________________ Controller (Principal Bennie G. Kniffen Accounting Officer)
/s/ J. Richard Seeds *By: ------------------------------ J. Richard Seeds Attorney-in-Fact II-4 EXHIBIT INDEX
Exhibit Number Description ------- ----------- 1.1 --Form of Underwriting Agreement. 5.1 --Opinion of Kelly, Hart & Hallman, P.C. as to legality of the securities registered hereby. 8.1 --Opinion of Butler & Binion, L.L.P. regarding federal income tax matters. 8.2 --Opinion of Morris, Laing, Evans, Brock & Kennedy, Chartered as to Kansas State tax matters. 10.1 --Form of 80% Net Overriding Royalty Conveyance--Kansas. 10.2 --Form of 80% Net Overriding Royalty Conveyance--Oklahoma. 10.3 --Form of 80% Net Overriding Royalty Conveyance--Wyoming. 15.1 --Awareness letter of Arthur Andersen LLP. 23.1 --Consent of Arthur Andersen LLP. 23.5 --Consent of Miller & Lents. 27.1 --Financial Data Schedule.
EX-1.1 2 FORM OF UNDERWRITING AGREEMENT EXHIBIT 1.1 Hugoton Royalty Trust Trust Units ---------- Underwriting Agreement ____________________, 1999 Hugoton Royalty Trust Trust Units --------- Underwriting Agreement ---------------------- ______________, 1999 Goldman, Sachs & Co., Lehman Brothers Inc. A.G. Edwards & Sons, Inc. Bear, Stearns & Co. Dain Rauscher Wessels a division of Dain Rauscher Incorporated Donaldson, Lufkin & Jenrette Securities Corporation, As representatives of the several Underwriters named in Schedule I hereto, c/o Goldman, Sachs & Co., 85 Broad Street New York, New York 10004 Dear Sirs: Cross Timbers Oil Company, a Delaware corporation (the "Company"), proposes, subject to the terms and conditions stated herein, to sell to the Underwriters named in Schedule I hereto (the "Underwriters") an aggregate of 15,000,000 units of beneficial interest ("Trust Units") in Hugoton Royalty Trust, a grantor trust formed under the laws of the State of Texas (the "Trust"), and, at the election of the Underwriters, up to 2,250,000 additional Trust Units. The aggregate of 15,000,000 Trust Units to be sold by the Company is herein called the "Firm Units" and the aggregate of 2,250,000 additional Trust Units to be sold by the Company at the election of the Underwriters is herein called the "Optional Units." The Firm Units and the Optional Units which the Underwriters elect to purchase pursuant to Section 2 hereof are referred to herein collectively as the "Units." 1. The Company represents and warrants to, and agrees with, each of the Underwriters that: (i) A joint registration statement of the Trust (on Form S-1) and the Company (on Form S-3) (File No. 333-68441) (the "Initial Registration Statement") in respect of the Units has been filed with the Securities and Exchange Commission (the "Commission"); the Initial Registration Statement and any post-effective amendment thereto, each in the form heretofore delivered to you, and, excluding exhibits thereto but including all documents incorporated by reference in the prospectus contained therein, to you for each of the other Underwriters, have been declared effective by the Commission in such form; other than a registration statement, if any, increasing the size of the offering (a "Rule 462(b) Registration Statement"), filed pursuant to Rule 462(b) under the Securities Act of 1933, as amended (the "Act"), which became effective upon filing, no other document with respect to the Initial Registration Statement or document incorporated by reference therein has heretofore been filed with the Commission; and no stop order suspending the effectiveness of the Initial Registration Statement, any post-effective amendment thereto or the Rule 462(b) Registration Statement, if any, has been issued and no proceeding for that purpose has been initiated or threatened by the Commission (any preliminary prospectus included in the Initial Registration Statement or filed with the Commission pursuant to Rule 424(a) of the rules and regulations of the Commission under the Act, is hereinafter called a "Preliminary Prospectus;" the various parts of the Initial Registration Statement and the Rule 462(b) Registration Statement, if any, including all exhibits thereto and including (i) the information contained in the form of final prospectus filed with the Commission pursuant to Rule 424(b) under the Act in accordance with Section 5(a) hereof and deemed by virtue of Rule 430A under the Act to be part of the Initial Registration Statement at the time it was declared effective and (ii) the documents incorporated by reference in the prospectus contained in the Initial Registration Statement at the time such part of the Initial Registration Statement became effective, each as amended at the time such part of the Initial Registration Statement became effective or such part of the Rule 462(b) Registration Statement, if any, became or hereafter becomes effective, are hereinafter collectively called the "Registration Statement;" such final prospectus, in the form first filed pursuant to Rule 424(b) under the Act, is hereinafter called the "Prospectus;" and any reference herein to any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include the documents incorporated by reference therein pursuant to Item 12 of Form S-3 under the Act, as of the date of such Preliminary Prospectus or Prospectus, as the case may be; any reference to any amendment or supplement to any Preliminary Prospectus or the Prospectus shall be deemed to refer to and include any documents filed after the date of such Preliminary Prospectus or Prospectus, as the case may be, under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and incorporated by reference in such Preliminary Prospectus or Prospectus, as the case may be; and any reference to any amendment to the Registration Statement shall be deemed to refer to and include any annual report of the Company filed pursuant to Section 13(a) or 15(d) of the Exchange Act after the effective date of the Initial Registration Statement that is incorporated by reference in the Registration Statement); (ii) No order preventing or suspending the use of any Preliminary Prospectus has been issued by the Commission, and each Preliminary Prospectus, at the time of filing thereof, conformed in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder, and did not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein; (iii) The documents incorporated by reference in the Prospectus, when they became effective or were filed with the Commission, as the case may be, conformed in all material -2- respects to the requirements of the Act or the Exchange Act, as applicable, and the rules and regulations of the Commission thereunder, and none of such documents contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and any further documents so filed and incorporated by reference in the Prospectus or any further amendment or supplement thereto, when such documents become effective or are filed with the Commission, as the case may be, will conform in all material respects to the requirements of the Act or the Exchange Act, as applicable, and the rules and regulations of the Commission thereunder and will not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein; (iv) The Registration Statement conforms, and the Prospectus and any further amendments or supplements to the Registration Statement or the Prospectus will conform, in all material respects to the requirements of the Act and the rules and regulations of the Commission thereunder and do not and will not, as of the applicable effective date as to the Registration Statement and any amendment thereto and as of the applicable filing date as to the Prospectus and any amendment or supplement thereto, contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, that this representation and warranty shall not apply to any statements or omissions made in reliance upon and in conformity with information furnished in writing to the Company by an Underwriter through Goldman, Sachs & Co. expressly for use therein; (v) The Trust has not sustained since the date of its formation any material loss or interference with respect to the Underlying Properties (as defined in the Prospectus) from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus; and, since the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been (a) any change in the number of outstanding Trust Units or (b) any material adverse change, or any development involving a prospective material adverse change, in or affecting the general affairs, financial position, or results of operations of the Trust, or management of the Underlying Properties, otherwise than as set forth or contemplated in the Prospectus; (vi) Neither the Company nor any of its subsidiaries has sustained since the date of the latest audited financial statements incorporated by reference in the Prospectus any material loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus; and, since the respective dates as of which information is given in the Registration Statement and the Prospectus, there has not been any change in the long-term debt of the Company or any of its subsidiaries or any material adverse -3- change, or any development involving a prospective material adverse change, in or affecting the general affairs, management, financial position, stockholders' equity or results of operations of the Company and its subsidiaries, otherwise than as set forth or contemplated in the Prospectus; (vii) (a) The Company has good and defensible title to the Underlying Properties, free and clear of all liens, encumbrances and defects, except (A) royalties, overriding royalties and other burdens under oil and gas leases, (B) easements, restrictions, rights-of-way and other matters that commonly affect property, (C) liens securing taxes and other governmental charges, or claims of materialmen, mechanics and similar persons, not yet due and payable, (D) liens and encumbrances under operating agreements, farmout agreements, unitization, pooling and commutation agreements, declarations and orders, and gas sales contracts, securing payment of amounts not yet due and payable and of a scope and nature customary in the oil and gas industry and (E) liens, encumbrances and defects that do not in the aggregate materially affect the value of the Underlying Properties or materially interfere with the use made or proposed to be made of such Underlying Properties by the Company; (b) the working interests in oil, gas and mineral leases or mineral interests which constitute a portion of the Underlying Properties held by the Company reflect in all material respects the right of the Company to explore or receive production from such Underlying Properties, and the care taken by the Company and its subsidiaries with respect to acquiring or otherwise procuring such leases or mineral interests was generally consistent with standard industry practices for acquiring or procuring leases and interests therein to explore such for hydrocarbons; and (c) the Trust has good and defensible title to the Net Profits Interests (as defined in the Prospectus), free and clear of all liens, encumbrances and defects, except liens securing taxes and other governmental charges and liens, encumbrances and defects that do not in the aggregate materially affect the value of the Net Profits Interests; (viii) The Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and conduct its business as described in the Prospectus, and has been duly qualified as a foreign corporation for the transaction of business and is in good standing under the laws of each other jurisdiction in which it owns or leases properties or conducts any business so as to require such qualification, or is subject to no material liability or disability by reason of the failure to be so qualified in any such jurisdiction, and each subsidiary of the Company has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation; (ix) (a) The Trust has been duly formed and is validly existing as a grantor trust under the laws of the State of Texas, with full trust power and authority to own its properties as described in the Prospectus; (b) the Royalty Trust Indenture, dated as of December 1, 1998, between the Company, as Grantor, and NationsBank, N.A., a banking association organized under the laws of the United States with its principal place of business in Dallas, Texas (the "Trustee"), as trustee, (such Royalty Trust Indenture being herein referred to as the "Indenture"), has been authorized, executed and delivered by the Company and the Trustee; (c) the Indenture is a valid and binding obligation of the Company enforceable against the Company in accordance with its terms, except -4- as the enforceability thereof may be limited by (A) bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors generally, and (B) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law); (d) the Net Overriding Royalty Conveyance (Oklahoma) dated as of December 1, 1998 by the Company in favor of the Trustee, as trustee in trust, the Net Overriding Royalty Conveyance (Kansas) dated as of December 1, 1998 by the Company in favor of the Trustee, as trustee in trust, and the Net Overriding Royalty Conveyance (Wyoming) dated as of December 1, 1998 by the Company in favor of the Trustee, as trustee in trust, (collectively, the "Conveyances"), will be duly authorized, executed and delivered by the Company and will be valid and binding obligations of the Company enforceable against the Company, except as the enforceability of each may be limited by (A) bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally, and (B) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law); (e) at the Closing, the Company will have made all necessary filings in the jurisdictions referred to in the Conveyances or, with respect to Net Profits Interests burdening Federal or Indian lands, under Federal law, including without limitation the filing of the Conveyances for recordation in the appropriate records pursuant to local recordation laws or, with respect to Net Profits Interests burdening Federal and Indian lands, pursuant to applicable Federal law; (f) the Indenture conforms and the Conveyances will conform in all material respects to the descriptions thereof in the Prospectus; (g) at the Closing, the Company will have assigned and contributed to the Trust the Net Profits Interests as described in the Prospectus and (h) holders of the certificates representing the Trust Units are entitled to the benefits of the Indenture; (x) There are 40,000,000 Trust Units authorized and issued under the Indenture; the Trust Units to be sold by the Company to the Underwriters hereunder have been duly and validly authorized and issued without the requirement for payment of any further consideration and conform to the description of the Trust Units contained in the Prospectus; and, except as set forth in the Prospectus; (xi) The Company has, and immediately prior to each Time of Delivery (as defined in Section 4 hereof) the Company will have, good and valid title to the Trust Units to be sold by the Company hereunder, free and clear of all liens, encumbrances, equities or claims, and the Company has full corporate power and authority to sell, assign, transfer and deliver such Trust Units hereunder; and, upon the delivery of such Trust Units and payment therefor pursuant hereto, good and valid title to such Trust Units, free and clear of all liens, encumbrances, equities or claims, will pass to the several Underwriters; (xii) All consents, approvals, authorizations and orders necessary for the transfer of the Net Profits Interests to the Trust as described in the Prospectus have been obtained and such transfer has not had the effect of creating any lien, claim, encumbrance or equity of any kind in favor of any person with respect to any of the Net Profits Interests (including any preferential right of purchase, or, with respect to any properties in which Grantor has acted as operator, any right to remove the Grantor as operator) except (i) to the extent such rights have been validly waived in -5- writing or (ii) to the extent such liens, claims, encumbrances or equities, which, if asserted or exercised, would not have a material adverse effect on the value of the Trust Units; (xiii) The formation of the Trust by the execution and delivery of the Indenture and the transfer of the Net Profits Interests by the Company to the Trust by the execution and delivery of the Conveyances, the sale of the Trust Units to be sold by the Company hereunder, the compliance by the Company and the Trust with all of the provisions of this Agreement, the Indenture and the Conveyances and the consummation of the transactions herein contemplated will not conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, the Indenture or any other indenture, mortgage, deed of trust, loan agreement or other agreement or instrument to which the Company or any of its subsidiaries or the Trust is a party or by which the Company or any of its subsidiaries or the Trust is bound or to which any of the property or assets of the Company or any of its subsidiaries or the Net Profit Interests is subject, nor will such action result in any violation of the provisions of the Certificate of Incorporation or Bylaws of the Company, the Indenture, or any statute or any order, rule or regulation of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or any of their properties; and no consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body is required for the sale of the Trust Units or the consummation by the Company of the transactions contemplated by this Agreement, except the registration under the Act of the Trust Units and such consents, approvals, authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Trust Units by the Underwriters; (xiv) Neither the Company nor any of its subsidiaries is in violation of its Certificate of Incorporation or Bylaws or in default in the performance or observance of any material obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, loan agreement, lease or any other agreement or instrument to which it is a party or by which it or any of its properties may be bound; (xv) The statements set forth in the Prospectus under the caption "Description of the Trust Units," insofar as they purport to constitute a summary of the terms of the Trust Units, and the statements under the captions "Federal Income Tax Consequences," and "State Tax Considerations" and "Underwriting," fairly and accurately describe the provisions of the laws and documents referred to therein in all material respects; (xvi) Other than as set forth in the Prospectus, there are no legal or governmental proceedings pending to which the Company or any of its subsidiaries or the Trust is a party or of which any property of the Company or any of its subsidiaries or the Net Profits Interests is the subject which, if determined adversely to the Company or any of its subsidiaries or the Trust or the Net Profits Interests, would individually or in the aggregate have a material adverse effect on the Net Profits Interests or the current or future consolidated financial position, owners' equity or results of operations of the Company and its subsidiaries or the Trust; and, to the best of the Company's -6- knowledge, no such proceedings are threatened or contemplated by governmental authorities or threatened by others; (xvii) Arthur Andersen L.L.P., who have certified certain financial statements of the Trust and the Underlying Properties included in the Prospectus and certain financial statements of the Company and its subsidiaries incorporated by reference therein, are independent public accountants as required by the Act and the rules and regulations of the Commission thereunder; (xviii) Neither the Company nor the Trust is or, after giving effect to the offering and sale of Trust Units, will be an "investment company" as such term is defined in the Investment Company Act of 1940, as amended (the "Investment Company Act"); (xix) Neither the Company nor any of its affiliates does business with the government of Cuba or with any person or affiliate located in Cuba within the meaning of Section 517.075, Florida Statutes; (xx) The Company has reviewed its operations and that of its subsidiaries and is in the process of reviewing the relevant operations of third parties with which the Company or any of its subsidiaries has a material relationship to evaluate the extent to which the business or operations of the Company or any of its subsidiaries will be affected by the Year 2000 Problem. As a result of such review, the Company has no reason to believe, and does not believe, that the Year 2000 Problem will have a material adverse effect on the general affairs, management, the current or future consolidated financial position, business prospects, stockholders' equity or results of operations of the Company and its subsidiaries or result in any material loss or interference with the Company's business or operations. The "Year 2000 Problem" as used herein means any significant risk that computer hardware or software used in the receipt, transmission, processing, manipulation, storage, retrieval, retransmission or other utilization of data or in the operation of mechanical or electrical systems of any kind will not, in the case of dates or time periods occurring after December 31, 1999, function at least as effectively as in the case of dates or time periods occurring prior to January 1, 2000; (xxi) The information supplied by the Company to its independent petroleum engineering consultants for purposes of preparing the reserve reports used to calculate estimates of reserves of the Trust and the Underlying Properties included in the Registration Statement, including, without limitation, production, costs of operation and development, current prices for production, agreements relating to current and future operations and sales of production, was true and correct in all material respects on the date supplied and was prepared in accordance with customary industry practices; Miller and Lents, Ltd., independent consulting petroleum engineers, who prepared estimates of the extent and value of proved oil and natural gas reserves of the Underlying Properties, are independent with respect to the Company and the Trust; (xxii) At the First Time of Delivery (as defined in Section 4), except for liens and encumbrances described in clauses (A), (B), (C) and (D) of Section 1(vii)(a) hereof, (a) any and all -7- liens or encumbrances on the Underlying Properties will be subordinated to the Net Profits Interests, and (b) all future liens or encumbrances on the Underlying Properties shall be subordinate and inferior to the Net Profits Interests; (xxiii) The Company has not taken and will not take, directly or indirectly, any action which is designed to or which has constituted or which might reasonably be expected to cause or result in stabilization or manipulation of the price of Trust Units or any security of the Company to facilitate the sale or resale of the Trust Units; and (xxiv) No consent, approval, authorization or filing is required under any law, rule or regulation of the States of Texas, Kansas, Oklahoma or Wyoming, or of the United States of America in order to permit the Trustee to act as Trustee of the Trust. 2. Subject to the terms and conditions herein set forth, (a) the Company agrees to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company at a purchase price of $______ per Trust Unit, the number of Firm Units set forth opposite the name of such Underwriter in Schedule I hereto and (b) in the event and to the extent that the Underwriters shall exercise the election to purchase Optional Units as provided below, the Company agrees to sell to each of the Underwriters, and each of the Underwriters agrees, severally and not jointly, to purchase from the Company, at the purchase price per Trust Unit set forth in clause (a) of this Section 2, that portion of the number of Optional Units as to which such election shall have been exercised (to be adjusted by you so as to eliminate fractional Trust Units) determined by multiplying such number of Optional Units by a fraction the numerator of which is the maximum number of Optional Units which such Underwriter is entitled to purchase as set forth opposite the name of such Underwriter in Schedule I hereto and the denominator of which is the maximum number of Optional Units which all of the Underwriters are entitled to purchase hereunder. The Company hereby grants to the Underwriters the right to purchase at their election up to 2,250,000 Optional Units, at the purchase price per Trust Unit set forth in the paragraph above, for the sole purpose of covering over- allotments in the sale of the Firm Units. Any such election to purchase Optional Units shall be made in proportion to the maximum number of Optional Units to be sold by the Company. Any such election to purchase Optional Units may be exercised only by written notice from you to the Company, given within a period of 30 calendar days after the date of this Agreement and setting forth the aggregate number of Optional Units to be purchased and the date on which such Optional Units are to be delivered, as determined by you but in no event earlier than the First Time of Delivery (as defined in Section 4 hereof) or, unless you and the Company otherwise agree in writing, earlier than two or later than ten business days after the date of such notice. 3. Upon the authorization by you of the release of the Firm Units, the several Underwriters propose to offer the Firm Units for sale upon the terms and conditions set forth in the Prospectus. -8- 4. (a) The Trust Units to be purchased by each Underwriter hereunder, in definitive form and in such denominations and registered in such names as Goldman, Sachs & Co. may request upon at least forty-eight hours' prior notice to the Company shall be delivered by or on behalf of the Company to Goldman, Sachs & Co. through the facilities of The Depository Trust Company for the account of such Underwriter, against payment on behalf of such Underwriter of the purchase price therefor by wire transfer of federal (same-day) funds to the account specified by the Company, to Goldman, Sachs & Co. at least forty-eight hours in advance. The Company will cause the certificates representing the Trust Units to be made available for checking and packaging at least twenty-four hours prior to the Time of Delivery (as defined below) with respect thereto at the office of The Depository Trust Company or its designated custodian (the "Designated Office"). The time and date of such delivery and payment shall be, with respect to the Firm Units, 9:30 a.m., New York City time, on _______________, 1999 or such other time and date as Goldman, Sachs & Co. and the Company may agree upon in writing, and, with respect to the Optional Units, 9:30 a.m., New York City time, on the date specified by Goldman, Sachs & Co. in the written notice given by Goldman, Sachs & Co. of the Underwriters' election to purchase such Optional Units, or such other time and date as Goldman, Sachs & Co. and the Company may agree upon in writing. Such time and date for delivery of the Firm Units is herein called the "First Time of Delivery," such time and date for delivery of the Optional Units, if not the First Time of Delivery, is herein called the "Second Time of Delivery," and each such time and date of delivery is herein called a "Time of Delivery." (b) The documents to be delivered at each Time of Delivery by or on behalf of the parties hereto pursuant to Section 7 hereof, including the cross receipt for the Trust Units and any additional documents requested by the Underwriters pursuant to Section 7 hereof, will be delivered at the offices of [________________] (the "Closing Location"), and certificates representing the Trust Units will be delivered at the Designated Office, all at such Time of Delivery. A meeting will be held at the Closing Location at _____p.m., New York City time, on the New York Business Day next preceding such Time of Delivery, at which meeting the final drafts of the documents to be delivered pursuant to the preceding sentence will be available for review by the parties hereto. For the purposes of this Section 4, "New York Business Day" shall mean each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which banking institutions in New York are generally authorized or obligated by law or executive order to close. 5. (a) The Company agrees with each of the Underwriters: (i) To prepare the Prospectus in a form approved by you and to file such Prospectus pursuant to Rule 424(b) under the Act not later than the Commission's close of business on the second business day following the execution and delivery of this Agreement, or, if applicable, such earlier time as may be required by Rule 430A(a)(3) under the Act; to make no further amendment or any supplement to the Registration Statement or Prospectus which shall be disapproved by you promptly after reasonable notice thereof; to advise you, promptly after it receives notice thereof, of the time when any amendment to the Registration Statement has been filed or becomes effective or any supplement to the Prospectus or any amended Prospectus has been filed and to furnish you copies thereof; to advise you, promptly after it receives notice thereof, of the -9- issuance by the Commission of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or Prospectus, of the suspension of the qualification of the Trust Units for offering or sale in any jurisdiction, of the initiation or threatening of any proceeding for any such purpose, or of any request by the Commission for the amending or supplementing of the Registration Statement or Prospectus or for additional information; and, in the event of the issuance of any stop order or of any order preventing or suspending the use of any Preliminary Prospectus or Prospectus or suspending any such qualification, promptly to use its best efforts to obtain the withdrawal of such order; (ii) Promptly from time to time to take such action as you may reasonably request to qualify the Trust Units for offering and sale under the securities laws of such jurisdictions as you may request and to comply with such laws so as to permit the continuance of sales and dealings therein in such jurisdictions in the United States for as long as may be necessary to complete the distribution of the Trust Units, provided that in connection therewith the Company shall not be required to qualify as a foreign corporation, to become subject to taxation or to file a general consent to service of process in any jurisdiction; (iii) Prior to 10:00 a.m., New York City time, on the New York Business Day next succeeding the date of this Agreement and from time to time, to furnish the Underwriters with copies of the Prospectus in New York City in such quantities as you may reasonably request, and, if the delivery of a prospectus is required at any time prior to the expiration of nine months after the time of issue of the Prospectus in connection with the offering or sale of the Trust Units and if at such time any events shall have occurred as a result of which the Prospectus as then amended or supplemented would include an untrue statement of a material fact or omit to state any material fact necessary in order to make the statements therein, in the light of the circumstances under which they were made when such Prospectus is delivered, not misleading, or, if for any other reason it shall be necessary during such period to amend or supplement the Prospectus or to file under the Exchange Act any document incorporated by reference in the Prospectus in order to comply with the Act or the Exchange Act, to notify you and to promptly amend or supplement the Prospectus or to file such document and to furnish without charge to each Underwriter and to any dealer in securities as many copies as you may from time to time reasonably request of the amended Prospectus or the supplement to the Prospectus which will correct such statement or omission or effect such compliance, and in case any Underwriter is required to deliver a prospectus in connection with sales of any of the Trust Units at any time nine months or more after the time of issue of the Prospectus, upon your request but at the expense of such Underwriter, to prepare and deliver to such Underwriter as many copies as you may request of an amended or supplemented Prospectus complying with Section 10(a)(3) of the Act; (iv) During the period beginning on the date hereof and continuing to and including the date that is 180 days after the date of the Prospectus, not to offer, sell, contract to sell, or transfer or distribute to stockholders (including any declaration of a distribution to stockholders of record as of any date prior to such date), or otherwise dispose of, except as provided hereunder, any Trust Units or other securities of the Trust, or other securities that are derived from the -10- Underlying Properties that are substantially similar to the Trust Units, including but not limited to any securities that are convertible into or exchangeable for, or that represent the right to receive, Trust Units or any such substantially similar securities (other than pursuant to the grant or exercise under employee benefit plans and awards of the Company of options to acquire Trust Units existing on the date of this agreement, provided that the optionee agrees in writing to be bound by the restrictions set forth in this clause (e)), without your prior written consent; (v) To use the net proceeds received by it from the sale of the Trust Units pursuant to this Agreement in the manner specified in the Prospectus under the caption "Use of Proceeds;" (vi) To use its best efforts to list the Trust Units on the New York Stock Exchange (the "Exchange"); (vii) To file with the Commission any information on Form 10-Q or Form 10-K as may be required by Rule 463 under the Act; and (viii) If the Company elects to rely upon Rule 462(b), the Company shall file a Rule 462(b) Registration Statement with the Commission in compliance with Rule 462(b) by 10:00 p.m., Washington, D.C. time, on the date of this Agreement, and the Company shall at the time of filing either pay to the Commission the filing fee for the Rule 462(b) Registration Statement or give irrevocable instructions for the payment of such fee pursuant to Rule 111(b) under the Act. (b) The Trustee, on behalf of the Trust, agrees with each of the Underwriters: (i) To cause the Trust to file promptly all reports and any definitive proxy or information statements required to be filed by the Trust with the Commission pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of the Prospectus and for so long as the delivery of a prospectus is required in connection with the offering or sale of the Trust Units; (ii) To cause the Trust to make generally available to holders of Trust Units as soon as practicable, but in any event not later than eighteen months after the effective date of the Registration Statement (as defined in Rule 158(c) under the Act), an earnings statement of the Trust (which need not be audited) complying with Section 11(a) of the Act and the rules and regulations of the Commission thereunder (including, at the option of the Trustee, Rule 158); (iii) To cause the Trust to furnish to Trust Unitholders as soon as practicable after the end of each fiscal year an annual report (including financial statements of the Trust certified by independent public accountants) and, as soon as practicable after the end of each of the first three quarters of each fiscal year (beginning with the fiscal quarter ending after the effective date of the Registration Statement), to make available to its Trust Unitholders summary financial information of the Trust for such quarter in reasonable detail, all as required by the Indenture; and -11- (iv) During a period of five years from the effective date of the Registration Statement, to cause the Trust to furnish to you copies of all reports or other communications (financial or other) of the Trust furnished to Trust Unitholders, and to deliver to you as soon as they are available, copies of any reports and financial statements of the Trust furnished to or filed with the Commission or any national securities exchange on which any class of securities of the Trust is listed. 6. The Company and the Trustee covenant and agree with one another and with the several Underwriters that (a) the Company will pay or cause to be paid the following: (i) the fees, disbursements and expenses of the Company's counsel and accountants and Trustee's counsel in connection with the formation of the Trust and the registration of the Trust Units under the Act and all other expenses in connection with the preparation, printing and filing of the Registration Statement, any Preliminary Prospectus and the Prospectus and amendments and supplements thereto and the mailing and delivering of copies thereof to the Underwriters and dealers; (ii) the cost of printing or producing any Agreement among Underwriters, this Agreement, the Blue Sky Memorandum, closing documents and any other documents in connection with the offering, purchase, sale and delivery of the Trust Units; (iii) all expenses in connection with the qualification of the Trust Units for offering and sale under state securities laws as provided in Section 5(b) hereof, including the fees and disbursements of counsel for the Underwriters in connection with such qualification and in connection with the Blue Sky survey; (iv) all fees and expenses in connection with the original listing of the Trust Units on the New York Stock Exchange and the filing fees incident to securing any required review by the National Association of Securities Dealers, Inc. of the terms of the sale of the Trust Units; (v) the cost of preparing certificates representing Trust Units; and (vi) all other costs and expenses incident to the performance of its obligations hereunder that are not otherwise specifically provided for in this Section and (b) the Trustee will cause the Trust to pay (i) the cost and charges of any transfer agent or registrar and (ii) the annual listing fees of the New York Stock Exchange. It is understood, however, that except as provided in this Section, and Sections 8 and 11 hereof, the Underwriters will pay all of their own costs and expenses, including the fees of their counsel, stock transfer taxes on resale of any of the Trust Units by them, and any advertising expenses connected with any offers they may make. 7. The obligations of the Underwriters hereunder, as to the Trust Units to be delivered at each Time of Delivery, shall be subject, in their discretion, to the condition that all representations and warranties and other statements of the Company herein are, at and as of such Time of Delivery, true and correct, the condition that the Company shall have performed all of its obligations hereunder theretofore to be performed, and the following additional conditions: (a) The Prospectus shall have been filed with the Commission pursuant to Rule 424(b) within the applicable time period prescribed for such filing by the rules and regulations under the Act and in accordance with Section 5(a) hereof; if the Company has elected to rely upon Rule 462(b), the Rule 462(b) Registration Statement shall have become effective by 10:00 p.m. Washington, D.C. time on the date of this Agreement; no stop order suspending the effectiveness of the Registration Statement or any part thereof shall have been issued and no proceeding for that purpose shall have -12- been initiated or threatened by the Commission; and all requests for additional information on the part of the Commission shall have been complied with to your reasonable satisfaction; (b) Andrews & Kurth L.L.P., counsel for the Underwriters, shall have furnished to you such opinion or opinions (a draft of such opinion is attached as Annex II(a) hereto), dated such Time of Delivery, with respect to the matters covered in paragraphs (i), (ii), (viii), (xii), and the matters set forth in the last paragraph of subsection (c) below, as well as other related matters as you may reasonably request, and such counsel shall have received such papers and information as they may reasonably request to enable them to pass upon such matters; (c) Kelly, Hart & Hallman, a professional corporation, counsel for the Company, shall have furnished to you their written opinion (a draft of such opinion is attached as Annex II(b) hereto), dated such Time of Delivery, in form and substance reasonably satisfactory to you, to the effect that: (i) The Company was incorporated, exists and is in good standing under the laws of the State of Delaware, with corporate power and authority to own its properties and conduct its business as described in the Prospectus; (ii) The Company is qualified as a foreign corporation for the transaction of business and is in good standing under the laws of the States of Texas, Kansas, Oklahoma and Wyoming and such other states set forth on an exhibit to such opinion, and such counsel has no knowledge that the nature of the properties of the Company or the conduct of its business requires qualification in other jurisdictions, except jurisdictions in which the Company is subject to no material liability or disability by reason of its failure to be so qualified; (iii) Each subsidiary of the Company was incorporated, exists and is in good standing under the laws of its jurisdiction of incorporation; all of the issued shares of capital stock of each such subsidiary have been validly authorized and issued, are fully paid and non-assessable, are owned of record by the Company directly or through subsidiaries, and such counsel has no knowledge of any adverse claim (within the meaning of Article 8 of the Uniform Commercial Code) thereto; (iv) The Trust has been duly formed and is validly existing as a grantor trust under the laws of the State of Texas; there are 40,000,000 Trust Units authorized and issued under the Indenture; and all of the outstanding Trust Units have been duly authorized, are fully paid without the requirement of any further consideration, and, assuming due execution by the Trustee of the certificates representing the Trust Units, are validly issued and entitle the Trust Unitholder thereof to the benefits of the Indenture; (v) Each of the Indenture and the Conveyances has been duly authorized, executed and delivered by the Company as grantor and, assuming the due authorization, execution and delivery thereof by the Trustee, are valid and binding obligations of the Company, enforceable -13- against the Company in accordance with their terms (except as regards the application of bankruptcy, insolvency, moratorium or other similar laws governing creditors' rights generally and the availability of the remedy of specific performance and the enforceability of provisions providing for indemnification for violations of federal securities laws); (vi) The Company is the record owner of the Trust Units to be sold by the Company to the Underwriters hereunder, and the Company has corporate power and authority to sell and deliver to the Underwriters certificates representing such Trust Units; such counsel has no knowledge that immediately prior to the Time of Delivery, the Company did not have good and valid title to such Trust Units sold at the Time of Delivery, free and clear of all adverse claims (within the meaning of Article 8 of the Uniform Commercial Code); and title to such Trust Units, free and clear of such adverse claims, has been transferred to each of the several Underwriters who purchased and took delivery of certificates representing such Trust Units in good faith and without notice of any adverse claim within the meaning of Article 8 of the Uniform Commercial Code; (vii) Such counsel has no knowledge, other than as set forth in the Prospectus, of any pending or overtly threatened legal or governmental proceedings to which the Company or any of its subsidiaries or the Trust is or may be a party or of which any property of the Company or any of its subsidiaries or the Trust is or may be subject which, if determined adversely to the Company or any of its subsidiaries or the Trust would, individually or in the aggregate, have a material adverse effect on (A) the consolidated financial position, equity or results of operations of the Company and its subsidiaries, (B) the financial condition of the trust corpus of the Trust or (C) the revenues and direct operating expenses of the Underlying Properties; (viii) This Agreement has been duly authorized, executed and delivered by the Company; (ix) The issue and sale of the Trust Units being delivered at the Time of Delivery by the Company and the compliance by the Company with all of its obligations under this Agreement and the Indenture will not (A) conflict with or result in a breach or violation of any of the terms or provisions of, or constitute a default under, the Indenture or, except with respect to any preferential purchase rights under applicable joint operating agreements, any other indenture, mortgage, deed of trust, loan agreement or other agreement or instrument known to such counsel to which the Company or any of its subsidiaries or the Trust is a party or by which the Company or any of its subsidiaries is bound or to which any of the property or assets of the Company or any of its subsidiaries or the Trust is subject, (B) violate any provisions of the Certificate of Incorporation or Bylaws of the Company or (C) violate any statute, rule or regulation known to such counsel or any order known to such counsel of any court or governmental agency or body having jurisdiction over the Company or any of its subsidiaries or the Trust or any of their properties; (x) No consent, approval, authorization, order, registration or qualification of or with any such court or governmental agency or body that is required for the issue and sale of the Trust Units, except the registration under the Act of the Trust Units, and such consents, approvals, -14- authorizations, registrations or qualifications as may be required under state securities or Blue Sky laws in connection with the purchase and distribution of the Trust Units by the Underwriters; (xi) Such counsel has no knowledge that the Company or any of its subsidiaries is in violation of its Certificate of Incorporation or By-laws or in default in the performance or observance of any material obligation, agreement, covenant or condition contained in any indenture, mortgage, deed of trust, loan agreement, or lease or agreement or other instrument known to such counsel to which it is a party or by which it or any of its properties may be bound; (xii) The statements set forth in the Prospectus under the caption "Description of Trust Units," insofar as they constitute matters of law, summaries of legal matters, documents or legal conclusions, have been reviewed by such counsel and are correct in all material respects; (xiii) Neither the Company nor the Trust is an "investment company," as such term is defined in the Investment Company Act; and (xiv) The Registration Statement and the Prospectus and any further amendments and supplements thereto made by the Company prior to the Time of Delivery (other than the financial statements, notes thereto and related schedules therein, and the information that is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel expresses no opinion) comply as to form in all material respects with the requirements of the Act and the rules and regulations thereunder; In addition to the opinions set forth above, such opinion shall also include a statement to the effect that although such counsel does not assume any responsibility for the accuracy, completeness or fairness of the statements contained in the Registration Statement, the Prospectus or the documents incorporated by reference in the Prospectus or any further amendment or supplement thereto, except for those referred to in the opinion in subsection (xii) above, nothing has come to the attention of such counsel that has caused them to believe that, (A) as of its effective date, the Registration Statement, or any further amendment thereto prior to such Time of Delivery (other than the financial statements, notes thereto and related schedules therein, and the information that is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel need express no opinion) contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, (B) as of its date, the Prospectus or any further amendment or supplement thereto prior to such Time of Delivery (other than the financial statements, notes thereto and related schedules therein, and the information that -15- is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel need express no opinion) contained an untrue statement of a material fact or omitted to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, or (C) as of such Time of Delivery, either the Registration Statement or the Prospectus or any further amendment or supplement thereto prior to such Time of Delivery (other than the financial statements, notes thereto and related schedules therein, and the information that is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel need express no opinion) contains an untrue statement of a material fact or omits to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; and such counsel does not know of any amendment to the Registration Statement required to be filed or of any contracts or other documents of a character required to be filed as an exhibit to the Registration Statement or required to be incorporated by reference into the Prospectus or required to be described in the Registration Statement or the Prospectus which are not filed or incorporated by reference or described as required; (d) Frank McDonald, general counsel to the Company, shall have furnished to you his written opinion in substantially the form attached hereto as Annex II(c), dated such time of Delivery, in form and substance reasonably satisfactory to you, to the effect that: (i) The documents incorporated by reference in the Prospectus or any further amendment or supplement thereto made by the Company prior to the Time of Delivery (other than the financial statements, notes thereto and related schedules therein, and the information that is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel expresses no opinion), when they were filed with the Commission complied as to form in all material respects with the requirements of the Exchange Act and the rules and regulations of the Commission thereunder; and (ii) As of the time they were filed with the Commission, such documents incorporated by reference in the Prospectus (other than the financial statements, notes thereto and related schedules therein, and the information that is extracted from the reports of Miller and Lents, Ltd. pertaining to oil and gas reserves that is included therein, as to which such counsel need express no opinion) did not contain an untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; (e) Butler and Binion L.L.P., a limited liability partnership, special tax counsel to the Company, shall have furnished to you their written opinion, dated such Time of Delivery, in form and substance reasonably satisfactory to you, to the effect that the statements set forth under the caption "Federal Income Tax Consequences" in the Prospectus, insofar as such statements set forth legal conclusions and summaries of legal matters, are correct in all material respects, subject to the qualifications stated therein; (f) Morris, Laing, Evans, Brock and Kennedy, chartered, special counsel to the Company for the State of Kansas, shall have furnished to you their written opinion with respect to certain tax matters in substantially the form attached hereto as Annex II(d), dated such Time of Delivery, in form and substance reasonably satisfactory to you, to the effect that: -16- (i) the activities of the Trust and the Trustee as permitted under the Indenture and the Conveyances will not subject either the Trust or the Trustee to income taxation by the State of Kansas; (ii) an owner of a Trust Unit who is not a Kansas resident will not be subject to Kansas income tax and will not be required to file a Kansas income tax return, provided that such Trust Unit and such Trust Unit owner's indirect interest in the Net Profits Interests (through ownership of such Trust Unit) are not employed by the Trust Unit owner in a trade, business, profession or occupation carried on in Kansas, and further provided that the Trust Unit owner is not otherwise subject to Kansas income tax; and (iii) nonresidents of Kansas will not be subject to Kansas income tax on gains from sales of Trust Units, subject to the same provisos set forth in opinion (ii), immediately above; (g) Each of Monnet, Hayes, Bullis, Thompson & Edwards L.L.P., Brown, Drew, Massey & Sullivan L.L.P. and Morris, Laing, Evans, Brock and Kennedy, chartered, special counsel to the Company for the states of Oklahoma, Wyoming and Kansas, respectively, shall have furnished to you their written opinions in substantially the form attached hereto as Annex II(e), dated such Time of Delivery, in form and substance reasonably satisfactory to you, to the effect that: (i) a court of competent jurisdiction of the state of such counsel should give effect to the choice of law provisions of the Conveyance and the Indenture; (ii) the Conveyance (i) has been properly filed of record and recorded in the appropriate real property records in the state of such counsel, (ii) is adequate and sufficient to legally convey to the Trustee the Net Profits Interests in the state of such counsel, and (iii) constitutes, in the state of such counsel, a perfected Conveyance and effective notice of the Net Profits Interests in the Underlying Properties located in the state of such counsel, which is and will be valid and binding against third parties subsequently acquiring interests in the Underlying Properties and is and will be superior to all future liens and encumbrances on the Underlying Properties (except for such liens and encumbrances for taxes and assessments not yet due and payable, and liens and encumbrances under operating agreements, unitization and pooling agreements, and gas sales contracts, securing payments of amounts not yet due and payable); (iii) no actions other than those described above are necessary to convey the Net Profits Interests in the state of such counsel and to publish notice thereof; (iv) the Net Profits Interests constitute property interests under the laws of the state of such counsel, and the Conveyance and the related Net Profits Interests should not constitute executory contracts as such term is used in the federal bankruptcy code; (v) neither the Trust nor the Trustee is required to qualify to transact business or appoint an agent for service of process in the state of such counsel as a result of the ownership, -17- operation or activities of the Trust or the Trustee with respect to the Trust, and the activities of the Trustee pursuant to the Indenture will not require the appointment of an ancillary trustee in the state of such counsel; (vi) neither a Trust Unit, nor the interest of a holder of a Trust Unit, constitutes an interest in real property under the laws of the state of such counsel, and a non-resident holder of a Trust Unit will not be subject to inheritance or gift taxation, intestate succession, elective shares of community property or require the filing of ancillary probate proceedings in such State solely by reason of ownership of Trust Units; (vii) a beneficial owner of a Trust Unit will not be subject to personal liability under state and local laws in the state of such counsel by virtue of said ownership, including liability regulating the discharge of materials into the environment or otherwise relating to the protection of the environment; (viii) the execution, delivery and performance by the Trustee of the Indenture will not violate or conflict with any law, administrative ruling or regulation of the state of such counsel; (ix) no consent, approval, authorization or filing is required under any law, rule or regulation of the state of such counsel (i) to permit the Trustee to act as trustee with respect to the oil and gas properties located in such state or (ii) in connection with the execution and delivery of the Conveyance, or necessary to the validity, legality or enforceability of the Conveyance; and (x) the income from the Net Profits Interests received by the Trust will not be subject to taxation at the Trust level by the state of such counsel or any political subdivision thereof. [A Trust Unitholder will not be subject to taxation by the state of such counsel or any political subdivision thereof with respect to income from the Net Profits Interests or ownership of Trust Units.] [A Trust Unitholder will be subject to taxation by the state of such counsel [or the applicable political subdivision] with respect to income from the Net Profits Interests or ownership of Trust Units and is required to report such income to the state of such counsel [or the applicable political subdivision] only if the amount of such income [during a fiscal year] exceeds $____________________________; (h) Thompson & Knight , A Professional Corporation, counsel for the Trustee, shall have furnished to you their written opinion, dated such Time of Delivery, in form and substance reasonably satisfactory to you, with respect to the matters set forth in clauses (i), (ii) and (iii) of Section 7(i) hereof and to the effect that this Agreement has been duly executed and delivered by the Trustee. Such opinion may be limited for all purposes to the laws of the State of Texas and United States federal law; (i) The Trustee shall have furnished to you a certificate, dated such Time of Delivery, executed by a duly authorized officer of the Trustee, representing and warranting to each of the Underwriters that: -18- (i) The Trustee is a national banking association authorized and empowered to act as trustee of the Trust pursuant to the Indenture, and no consent, approval, authorization or filing is required under any law, rule or regulation of the State of Texas or of the United States of America in order to permit the Trustee to act as trustee of the Trust; (ii) The Indenture has been executed and delivered by the Trustee and, assuming the due authorization, execution and delivery thereof by the Company, is a valid and binding obligation of the Trustee, enforceable against the Trustee in accordance with its terms, except as the enforceability thereof may be limited (A) by bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors rights generally, (B) by general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law), (C) to the extent provisions provide indemnification for violations of federal securities laws, and (D) by considerations of public policy; and the Conveyances have been properly executed by the Trustee; and (iii) There are 40,000,000 Trust Units authorized and outstanding under the Indenture, all of which have been properly issued in accordance with the Indenture; certificates representing the Trust Units have been duly executed by the Trustee; and holders of certificates representing the Trust Units are entitled to the benefits of the Indenture; (j) On the date of the Prospectus at a time prior to the execution of this Agreement, at 9:30 a.m., New York City time, on the effective date of any post- effective amendment to the Registration Statement filed subsequent to the date of this Agreement and also at each Time of Delivery, Arthur Andersen L.L.P. shall have furnished to you a letter or letters, dated the respective dates of delivery thereof, in form and substance satisfactory to you, to the effect set forth in Annex I hereto; (k) Neither the Company nor any of its subsidiaries, taken together, the Trust nor the Underlying Properties shall have sustained since the date of the last audited financial statements included or incorporated by reference in the Prospectus any loss or interference with its business from fire, explosion, flood or other calamity, whether or not covered by insurance, or from any labor dispute or court or governmental action, order or decree, otherwise than as set forth or contemplated in the Prospectus, and (ii) since the respective dates as of which information is given in the Prospectus there shall not have been any change in the capital stock or long-term debt of the Company or any of its subsidiaries, taken together, or the imposition of any liabilities on the Trust, or any change, or any development involving a prospective change, in or affecting the general affairs, management, financial position, shareholders' equity or results of operations of the Company and its subsidiaries, or any change, or any development involving a prospective change, in or affecting either (A) the general affairs or financial condition of the Trust, or (B) the management or results of operations of the Underlying Properties otherwise than as set forth or contemplated in the Prospectus, the effect of which, in any such case described in clause (i) or (ii), is in the judgment of the Representatives so material and adverse as to make it impracticable or inadvisable to proceed -19- with the public offering or the delivery of the Trust Units being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; (l) On or after the date hereof there shall not have occurred any of the following: (i) a suspension or material limitation in trading in securities generally on the New York Stock Exchange; (ii) a suspension or material limitation in trading in the Trust Units or the Company's securities on the New York Stock Exchange; (iii) a general moratorium on commercial banking activities declared by either Federal or New York State authorities; or (iv) the outbreak or escalation of hostilities involving the United States or the declaration by the United States of war or national emergency if the effect of any such event specified in this clause (iv) in the judgment of the Representatives makes it impracticable or inadvisable to proceed with the public offering or the delivery of the Trust Units being delivered at such Time of Delivery on the terms and in the manner contemplated in the Prospectus; (m) The Trust Units at such Time of Delivery shall have been duly listed on the New York Stock Exchange; (n) The Company shall have complied with the provisions of Section 5(c) hereof with respect to the furnishing of Prospectuses on the New York Business Day next succeeding the date of this Agreement; (o) The Company shall have furnished or caused to be furnished to you at such Time of Delivery certificates of officers of the Company, satisfactory to you as to the accuracy, in all material respects, of the representations and warranties of the Company herein at and as of such Time of Delivery, as to the performance, in all material respects, by the Company of all of its respective obligations hereunder to be performed at or prior to such Time of Delivery, and as to such other matters as you may reasonably request, and the Company shall have furnished or caused to be furnished certificates as to the matters set forth in subsections (a) and (k) of this Section; and (p) The Company shall have furnished or caused to be furnished to you at 10:00 a.m., New York City time on the effective date of the Registration Statement and the most-recently filed post-effective amendment to the Registration Statement and also at such Time of Delivery, letters from Miller and Lents, Ltd. dated the respective date of delivery in form and substance satisfactory to you. 8. (a) The Company and the Trust (solely from the assets of the Trust and without liability or obligation of the Trustee or any Trust Unitholder) will jointly and severally indemnify and hold harmless each Underwriter against any losses, claims, damages or liabilities, joint or several, to which such Underwriter may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact -20- required to be stated therein or necessary to make the statements therein not misleading, and will reimburse each Underwriter for any legal or other expenses reasonably incurred by such Underwriter in connection with investigating or defending any such action or claim as such expenses are incurred; provided, however, that neither the Company nor the Trust shall be liable in any such case to the extent that any such loss, claim, damage or liability arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement in reliance upon and in conformity with written information furnished to the Company by any Underwriter through Goldman, Sachs & Co. expressly for use therein; and provided, further, that neither the Underwriters nor any other person or entity entitled to seek indemnification from the Trust under this Section 8(a) shall attempt to enforce its rights hereunder in any circumstance in which such enforcement would result in any liability to the Trustee or any Trust Unitholder; (b) Each Underwriter will indemnify and hold harmless the Company, the Trust and the Trustee against any losses, claims, damages or liabilities to which the Company, the Trust or the Trustee may become subject, under the Act or otherwise, insofar as such losses, claims, damages or liabilities (or actions in respect thereof) arise out of or are based upon an untrue statement or alleged untrue statement of a material fact contained in any Preliminary Prospectus, the Registration Statement or the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in any Preliminary Prospectus, the Registration Statement or the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by such Underwriter through Goldman, Sachs & Co. expressly for use therein; and will reimburse the Company, the Trust and the Trustee for any legal or other expenses reasonably incurred by the Company, the Trust or the Trustee in connection with investigating or defending any such action or claim as such expenses are incurred; (c) Promptly after receipt by an indemnified party under subsection (a) or (b) above of notice of the commencement of any action, such indemnified party shall, if a claim in respect thereof is to be made against the indemnifying party under such subsection, notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party shall not relieve it from any liability which it may have to any indemnified party otherwise than under such subsection. In case any such action shall be brought against any indemnified party and it shall notify the indemnifying party of the commencement thereof, the indemnifying party shall be entitled to participate therein and, to the extent that it shall wish, jointly with any other indemnifying party similarly notified, to assume the defense thereof, with counsel reasonably satisfactory to such indemnified party (which shall not, except with the consent of the indemnified party, be counsel to the indemnifying party), and, after notice from the indemnifying party to such indemnified party of its election so to assume the defense thereof, the indemnifying party shall not be liable to such indemnified party under such subsection for any legal expenses of other counsel or any other expenses, in each case subsequently incurred by such indemnified party, in connection with the -21- defense thereof other than reasonable costs of investigation. No indemnifying party shall, without the written consent of the indemnified party, effect the settlement or compromise of, or consent to the entry of any judgment with respect to, any pending or threatened action or claim in respect of which indemnification or contribution may be sought hereunder (whether or not the indemnified party is an actual or potential party to such action or claim) unless such settlement, compromise or judgment (i) includes an unconditional release of the indemnified party from all liability arising out of such action or claim and (ii) does not include a statement as to or an admission of fault, culpability or a failure to act, by or on behalf of any indemnified party. No indemnifying party shall be required to indemnify an indemnified party for any amount paid or payable by such indemnified party in the settlement of any action, proceeding or investigation without the written consent of such indemnifying party, which consent shall not be unreasonably withheld; (d) If the indemnification provided for in this Section 8 is unavailable to or insufficient to hold harmless an indemnified party under subsection (a) or (b) above in respect of any losses, claims, damages or liabilities (or actions in respect thereof) referred to therein, then each indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (or actions in respect thereof) in such proportion as is appropriate to reflect the relative benefits received by the Company and the Trust on the one hand and the Underwriters on the other from the offering of the Trust Units. If, however, the allocation provided by the immediately preceding sentence is not permitted by applicable law or if the indemnified party failed to give the notice required under subsection (c) above, then each indemnifying party shall contribute to such amount paid or payable by such indemnified party in such proportion as is appropriate to reflect not only such relative benefits but also the relative fault of the Company and the Trust on the one hand and the Underwriters on the other in connection with the statements or omissions which resulted in such losses, claims, damages or liabilities (or actions in respect thereof), as well as any other relevant equitable considerations (including the failure of the indemnified party to give the notice required under subsection (c) above). The relative benefits received by the Company on the one hand and the Underwriters on the other shall be deemed to be in the same proportion as the total net proceeds from the offering (before deducting expenses) received by the Company bear to the total underwriting discounts and commissions received by the Underwriters in each case as set forth in the table on the cover page of the Prospectus. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Company on the one hand or the Underwriters on the other and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Company, the Trustee (on behalf of the Trust) and the Underwriters agree that it would not be just and equitable if contributions pursuant to this subsection (d) were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to above in this subsection (d). The amount paid or payable by an indemnified party as a result of the losses, claims, damages or liabilities (or actions in respect thereof) referred to above in this subsection (d) shall be deemed to include any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or -22- defending any such action or claim. Notwithstanding the provisions of this subsection (d), no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Trust Units underwritten by it and distributed to the public exceeds the amount of any damages which such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations in this subsection (d) to contribute are several in proportion to their respective underwriting obligations and not joint; and (e) The obligations of the Company and the Trust under this Section 8 shall be in addition to any liability which the Company and the Trust may otherwise have and shall extend, upon the same terms and conditions, to each person, if any, who controls any Underwriter within the meaning of the Act; and the obligations of the Underwriters under this Section 8 shall be in addition to any liability which the respective Underwriters may otherwise have and shall extend, upon the same terms and conditions, to each officer and director of the Company and the Trustee and to each person, if any, who controls the Company or the Trustee within the meaning of the Act. 9. (a) If any Underwriter shall default in its obligation to purchase the Trust Units which it has agreed to purchase hereunder at a Time of Delivery, you may in your discretion arrange for you or another party or other parties to purchase such Trust Units on the terms contained herein. If within thirty-six hours after such default by any Underwriter you do not arrange for the purchase of such Trust Units, then the Company shall be entitled to a further period of thirty-six hours within which to procure another party or other parties reasonably satisfactory to you to purchase such Trust Units on such terms. In the event that, within the respective prescribed periods, you notify the Company that you have so arranged for the purchase of such Trust Units, or the Company, notifies you that it has so arranged for the purchase of such Trust Units, you or the Company shall have the right to postpone a Time of Delivery for a period of not more than seven days, in order to effect whatever changes may thereby be made necessary in the Registration Statement or the Prospectus, or in any other documents or arrangements, and the Company agrees to file promptly any amendments to the Registration Statement or the Prospectus which in your reasonable opinion may thereby be made necessary. The term "Underwriter" as used in this Agreement shall include any person substituted under this Section with like effect as if such person had originally been a party to this Agreement with respect to such Trust Units; (b) If, after giving effect to any arrangements for the purchase of the Trust Units of a defaulting Underwriter or Underwriters by you and the Company as provided in subsection (a) above, the aggregate number of Trust Units which remains unpurchased does not exceed one-eleventh of the aggregate number of all the Trust Units to be purchased at such Time of Delivery, then the Company shall have the right to require each non-defaulting Underwriter to purchase the number of Trust Units which such Underwriter agreed to purchase hereunder at such Time of Delivery and, in addition, to require each non-defaulting Underwriter to purchase its pro rata share (based on the number of Trust Units which such Underwriter agreed to purchase hereunder) of the -23- Trust Units of such defaulting Underwriter or Underwriters for which such arrangements have not been made; but nothing herein shall relieve a defaulting Underwriter from liability for its default; and (c) If, after giving effect to any arrangements for the purchase of the Trust Units of a defaulting Underwriter or Underwriters by you and the Company as provided in subsection (a) above, the aggregate number of such Trust Units which remains unpurchased exceeds one-eleventh of the aggregate number of all the Trust Units to be purchased at such Time of Delivery, or if the Company shall not exercise the right described in subsection (b) above to require non- defaulting Underwriters to purchase Trust Units of a defaulting Underwriter or Underwriters, then this Agreement (or, with respect to the Second Time of Delivery, the obligations of the Underwriters to purchase and of the Company to sell the Optional Units) shall thereupon terminate, without liability on the part of any non-defaulting Underwriter or the Company or the Trustee, except for the expenses to be borne by the Company, the Trustee and the Underwriters as provided in Section 6 hereof and the indemnity and contribution agreements in Section 8 hereof; but nothing herein shall relieve a defaulting Underwriter from liability for its default. 10. The respective indemnities, agreements, representations, warranties and other statements of the Company, the Trust and the several Underwriters, as set forth in this Agreement or made by or on behalf of them, respectively, pursuant to this Agreement, shall remain in full force and effect, regardless of any investigation (or any statement as to the results thereof) made by or on behalf of any Underwriter or any controlling person of any Underwriter, or the Company, the Trust or the Trustee, or any officer or director or controlling person of the Company or any officer or director or controlling person of the Trustee, and shall survive delivery of any payment for the Trust Units. 11. If this Agreement shall be terminated pursuant to Section 9 hereof, neither the Company nor the Trust shall then be under any liability to any Underwriter except as provided in Section 6 and Section 8 hereof; but, if for any other reason any Trust Units are not delivered by or on behalf of the Company as provided herein, the Company will reimburse the Underwriters through you for all out-of-pocket expenses approved in writing by you, including fees and disbursements of counsel, reasonably incurred by the Underwriters in making preparations for the purchase, sale and delivery of the Trust Units not so delivered, but the Company shall then be under no further liability to any Underwriter in respect of the Trust Units not so delivered except as provided in Section 6 and Section 8 hereof. 12. In all dealings hereunder, you shall act on behalf of each of the Underwriters, and the parties hereto shall be entitled to act and rely upon any statement, request, notice or agreement on behalf of any Underwriter made or given by you jointly or by Goldman, Sachs & Co. on behalf of you as the representatives. All statements, requests, notices and agreements hereunder shall be in writing, and if to the Underwriters shall be delivered or sent by mail, telex or facsimile transmission to you as the -24- representatives in care of Goldman, Sachs & Co., at 32 Old Slip, 9th Floor, New York, New York 10005, Attention: Registration Department; and if to the Company shall be delivered or sent by mail, telex or facsimile transmission to the address of the Company set forth in the Registration Statement, Attention: Secretary; and if to the Trust shall be delivered or sent by mail, telex or facsimile transmission to 901 Main Street, 17th Floor, Dallas, Texas 75202, Attention: Ron E. Hooper; provided, however, that any notice to an Underwriter pursuant to Section 8(d) hereof shall be delivered or sent by mail, telex or facsimile transmission to such Underwriter at its address set forth in its Underwriters' Questionnaire or telex constituting such Questionnaire, which address will be supplied to the Company or the Trustee by you upon request. Any such statements, requests, notices or agreements shall take effect upon receipt thereof. 13. This Agreement shall be binding upon, and inure solely to the benefit of, the Underwriters, the Company and the Trust and, to the extent provided in Sections 8 and 10 hereof, the officers and directors of the Company and the Trustee and each person who controls the Company, the Trustee or any Underwriter, and their respective heirs, executors, administrators, successors and assigns, and no other person shall acquire or have any right under or by virtue of this Agreement. The Trustee has executed this Agreement solely in its capacity as trustee of the Trust and shall have no liability or obligation hereunder other than the obligation, in such capacity, to cause the Trust to perform its obligations hereunder. No purchaser of any of the Trust Units from any Underwriter shall be deemed a successor or assign by reason merely of such purchase. 14. Time shall be of the essence of this Agreement. As used herein, the term "business day" shall mean any day when the Commission's office in Washington, D.C. is open for business. 15. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. 16. This Agreement may be executed by any one or more of the parties hereto in any number of counterparts, each of which shall be deemed to be an original, but all such counterparts shall together constitute one and the same instrument. If the foregoing is in accordance with your understanding, please sign and return to us 10 (ten) counterparts hereof, and upon the acceptance hereof by you, on behalf of each of the Underwriters, this letter and such acceptance hereof shall constitute a binding agreement among each of the Underwriters, the Company and the Trust. It is understood that your acceptance of this letter on behalf of each of the Underwriters is pursuant to the authority set forth in a form of Agreement among Underwriters the form of which shall be submitted to the Company and the Trustee for examination, upon request, but without warranty on your part as to the authority of the signers thereof. Very truly yours, Cross Timbers Oil Company -25- By: -------------------------------- Name: ------------------------------ Title: ----------------------------- -26- Hugoton Royalty Trust By: NationsBank, N.A., Trustee By: --------------------------------------- Name: Ron E. Hooper Title: Vice President Accepted as of the date hereof: Goldman, Sachs & Co. Lehman Brothers Inc. A.G. Edwards & Sons, Inc. Bear, Stearns & Co. Dean Rauscher Wessels, a division of Dean Rauscher Incorporated Donaldson, Lufkin & Jenrette Securities Corporation By: --------------------------------------- (Goldman, Sachs & Co.) By Lehman Brothers Inc. By: -------------------------------------- Name/Title: -------------------------- On behalf of each of the Underwriters -27 SCHEDULE I
Number of Optional Units to be Total Number of Purchased if Firm Units Maximum Option Underwriter to be Purchased Exercised - ------------------------------------------------------ --------------- -------------- Goldman, Sachs & Co................................... Lehman Brothers Inc................................... Bear, Stearns & Co.................................... Dain Rauscher Wessels................................. a division of Dain Rauscher Incorporated.......... Donaldson, Lufkin & Jenrette Securities Corporation... A.G. Edwards & Sons, Inc.............................. Total.............................................. --------------- -------------- =============== ==============
-28- ANNEX I ACCOUNTANT'S COMFORT LETTER REQUIREMENTS Pursuant to Section 7(d) of the Underwriting Agreement, the accountants shall furnish letters to the Underwriters to the effect that: (i) They are independent certified public accountants with respect to the Company and the Trust within the meaning of the Act and the applicable published rules and regulations thereunder adopted by the SEC; (ii) In their opinion, the consolidated financial statements of the Company as of December 31, 1997, the statements of revenue and direct operating expenses of the Underlying Properties for each of the three years in the period ended November 30, 1998 and the statement of assets and trust corpus as of December 4, 1998 audited by them and included or incorporated by reference in the Prospectus or the Registration Statement comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations adopted by the SEC. (iii) They have made a review in accordance with standards established by the American Institute of Certified Public Accountants of (A) the unaudited interim consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Company's quarterly report on Form 10-Q incorporated by reference into the Prospectus, and on the basis of specified procedures including inquiries of officials of the Company who have responsibility for financial and accounting matters regarding whether the unaudited consolidated financial statements referred to in paragraph (vi)(A)(i) below are stated on a basis substantially consistent with that of the audited consolidated financial statements incorporated by reference in the Registration Statement, comply as to form in all material respects with the applicable accounting requirements of the Act and the Exchange Act and the related published rules and regulations, nothing came to their attention that caused them to believe that the unaudited condensed consolidated financial statements do not comply as to form in all material respects with the applicable accounting requirements of the Act and the related published rules and regulations; (iv) The unaudited selected financial information with respect to the consolidated results of operations and financial position of the Company for the five most recent fiscal years incorporated by reference in the Prospectus and included in Item 6 of the Company's Annual Report on Form 10-K for the most recent fiscal year agrees with the corresponding amounts (after restatements where applicable) in the audited consolidated financial statements for such five fiscal years which were included or incorporated by reference in the Company's Annual Reports on Form 10-K for such fiscal years; (v) They have compared the information in the Prospectus under selected captions with the disclosure requirements of Regulation S-K and on the basis of limited procedures specified in -29- such letter nothing came to their attention as a result of the foregoing procedures that caused them to believe that this information does not conform in all material respects with the disclosure requirements of Items 301, 302, 402 and 503(d), respectively, of Regulation S-K; (vi) On the basis of limited procedures, not constituting an audit in accordance with generally accepted auditing standards, consisting of a reading of the unaudited financial statements and other information referred to below, a reading of the latest available interim financial statements of the Company and its subsidiaries, read the minute books of the Company and its subsidiaries since the date of the latest audited financial statements included in the Prospectus, inquiries of certain officials of the Company who have responsibility for financial and accounting matters and such other inquiries and procedures as may be specified in such letter, nothing came to their attention that caused them to believe that: (A) (i) the unaudited consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Company's quarterly report on Form 10-Q incorporated by reference into the Prospectus, are not stated on a basis substantially consistent with that of the audited consolidated financial statements incorporated by reference in the Registration Statement or (ii) any material modifications should be made to the unaudited condensed consolidated statements of income, consolidated balance sheets and consolidated statements of cash flows included in the Company's quarterly report on Form 10-Q incorporated by reference into the Prospectus, for them to be in conformity with generally accepted accounting principles; (B) any other unaudited income statement data and balance sheet items included in the Prospectus do not agree with the corresponding items in the unaudited consolidated financial statements from which such data and items were derived, and any such unaudited data and items were not determined on a basis substantially consistent with the basis for the corresponding amounts in the audited consolidated financial statements included or incorporated by reference in the Prospectus; (C) the unaudited financial statements which were not included in the Prospectus but from which were derived any unaudited condensed financial statements referred to in Clause (A) and any unaudited income statement data and balance sheet items included in the Prospectus and referred to in Clause (B) were not determined on a basis substantially consistent with the basis for the audited consolidated financial statements included or incorporated by reference in the Prospectus; (D) as of a specified date not more than five days prior to the date of such letter, there have been (i) any increase in the consolidated long- term debt of the Company and its subsidiaries, or any decreases in consolidated net current assets or stockholders' equity of the Company and its subsidiaries, or any changes in any other Company items specified by the Representatives or (ii) any incurrence of liabilities by the Trust, or any decreases in assets or trust corpus of the Trust or other items specified by the Representatives, or any changes in -30- any other Trust items specified by the Representatives, in each case as compared with amounts shown in the latest balance sheet included or incorporated by reference in the Prospectus, except in each case for changes, increases or decreases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (E) for the period from the date of the latest financial statements included or incorporated by reference in the Prospectus to the specified date referred to in clause (E) there were any decreases in consolidated net revenues or operating profit or the total or per share amounts of consolidated net income of the Company or the excess of revenues over direct operating expenses of the Underlying Properties, or changes in other items specified by the Representatives relating to the results of operations of the Company and its subsidiaries or the Underlying Properties, in each case as compared with the comparable period of the preceding year and with any other period of corresponding length specified by the Representatives, except in each case for decreases or increases which the Prospectus discloses have occurred or may occur or which are described in such letter; and (vii) In addition to the examination referred to in their reports included or incorporated by reference in the Prospectus and the limited procedures, inspection of minute books, inquiries and other procedures referred to in paragraphs (iii) and (vi) above, they have carried out certain specified procedures, not constituting an audit in accordance with generally accepted auditing standards, with respect to certain amounts, percentages and financial information specified by the Representatives, which are derived from the general accounting records of the Company and its subsidiaries, which appear in the Prospectus (excluding documents incorporated by reference) or in Part II of, or in exhibits and schedules to, the Registration Statement specified by the Representatives or in documents incorporated by reference specified by the Representatives, and have compared certain of such amounts, percentages and financial information with the accounting records of the Company and its subsidiaries and have found them to be in agreement. -31- EX-5.1 3 OPINION OF KELLY, HART & HALLMAN, P.C. EXHIBIT 5.1 Kelly, Hart & Hallman (a professional corporation) 201 Main Street, Suite 2500 Fort Worth, Texas 76102 January __, 1999 Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, Texas 76102 Re: Hugoton Royalty Trust and Cross Timbers Oil Company Registration Statement on Form S-1/S-3 -------------------------------------- Gentlemen: This firm has acted as counsel to Cross Timbers Oil Company, a Delaware corporation (the "Company"), in connection with the filing by the Hugoton Royalty Trust (the "Trust") and the Company of a registration statement on Form S-1/S-3, No. 333-68441 (the "Registration Statement"), with the Securities and Exchange Commission pursuant to the Securities Act of 1933, as amended, for the registration of the sale of up to 17,250,000 units of beneficial interest in the Trust (the "Trust Units"). The opinion set forth below is given pursuant to Item 601(b)(5) of Regulation S-K for inclusion as Exhibit 5.1 to the Registration Statement and pertains to the offering of such Trust Units. In connection with this opinion, we have made the following assumptions: (i) all documents submitted to or reviewed by us, including all amendments and supplements thereto, are accurate and complete and if not originals are true and correct copies of the originals; (ii) the signatures on each of such documents by the parties thereto are genuine; (iii) each individual who signed such documents had the legal capacity to do so; and (iv) all persons who signed such documents on behalf of a corporation were duly authorized to do so. We have assumed that there are no amendments, modifications or supplements to such documents other than those amendments, modifications and supplements that are known to us. Based on the foregoing, and subject to the limitations and qualifications set forth herein, we are of the opinion that: 1. The Trust was formed and is validly existing under the laws of the State of Texas. 2. The Trust Units have been duly authorized and are validly issued under the laws of the State of Texas and fully paid without the requirement of any further consideration. Cross Timbers Oil Company January __, 1999 Page 2 This opinion is further limited and qualified in all respects as follows: A. The opinion is specifically limited to matters of the existing laws of the State of Texas. We express no opinion as to the applicability of the laws of any other particular jurisdiction to the transactions described in this opinion. B. This opinion is limited to the specific opinions stated herein, and no other opinion is implied or may be inferred beyond the specific opinions expressly stated herein. C. This opinion is based on our knowledge of the law and facts as of the date hereof. We assume no duty to update or supplement this opinion to reflect any facts or circumstances that may hereafter come to our attention or to reflect any changes in any law that may hereafter occur or become effective. We call your attention to the fact that certain members of the law firm have directly or indirectly invested in the Company's common stock. This opinion is intended solely for your benefit. It is not to be quoted in whole or in part, disclosed, made available to or relied upon by any other person, firm or entity without our express prior written consent. We hereby consent to the use of this opinion in the above-referenced Registration Statement. In giving such consent, we do not admit that we come within the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the Securities and Exchange Commission promulgated thereunder. Respectfully submitted, KELLY, HART & HALLMAN (a professional corporation) EX-8.1 4 OPINION OF BUTLER BINION, L.L.P. Exhibit 8.1 Butler & Binion L.L.P. 1000 Louisiana, Suite 1600 Houston, Texas 77002 January __, 1999 Board of Directors Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, Texas 76102 Gentlemen: We have acted as special tax counsel to Cross Timbers Oil Company, a Delaware corporation (the "Company"), in connection with the formation of the Hugoton Royalty Trust, an express trust formed under the laws of the State of Texas ("Trust") and the proposed sale of Units by the Company as described in the Registration Statement on Form S-1/S-3 (Registration No. 333-68441) and the prospectus included as part of such Registration Statement (the "Prospectus"), filed with the Securities and Exchange Commission on December 4, 1998, as amended by Pre-Effective Amendment No. 1 thereto filed on January __, 1999 [and any subsequent amendments]. In connection with such representation, we have reviewed the following documents: (i) the Hugoton Royalty Trust Indenture (the "Trust Indenture") dated as of December 1, 1998 among the Company and NationsBank, N.A. (the "Trustee"), (ii) the Net Overriding Royalty Conveyance dated as of December 1, 1998, conveying net overriding royalty interests in Kansas properties from the Company to the Trust; (iii) the Net Overriding Royalty Conveyance dated as of December 1, 1998, conveying net overriding royalty interests in Oklahoma properties from the Company to the Trust; (iv) the Net Overriding Royalty Conveyance dated December 1, 1998, conveying net overriding royalty interests in Wyoming properties from the Company to the Trust (collectively, the "Conveyances"), and (iv) the Prospectus. We have been requested to furnish our opinion as to the material federal income tax consequences of the formation and operation of the Trust. Our opinion is limited to the federal income tax matters stated herein as of the date hereof, and no opinion is implied or may be inferred beyond the matters expressly stated herein. We express no opinion as to the impact of the tax laws of any state on an investment in the Trust. In rendering the following opinion we have assumed the authenticity of all documents reviewed by us purporting to be originals, and the conformity with the originals of documents purporting to be copies. We have assumed that the Trust Indenture and the Conveyances, at the time of delivery, were January __, 1999 Page 2 - ---------------------------- duly authorized, executed and delivered by the parties thereto. We have also assumed that all representations and warranties (other than as to the subject matter expressed herein) made by each of the parties to the Underwriting Agreement, Trust Indenture and Conveyances were and are true, correct and complete, and have relied upon said representations and warranties for the purposes hereof. Based on the foregoing, we confirm that the statements set forth under the captions "Federal Income Tax Consequences" in the Prospectus, insofar as such statements set forth legal conclusions and summaries of legal matters, are accurate in all material respects, subject to the qualifications stated therein. Our opinion is based on the Internal Revenue Code of 1986, as amended, the presently effective regulations thereunder, reported judicial decisions and published revenue rulings and other administrative interpretations as of the date hereof. It may be modified as a result of subsequent legislation, regulations or other administrative or court interpretations, any of which could be retroactive in effect. Our opinion is not binding on the Internal Revenue Service ("IRS") or the courts, and no assurance can be given that the IRS will not challenge the tax treatment described in the Prospectus or that, if it does, such challenge would not be successful. We hereby consent to the use of our name in the Registration Statement and under the caption "Federal Income Tax Consequences" in the Prospectus and consent to the filing of this opinion as an Exhibit to the Registration Statement. Very truly yours, BUTLER & BINION, L.L.P. EX-8.2 5 OPINION OF MORRIS, LAING, EVANS, BROCK & KENNEDY Exhibit 8.2 [LOGO OF MORRIS, LAING, EVANS, BROCK & KENNEDY, CHARTERED APPEARS HERE] January __, 1999 Cross Timbers Oil Company 810 Houston Street - Suite 2000 Fort Worth, TX 76102-6298 Gentlemen: We have reviewed the Hugoton Royalty Trust Royalty Trust Indenture dated as of December 1, 1998 ("the Royalty Trust Indenture"), Conveyance and the prospectus (the "Prospectus") contained in the Registration Statement No. 333-68441 filed December 4, 1998, relating to Units of Beneficial Interest (the "Units") in the Hugoton Royalty Trust (the "Trust"). All terms capitalized in this letter and not defined in this letter shall have the same meanings given to them in the Royalty Trust Indenture. In offering the opinions set out below, we are relying upon the provisions as contained in the foregoing documents. Although there is no clearly determinative Kansas law on the questions, we are of the opinion that as to Units owned by an individual who is not a resident of the state of Kansas, the Units will be treated as intangible personal property, rather than as interests in tangible personal property having a situs in Kansas, for purposes of death tax, probate, and devolution of title. With one possible exception discussed below, a Unit owned by an individual who is not a resident of the state of Kansas at the date of death would not be subject to probate in Kansas or to Kansas estate tax. If the certificate representing a Unit is physically located in Kansas at the time of the nonresident owner's death, a Kansas statute declares that Kansas courts have jurisdiction to probate the Unit. In that situation the Unit would arguably also be subject to Kansas estate tax. Kansas has no gift tax. It is well established under Kansas law that an oil and gas lease covering Kansas land, and interests in such a lease, are intangible personal property unless defined otherwise by statute for a particular purpose. In this connection, we note that prior to July 1, 1998, for inheritance tax purposes, Kansas Statutes Annotated (S)79-1559 defined oil and gas leases on lands in this state and all interests created thereby, or arising therefrom, as tangible personal property having a tax situs in this state. That statutory section was repealed effective July 1, 1998, and the definition quoted above Cross Timbers Oil Company Page 2 January __, 1999 was not reinserted into any other statutory section. We believe that this repeal therefore revives the applicability of the opinion of the Kansas Supreme Court in the Denver National Bank of Denver, Colorado v. State Commission of Revenue and Taxation of the State of Kansas, 176 Kan. 617 (1954). In that case, the Kansas Supreme Court held that an interest in an oil and gas lease is intangible personal property and has a tax situs in the state of the residence of its owner at the time of death. K.S.A. (S)79-1559, and its predecessors, all of which have now been repealed, were adopted by the Kansas legislature in response to the Denver National Bank opinion. Although there is no determinative precedent, and Kansas taxing authorities may adopt a contrary view, we are of the opinion that: 1. The activities of the Trust and the Trustee as permitted under the Royalty Trust Indenture and the Conveyances will not subject either the Trust or the Trustee to income taxation by the State of Kansas; 2. An owner of a Unit who is not a Kansas resident will not be subject to Kansas income tax and will not be required to file a Kansas income tax return, provided that such Unit and such Unit owner's indirect interest in the Royalties (through ownership of such Unit) are not employed by the Unit owner in a trade, business, profession or occupation carried on in Kansas, and further provided that the Unit owner is not otherwise subject to Kansas income tax; and 3. Nonresidents of Kansas will not be subject to Kansas income tax on gains from sales of Units, subject to the same provisos set forth in opinion 2, immediately above. In rendering these opinions, we have assumed that the Trust (i) will not own any property in Kansas other than the Royalties, (ii) will not conduct any activities in Kansas other than ownership of the Royalties for the benefit of the Unit holders, and (iii) is a grantor trust for federal income tax purposes. Because no Kansas court decisions, statutory provisions, or Kansas Department of Revenue rulings have specifically addressed the precise questions upon which we opine herein, all opinions expressed in this letter must be considered in light of the lack of such authority. Cross Timbers Oil Company Page 3 January __, 1999 These opinions are based on Kansas law as of the date of this letter, and we disclaim any responsibility to advise you of any subsequent changes in Kansas law that might affect our opinions. We are furnishing this opinion letter to you solely for your benefit. It is not to be quoted in whole or in part, disclosed, made available to or relied upon by any other person, firm or entity without our express prior written consent. We hereby consent to the use of this opinion in the above-referenced Registration Statement and to the use of our name in the Section of the Prospectus captioned "State Tax Considerations." Very truly yours, MORRIS, LAING, EVANS, BROCK & KENNEDY, Chartered Robert I. Guenthner EX-10.1 6 FORM OF 80% NET OVERRIDING ROYALTY CONVEYANCE-KS Exhibit 10.1 NET OVERRIDING ROYALTY CONVEYANCE Hugoton Royalty Trust STATE OF KANSAS (S) (S) COUNTIES OF FINNEY, (S) KNOW ALL MEN BY THESE PRESENTS: GRANT, HASKELL, KEARNY, (S) MEADE, MORTON, SEWARD, (S) AND STEVENS (S) THAT CROSS TIMBERS OIL COMPANY, a corporation formed under the laws of the State of Delaware ("Assignor"), for and in consideration of the sum of Ten Dollars ($10.00) and other good and valuable consideration to Assignor paid by NATIONSBANK, N.A., a bank organized under the laws of the United States, acting not in its individual corporate capacity but solely as trustee under that certain Trust Indenture establishing the Hugoton Royalty Trust dated as of December 1, 1998 ("Assignee"), the receipt and sufficiency of which are hereby acknowledged, has bargained, sold, granted, conveyed, transferred, assigned, set over and delivered, and by these presents does bargain, sell, grant, convey, transfer, assign, set over and deliver unto Assignee a net overriding royalty interest ("the Royalty Interest") in and to the Subject Hydrocarbons in and under, and if, as and when produced, saved and sold from, the Subject Lands during the term of the Subject Interests equal to eighty percent (80%) of the Net Proceeds attributable to the Subject Interests, as each of the above capitalized words is defined in Article I hereof and all as more fully provided herein. TO HAVE AND TO HOLD the Royalty Interest, together with all and singular the rights and appurtenances thereto in anywise belonging, unto Assignee, its successors and assigns, subject, however, to the terms and provisions of this Conveyance; and Assignor does by these presents bind and obligate itself, its successors and assigns, to WARRANT and FOREVER defend all and singular the Royalty Interest unto the said Assignee, its successors and assigns, against every person whomsoever lawfully claiming or to claim the same or any part thereof by, through or under Assignor, but not otherwise. ARTICLE I DEFINITIONS As used herein, the following words, terms or phrases have the following meanings: SECTION 1.01. "Affiliate" means, as to the party specified, any Person controlling, controlled by or under common control with such party, with the concept of control in such context meaning the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of another, whether through the ownership of voting securities, by contract or otherwise. The Trust shall not be deemed an Affiliate of Assignor. SECTION 1.02. "Assignor" means the Assignor named herein while Assignor owns all or any part of or interest in the Subject Interests and any other Person or Persons (excluding Assignee) who hereafter may acquire all or any part of or interest in the Subject Interests. SECTION 1.03. "Assignee" means the Assignee named herein (and any successor Trustee under the Trust Indenture) while it owns all or any part of or interest in the Royalty Interest and any other Person or Persons who may acquire legal title to all or any part of or interest in the Royalty Interest. SECTION 1.04. "Computation Period" means (i) initially, the period commencing on the Effective Date and ending on February 28, 1999, and (ii) each calendar month thereafter. SECTION 1.05. "Conveyance" means this Net Overriding Royalty Conveyance. SECTION 1.06. "Effective Date" means 7:00 o'clock A.M., local time in effect at the location of each Subject Interest, on December 1, 1998. SECTION 1.07. "Excess Production Costs" means, for any Computation Period, an amount equal to the excess, if any, of Production Costs for such Computation Period over Gross Proceeds for such Computation Period. SECTION 1.08. "Existing Sales Contracts" means all contracts and agreements in effect as of the Effective Date between or among Assignor and any Affiliate of Assignor, or between or among any Affiliates of Assignor, for the Sale, Processing, treatment, compression, gathering or transportation of Subject Hydrocarbons. SECTION 1.09. "Gross Proceeds" means, for any Computation Period, and subject to Section 2.01 (i) during the term of the Existing Sales Contracts, the proceeds received by Assignor under the Existing Sales Contracts attributable to the Sale of Subject Hydrocarbons Sold during such Computation Period by Assignor after the Effective Date, and (ii) as to Subject Hydrocarbons Sold by Assignor during such Computation Period after the Effective Date other than under the Existing Sales Contracts (A) if Sold under a Sales Contract with a Non-Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract, or (B) if Sold under a Sales Contract with an Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract but in no event less than 98% of the proceeds received by such Affiliate upon the resale of such Subject Hydrocarbons to a Non-Affiliate of Assignor, and (iii) the proceeds received by Assignor in respect of underproduced gas imbalances attributable to the Subject Interests as of the Effective Date, but in all instances, subject to the following: 2 (a) There shall be excluded from Gross Proceeds all Property Taxes that are deducted or excluded from proceeds of Sale received by Assignor. (b) There shall be excluded any amount for Subject Hydrocarbons attributable to nonconsent operations conducted with respect to the Subject Interests (or any portion thereof) as to which Assignor shall be a nonconsenting party and which is dedicated to the recoupment or reimbursement of costs and expenses of the consenting party or parties by the terms of the relevant operating agreement, unit agreement, contract for development or other instrument providing for such nonconsent operations. Assignor agrees that its election not to participate in such operations shall be made in conformity with the provisions of Section 6.01 of this Conveyance, but third persons shall not be under any duty to determine that such election so conformed. (c) There shall be excluded any amount which Assignor shall receive as any of the following: consideration for transfer or sale of any of the Subject Interests (subject to the Royalty Interest) or equipment or other personal property or fixtures on the Subject Lands; payments for gas not taken, when such payments are made (but to the extent such payments are allocated to gas taken in the future such payments shall be included without interest in Gross Proceeds when such gas is taken); damages arising from any cause other than drainage or reservoir injury; rental for reservoir use; payments made to Assignor in connection with the drilling of any well on any of the Subject Lands or lands in the vicinity thereof (such exclusion including dry and bottom hole payments, provided that if such well is drilled on the Subject Lands and Assignor incurs Production Costs in connection therewith such payments shall reduce Production Costs) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; provided there shall be included in Gross Proceeds advance or prepaid payments for future production received by Assignor to the extent not subject to repayment in the event of insufficient subsequent production (and to the extent so subject to repayment shall be included without interest in Gross Proceeds when the Subject Hydrocarbons on which such payment was so advanced or prepaid are actually produced) and payments made to Assignor in connection with the deferring of drilling of any well on any of the Subject Lands (including payments from an operator in the vicinity for refraining from drilling an offset well). (d) There shall be excluded any amount for Subject Hydrocarbons lost in the production or marketing thereof or used by Assignor in conformity with ordinary or prudent practices for drilling, production and plant operations (including gas injection, secondary recovery, pressure maintenance, repressuring, cycling operations, plant fuel or shrinkage) conducted for the purpose of drilling for, producing or Processing Subject Hydrocarbons or for operations on any unit or plant to which the Subject Interests are committed, but only so long as such Subject Hydrocarbons are so used. 3 (e) Amounts received as a loan by Assignor from a purchaser of Subject Hydrocarbons, whether with or without interest, shall not be considered to be derived from the sale of Subject Hydrocarbons. (f) If a controversy or possible controversy exists (whether by reason of any statute, order, decree, rule, regulation, contract or otherwise) between Assignor and any purchaser as to the correct sales price of any Subject Hydrocarbons or, for any other reason, as to Assignor's right to receive or collect the proceeds of sale of any Subject Hydrocarbons, then (i) amounts withheld by the purchaser or deposited by it with an escrow agent shall not be considered to be received by Assignor until actually collected by Assignor, but the amounts received by Assignor shall include any interest, penalty or other amount paid to Assignor in respect thereof; (ii) amounts received by Assignor and promptly deposited by it with an escrow agent shall not be considered to have been received by Assignor, but all amounts thereafter paid to Assignor by such escrow agent shall be considered to be amounts received from the Sale of Subject Hydrocarbons; and (iii) amounts received by Assignor and not deposited with an escrow agent shall be considered to be received for purposes of this Section 1.09. SECTION 1.10. "Hydrocarbons" means oil, gas (which term includes coal bed gas, coal seam gas and methane) and all other minerals produced in association with oil or gas (including, but not limited to, helium, sulphur and carbon dioxide), but excluding all other minerals, whether similar or dissimilar. SECTION 1.11. "Monthly Record Date" for each month means the close of business on the last day of such month which is not a Saturday, Sunday or other day on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law, unless Assignee determines that a different date is required to comply with applicable law or the rules of a securities exchange or quotation system pursuant to the terms of the Trust Indenture, in which event it means such different date. SECTION 1.12. "Net Proceeds" means, for any Computation Period, the excess of Gross Proceeds for such Computation Period over Production Costs for such Computation Period. SECTION 1.13. "Non-Affiliate" means, as to the party specified, any Person who is not an Affiliate of such party. SECTION 1.14. "Person" means any individual, corporation, partnership, limited liability company, trust, estate or other entity, organization or association. 4 SECTION 1.15. "Prime Interest Rate" means the variable rate of interest most recently announced by NationsBank, N.A. as its "prime rate." SECTION 1.16. "Process" or "Processing" means to extract or otherwise recover natural gas liquids from natural gas included in the Subject Hydrocarbons through the processes of absorption, condensation, adsorption, cryogenic or other methods in a manner that does not constitute Separation. SECTION 1.17. "Processing Costs" means the costs to Assignor or any Affiliate of Assignor to Process Subject Hydrocarbons before the Sale thereof, which costs for purposes hereof shall consist of the sum of (a) any such Processing charges paid to Non-Affiliates, (b) the charges by Affiliates of Assignor under Existing Sales Contracts, and (c) the charges by Affiliates of Assignor other than under Existing Sales Contracts so long as such charges do not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges. If Assignor (or its Affiliates) receives a share of the production of others or of plant products therefrom (or proceeds of sale thereof) for Processing such production of others, such share shall not be included in Subject Hydrocarbons (or Gross Proceeds). If Assignor (or its Affiliates) does not bear any Processing Costs but the owners or operators of a plant receive a share of the Subject Hydrocarbons (or proceeds of sale thereof) for Processing them, such share (or proceeds) shall be excluded from the Subject Hydrocarbons (and Gross Proceeds). SECTION 1.18. "Production Costs" means, for any Computation Period, to the extent not excluded for purposes of calculating Gross Proceeds, whether capital or non-capital in nature, (a) the sum of (i) all amounts paid by Assignor or any Affiliate of Assignor as any of the following: royalty, overriding royalty or other presently existing burden against production or the proceeds of Sale of production attributable to the Subject Interests; delay rental; shut-in gas well royalty or payment; minimum royalty; payments to lessors or others in the area in connection with the drilling or deferring of drilling of any well on any of the Subject Lands or lands in the vicinity thereof (including dry and bottom hole payments and payments made to others for refraining from drilling an offset well) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; and rent and other consideration paid for use of or damage to the surface; (ii) the Property Tax Accrual; (iii) the overhead costs paid by Assignor or any Affiliate of Assignor under any joint operating agreement applicable to any of the Subject Interests to which 5 Assignor and one or more Non-Affiliates of Assignor are parties and where Assignor or any Affiliate of Assignor is not the operator of such Subject Interest; (iv) the overhead rate provided for in any joint operating agreement applicable to any of the Subject Interests where Assignor or any Affiliate of Assignor is the operator of such Subject Interests, less the portion, if any, of the overhead rate due from Non-Affiliates of Assignor; (v) with respect to any Subject Interests operated by Assignor or any of its Affiliates and not subject to a joint operating agreement, an overhead fee as shown on Schedule B attached hereto and subject to adjustment as provided in Schedule B attached hereto; (vi) all other costs, expenses and liabilities (including Processing Costs) paid or incurred by Assignor or any Affiliate of Assignor for investigating, exploring, prospecting, drilling and mining for, operating and producing Subject Hydrocarbons and sale and marketing thereof, including without implied limitation: costs for equipping, plugging back, reworking, completing, recompleting and plugging and abandoning of any well on the Subject Lands and of making the Subject Hydrocarbons ready or available for market; costs for construction and operation of gathering lines, tanks, transmission lines, meters and other production and delivery facilities; costs, whether paid in cash or by a share of Subject Hydrocarbons, of transporting, compressing, dehydrating, separating, treating, storing and marketing the Subject Hydrocarbons and disposing of extraneous substances produced in association with Subject Hydrocarbons (provided that such costs, if paid to or incurred by an Affiliate of Assignor other than pursuant to an Existing Sales Contract, shall not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges); costs for secondary recovery, pressure maintenance, repressuring, cycling and other operations conducted for the purpose of enhancing production; costs or expenses (whether paid in cash or by delivery of gas) incurred in resolving overproduced gas imbalances attributable to the Subject Interests as of the Effective Date and thereafter; and costs for litigation concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests; and costs for litigation or regulatory proceedings concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests or to protect or enforce any rights, contractual or otherwise, of Assignor to produce or market Subject Hydrocarbons therefrom; (vii) Excess Production Costs for the preceding Computation Period (including any remaining Excess Production Costs carried forward from any preceding Computation Period); 6 (viii) interest on the amount of Excess Production Costs at the beginning of any Computation Period, calculated from the first day to the last day of the Computation Period, at the Prime Interest Rate in effect at the beginning of such Computation Period; (ix) any amounts paid by Assignor or any Affiliate of Assignor whether as refund, interest or penalty, to a purchaser or any governmental agency or other Person because the amount initially received by Assignor (or Affiliate of Assignor) as sales price for Sales after the Effective Date was more or allegedly more than permitted by the terms of any applicable contract, statute, regulation, order, decree or other obligation; provided such amounts (in the case of a refund), or the amounts with respect to which the interest or penalty was paid, were previously included in Gross Proceeds; (x) any other amounts paid by Assignor or any Affiliate of Assignor with respect to ownership or operation of the Subject Interests after the Effective Date or Sales of production therefrom after the Effective Date, whether as refund, fine, interest or penalty, pursuant to litigation or settlement of threatened litigation or order of governmental agency, provided that Assignor has not breached Section 6.01 hereof; (xi) all consideration hereafter paid and costs and expenses hereafter incurred by Assignor or any Affiliate of Assignor for any renewals or extensions of leases or other rights acquired after the Effective Date which are included in the definition herein of Subject Interests; and (xii) any accrual or reserve which Assignor or any Affiliate of Assignor shall have the right, at its election, to charge to Production Costs for operations (other than day-to-day operations) budgeted under an operating agreement or approved under an authorization for expenditures ("AFE"), which accrual or reserve may be based on the reasonably expected time of performing such operation or on an estimated percentage of completion of the operation or on any other reasonable method, and which accrual is in lieu of charging the cost of such operation when paid for by Assignor (or Affiliate of Assignor) but which shall be adjusted if and to the extent actual costs differ from such accrual or reserve; (b) but excluding (i) costs which would otherwise be treated as Production Costs (but which shall not be so treated for purposes hereof until the following amounts have been fully credited against such costs) equal to amounts reimbursed or credited to Assignor by insurance from damage to property, by sales of property or transfers of 7 property off the leases included in the Subject Interests or by proceeds from unitization or other disposition of property; and (ii) except for resolution of gas imbalances which are included in Section 1.18(a)(vi) above, any amounts which would otherwise be Production Costs but which are attributable to periods before the Effective Date; and (iii) costs that otherwise would be treated as Production Costs but which have already been excluded or deducted from Gross Proceeds under Section 1.09; and (iv) costs incurred by any Affiliate of Assignor for which such Affiliate has received a fee, reimbursement or other payment from Assignor, where such payment by Assignor constitutes a Production Cost; and (v) costs paid or accrued by Assignor during the month of December 1998 for the drilling, equipping, reworking, plugging back, completing or recompleting of any well on the Subject Lands. SECTION 1.19. "Property Taxes" means the sum of all general property (ad valorem), production, severance, sales, gathering and excise taxes and other taxes (whether state, federal or otherwise), except income taxes, assessed or levied on or in connection with the Subject Interests, the Royalty Interest or the production therefrom or equipment on the Subject Lands, or against Assignor as owner of the Subject Interests or Assignee as owner of the Royalty Interest. SECTION 1.20. "Property Tax Accrual" means, for any Computation Period, an amount that may be set aside by Assignor as an accrual to be applied against Property Taxes other than those that are deducted or excluded from Gross Proceeds pursuant to Section 1.09(a) above, which accruals shall be adjusted to the extent actual Property Taxes differ. SECTION 1.21. "Sale" and "Sold" mean all forms of dispositions of Subject Hydrocarbons for value, including exchanges and other dispositions for value. SECTION 1.22. "Sales Contracts" means all contracts and agreements for the sale of Subject Hydrocarbons. SECTION 1.23. "Separation" means liquid separation operations in the vicinity of the well using a conventional mechanical liquid gas separator but excluding operations involving heat exchange, adiabatic cooling, absorption, adsorption or refrigeration principles. SECTION 1.24. "Subject Hydrocarbons" means all Hydrocarbons in and under, and which may be produced, saved and sold from, and which shall accrue and be attributable to, the Subject Interests, including plant products attributable thereto from Processing gas or casinghead gas included 8 in the Subject Hydrocarbons before sale thereof (but not including products derived from processing oil). SECTION 1.25. "Subject Interests" means, subject to the exclusions stated below, each kind and character of right, title, claim or interest which Assignor has on the Effective Date in or under each oil, gas or mineral lease, unitization or pooling agreement (and the units created thereby), royalty interests, overriding royalty interests, fee mineral interests and net profits interests and any other agreements, conveyances, assignments or instruments which are described or referred to in Schedule A, and all the right, title, claim or interest which Assignor has on the Effective Date in and to the Subject Lands, whether such right, title, claim or interest be under and by virtue of a lease, a unitization or pooling agreement or order, an operating agreement, a division order, a transfer order or any other type of agreement, conveyance, assignment or instrument or under any other type of claim or title, legal or equitable, recorded or unrecorded, even though Assignor's interests be incorrectly or incompletely described in, or a description thereof be omitted from, Schedule A, all as the same shall be enlarged by the discharge of any payments out of production or by the removal of any charges or encumbrances to which any of the same are subject and any and all renewals and extensions of any of the same, but subject to all burdens to which Assignor's such right, title, claim or interest is subject (while same remains so subject), limited, however, if Assignor's interest in any Subject Interest should terminate at any time, to the period to which Assignor's interest in such Subject Interest is limited. There shall be excluded from the term "Subject Interests" any interest hereafter acquired by Assignor in and to any of the Subject Lands, except any interest acquired pursuant to existing agreements for no new consideration and renewals or extensions of existing leases and other such agreements. For purposes of this Conveyance "renewals or extensions" of any lease or other such agreement shall be limited to renewals or extensions of an existing lease or other such agreement obtained by the present owner thereof (or such owner's successors in interest) while such lease is in force or within six months after such lease or other such agreement terminates. Assignor shall be under no duty to seek renewals or extensions of any lease or other such agreement. SECTION 1.26. "Subject Lands" means the lands which are described in and which are subject to the oil, gas or mineral leases, unitization or pooling agreements or orders, operating agreements, division orders, transfer orders or other type of agreement, conveyance, assignment or instrument described in Schedule A attached hereto, provided that, where the description in Schedule A excepts land or refers to an instrument insofar only as it covers certain land or certain depths in certain land, no interest in such excepted land or depths or in land other that to which such reference is limited shall be included in the terms "Subject Lands" or "Subject Interests". SECTION 1.27. "Trust" means the Hugoton Royalty Trust established by the Trust Indenture. SECTION 1.28. "Trust Indenture" means the Royalty Trust Indenture by and between Cross Timbers Oil Company and NationsBank, N.A. dated as of December 1, 1998, establishing the Hugoton Royalty Trust, an express Texas Trust under the Texas Trust Code. 9 ARTICLE II MARKETING OF SUBJECT HYDROCARBONS SECTION 2.01. Sales Contracts. Assignor, to the extent it has the right to do so, shall market or cause to be marketed the Subject Hydrocarbons and Assignee shall have no authority to market the Subject Hydrocarbons or to take in-kind any Subject Hydrocarbons. For such purpose, Sales of Subject Hydrocarbons may continue to be made pursuant to Existing Sales Contracts. Assignor may amend such Existing Sales Contracts and may enter into one or more Sales Contracts in the future at the prices and on the terms Assignor shall deem proper in Assignor's sole and absolute discretion, which may include sales to Affiliates of Assignor. Further, Assignor may commit any of the Subject Interests (including the Royalty Interest attributable thereto) to one or more agreements for Processing pursuant to which, by way of example and not by way of limitation, the plant owner or operator (which may be an Affiliate of Assignor) receives a portion of the Subject Hydrocarbons or plant products derived therefrom or proceeds of the Sale thereof as a fee for Processing. Gross Proceeds of Subject Hydrocarbons shall be determined on the basis of amounts actually received by Assignor (and not, except as provided in Section 1.09, proceeds received by any of Assignor's Affiliates) from Sales under Sales Contracts regardless of whether at the time of production or Sale market value should be different from proceeds of Sale. In no event shall Gross Proceeds or Production Costs include any revenues, expenses, gains or losses resulting from option transactions or other futures or hedging transactions (other than forward Sales of the Subject Hydrocarbons) which, if engaged in by Assignor or any of its Affiliates in respect of Subject Hydrocarbons, shall be solely for the account of Assignor or such Affiliate. SECTION 2.02. Delivery of Subject Hydrocarbons. All Subject Hydrocarbons Sold by Assignor, whether pursuant to Sales Contracts or otherwise, shall be delivered, by Assignor to the purchasers thereof, into the pipelines to which the wells producing such Subject Hydrocarbons may be connected or to such other point of purchase as is reasonably required in the marketing of such Subject Hydrocarbons. SECTION 2.03. Reliance by Third Party. As to any party, the acts of Assignor shall be binding on Assignee. It shall not be necessary for Assignee to join with Assignor in any division or transfer order, lease extension or Sales Contract, and proceeds of Sale of the Subject Hydrocarbons shall be paid by the purchasers thereof (or others disbursing proceeds) directly to Assignor without necessity of joinder by or consent of Assignee. ARTICLE III PAYMENTS SECTION 3.01. Payment. On or before each Monthly Record Date, beginning with the Monthly Record Date for March, 1999, Assignor shall pay to Assignee as an overriding royalty 10 hereunder an amount equal to eighty percent (80%) of the Net Proceeds for the preceding Computation Period. SECTION 3.02. Interest on Past Due Payments. Except as otherwise provided in Section 9.05 hereof, any amount not paid by Assignor to Assignee when due shall bear, and Assignor will pay, interest determined at the end of each month, from such due date until such amount is paid, at the rate of the lesser of (a) the Prime Interest Rate plus 4% or (b) the maximum lawful contract rate of interest permitted by the applicable usury laws, now or hereafter enacted, which interest rate (the "Maximum Rate") shall change when and as said laws change, effective at the close of business on the day such change in said laws becomes effective; but, if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). SECTION 3.03. Overpayment. If at any time Assignor pays Assignee more than the amount due, Assignee shall not be obligated to return any such overpayment, but the amount or amounts otherwise payable to Assignee for any subsequent period or periods shall be reduced by such overpayment, plus an amount equal to interest during the period of such overpayment at the rate of the lesser of (a) the Prime Interest Rate or (b) the Maximum Rate; but if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). ARTICLE IV RECORDS AND REPORTS SECTION 4.01. Books and Records. Assignor shall at all times maintain true and correct books and records sufficient to determine the amounts payable to Assignee hereunder, including, but not limited to, a Net Proceeds account to which Gross Proceeds and Production Costs are credited and charged. SECTION 4.02. Inspections. The books and records referred to in Section 4.01 shall be open for inspection by Assignee and its agents and representatives at the office of Assignor during normal business hours and after reasonable advance notice. SECTION 4.03. Quarterly Statements. Within thirty (30) days next following the close of each calendar quarter, Assignor shall deliver to Assignee a statement showing the computation of Net Proceeds attributable to such quarter. SECTION 4.04. Assignee's Exceptions to Quarterly Statements. If Assignee shall take exception to any item or items included in the quarterly statements rendered by Assignor, Assignee shall notify Assignor in writing within 180 days after the receipt of the report and annual audit furnished pursuant to Section 4.07 hereof, setting forth in such notice the specific charges complained of and to which exception is taken or the specific credits which should have been made and allowed; and, with respect to such complaints and exceptions as are justified, adjustment shall be made. If Assignee shall fail to give Assignor notice of such complaints and exceptions prior to the expiration 11 of such 180 day period, then the statements for such calendar year as originally rendered by Assignor shall be deemed to be correct as rendered. SECTION 4.05. Geological and Other Data. Upon request by Assignee, Assignor shall, subject to the limitations of confidentiality or nondisclosure obligations to co-owners or other third parties, furnish to Assignee access to all geological, well and production data which Assignor has on hand relating to operations on the Subject Interests. Assignor will use reasonable efforts to obtain waivers of any such confidentiality or nondisclosure obligations that prevent it from providing to Assignee any requested information, but Assignor shall not be obligated to incur any expense or detriment above a nominal amount to obtain such waiver. Assignor shall also furnish to Assignee, upon request by Assignee, reports showing the status of development, producing and other operations conducted by Assignor on the Subject Interests. Assignor shall, upon request by Assignee, furnish to Assignee all reserve reports or studies in the possession of Assignor from time to time relating to the Subject Interests, whether prepared by Assignor or by third party consulting engineers; provided, it is agreed that Assignor makes no representations or warranties as to the accuracy or completeness of any such reports or studies and shall have no liability to Assignee or any other Person resulting from their use of such reports or studies, and Assignee agrees not to attribute to Assignor or such third-party consulting engineers any such reports or studies or the contents thereof in any securities filings or reports to owners or holders of "Beneficial Interests" in the Trust. All information furnished to Assignee pursuant to this section is confidential and for the sole benefit of Assignee and shall not be shown by Assignee to any other Person, except that this provision shall not prohibit the disclosure by Assignee of any information that (i) at the time of disclosure is generally available to the public (other than as a result of a disclosure by Assignee), (ii) was available to Assignee on a nonconfidential basis from a source other than Assignor, provided that such source is not known by Assignee to be bound by a confidentiality obligation owed to Assignor, or (iii) Assignee is legally required to disclose, provided that Assignee has given to Assignor notice of such requirement and a reasonable opportunity to seek, at Assignor's expense, a protective order and other appropriate relief from such requirement. SECTION 4.06. Monthly Estimates. On or before ten days (excluding Saturdays, Sundays and other days on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law) before each Monthly Record Date (beginning with the Monthly Record Date for March, 1999), Assignor shall deliver to Assignee a statement of Assignor's best estimate of the amount payable to Assignee on or before such Monthly Record Date. SECTION 4.07. Annual Audits and Reports. Within 90 days after the end of the calendar year, Assignor shall deliver to Assignee a statement which has been audited by a nationally recognized firm of independent public accountants selected by Assignor, which shall show the information provided for in Section 4.03 on an annual basis. Assignee shall bear the cost of each such audit. 12 SECTION 4.08. Reserve Reports. Assignor may, but is not obligated to, provide an annual reserve report for the Royalty Interest prepared by independent consulting reservoir engineers. If such reserve report is provided by Assignor, Assignee will reimburse Assignor for the cost thereof. ARTICLE V LIABILITY OF ASSIGNEE In no event shall Assignee be liable or responsible in any way for any Production Costs (including Excess Production Costs) or other costs or liabilities incurred by Assignor or others attributable to the Subject Interests or to the Hydrocarbons produced therefrom. ARTICLE VI OPERATION OF SUBJECT INTERESTS SECTION 6.01. Prudent Operator Standard. Assignor agrees, to the extent it has the legal right to do so under the terms of any lease, operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof), that it will conduct and carry on the maintenance and operation of the Subject Interests with reasonable and prudent business judgment and in accordance with good oil and gas field practices, and that it will drill such wells as a reasonably prudent operator would drill from time to time in order to protect the Subject Interests from drainage. However, nothing contained in this Section 6.01 shall be deemed to prevent or restrict Assignor from electing not to participate in any operation which is to be conducted under the terms of any operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof) and allowing consenting parties to conduct nonconsent operations thereon, if such election is made by Assignor in good faith. Notwithstanding anything elsewhere herein to the contrary, Assignor shall never be liable to Assignee for the manner in which Assignor performs its duties hereunder as long as Assignor has acted in good faith. SECTION 6.02. Abandonment of Properties. Nothing herein contained shall obligate Assignor to continue to operate any well or to operate or maintain in force or attempt to maintain in force any of the Subject Interests when, in Assignor's opinion, such well or Subject Interest ceases to produce or is not capable of producing Hydrocarbons in paying quantities. The expiration of a Subject Interest in accordance with the terms and conditions applicable thereto shall not be considered to be a voluntary surrender or abandonment thereof. SECTION 6.03. Insurance. Although Assignor is permitted to carry policies of insurance covering the property upon the Subject Interests and risks incident to the operation thereof and to charge premiums therefor to the Net Proceeds account, Assignor shall not be required to carry insurance on such property or covering any of such risks unless it elects to do so. In no event shall Assignor be liable to Assignee on account of any losses sustained which are not covered by insurance. 13 SECTION 6.04. Certain Rights to Manage the Subject Interests. Notwithstanding anything in this Conveyance to the contrary, Assignor shall have the right and power, acting in good faith and as a reasonably prudent oil and gas operator, to execute, deliver, and perform operating agreements, oil and gas leases, farmout agreements, exploration agreements, participation agreements, drilling agreements, acreage contribution agreements, dry-hole agreements, bottom-hole agreements, joint venture agreements, partnership agreements, and other similar instruments and agreements that cover or affect the Subject Interests and to make all decisions or elections required thereunder, including, but not limited to, decisions to consent or non-consent to drilling and other operations. The applicable Royalty Interest shall in each case be bound by such instrument or agreement (and decisions or elections thereunder), without the necessity of any execution, consent, joinder, or ratification by Assignee, and the Royalty Interest shall thereafter be calculated and paid with respect to the interests reserved, obtained, or modified by Assignor in such transaction, not by reference to the Subject Interests that existed before such transaction. For example, but not by way of limitation, (a) Assignor may farm out any Subject Interest that is an oil and gas lease, and the Subject Interest therein shall subsequently be the overriding royalty interest, reversionary working interest, and/or other rights and interests reserved by Assignor in the farmout, not the original leasehold interest, or (b) Assignor may execute an oil and gas lease to cover any Subject Interest that is a mineral interest, and the Subject Interest shall subsequently be the royalty and other lease benefits obtained or reserved by Assignor in such lease, not the original mineral interest. ARTICLE VII POOLING AND UNITIZATION SECTION 7.01. Pooled Subject Interests. To the extent any of the Subject Interests have been heretofore pooled and unitized for the production of Hydrocarbons, such Subject Interests are and shall be subject to the terms and provisions of such pooling and unitization agreements, and the Royalty Interest in each such Subject Interest shall apply to and affect only the production from such units which accrues to such Subject Interest under and by virtue of the applicable pooling and unitization agreements. SECTION 7.02. Right to Pool and Unitize. Assignor shall have the exclusive right and power (as between Assignor and Assignee), exercisable only during the period provided in Section 7.03 hereof, to pool or unitize any of the Subject Interests and to alter, change or amend or terminate any pooling or unitization agreements heretofore or hereafter entered into, as to all or any part of the Subject Lands, as to any one or more of the formations or horizons thereunder, and as to any one or more Hydrocarbons, upon such terms and provisions as Assignor shall in its sole and absolute discretion determine. If and whenever through the exercise of such right and power, or pursuant to any law hereafter enacted or any rule, regulation or order of any governmental body or official hereafter promulgated, any of the Subject Interests are pooled or unitized in any manner, the Royalty Interest insofar as it affects such Subject Interest shall also be pooled and unitized, and in any such event such Royalty Interest in such Subject Interest shall apply to and affect only the production which accrues to such Subject Interest under and by virtue of the pooling and unitization, and it shall 14 not be necessary for Assignee to agree to, consent to, ratify, confirm or adopt any exercise of such right and power by Assignor. SECTION 7.03. Applicable Period. Assignor's power and rights in Section 7.02 shall be exercisable only during the period of the life of the last survivor of the descendants of the signers of the Declaration of Independence living on the date of execution hereof, plus twenty-one (21) years after the death of such last survivor, or the term of this Conveyance, whichever period shall first expire. ARTICLE VIII GOVERNMENT REGULATION All obligations of Assignor hereunder shall be subject to all present and future valid federal, state and local laws, statutes, codes and orders; and all applicable rules, orders, regulations and decisions of every court, governmental agency, body or authority having jurisdiction over the Hydrocarbons in and under and that may be produced from the Subject Interests. Assignor's obligations are specifically, but not by way of limitation, subject, to the extent in effect, to all applicable provisions of the Emergency Petroleum Allocation Act of 1973, the Department of Energy Organization Act, the Natural Gas Act, the Natural Gas Policy Act of 1978, the Natural Gas Wellhead Decontrol Act of 1989 and each other statute purporting to provide regulation of the Sale of Hydrocarbons or establishing maximum prices at which the same may be Sold and all applicable laws, orders, rules and regulations thereunder of the Federal Energy Regulatory Commission, the Department of Energy and each other legislative or governmental body, agency, board or commission having jurisdiction. If maximum rates permitted under such statutes, rules and regulations for the Subject Hydrocarbons are lower than prices established in Sales Contracts, then the lower regulated prices received by Assignor shall control. Assignor shall be entitled to use its reasonable discretion in making filings, for itself and on behalf of Assignee, with the Federal Energy Regulatory Commission, the Department of Energy or any other governmental body, agency, board or commission having jurisdiction, affecting the price or prices at which Subject Hydrocarbons may be Sold, and with purchasers of production, operators or others with respect to any excise tax. ARTICLE IX ASSIGNMENTS SECTION 9.01. Assignment by Assignor. Assignor shall have the right to assign, sell, transfer, convey, mortgage or pledge the Subject Interests, or any part thereof, subject to the Royalty Interest and the terms and provisions of this Conveyance. From and after the effective date of any such assignment, sale, transfer or conveyance by Assignor, the assignee thereunder shall succeed to all the requirements upon and responsibilities of Assignor hereunder, as to the interests in the Subject Interests so acquired by such assignee, and, from and after the said effective date, Assignor shall be 15 relieved of such requirements and responsibilities, excepting only those accrued or due for performance prior to such effective date. SECTION 9.02. Partial Assignment. If Assignor assigns its interest under the Subject Interests as to some of such Subject Interests or as to some part thereof, then, effective as of the date of such assignment, in determining the Royalty Interest payable with respect to production from such assigned Subject Interests or parts thereof, the Gross Proceeds, Production Costs and Net Proceeds attributable to such assigned interests will be computed and determined by the assignee of such assigned interests in the aggregate as to the assigned interests owned by such assignee, but separate from and not aggregated with the computation and determination made by Assignor as to Subject Interests that have not been assigned by Assignor. SECTION 9.03. Assignment by Assignee. Assignee has the right to assign the Royalty Interest in whole or in part only as authorized by the Trust Indenture. However, no such assignment will affect the method of computing Net Proceeds, and if more than one Person becomes entitled to participate in the Royalty Interest, Assignor may withhold from such other Person payments to which such Person would otherwise be entitled hereunder and the furnishing of any data or information which Assignor is required by the terms hereof to furnish Assignee until Assignor is furnished a recordable instrument executed by or binding upon all Persons interested in the Royalty Interest designating one Person who is to receive such payments, data and information. In making conveyances or assignments of any of the Subject Interests (to the extent permitted hereunder), Assignee need not vest in its grantee or assignee all of the rights of Assignee hereunder with respect to the interest in the Subject Interests so conveyed or assigned. SECTION 9.04. Certain Sales of Subject Interests. Subject to the limitations set forth in Section 3.02(b) of the Trust Indenture, Assignor may cause the sale of certain Subject Interests, including the appurtenant Royalty Interest from time to time and Assignee will join in such sales as provided in the Trust Indenture. The proceeds of any such sale shall be apportioned and paid as provided in the Trust Indenture, but the purchasers of such Subject Interests (inclusive of the appurtenant Royalty Interest) may pay the full amount of the purchase price therefor to Assignor and shall have no responsibility to see to the proper allocation thereof between Assignor and Assignee. SECTION 9.05. Change in Ownership. No change of ownership or right to receive payment of the Royalty Interest, or of any part thereof, however accomplished, shall be binding upon Assignor until notice thereof shall have been furnished by the Person claiming the benefit thereof, and then only with respect to payments thereafter made. Notice of sale or assignment shall consist of a certified copy of the recorded instrument accomplishing the same; notice of change of ownership or right to receive payment accomplished in any other manner (for example by reason of incapacity, death or dissolution) shall consist of certified copies of recorded documents and complete proceedings legally binding and conclusive of the rights of all parties. Until such notice accompanied by such documentation shall have been furnished Assignor as above provided, the payment or tender of all sums payable on the Royalty Interest may be made in the manner provided herein precisely as if no such change in interest or ownership or right to receive payment had occurred, or (at Assignor's 16 election) Assignor shall have the right to suspend payment of such sums without interest in the event of such change until such documentation is furnished. The kind of notice herein provided shall be exclusive, and no other kind, whether actual or constructive, shall be binding on Assignor. SECTION 9.06. Rights of Mortgagee or Trustee. If Assignee shall at any time execute a mortgage or deed of trust covering all or part of the Royalty Interest, the mortgagee(s) or trustee(s) therein named or the holder of any obligation secured thereby shall be entitled, to the extent such mortgage or deed of trust so provides, to exercise all the rights, remedies, powers and privileges conferred upon Assignee by the terms of this Conveyance and to give or withhold all consents required to be obtained hereunder by Assignee, but the provisions of this Section 9.06 shall in no way be deemed or construed to impose upon Assignor any obligation or liability undertaken by Assignee under such mortgage or deed of trust or under the obligation secured thereby. ARTICLE X MISCELLANEOUS SECTION 10.01. Proportionate Reduction. In the event of failure or deficiency in title to any of the Subject Interests, the portion of the production from such Subject Interest out of which the Royalty Interest attributable to such Subject Interest shall be payable shall be reduced in the same proportion that such Subject Interest is reduced. Notwithstanding the foregoing, if any Person claims that this Conveyance gives rise to a preferential right of such Person to acquire any portion of the Royalty Interest (or any of the Subject Interests), then Assignor shall indemnify Assignee and the trustee of the Trust against any liability, expense, damage or loss in regard to such claim and the provisions of Section 6.05 of the Trust Indenture shall apply with respect to such indemnity obligation. If such claim results in the acquisition of any portion of the Royalty Interest by the Person claiming the preferential right then, subject to the proviso below, Assignor shall pay to Assignee the amount determined by multiplying (i) the product of 40,000,000 multiplied by the initial public offering price of the Trust's units of beneficial interest by (ii) a fraction, the numerator of which is the value of the portion of the Royalty Interest acquired by the Person claiming the preferential right, as determined by reference to the most recent Reserve Report (as defined in the Trust Indenture) of the Trust and the denominator of which is the value of all the Royalty Interest as determined by reference to such Reserve Report; provided, however, that if the Person claiming such preferential right makes any payment to the Trust in connection with the acquisition of a portion of the Royalty Interest, then the amount of such payment shall be credited against Assignor's payment obligation set forth above, but not to create a negative number. SECTION 10.02. Term. This Conveyance shall remain in force as long as any of the Subject Interests are in effect. SECTION 10.03. Further Assurances. Should any additional instruments of assignment and conveyance be required to describe more specifically any interests subject hereto, Assignor agrees to execute and deliver the same. Also, if any other or additional instruments are required in 17 connection with the transfer of State, Federal or Indian lease interests in order to comply with applicable laws, regulations or agreements, Assignor will execute and deliver the same. SECTION 10.04. Notices. All notices, statements, payments and communications between the parties hereto shall be deemed to have been sufficiently given and delivered if enclosed in a post paid wrapper and deposited in the United States Mails directed, or if personally delivered, to the party to whom the same is directed or to be furnished or made at the respective addresses, as follows: If to Assignor: Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, Texas 76102 Attention: Corporate Secretary If to Assignee: NationsBank, N.A. 17th Floor 901 Main Street NationsBank Plaza Dallas, Texas 75202 Attention: Trust Department Either party or the successors or assignees of the interest or rights or obligations of either party hereunder may change its address or designate a new or different address or addresses for the purposes hereof by a similar notice given or directed to all parties interested hereunder at the time. SECTION 10.05. Binding Effect. This Conveyance shall bind and inure to the benefit of the successors and assigns of Assignor and Assignee. SECTION 10.06. Governing Law. The validity, effect and construction of this Conveyance shall be governed by the laws of the State of Texas. SECTION 10.07. Headings. Article and Section headings used in this Conveyance are for convenience only and shall not affect the construction of this Conveyance. SECTION 10.08. Substitution of Warranty. This instrument is made with full substitution and subrogation of Assignee in and to all covenants of warranty by others heretofore given or made with respect to the Subject Interests or any part thereof or interest therein. 18 SECTION 10.09. Counterpart Execution. This Conveyance may be executed in multiple counterparts, each of which shall be an original. Certain counterparts may have descriptions relating to different recording jurisdictions omitted from Schedule A. A counterpart with all such descriptions is being filed for record in Seward County, Kansas. Where a description covers an interest located in more than one county, such description may be included in counterparts recorded in each county but such inclusion of the same description in more than one counterpart does not have any cumulative effect as to the interests covered by such description. IN WITNESS WHEREOF, each of the parties hereto has caused this Conveyance to be executed in its name and behalf and delivered as of the Effective Date. ATTEST: CROSS TIMBERS OIL COMPANY /s/ VIRGINIA ANDERSON - ---------------------------- Virginia Anderson, Secretary of Cross Timbers Oil Company By: /s/ VAUGHN O. VENNERBERG, II ---------------------------------- Vaughn O. Vennerberg, II Senior Vice President - Land ATTEST: NATIONSBANK, N.A., acting not in its individual capacity but solely as the Trustee of the Hugoton Royalty Trust /s/ DONALD A. YUCHS - ---------------------------- By: /s/ RON E. HOOPER ---------------------------------- Ron E. Hooper, Vice President 19 STATE OF TEXAS (S) (S) COUNTY OF TARRANT (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Vaughn O. Vennerberg II, Senior Vice President - Land of Cross Timbers Oil Company, on behalf of said corporation. Commission Expires: /s/ KIM FIELDS RHOADS 11-13-99 -------------------------------------------- - -------- Notary Public State of Texas [NOTARY SEAL APPEARS HERE] THE STATE OF TEXAS (S) (S) COUNTY OF DALLAS (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Ron E. Hooper, Vice President of NationsBank, N.A., Trustee of the Hugoton Royalty Trust, on behalf of said Bank as Trustee of the Hugoton Royalty Trust. Commission Expires: /s/ JANA L. EGELER 10-22-02 -------------------------------------------- - -------- Notary Public State of Texas [NOTARY SEAL APPEARS HERE] 20 SCHEDULE A [Description of Subject Interests - Omitted] 21 SCHEDULE B Attached to and made a part of that certain Net Overriding Royalty Conveyance (Hugoton Royalty Trust) dated effective December 1, 1998 (the "Conveyance") ACCOUNTING PROCEDURE I. GENERAL PROVISIONS 1. Definitions "Joint Property" shall mean the real and personal property subject to the Conveyance. "Joint Operations" shall mean all operations necessary or proper for the development, operation, protection and maintenance of the Joint Property. "Joint Account" shall mean the account showing the charges paid and credits received in the conduct of the Joint Operations and which are used in the calculation of Gross Proceeds, Net Proceeds, Processing Costs and Production Costs, as said terms are defined in the Conveyance. "Operator" shall mean Cross Timbers Oil Company or any of its affiliates that conduct Joint Operations on the Joint Property. "Parties" shall mean Operator and the Hugoton Royalty Trust (herein referred to as the "Trust"). "First Level Supervisors" shall mean those employees whose primary function in Joint Operations is the direct supervision of other employees and/or contract labor directly employed on the Joint Property in a field operating capacity. "Technical Employees" shall mean those employees having special and specific engineering, geological or other professional skills, and whose primary function in Joint Operations is the handling of specific operating conditions and problems for the benefit of the Joint Property. "Personal Expenses" shall mean travel and other reasonable reimbursable expenses of Operator's employees. "Material" shall mean personal property, equipment or supplies acquired or held for use on the Joint Property. "Controllable Material" shall mean Material which at the time is so classified in the Material Classification Manual as most recently recommended by the Council of Petroleum Accountants Societies. 2. Designation and Responsibilities of Operator Cross Timbers Oil Company shall be the Operator of the Joint Property, and shall, to the extent it has the legal right to do so, conduct and direct and have full control of all operations on the Joint Property as permitted and required by, and within the limits of the Conveyance. 3. Payments and Accounting Except as herein otherwise specifically provided, Operator shall promptly pay and discharge expenses incurred in the development and operation of the Joint Property and shall charge the Joint Account with the appropriate proportionate share upon the expense basis provided herein. Operator shall keep an accurate record of the expenses incurred and charges and credits made and received. 4. Application of Agreement This Accounting Procedure will apply to Joint Properties where Cross Timbers Oil Company is the Operator and the Operator owns all or a portion of the leasehold interest in the Joint Properties. In the event there is an existing Accounting Procedure or related instrument governing the operations of the Joint Properties, this Accounting Procedure will control except as to the overhead rate stated in the existing Accounting Procedure or related instrument. 1 5. Conflicts In the event there exists any conflict between the terms of this Accounting Procedure or any Accounting Procedure that applies to the Joint Properties and the Conveyance to which it is attached, the Conveyance will control. II. DIRECT CHARGES Operator shall charge the Joint Account with the following items, which shall be allocated to Processing Costs or Production Costs as appropriate: 1. Ecological and Environmental Costs incurred for the benefit of the Joint Property as a result of governmental or regulatory requirements to satisfy environmental considerations applicable to the Joint Operations. Such costs may include surveys of an ecological or archaeological nature and pollution control procedures as required by applicable laws and regulations, and costs related to employees of Operator performing any environmental work involving the Joint Property. 2. Rentals and Royalties Lease rentals and royalties paid by Operator for the Joint Operations. 3. Labor A. (1) Salaries and wages of Operator's field employees employed on the Joint Property in the conduct of Joint Operations. (2) Salaries of First Level Supervisors in the field. (3) Salaries and wages of Technical Employees directly employed on the Joint Property. (4) Salaries and wages of Technical Employees either temporarily or permanently assigned to and directly employed in the operation of the Joint Property. (5) Salaries and wages of support employees whose duties are primarily field related in connection with the Joint Operations, regardless of their location (e.g., field superintendents and clerical employees located in the field). B. Operator's cost of holiday, vacation, sickness and disability benefits and other customary allowances paid to employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. Such costs under this Paragraph 3B may be charged on a "when and as paid basis" or by "percentage assessment" on the amount of salaries and wages chargeable to the Joint Account under Paragraph 3A of this Section II. If percentage assessment is used, the rate shall be based on the Operator's cost experience. C. Expenditures or contributions made pursuant to assessments imposed by governmental authority which are applicable to Operator's costs chargeable to the Joint Account under Paragraphs 3A and 3B of this Section II. D. Personal Expenses of those employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. 4. Employee Benefits Operator's current costs of established plans for employees' group life insurance, hospitalization, pension, retirement, stock purchase, thrift, bonus, and other benefit plans of a like nature, applicable to Operator's labor cost chargeable to the Joint Account under 2 Paragraph 3A and 3B of this Section II shall be Operator's actual cost not to exceed the percent most recently recommended by the Council of Petroleum Accountants Societies. 5. Material Material purchased or furnished by Operator for use on the Joint Property as provided under Section IV. Only such Material shall be purchased for or transferred to the Joint Property as may be required for immediate use and is reasonably practical and consistent with efficient and economical operations. The accumulation of surplus stocks shall be avoided. 6. Transportation Transportation of employees and Material necessary for the Joint Operations but subject to the following limitations: A. If Material is moved to the Joint Property from the Operator's warehouse or other properties, no charge shall be made to the Joint Account for a distance greater than the distance from the nearest reliable supply store where like material is normally available or railway receiving point nearest the Joint Property. B. If surplus Material is moved to Operator's warehouse or other storage point, no charge shall be made to the Joint Account for a distance greater than the distance to the nearest reliable supply store where like material is normally available, or railway receiving point nearest the Joint Property. No charge shall be made to the Joint Account for moving Material to other properties belonging to Operator. C. In the application of subparagraphs A and B above, the option to equalize or charge actual trucking cost is available when the actual charge is $400 or less excluding accessorial charges. The $400 will be adjusted to the amount most recently recommended by the Council of Petroleum Accountants Societies. 7. Services The cost of contract services, equipment and utilities provided by outside sources, except services excluded by Paragraph 10 of Section II and Paragraph i, ii, and iii, of Section III. The cost of professional consultant services and contract services of technical personnel directly engaged on the Joint Property if such charges are excluded from the overhead rates. 8. Equipment and Facilities Furnished By Operator A. Operator shall charge the Joint Account for use of equipment and facilities owned by Operator or any of its affiliates at rates commensurate with costs of ownership and operation. Such rates shall include costs of maintenance, repairs, other operating expense, insurance, taxes, depreciation, and interest on gross investment less accumulated depreciation not to exceed twelve percent (12%) per annum. Such rates shall not exceed average commercial rates currently prevailing in the immediate area of the Joint Property. B. In lieu of charges in paragraph 8A above, Operator may elect to use average commercial rates prevailing in the immediate area of the Joint Property less 20%. For automotive equipment, Operator may elect to use rates published by the Petroleum Motor Transport Association. C. This Paragraph 8 shall not affect any current charges made by Operator to the Joint Account related to transportation, gathering, treating, compression or processing or related charges by an affiliate of Operator. 9. Damages and Losses to Joint Property All costs or expenses necessary for the repair or replacement of Joint Property made necessary because of damages or losses incurred by fire, flood, storm, theft, accident, or other cause, except those resulting from Operator's gross negligence or willful misconduct. 10. Legal Expense Expense of handling, investigating and settling litigation or claims, discharging of liens, payment of judgments and amounts paid for settlement of claims incurred in or resulting from operations under the Conveyance or necessary to protect or recover the Joint 3 Property, and the costs and expenses incurred in connection with hearings and other matters before governmental bodies and agencies and costs and expenses incurred in curing title to the Joint Property. Costs incurred by Operator in procuring abstracts and fees paid outside attorneys for title examination (including preliminary, supplemental, shut-in gas royalty opinions and division order title opinions) shall be borne by the Joint Account. Operator shall make no charge for services rendered by its staff attorneys or other personnel in the performance of the above functions. All other legal expense is considered to be covered by the overhead provisions of Section III. 11. Taxes All taxes of every kind and nature assessed or levied upon or in connection with the Joint Property, the operation thereof, or the production therefrom, and which taxes have been paid by the Operator for the benefit of the Parties. If the ad valorem taxes are based in whole or in part upon separate valuations of each party's interest, then notwithstanding anything to the contrary herein, charges to the Joint Account shall be made and paid by the Parties hereto in accordance with the tax value generated by each party's interest. 12. Insurance Net premiums paid for insurance required to be carried for the Joint Operations for the protection of the Parties. In the event Joint Operations are conducted in a state in which Operator may act as self-insurer for Worker's Compensation and/or Employers Liability under the respective state's laws, Operator may, at its election, include the risk under its self-insurance program and in that event, Operator shall include a charge at Operator's cost not to exceed manual rates. 13. Abandonment and Reclamation Costs incurred for abandonment of the Joint Property, including costs required by governmental or other regulatory authority. 14. Communications Cost of acquiring, leasing, installing, operating, repairing and maintaining communication systems, including radio and microwave facilities or any form of telephonic equipment or service used in serving the Joint Property. In the event communication facilities/systems serving the Joint Property are Operator owned, charges to the Joint Account shall be made as provided in Paragraph 8 of this Section II. 15. Other Expenditures Any other expenditure not covered or dealt with in the foregoing provisions of this Section II, or in Section III and which is of direct benefit to the Joint Property and is incurred by the Operator in the necessary and proper conduct of the Joint Operations. III. OVERHEAD 1. Overhead - Drilling and Producing Operations i. As compensation for administrative, supervision, office services and warehousing costs, Operator shall charge drilling and producing operations on a Fixed Rate Basis, Paragraph 1A. Such charge shall be in lieu of costs and expenses of all offices and salaries or wages plus applicable burdens and expenses of all personnel, except those directly chargeable under Paragraph 3A, Section II. The cost and expense of services from outside sources in connection with matters of taxation, traffic, accounting or matters before or involving governmental agencies shall not be considered as included in the overhead rates. ii. The salaries, wages and Personal Expenses of Technical Employees and/or the cost of professional consultant services and contract services of technical personnel directly employed on the Joint Property shall not be covered by the overhead rates. iii. The salaries, wages and Personal Expenses of Technical Employees and/or costs of professional consultant services and contract services of technical personnel either temporarily or permanently assigned to and directly employed in the operation of the Joint Property shall not be covered by the overhead rates. 4 A. Overhead - Fixed Rate Basis (1) Operator shall charge the Joint Account at the following rates per well per month: For wells located in the Hugoton Field Drilling Well Rate $2,350.00 (Prorated for less than a full month) Producing Well Rate $235.00 For wells located in all other areas Drilling Well Rate $4,760.00 (Prorated for less than a full month) Producing Well Rate $476.00 (2) Application of Overhead - Fixed Rate Basis shall be as follows: (a) Drilling Well Rate (1) Charges for drilling wells shall begin on the date the well is spudded and terminate on the date the drilling rig, completion rig, or other units used in completion of the well is released, whichever is later, except that no charge shall be made during suspension of drilling or completion operations for fifteen (15) or more consecutive calendar days. (2) Charges for wells undergoing any type of workover or recompletion or swabbing shall be made at the drilling well rate. Such charges shall be applied for the period from date such operations, with rig or other units used, commence through date of rig or other unit release, except that no charge shall be made during suspension of operations for fifteen (15) or more consecutive calendar days. (b) Producing Well Rates (1) An active well either produced or injected into for any portion of the month shall be considered as a one-well charge for the entire month. (2) Each active completion in a multi-completed well in which production is not commingled down hole shall be considered as a one-well charge providing each completion is considered a separate well by the governing regulatory authority. (3) An inactive gas well shut in because of overproduction or failure of purchaser to take the production shall be considered as a one-well charge providing the gas well is directly connected to a permanent sales outlet. (4) A one-well charge shall be made for the month in which plugging and abandonment operations are completed on any well. This one-well charge shall be made whether or not the well has produced except when drilling well rate applies. (5) All other inactive wells (including but not limited to inactive wells covered by unit allowable, lease allowable, transferred allowable, etc.) shall not qualify for an overhead charge. (3) The well rates shall be adjusted as of the first day of April each year beginning in 1999. The adjustment shall be computed by multiplying the rate currently in use by the percentage increase or decrease in the average weekly earnings of Crude Petroleum and Gas Production Workers for the last calendar year compared to the calendar year preceding as shown by the index of average weekly earnings of Crude Petroleum and Gas Production Workers as 5 published by the United States Department of Labor, Bureau of Labor Statistics. The adjusted rates shall be the rates currently in use, plus or minus the computed adjustment. 2. Overhead - Major Construction To compensate Operator for overhead costs incurred in the construction and installation of fixed assets, the expansion of fixed assets, and any other project clearly discernable as a fixed asset required for the development and operation of the Joint Property, Operator shall charge the Joint Account for overhead based on the following rates for any Major Construction project in excess of $25,000.00: A. 5% of first $100,000 or total cost if less, plus B. 3% of costs in excess of $100,000 but less than $1,000,000, plus C. 2% of costs in excess of $1,000,000. Total cost shall mean the gross cost of any one project. For the purpose of this paragraph, the component parts of a single project shall not be treated separately and the cost of drilling and workover wells and artificial lift equipment shall be excluded. 3. Catastrophe Overhead To compensate Operator for overhead costs incurred in the event of expenditures resulting from a single occurrence due to oil spill, blowout, explosion, fire, storm, hurricane, or other catastrophes as agreed to by the Parties, which are necessary to restore the Joint Property to the equivalent condition that existed prior to the event causing the expenditures, Operator shall charge the Joint Account for overhead based on the following rates: A. 5% of total costs through $100,000; plus B. 3% of total costs in excess of $100,000 but less than $1,000,000; plus C. 2% of total costs in excess of $1,000,000. Expenditures subject to the overheads in this Section 3 above will not be reduced by insurance recoveries, and no other overhead provisions of this Section III shall apply. IV. PRICING OF JOINT ACCOUNT MATERIAL PURCHASES, TRANSFERS AND DISPOSITIONS Operator is responsible for Joint Account Materials and shall make proper and timely charges and credits for all Material movements affecting the Joint Property. Operator shall provide all Material for use on the Joint Property. Operator shall make timely disposition of idle and/or surplus Material, such disposal being made either through sale to Operator, or sale to outsiders. Operator may purchase, but shall be under no obligation to purchase, interest of the Trust in surplus condition A or B Material at the prices defined below. 1. Purchases Material purchased shall be charged at the price paid by Operator after deduction of all discounts, adjustments or rebates received. In case of Material found to be defective or returned to vendor for any other reasons, credit shall be passed to the Joint Account when adjustment has been received by the Operator. 2. Transfers and Dispositions Material furnished to the Joint Property and Material transferred from the Joint Property or disposed of by the Operator shall be priced on the following basis exclusive of cash discounts: A. New Material (Condition A) (1) Tubular Goods Other than Line Pipe 6 (a) Tubular goods, sized 2-3/8 inches OD and larger, except line pipe, shall be priced at Eastern mill published carload prices effective as of date of movement plus transportation cost using the 80,000 pound carload weight basis to the railway receiving point nearest the Joint Property for which published rail rates for tubular good exist. If the 80,000 pound rail rate is not offered, the 70,000 pound or 90,000 pound rail rate may be used. Freight charges for tubing will be calculated from Lorain, Ohio and casing from Youngstown, Ohio. (b) For grades which are special to one mill only, prices shall be computed at the mill base of that mill plus transportation cost from that mill to the railway receiving point nearest the Joint Property as provided above in Paragraph 2.a.(1)(a). For transportation cost from points other than Eastern mills, the 30,000 pound Oil Field Haulers Association interstate truck rate shall be used. (c) Special end finish tubular goods shall be priced at the lowest published out-of-stock price, f.o.b. Houston, Texas, plus transportation cost, using Oil Field Haulers Association interstate 30,000 pound truck rate, to the railway receiving point nearest the Joint Property. (d) Macaroni tubing (size less than 2-3/8 inch OD) shall be priced at the lowest published out-of-stock prices f.o.b. the supplier plus transportation costs, using the Oil Field Haulers Association interstate truck rate per weight of tubing transferred, to the railway receiving point nearest the Joint Property. (2) Line Pipe (a) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) 30,000 pounds or more shall be priced under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (b) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) less than 30,000 pounds shall be priced at Eastern mill published carload base prices effective as of date of shipment, plus 20 percent, plus transportation costs based on freight rates as set forth under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (c) Line pipe 24 inch OD and over and 3/4 inch wall and larger shall be priced f.o.b. the point of manufacture at current new published prices plus transportation cost to the railway receiving point nearest the Joint Property. (d) Line pipe, including fabricated line pipe, drive pipe and conduit not listed on published price lists shall be priced at quoted prices plus freight to the railway receiving point nearest the Joint Property or at prices agreed to by the Parties. (3) Other Material shall be priced at the current new price, in effect at date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. (4) Unused new Material, except tubular goods, moved from the Joint Property shall be priced at the current new price, in effect on date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. Unused new tubulars will be priced as provided above in Paragraph 2 A (1) and (2). B. Good Used Material (Condition B) Material in sound and serviceable condition and suitable for reuse without reconditioning: (1) Material moved to the Joint Property At seventy-five percent (75%) of current new price, as determined by Paragraph A. 7 (2) Material used on and moved from the Joint Property (a) At seventy-five percent (75%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as new Material. (b) At sixty-five percent (65%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as used Material. (3) Material not used on and moved from the Joint Property At seventy-five percent (75%) of current new price as determined by Paragraph A. The cost of reconditioning, if any, shall be absorbed by the transferring property. C. Other Used Material (1) Condition C Material which is not in sound and serviceable condition and suitable for its original function until after reconditioning shall be priced at fifty percent (50%) of current new price as determined by Paragraph A. The cost of reconditioning shall be charged to the receiving property, provided Condition C value plus cost of reconditioning does not exceed Condition B value. (2) Condition D Material, excluding junk, no longer suitable for its original purpose, but usable for some other purpose shall be priced on a basis commensurate with its use. Operator may dispose of Condition D Material under procedures normally used by Operator without prior approval of the Assignee. (a) Casing, tubing or drill pipe used as line pipe shall be priced as Grade A and B seamless line pipe of comparable size and weight. Used casing, tubing or drill pipe utilized as line pipe shall be priced at used line pipe prices. (b) Casing, tubing or drill pipe used as higher pressure service lines than standard line pipe, e.g. power oil lines, shall be priced under normal pricing procedures for casing, tubing, or drill pipe. Upset tubular goods shall be priced on a non upset basis. (3) Condition E Junk shall be priced at prevailing prices. Operator may dispose of Condition E Material under procedures normally utilized by Operator without prior approval of Non-Operators. D. Obsolete Material Material which is serviceable and usable for its original function but condition and/or value of such Material is not equivalent to that which would justify a price as provided above may be specially priced as reasonably determined by Operator. Such price should result in the Joint Account being charged with the value of the service rendered by such Material. E. Pricing Conditions (1) Loading and unloading costs related to the movement of the Material to the Joint Property shall be charged in accordance with the methods specified in COPAS Bulletin 21. (2) Material involving erection costs shall be charged at applicable percentage of the current knocked-down price of new Material. 8 3. Premium Prices Whenever Material is not readily obtainable at published or listed prices because of national emergencies, strikes or other unusual causes over which the Operator has no control, the Operator may charge the Joint Account for the required Material at the Operator's actual cost incurred in providing such Material, in making it suitable for use, and in moving it to the Joint Property. 4. Warranty of Material Furnished by Operator Operator does not warrant the Material furnished. In case of defective Material, credit shall not be passed to the Joint Account until adjustment has been received by Operator from the manufacturers or their agents. V. INVENTORIES The Operator shall maintain detailed records of Controllable Material. 1. Periodic Inventories, Notice and Representation At reasonable intervals, inventories shall be taken by Operator of the Joint Account Controllable Material. 2. Reconciliation and Adjustment of Inventories Adjustments to the Joint Account resulting from the reconciliation of a physical inventory shall be made within six months following the taking of the inventory. Inventory adjustments shall be made by Operator to the Joint Account for overages and shortages, but Operator shall be held accountable only for shortages due to lack of reasonable diligence. 3. Special Inventories Special inventories may be taken whenever there is any sale, change of interest, or change of Operator in the Joint Property. It shall be the duty of the party selling to notify all other Parties as quickly as possible after the transfer of interest takes place. In such cases, both the seller and the purchaser shall be governed by such inventory. In cases involving a change of Operator, all Parties shall be governed by such inventory. 4. Expense of Conducting Inventories A. The expense of conducting periodic inventories shall not be charged to the Joint Account. B. The expense of conducting special inventories shall be charged to the Parties requesting such inventories, except inventories required due to change of Operator shall be charged to the Joint Account. 9 EX-10.2 7 FORM OF 80% NET OVERRIDING ROYALTY CONVEYANCE-OK Exhibit 10.2 NET OVERRIDING ROYALTY CONVEYANCE Hugoton Royalty Trust STATE OF OKLAHOMA (S) (S) COUNTIES OF BEAVER, (S) BECKHAM, CIMARRON, (S) KNOW ALL MEN BY THESE PRESENTS: ELLIS, HARPER, MAJOR, (S) TEXAS, WASHITA, WOODS (S) AND WOODWARD (S) THAT CROSS TIMBERS OIL COMPANY, a corporation formed under the laws of the State of Delaware ("Assignor"), for and in consideration of the sum of Ten Dollars ($10.00) and other good and valuable consideration to Assignor paid by NATIONSBANK, N.A., a bank organized under the laws of the United States, acting not in its individual corporate capacity but solely as trustee under that certain Trust Indenture establishing the Hugoton Royalty Trust dated as of December 1, 1998 ("Assignee"), the receipt and sufficiency of which are hereby acknowledged, has bargained, sold, granted, conveyed, transferred, assigned, set over and delivered, and by these presents does bargain, sell, grant, convey, transfer, assign, set over and deliver unto Assignee a net overriding royalty interest ("the Royalty Interest") in and to the Subject Hydrocarbons in and under, and if, as and when produced, saved and sold from, the Subject Lands during the term of the Subject Interests equal to eighty percent (80%) of the Net Proceeds attributable to the Subject Interests, as each of the above capitalized words is defined in Article I hereof and all as more fully provided herein. TO HAVE AND TO HOLD the Royalty Interest, together with all and singular the rights and appurtenances thereto in anywise belonging, unto Assignee, its successors and assigns, subject, however, to the terms and provisions of this Conveyance; and Assignor does by these presents bind and obligate itself, its successors and assigns, to WARRANT and FOREVER defend all and singular the Royalty Interest unto the said Assignee, its successors and assigns, against every person whomsoever lawfully claiming or to claim the same or any part thereof by, through or under Assignor, but not otherwise. ARTICLE I DEFINITIONS As used herein, the following words, terms or phrases have the following meanings: SECTION 1.01. "Affiliate" means, as to the party specified, any Person controlling, controlled by or under common control with such party, with the concept of control in such context meaning the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of another, whether through the ownership of voting securities, by contract or otherwise. The Trust shall not be deemed an Affiliate of Assignor. SECTION 1.02. "Assignor" means the Assignor named herein while Assignor owns all or any part of or interest in the Subject Interests and any other Person or Persons (excluding Assignee) who hereafter may acquire all or any part of or interest in the Subject Interests. SECTION 1.03. "Assignee" means the Assignee named herein (and any successor Trustee under the Trust Indenture) while it owns all or any part of or interest in the Royalty Interest and any other Person or Persons who may acquire legal title to all or any part of or interest in the Royalty Interest. SECTION 1.04. "Computation Period" means (i) initially, the period commencing on the Effective Date and ending on February 28, 1999, and (ii) each calendar month thereafter. SECTION 1.05. "Conveyance" means this Net Overriding Royalty Conveyance. SECTION 1.06. "Effective Date" means 7:00 o'clock A.M., local time in effect at the location of each Subject Interest, on December 1, 1998. SECTION 1.07. "Excess Production Costs" means, for any Computation Period, an amount equal to the excess, if any, of Production Costs for such Computation Period over Gross Proceeds for such Computation Period. SECTION 1.08. "Existing Sales Contracts" means all contracts and agreements in effect as of the Effective Date between or among Assignor and any Affiliate of Assignor, or between or among any Affiliates of Assignor, for the Sale, Processing, treatment, compression, gathering or transportation of Subject Hydrocarbons. SECTION 1.09. "Gross Proceeds" means, for any Computation Period, and subject to Section 2.01 (i) during the term of the Existing Sales Contracts, the proceeds received by Assignor under the Existing Sales Contracts attributable to the Sale of Subject Hydrocarbons Sold during such Computation Period by Assignor after the Effective Date, and (ii) as to Subject Hydrocarbons Sold by Assignor during such Computation Period after the Effective Date other than under the Existing Sales Contracts (A) if Sold under a Sales Contract with a Non-Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract, or (B) if Sold under a Sales Contract with an Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract but in no event less than 98% of the proceeds received by such Affiliate upon the resale of such Subject Hydrocarbons to a Non-Affiliate of Assignor, and (iii) the proceeds received by Assignor in respect of underproduced gas imbalances attributable to the Subject Interests as of the Effective Date, but in all instances, subject to the following: 2 (a) There shall be excluded from Gross Proceeds all Property Taxes that are deducted or excluded from proceeds of Sale received by Assignor. (b) There shall be excluded any amount for Subject Hydrocarbons attributable to nonconsent operations conducted with respect to the Subject Interests (or any portion thereof) as to which Assignor shall be a nonconsenting party and which is dedicated to the recoupment or reimbursement of costs and expenses of the consenting party or parties by the terms of the relevant operating agreement, unit agreement, contract for development or other instrument providing for such nonconsent operations. Assignor agrees that its election not to participate in such operations shall be made in conformity with the provisions of Section 6.01 of this Conveyance, but third persons shall not be under any duty to determine that such election so conformed. (c) There shall be excluded any amount which Assignor shall receive as any of the following: consideration for transfer or sale of any of the Subject Interests (subject to the Royalty Interest) or equipment or other personal property or fixtures on the Subject Lands; payments for gas not taken, when such payments are made (but to the extent such payments are allocated to gas taken in the future such payments shall be included without interest in Gross Proceeds when such gas is taken); damages arising from any cause other than drainage or reservoir injury; rental for reservoir use; payments made to Assignor in connection with the drilling of any well on any of the Subject Lands or lands in the vicinity thereof (such exclusion including dry and bottom hole payments, provided that if such well is drilled on the Subject Lands and Assignor incurs Production Costs in connection therewith such payments shall reduce Production Costs) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; provided there shall be included in Gross Proceeds advance or prepaid payments for future production received by Assignor to the extent not subject to repayment in the event of insufficient subsequent production (and to the extent so subject to repayment shall be included without interest in Gross Proceeds when the Subject Hydrocarbons on which such payment was so advanced or prepaid are actually produced) and payments made to Assignor in connection with the deferring of drilling of any well on any of the Subject Lands (including payments from an operator in the vicinity for refraining from drilling an offset well). (d) There shall be excluded any amount for Subject Hydrocarbons lost in the production or marketing thereof or used by Assignor in conformity with ordinary or prudent practices for drilling, production and plant operations (including gas injection, secondary recovery, pressure maintenance, repressuring, cycling operations, plant fuel or shrinkage) conducted for the purpose of drilling for, producing or Processing Subject Hydrocarbons or for operations on any unit or plant to which the Subject Interests are committed, but only so long as such Subject Hydrocarbons are so used. 3 (e) Amounts received as a loan by Assignor from a purchaser of Subject Hydrocarbons, whether with or without interest, shall not be considered to be derived from the sale of Subject Hydrocarbons. (f) If a controversy or possible controversy exists (whether by reason of any statute, order, decree, rule, regulation, contract or otherwise) between Assignor and any purchaser as to the correct sales price of any Subject Hydrocarbons or, for any other reason, as to Assignor's right to receive or collect the proceeds of sale of any Subject Hydrocarbons, then (i) amounts withheld by the purchaser or deposited by it with an escrow agent shall not be considered to be received by Assignor until actually collected by Assignor, but the amounts received by Assignor shall include any interest, penalty or other amount paid to Assignor in respect thereof; (ii) amounts received by Assignor and promptly deposited by it with an escrow agent shall not be considered to have been received by Assignor, but all amounts thereafter paid to Assignor by such escrow agent shall be considered to be amounts received from the Sale of Subject Hydrocarbons; and (iii) amounts received by Assignor and not deposited with an escrow agent shall be considered to be received for purposes of this Section 1.09. SECTION 1.10. "Hydrocarbons" means oil, gas (which term includes coal bed gas, coal seam gas and methane) and all other minerals produced in association with oil or gas (including, but not limited to, helium, sulphur and carbon dioxide), but excluding all other minerals, whether similar or dissimilar. SECTION 1.11. "Monthly Record Date" for each month means the close of business on the last day of such month which is not a Saturday, Sunday or other day on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law, unless Assignee determines that a different date is required to comply with applicable law or the rules of a securities exchange or quotation system pursuant to the terms of the Trust Indenture, in which event it means such different date. SECTION 1.12. "Net Proceeds" means, for any Computation Period, the excess of Gross Proceeds for such Computation Period over Production Costs for such Computation Period. SECTION 1.13. "Non-Affiliate" means, as to the party specified, any Person who is not an Affiliate of such party. SECTION 1.14. "Person" means any individual, corporation, partnership, limited liability company, trust, estate or other entity, organization or association. 4 SECTION 1.15. "Prime Interest Rate" means the variable rate of interest most recently announced by NationsBank, N.A. as its "prime rate." SECTION 1.16. "Process" or "Processing" means to extract or otherwise recover natural gas liquids from natural gas included in the Subject Hydrocarbons through the processes of absorption, condensation, adsorption, cryogenic or other methods in a manner that does not constitute Separation. SECTION 1.17. "Processing Costs" means the costs to Assignor or any Affiliate of Assignor to Process Subject Hydrocarbons before the Sale thereof, which costs for purposes hereof shall consist of the sum of (a) any such Processing charges paid to Non-Affiliates, (b) the charges by Affiliates of Assignor under Existing Sales Contracts, and (c) the charges by Affiliates of Assignor other than under Existing Sales Contracts so long as such charges do not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges. If Assignor (or its Affiliates) receives a share of the production of others or of plant products therefrom (or proceeds of sale thereof) for Processing such production of others, such share shall not be included in Subject Hydrocarbons (or Gross Proceeds). If Assignor (or its Affiliates) does not bear any Processing Costs but the owners or operators of a plant receive a share of the Subject Hydrocarbons (or proceeds of sale thereof) for Processing them, such share (or proceeds) shall be excluded from the Subject Hydrocarbons (and Gross Proceeds). SECTION 1.18. "Production Costs" means, for any Computation Period, to the extent not excluded for purposes of calculating Gross Proceeds, whether capital or non-capital in nature, (a) the sum of (i) all amounts paid by Assignor or any Affiliate of Assignor as any of the following: royalty, overriding royalty or other presently existing burden against production or the proceeds of Sale of production attributable to the Subject Interests; delay rental; shut-in gas well royalty or payment; minimum royalty; payments to lessors or others in the area in connection with the drilling or deferring of drilling of any well on any of the Subject Lands or lands in the vicinity thereof (including dry and bottom hole payments and payments made to others for refraining from drilling an offset well) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; and rent and other consideration paid for use of or damage to the surface; (ii) the Property Tax Accrual; (iii) the overhead costs paid by Assignor or any Affiliate of Assignor under any joint operating agreement applicable to any of the Subject Interests to which 5 Assignor and one or more Non-Affiliates of Assignor are parties and where Assignor or any Affiliate of Assignor is not the operator of such Subject Interest; (iv) the overhead rate provided for in any joint operating agreement applicable to any of the Subject Interests where Assignor or any Affiliate of Assignor is the operator of such Subject Interests, less the portion, if any, of the overhead rate due from Non-Affiliates of Assignor; (v) with respect to any Subject Interests operated by Assignor or any of its Affiliates and not subject to a joint operating agreement, an overhead fee as shown on Schedule B attached hereto and subject to adjustment as provided in Schedule B attached hereto; (vi) all other costs, expenses and liabilities (including Processing Costs) paid or incurred by Assignor or any Affiliate of Assignor for investigating, exploring, prospecting, drilling and mining for, operating and producing Subject Hydrocarbons and sale and marketing thereof, including without implied limitation: costs for equipping, plugging back, reworking, completing, recompleting and plugging and abandoning of any well on the Subject Lands and of making the Subject Hydrocarbons ready or available for market; costs for construction and operation of gathering lines, tanks, transmission lines, meters and other production and delivery facilities; costs, whether paid in cash or by a share of Subject Hydrocarbons, of transporting, compressing, dehydrating, separating, treating, storing and marketing the Subject Hydrocarbons and disposing of extraneous substances produced in association with Subject Hydrocarbons (provided that such costs, if paid to or incurred by an Affiliate of Assignor other than pursuant to an Existing Sales Contract, shall not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges); costs for secondary recovery, pressure maintenance, repressuring, cycling and other operations conducted for the purpose of enhancing production; costs or expenses (whether paid in cash or by delivery of gas) incurred in resolving overproduced gas imbalances attributable to the Subject Interests as of the Effective Date and thereafter; and costs for litigation concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests; and costs for litigation or regulatory proceedings concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests or to protect or enforce any rights, contractual or otherwise, of Assignor to produce or market Subject Hydrocarbons therefrom; (vii) Excess Production Costs for the preceding Computation Period (including any remaining Excess Production Costs carried forward from any preceding Computation Period); 6 (viii) interest on the amount of Excess Production Costs at the beginning of any Computation Period, calculated from the first day to the last day of the Computation Period, at the Prime Interest Rate in effect at the beginning of such Computation Period; (ix) any amounts paid by Assignor or any Affiliate of Assignor whether as refund, interest or penalty, to a purchaser or any governmental agency or other Person because the amount initially received by Assignor (or Affiliate of Assignor) as sales price for Sales after the Effective Date was more or allegedly more than permitted by the terms of any applicable contract, statute, regulation, order, decree or other obligation; provided such amounts (in the case of a refund), or the amounts with respect to which the interest or penalty was paid, were previously included in Gross Proceeds; (x) any other amounts paid by Assignor or any Affiliate of Assignor with respect to ownership or operation of the Subject Interests after the Effective Date or Sales of production therefrom after the Effective Date, whether as refund, fine, interest or penalty, pursuant to litigation or settlement of threatened litigation or order of governmental agency, provided that Assignor has not breached Section 6.01 hereof; (xi) all consideration hereafter paid and costs and expenses hereafter incurred by Assignor or any Affiliate of Assignor for any renewals or extensions of leases or other rights acquired after the Effective Date which are included in the definition herein of Subject Interests; and (xii) any accrual or reserve which Assignor or any Affiliate of Assignor shall have the right, at its election, to charge to Production Costs for operations (other than day-to-day operations) budgeted under an operating agreement or approved under an authorization for expenditures ("AFE"), which accrual or reserve may be based on the reasonably expected time of performing such operation or on an estimated percentage of completion of the operation or on any other reasonable method, and which accrual is in lieu of charging the cost of such operation when paid for by Assignor (or Affiliate of Assignor) but which shall be adjusted if and to the extent actual costs differ from such accrual or reserve; (b) but excluding (i) costs which would otherwise be treated as Production Costs (but which shall not be so treated for purposes hereof until the following amounts have been fully credited against such costs) equal to amounts reimbursed or credited to Assignor by insurance from damage to property, by sales of property or transfers of 7 property off the leases included in the Subject Interests or by proceeds from unitization or other disposition of property; and (ii) except for resolution of gas imbalances which are included in Section 1.18(a)(vi) above, any amounts which would otherwise be Production Costs but which are attributable to periods before the Effective Date; and (iii) costs that otherwise would be treated as Production Costs but which have already been excluded or deducted from Gross Proceeds under Section 1.09; and (iv) costs incurred by any Affiliate of Assignor for which such Affiliate has received a fee, reimbursement or other payment from Assignor, where such payment by Assignor constitutes a Production Cost; and (v) costs paid or accrued by Assignor during the month of December 1998 for the drilling, equipping, reworking, plugging back, completing or recompleting of any well on the Subject Lands. SECTION 1.19. "Property Taxes" means the sum of all general property (ad valorem), production, severance, sales, gathering and excise taxes and other taxes (whether state, federal or otherwise), except income taxes, assessed or levied on or in connection with the Subject Interests, the Royalty Interest or the production therefrom or equipment on the Subject Lands, or against Assignor as owner of the Subject Interests or Assignee as owner of the Royalty Interest. SECTION 1.20. "Property Tax Accrual" means, for any Computation Period, an amount that may be set aside by Assignor as an accrual to be applied against Property Taxes other than those that are deducted or excluded from Gross Proceeds pursuant to Section 1.09(a) above, which accruals shall be adjusted to the extent actual Property Taxes differ. SECTION 1.21. "Sale" and "Sold" mean all forms of dispositions of Subject Hydrocarbons for value, including exchanges and other dispositions for value. SECTION 1.22. "Sales Contracts" means all contracts and agreements for the sale of Subject Hydrocarbons. SECTION 1.23. "Separation" means liquid separation operations in the vicinity of the well using a conventional mechanical liquid gas separator but excluding operations involving heat exchange, adiabatic cooling, absorption, adsorption or refrigeration principles. SECTION 1.24. "Subject Hydrocarbons" means all Hydrocarbons in and under, and which may be produced, saved and sold from, and which shall accrue and be attributable to, the Subject Interests, including plant products attributable thereto from Processing gas or casinghead gas included 8 in the Subject Hydrocarbons before sale thereof (but not including products derived from processing oil). SECTION 1.25. "Subject Interests" means, subject to the exclusions stated below, each kind and character of right, title, claim or interest which Assignor has on the Effective Date in or under each oil, gas or mineral lease, unitization or pooling agreement (and the units created thereby), royalty interests, overriding royalty interests, fee mineral interests and net profits interests and any other agreements, conveyances, assignments or instruments which are described or referred to in Schedule A, and all the right, title, claim or interest which Assignor has on the Effective Date in and to the Subject Lands, whether such right, title, claim or interest be under and by virtue of a lease, a unitization or pooling agreement or order, an operating agreement, a division order, a transfer order or any other type of agreement, conveyance, assignment or instrument or under any other type of claim or title, legal or equitable, recorded or unrecorded, even though Assignor's interests be incorrectly or incompletely described in, or a description thereof be omitted from, Schedule A, all as the same shall be enlarged by the discharge of any payments out of production or by the removal of any charges or encumbrances to which any of the same are subject and any and all renewals and extensions of any of the same, but subject to all burdens to which Assignor's such right, title, claim or interest is subject (while same remains so subject), limited, however, if Assignor's interest in any Subject Interest should terminate at any time, to the period to which Assignor's interest in such Subject Interest is limited. There shall be excluded from the term "Subject Interests" any interest hereafter acquired by Assignor in and to any of the Subject Lands, except any interest acquired pursuant to existing agreements for no new consideration and renewals or extensions of existing leases and other such agreements. For purposes of this Conveyance "renewals or extensions" of any lease or other such agreement shall be limited to renewals or extensions of an existing lease or other such agreement obtained by the present owner thereof (or such owner's successors in interest) while such lease is in force or within six months after such lease or other such agreement terminates. Assignor shall be under no duty to seek renewals or extensions of any lease or other such agreement. SECTION 1.26. "Subject Lands" means the lands which are described in and which are subject to the oil, gas or mineral leases, unitization or pooling agreements or orders, operating agreements, division orders, transfer orders or other type of agreement, conveyance, assignment or instrument described in Schedule A attached hereto, provided that, where the description in Schedule A excepts land or refers to an instrument insofar only as it covers certain land or certain depths in certain land, no interest in such excepted land or depths or in land other that to which such reference is limited shall be included in the terms "Subject Lands" or "Subject Interests". SECTION 1.27. "Trust" means the Hugoton Royalty Trust established by the Trust Indenture. SECTION 1.28. "Trust Indenture" means the Royalty Trust Indenture by and between Cross Timbers Oil Company and NationsBank, N.A. dated as of December 1, 1998, establishing the Hugoton Royalty Trust, an express Texas Trust under the Texas Trust Code. 9 ARTICLE II MARKETING OF SUBJECT HYDROCARBONS SECTION 2.01. Sales Contracts. Assignor, to the extent it has the right to do so, shall market or cause to be marketed the Subject Hydrocarbons and Assignee shall have no authority to market the Subject Hydrocarbons or to take in-kind any Subject Hydrocarbons. For such purpose, Sales of Subject Hydrocarbons may continue to be made pursuant to Existing Sales Contracts. Assignor may amend such Existing Sales Contracts and may enter into one or more Sales Contracts in the future at the prices and on the terms Assignor shall deem proper in Assignor's sole and absolute discretion, which may include sales to Affiliates of Assignor. Further, Assignor may commit any of the Subject Interests (including the Royalty Interest attributable thereto) to one or more agreements for Processing pursuant to which, by way of example and not by way of limitation, the plant owner or operator (which may be an Affiliate of Assignor) receives a portion of the Subject Hydrocarbons or plant products derived therefrom or proceeds of the Sale thereof as a fee for Processing. Gross Proceeds of Subject Hydrocarbons shall be determined on the basis of amounts actually received by Assignor (and not, except as provided in Section 1.09, proceeds received by any of Assignor's Affiliates) from Sales under Sales Contracts regardless of whether at the time of production or Sale market value should be different from proceeds of Sale. In no event shall Gross Proceeds or Production Costs include any revenues, expenses, gains or losses resulting from option transactions or other futures or hedging transactions (other than forward Sales of the Subject Hydrocarbons) which, if engaged in by Assignor or any of its Affiliates in respect of Subject Hydrocarbons, shall be solely for the account of Assignor or such Affiliate. SECTION 2.02. Delivery of Subject Hydrocarbons. All Subject Hydrocarbons Sold by Assignor, whether pursuant to Sales Contracts or otherwise, shall be delivered, by Assignor to the purchasers thereof, into the pipelines to which the wells producing such Subject Hydrocarbons may be connected or to such other point of purchase as is reasonably required in the marketing of such Subject Hydrocarbons. SECTION 2.03. Reliance by Third Party. As to any party, the acts of Assignor shall be binding on Assignee. It shall not be necessary for Assignee to join with Assignor in any division or transfer order, lease extension or Sales Contract, and proceeds of Sale of the Subject Hydrocarbons shall be paid by the purchasers thereof (or others disbursing proceeds) directly to Assignor without necessity of joinder by or consent of Assignee. ARTICLE III PAYMENTS SECTION 3.01. Payment. On or before each Monthly Record Date, beginning with the Monthly Record Date for March, 1999, Assignor shall pay to Assignee as an overriding royalty 10 hereunder an amount equal to eighty percent (80%) of the Net Proceeds for the preceding Computation Period. SECTION 3.02. Interest on Past Due Payments. Except as otherwise provided in Section 9.05 hereof, any amount not paid by Assignor to Assignee when due shall bear, and Assignor will pay, interest determined at the end of each month, from such due date until such amount is paid, at the rate of the lesser of (a) the Prime Interest Rate plus 4% or (b) the maximum lawful contract rate of interest permitted by the applicable usury laws, now or hereafter enacted, which interest rate (the "Maximum Rate") shall change when and as said laws change, effective at the close of business on the day such change in said laws becomes effective; but, if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). SECTION 3.03. Overpayment. If at any time Assignor pays Assignee more than the amount due, Assignee shall not be obligated to return any such overpayment, but the amount or amounts otherwise payable to Assignee for any subsequent period or periods shall be reduced by such overpayment, plus an amount equal to interest during the period of such overpayment at the rate of the lesser of (a) the Prime Interest Rate or (b) the Maximum Rate; but if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). ARTICLE IV RECORDS AND REPORTS SECTION 4.01. Books and Records. Assignor shall at all times maintain true and correct books and records sufficient to determine the amounts payable to Assignee hereunder, including, but not limited to, a Net Proceeds account to which Gross Proceeds and Production Costs are credited and charged. SECTION 4.02. Inspections. The books and records referred to in Section 4.01 shall be open for inspection by Assignee and its agents and representatives at the office of Assignor during normal business hours and after reasonable advance notice. SECTION 4.03. Quarterly Statements. Within thirty (30) days next following the close of each calendar quarter, Assignor shall deliver to Assignee a statement showing the computation of Net Proceeds attributable to such quarter. SECTION 4.04. Assignee's Exceptions to Quarterly Statements. If Assignee shall take exception to any item or items included in the quarterly statements rendered by Assignor, Assignee shall notify Assignor in writing within 180 days after the receipt of the report and annual audit furnished pursuant to Section 4.07 hereof, setting forth in such notice the specific charges complained of and to which exception is taken or the specific credits which should have been made and allowed; and, with respect to such complaints and exceptions as are justified, adjustment shall be made. If Assignee shall fail to give Assignor notice of such complaints and exceptions prior to the expiration 11 of such 180 day period, then the statements for such calendar year as originally rendered by Assignor shall be deemed to be correct as rendered. SECTION 4.05. Geological and Other Data. Upon request by Assignee, Assignor shall, subject to the limitations of confidentiality or nondisclosure obligations to co-owners or other third parties, furnish to Assignee access to all geological, well and production data which Assignor has on hand relating to operations on the Subject Interests. Assignor will use reasonable efforts to obtain waivers of any such confidentiality or nondisclosure obligations that prevent it from providing to Assignee any requested information, but Assignor shall not be obligated to incur any expense or detriment above a nominal amount to obtain such waiver. Assignor shall also furnish to Assignee, upon request by Assignee, reports showing the status of development, producing and other operations conducted by Assignor on the Subject Interests. Assignor shall, upon request by Assignee, furnish to Assignee all reserve reports or studies in the possession of Assignor from time to time relating to the Subject Interests, whether prepared by Assignor or by third party consulting engineers; provided, it is agreed that Assignor makes no representations or warranties as to the accuracy or completeness of any such reports or studies and shall have no liability to Assignee or any other Person resulting from their use of such reports or studies, and Assignee agrees not to attribute to Assignor or such third-party consulting engineers any such reports or studies or the contents thereof in any securities filings or reports to owners or holders of "Beneficial Interests" in the Trust. All information furnished to Assignee pursuant to this section is confidential and for the sole benefit of Assignee and shall not be shown by Assignee to any other Person, except that this provision shall not prohibit the disclosure by Assignee of any information that (i) at the time of disclosure is generally available to the public (other than as a result of a disclosure by Assignee), (ii) was available to Assignee on a nonconfidential basis from a source other than Assignor, provided that such source is not known by Assignee to be bound by a confidentiality obligation owed to Assignor, or (iii) Assignee is legally required to disclose, provided that Assignee has given to Assignor notice of such requirement and a reasonable opportunity to seek, at Assignor's expense, a protective order and other appropriate relief from such requirement. SECTION 4.06. Monthly Estimates. On or before ten days (excluding Saturdays, Sundays and other days on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law) before each Monthly Record Date (beginning with the Monthly Record Date for March, 1999), Assignor shall deliver to Assignee a statement of Assignor's best estimate of the amount payable to Assignee on or before such Monthly Record Date. SECTION 4.07. Annual Audits and Reports. Within 90 days after the end of the calendar year, Assignor shall deliver to Assignee a statement which has been audited by a nationally recognized firm of independent public accountants selected by Assignor, which shall show the information provided for in Section 4.03 on an annual basis. Assignee shall bear the cost of each such audit. 12 SECTION 4.08. Reserve Reports. Assignor may, but is not obligated to, provide an annual reserve report for the Royalty Interest prepared by independent consulting reservoir engineers. If such reserve report is provided by Assignor, Assignee will reimburse Assignor for the cost thereof. ARTICLE V LIABILITY OF ASSIGNEE In no event shall Assignee be liable or responsible in any way for any Production Costs (including Excess Production Costs) or other costs or liabilities incurred by Assignor or others attributable to the Subject Interests or to the Hydrocarbons produced therefrom. ARTICLE VI OPERATION OF SUBJECT INTERESTS SECTION 6.01. Prudent Operator Standard. Assignor agrees, to the extent it has the legal right to do so under the terms of any lease, operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof), that it will conduct and carry on the maintenance and operation of the Subject Interests with reasonable and prudent business judgment and in accordance with good oil and gas field practices, and that it will drill such wells as a reasonably prudent operator would drill from time to time in order to protect the Subject Interests from drainage. However, nothing contained in this Section 6.01 shall be deemed to prevent or restrict Assignor from electing not to participate in any operation which is to be conducted under the terms of any operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof) and allowing consenting parties to conduct nonconsent operations thereon, if such election is made by Assignor in good faith. Notwithstanding anything elsewhere herein to the contrary, Assignor shall never be liable to Assignee for the manner in which Assignor performs its duties hereunder as long as Assignor has acted in good faith. SECTION 6.02. Abandonment of Properties. Nothing herein contained shall obligate Assignor to continue to operate any well or to operate or maintain in force or attempt to maintain in force any of the Subject Interests when, in Assignor's opinion, such well or Subject Interest ceases to produce or is not capable of producing Hydrocarbons in paying quantities. The expiration of a Subject Interest in accordance with the terms and conditions applicable thereto shall not be considered to be a voluntary surrender or abandonment thereof. SECTION 6.03. Insurance. Although Assignor is permitted to carry policies of insurance covering the property upon the Subject Interests and risks incident to the operation thereof and to charge premiums therefor to the Net Proceeds account, Assignor shall not be required to carry insurance on such property or covering any of such risks unless it elects to do so. In no event shall Assignor be liable to Assignee on account of any losses sustained which are not covered by insurance. 13 SECTION 6.04. Certain Rights to Manage the Subject Interests. Notwithstanding anything in this Conveyance to the contrary, Assignor shall have the right and power, acting in good faith and as a reasonably prudent oil and gas operator, to execute, deliver, and perform operating agreements, oil and gas leases, farmout agreements, exploration agreements, participation agreements, drilling agreements, acreage contribution agreements, dry-hole agreements, bottom-hole agreements, joint venture agreements, partnership agreements, and other similar instruments and agreements that cover or affect the Subject Interests and to make all decisions or elections required thereunder, including, but not limited to, decisions to consent or non-consent to drilling and other operations. The applicable Royalty Interest shall in each case be bound by such instrument or agreement (and decisions or elections thereunder), without the necessity of any execution, consent, joinder, or ratification by Assignee, and the Royalty Interest shall thereafter be calculated and paid with respect to the interests reserved, obtained, or modified by Assignor in such transaction, not by reference to the Subject Interests that existed before such transaction. For example, but not by way of limitation, (a) Assignor may farm out any Subject Interest that is an oil and gas lease, and the Subject Interest therein shall subsequently be the overriding royalty interest, reversionary working interest, and/or other rights and interests reserved by Assignor in the farmout, not the original leasehold interest, or (b) Assignor may execute an oil and gas lease to cover any Subject Interest that is a mineral interest, and the Subject Interest shall subsequently be the royalty and other lease benefits obtained or reserved by Assignor in such lease, not the original mineral interest. ARTICLE VII POOLING AND UNITIZATION SECTION 7.01. Pooled Subject Interests. To the extent any of the Subject Interests have been heretofore pooled and unitized for the production of Hydrocarbons, such Subject Interests are and shall be subject to the terms and provisions of such pooling and unitization agreements, and the Royalty Interest in each such Subject Interest shall apply to and affect only the production from such units which accrues to such Subject Interest under and by virtue of the applicable pooling and unitization agreements. SECTION 7.02. Right to Pool and Unitize. Assignor shall have the exclusive right and power (as between Assignor and Assignee), exercisable only during the period provided in Section 7.03 hereof, to pool or unitize any of the Subject Interests and to alter, change or amend or terminate any pooling or unitization agreements heretofore or hereafter entered into, as to all or any part of the Subject Lands, as to any one or more of the formations or horizons thereunder, and as to any one or more Hydrocarbons, upon such terms and provisions as Assignor shall in its sole and absolute discretion determine. If and whenever through the exercise of such right and power, or pursuant to any law hereafter enacted or any rule, regulation or order of any governmental body or official hereafter promulgated, any of the Subject Interests are pooled or unitized in any manner, the Royalty Interest insofar as it affects such Subject Interest shall also be pooled and unitized, and in any such event such Royalty Interest in such Subject Interest shall apply to and affect only the production which accrues to such Subject Interest under and by virtue of the pooling and unitization, and it shall 14 not be necessary for Assignee to agree to, consent to, ratify, confirm or adopt any exercise of such right and power by Assignor. SECTION 7.03. Applicable Period. Assignor's power and rights in Section 7.02 shall be exercisable only during the period of the life of the last survivor of the descendants of the signers of the Declaration of Independence living on the date of execution hereof, plus twenty-one (21) years after the death of such last survivor, or the term of this Conveyance, whichever period shall first expire. ARTICLE VIII GOVERNMENT REGULATION All obligations of Assignor hereunder shall be subject to all present and future valid federal, state and local laws, statutes, codes and orders; and all applicable rules, orders, regulations and decisions of every court, governmental agency, body or authority having jurisdiction over the Hydrocarbons in and under and that may be produced from the Subject Interests. Assignor's obligations are specifically, but not by way of limitation, subject, to the extent in effect, to all applicable provisions of the Emergency Petroleum Allocation Act of 1973, the Department of Energy Organization Act, the Natural Gas Act, the Natural Gas Policy Act of 1978, the Natural Gas Wellhead Decontrol Act of 1989 and each other statute purporting to provide regulation of the Sale of Hydrocarbons or establishing maximum prices at which the same may be Sold and all applicable laws, orders, rules and regulations thereunder of the Federal Energy Regulatory Commission, the Department of Energy and each other legislative or governmental body, agency, board or commission having jurisdiction. If maximum rates permitted under such statutes, rules and regulations for the Subject Hydrocarbons are lower than prices established in Sales Contracts, then the lower regulated prices received by Assignor shall control. Assignor shall be entitled to use its reasonable discretion in making filings, for itself and on behalf of Assignee, with the Federal Energy Regulatory Commission, the Department of Energy or any other governmental body, agency, board or commission having jurisdiction, affecting the price or prices at which Subject Hydrocarbons may be Sold, and with purchasers of production, operators or others with respect to any excise tax. ARTICLE IX ASSIGNMENTS SECTION 9.01. Assignment by Assignor. Assignor shall have the right to assign, sell, transfer, convey, mortgage or pledge the Subject Interests, or any part thereof, subject to the Royalty Interest and the terms and provisions of this Conveyance. From and after the effective date of any such assignment, sale, transfer or conveyance by Assignor, the assignee thereunder shall succeed to all the requirements upon and responsibilities of Assignor hereunder, as to the interests in the Subject Interests so acquired by such assignee, and, from and after the said effective date, Assignor shall be 15 relieved of such requirements and responsibilities, excepting only those accrued or due for performance prior to such effective date. SECTION 9.02. Partial Assignment. If Assignor assigns its interest under the Subject Interests as to some of such Subject Interests or as to some part thereof, then, effective as of the date of such assignment, in determining the Royalty Interest payable with respect to production from such assigned Subject Interests or parts thereof, the Gross Proceeds, Production Costs and Net Proceeds attributable to such assigned interests will be computed and determined by the assignee of such assigned interests in the aggregate as to the assigned interests owned by such assignee, but separate from and not aggregated with the computation and determination made by Assignor as to Subject Interests that have not been assigned by Assignor. SECTION 9.03. Assignment by Assignee. Assignee has the right to assign the Royalty Interest in whole or in part only as authorized by the Trust Indenture. However, no such assignment will affect the method of computing Net Proceeds, and if more than one Person becomes entitled to participate in the Royalty Interest, Assignor may withhold from such other Person payments to which such Person would otherwise be entitled hereunder and the furnishing of any data or information which Assignor is required by the terms hereof to furnish Assignee until Assignor is furnished a recordable instrument executed by or binding upon all Persons interested in the Royalty Interest designating one Person who is to receive such payments, data and information. In making conveyances or assignments of any of the Subject Interests (to the extent permitted hereunder), Assignee need not vest in its grantee or assignee all of the rights of Assignee hereunder with respect to the interest in the Subject Interests so conveyed or assigned. SECTION 9.04. Certain Sales of Subject Interests. Subject to the limitations set forth in Section 3.02(b) of the Trust Indenture, Assignor may cause the sale of certain Subject Interests, including the appurtenant Royalty Interest from time to time and Assignee will join in such sales as provided in the Trust Indenture. The proceeds of any such sale shall be apportioned and paid as provided in the Trust Indenture, but the purchasers of such Subject Interests (inclusive of the appurtenant Royalty Interest) may pay the full amount of the purchase price therefor to Assignor and shall have no responsibility to see to the proper allocation thereof between Assignor and Assignee. SECTION 9.05. Change in Ownership. No change of ownership or right to receive payment of the Royalty Interest, or of any part thereof, however accomplished, shall be binding upon Assignor until notice thereof shall have been furnished by the Person claiming the benefit thereof, and then only with respect to payments thereafter made. Notice of sale or assignment shall consist of a certified copy of the recorded instrument accomplishing the same; notice of change of ownership or right to receive payment accomplished in any other manner (for example by reason of incapacity, death or dissolution) shall consist of certified copies of recorded documents and complete proceedings legally binding and conclusive of the rights of all parties. Until such notice accompanied by such documentation shall have been furnished Assignor as above provided, the payment or tender of all sums payable on the Royalty Interest may be made in the manner provided herein precisely as if no such change in interest or ownership or right to receive payment had occurred, or (at Assignor's 16 election) Assignor shall have the right to suspend payment of such sums without interest in the event of such change until such documentation is furnished. The kind of notice herein provided shall be exclusive, and no other kind, whether actual or constructive, shall be binding on Assignor. SECTION 9.06. Rights of Mortgagee or Trustee. If Assignee shall at any time execute a mortgage or deed of trust covering all or part of the Royalty Interest, the mortgagee(s) or trustee(s) therein named or the holder of any obligation secured thereby shall be entitled, to the extent such mortgage or deed of trust so provides, to exercise all the rights, remedies, powers and privileges conferred upon Assignee by the terms of this Conveyance and to give or withhold all consents required to be obtained hereunder by Assignee, but the provisions of this Section 9.06 shall in no way be deemed or construed to impose upon Assignor any obligation or liability undertaken by Assignee under such mortgage or deed of trust or under the obligation secured thereby. ARTICLE X MISCELLANEOUS SECTION 10.01. Proportionate Reduction. In the event of failure or deficiency in title to any of the Subject Interests, the portion of the production from such Subject Interest out of which the Royalty Interest attributable to such Subject Interest shall be payable shall be reduced in the same proportion that such Subject Interest is reduced. Notwithstanding the foregoing, if any Person claims that this Conveyance gives rise to a preferential right of such Person to acquire any portion of the Royalty Interest (or any of the Subject Interests), then Assignor shall indemnify Assignee and the trustee of the Trust against any liability, expense, damage or loss in regard to such claim and the provisions of Section 6.05 of the Trust Indenture shall apply with respect to such indemnity obligation. If such claim results in the acquisition of any portion of the Royalty Interest by the Person claiming the preferential right then, subject to the proviso below, Assignor shall pay to Assignee the amount determined by multiplying (i) the product of 40,000,000 multiplied by the initial public offering price of the Trust's units of beneficial interest by (ii) a fraction, the numerator of which is the value of the portion of the Royalty Interest acquired by the Person claiming the preferential right, as determined by reference to the most recent Reserve Report (as defined in the Trust Indenture) of the Trust and the denominator of which is the value of all the Royalty Interest as determined by reference to such Reserve Report; provided, however, that if the Person claiming such preferential right makes any payment to the Trust in connection with the acquisition of a portion of the Royalty Interest, then the amount of such payment shall be credited against Assignor's payment obligation set forth above, but not to create a negative number. SECTION 10.02. Term. This Conveyance shall remain in force as long as any of the Subject Interests are in effect. SECTION 10.03. Further Assurances. Should any additional instruments of assignment and conveyance be required to describe more specifically any interests subject hereto, Assignor agrees to execute and deliver the same. Also, if any other or additional instruments are required in 17 connection with the transfer of State, Federal or Indian lease interests in order to comply with applicable laws, regulations or agreements, Assignor will execute and deliver the same. SECTION 10.04. Notices. All notices, statements, payments and communications between the parties hereto shall be deemed to have been sufficiently given and delivered if enclosed in a post paid wrapper and deposited in the United States Mails directed, or if personally delivered, to the party to whom the same is directed or to be furnished or made at the respective addresses, as follows: If to Assignor: Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, Texas 76102 Attention: Corporate Secretary If to Assignee: NationsBank, N.A. 17th Floor 901 Main Street NationsBank Plaza Dallas, Texas 75202 Attention: Trust Department Either party or the successors or assignees of the interest or rights or obligations of either party hereunder may change its address or designate a new or different address or addresses for the purposes hereof by a similar notice given or directed to all parties interested hereunder at the time. SECTION 10.05. Binding Effect. This Conveyance shall bind and inure to the benefit of the successors and assigns of Assignor and Assignee. SECTION 10.06. Governing Law. The validity, effect and construction of this Conveyance shall be governed by the laws of the State of Texas. SECTION 10.07. Headings. Article and Section headings used in this Conveyance are for convenience only and shall not affect the construction of this Conveyance. SECTION 10.08. Substitution of Warranty. This instrument is made with full substitution and subrogation of Assignee in and to all covenants of warranty by others heretofore given or made with respect to the Subject Interests or any part thereof or interest therein. 18 SECTION 10.09. Counterpart Execution. This Conveyance may be executed in multiple counterparts, each of which shall be an original. Certain counterparts may have descriptions relating to different recording jurisdictions omitted from Schedule A. A counterpart with all such descriptions is being filed for record in Major County, Oklahoma. Where a description covers an interest located in more than one county, such description may be included in counterparts recorded in each county but such inclusion of the same description in more than one counterpart does not have any cumulative effect as to the interests covered by such description. IN WITNESS WHEREOF, each of the parties hereto has caused this Conveyance to be executed in its name and behalf and delivered as of the Effective Date. ATTEST: CROSS TIMBERS OIL COMPANY /s/ VIRGINIA ANDERSON - ----------------------------- Virginia Anderson, Secretary of Cross Timbers Oil Company By: /s/ VAUGHN O. VENNERBERG, II -------------------------------- Vaughn O. Vennerberg, II Senior Vice President - Land ATTEST: NATIONSBANK, N.A., acting not in its individual capacity but solely as the /s/ DONALD A. YUCHS Trustee of the Hugoton Royalty Trust - ----------------------------- By: /s/ RON E. HOOPER ------------------------------- Ron E. Hooper, Vice President 19 STATE OF TEXAS (S) (S) COUNTY OF TARRANT (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Vaughn O. Vennerberg II, Senior Vice President - Land of Cross Timbers Oil Company, on behalf of said corporation. Commission Expires: /s/ KIM FIELDS RHOADS 11-33-99 ------------------------------------- - -------- Notary Public State of Texas [NOTARY SEAL APPEARS HERE] THE STATE OF TEXAS (S) (S) COUNTY OF DALLAS (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Ron E. Hooper, Vice President of NationsBank, N.A., Trustee of the Hugoton Royalty Trust, on behalf of said Bank as Trustee of the Hugoton Royalty Trust. Commission Expires: /s/ JANA L. EGELER 10-22-02 ------------------------------------- - -------- Notary Public State of Texas [NOTARY SEAL APPEARS HERE] 20 SCHEDULE A [Description of Subject Interests - Omitted] 21 SCHEDULE B Attached to and made a part of that certain Net Overriding Royalty Conveyance (Hugoton Royalty Trust) dated effective December 1, 1998 (the "Conveyance") ACCOUNTING PROCEDURE I. GENERAL PROVISIONS 1. Definitions "Joint Property" shall mean the real and personal property subject to the Conveyance. "Joint Operations" shall mean all operations necessary or proper for the development, operation, protection and maintenance of the Joint Property. "Joint Account" shall mean the account showing the charges paid and credits received in the conduct of the Joint Operations and which are used in the calculation of Gross Proceeds, Net Proceeds, Processing Costs and Production Costs, as said terms are defined in the Conveyance. "Operator" shall mean Cross Timbers Oil Company or any of its affiliates that conduct Joint Operations on the Joint Property. "Parties" shall mean Operator and the Hugoton Royalty Trust (herein referred to as the "Trust"). "First Level Supervisors" shall mean those employees whose primary function in Joint Operations is the direct supervision of other employees and/or contract labor directly employed on the Joint Property in a field operating capacity. "Technical Employees" shall mean those employees having special and specific engineering, geological or other professional skills, and whose primary function in Joint Operations is the handling of specific operating conditions and problems for the benefit of the Joint Property. "Personal Expenses" shall mean travel and other reasonable reimbursable expenses of Operator's employees. "Material" shall mean personal property, equipment or supplies acquired or held for use on the Joint Property. "Controllable Material" shall mean Material which at the time is so classified in the Material Classification Manual as most recently recommended by the Council of Petroleum Accountants Societies. 2. Designation and Responsibilities of Operator Cross Timbers Oil Company shall be the Operator of the Joint Property, and shall, to the extent it has the legal right to do so, conduct and direct and have full control of all operations on the Joint Property as permitted and required by, and within the limits of the Conveyance. 3. Payments and Accounting Except as herein otherwise specifically provided, Operator shall promptly pay and discharge expenses incurred in the development and operation of the Joint Property and shall charge the Joint Account with the appropriate proportionate share upon the expense basis provided herein. Operator shall keep an accurate record of the expenses incurred and charges and credits made and received. 4. Application of Agreement This Accounting Procedure will apply to Joint Properties where Cross Timbers Oil Company is the Operator and the Operator owns all or a portion of the leasehold interest in the Joint Properties. In the event there is an existing Accounting Procedure or related instrument governing the operations of the Joint Properties, this Accounting Procedure will control except as to the overhead rate stated in the existing Accounting Procedure or related instrument. 1 5. Conflicts In the event there exists any conflict between the terms of this Accounting Procedure or any Accounting Procedure that applies to the Joint Properties and the Conveyance to which it is attached, the Conveyance will control. II. DIRECT CHARGES Operator shall charge the Joint Account with the following items, which shall be allocated to Processing Costs or Production Costs as appropriate: 1. Ecological and Environmental Costs incurred for the benefit of the Joint Property as a result of governmental or regulatory requirements to satisfy environmental considerations applicable to the Joint Operations. Such costs may include surveys of an ecological or archaeological nature and pollution control procedures as required by applicable laws and regulations, and costs related to employees of Operator performing any environmental work involving the Joint Property. 2. Rentals and Royalties Lease rentals and royalties paid by Operator for the Joint Operations. 3. Labor A. (1) Salaries and wages of Operator's field employees employed on the Joint Property in the conduct of Joint Operations. (2) Salaries of First Level Supervisors in the field. (3) Salaries and wages of Technical Employees directly employed on the Joint Property. (4) Salaries and wages of Technical Employees either temporarily or permanently assigned to and directly employed in the operation of the Joint Property. (5) Salaries and wages of support employees whose duties are primarily field related in connection with the Joint Operations, regardless of their location (e.g., field superintendents and clerical employees located in the field). B. Operator's cost of holiday, vacation, sickness and disability benefits and other customary allowances paid to employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. Such costs under this Paragraph 3B may be charged on a "when and as paid basis" or by "percentage assessment" on the amount of salaries and wages chargeable to the Joint Account under Paragraph 3A of this Section II. If percentage assessment is used, the rate shall be based on the Operator's cost experience. C. Expenditures or contributions made pursuant to assessments imposed by governmental authority which are applicable to Operator's costs chargeable to the Joint Account under Paragraphs 3A and 3B of this Section II. D. Personal Expenses of those employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. 4. Employee Benefits Operator's current costs of established plans for employees' group life insurance, hospitalization, pension, retirement, stock purchase, thrift, bonus, and other benefit plans of a like nature, applicable to Operator's labor cost chargeable to the Joint Account under 2 Paragraph 3A and 3B of this Section II shall be Operator's actual cost not to exceed the percent most recently recommended by the Council of Petroleum Accountants Societies. 5. Material Material purchased or furnished by Operator for use on the Joint Property as provided under Section IV. Only such Material shall be purchased for or transferred to the Joint Property as may be required for immediate use and is reasonably practical and consistent with efficient and economical operations. The accumulation of surplus stocks shall be avoided. 6. Transportation Transportation of employees and Material necessary for the Joint Operations but subject to the following limitations: A. If Material is moved to the Joint Property from the Operator's warehouse or other properties, no charge shall be made to the Joint Account for a distance greater than the distance from the nearest reliable supply store where like material is normally available or railway receiving point nearest the Joint Property. B. If surplus Material is moved to Operator's warehouse or other storage point, no charge shall be made to the Joint Account for a distance greater than the distance to the nearest reliable supply store where like material is normally available, or railway receiving point nearest the Joint Property. No charge shall be made to the Joint Account for moving Material to other properties belonging to Operator. C. In the application of subparagraphs A and B above, the option to equalize or charge actual trucking cost is available when the actual charge is $400 or less excluding accessorial charges. The $400 will be adjusted to the amount most recently recommended by the Council of Petroleum Accountants Societies. 7. Services The cost of contract services, equipment and utilities provided by outside sources, except services excluded by Paragraph 10 of Section II and Paragraph i, ii, and iii, of Section III. The cost of professional consultant services and contract services of technical personnel directly engaged on the Joint Property if such charges are excluded from the overhead rates. 8. Equipment and Facilities Furnished By Operator A. Operator shall charge the Joint Account for use of equipment and facilities owned by Operator or any of its affiliates at rates commensurate with costs of ownership and operation. Such rates shall include costs of maintenance, repairs, other operating expense, insurance, taxes, depreciation, and interest on gross investment less accumulated depreciation not to exceed twelve percent (12%) per annum. Such rates shall not exceed average commercial rates currently prevailing in the immediate area of the Joint Property. B. In lieu of charges in paragraph 8A above, Operator may elect to use average commercial rates prevailing in the immediate area of the Joint Property less 20%. For automotive equipment, Operator may elect to use rates published by the Petroleum Motor Transport Association. C. This Paragraph 8 shall not affect any current charges made by Operator to the Joint Account related to transportation, gathering, treating, compression or processing or related charges by an affiliate of Operator. 9. Damages and Losses to Joint Property All costs or expenses necessary for the repair or replacement of Joint Property made necessary because of damages or losses incurred by fire, flood, storm, theft, accident, or other cause, except those resulting from Operator's gross negligence or willful misconduct. 10. Legal Expense Expense of handling, investigating and settling litigation or claims, discharging of liens, payment of judgments and amounts paid for settlement of claims incurred in or resulting from operations under the Conveyance or necessary to protect or recover the Joint 3 Property, and the costs and expenses incurred in connection with hearings and other matters before governmental bodies and agencies and costs and expenses incurred in curing title to the Joint Property. Costs incurred by Operator in procuring abstracts and fees paid outside attorneys for title examination (including preliminary, supplemental, shut-in gas royalty opinions and division order title opinions) shall be borne by the Joint Account. Operator shall make no charge for services rendered by its staff attorneys or other personnel in the performance of the above functions. All other legal expense is considered to be covered by the overhead provisions of Section III. 11. Taxes All taxes of every kind and nature assessed or levied upon or in connection with the Joint Property, the operation thereof, or the production therefrom, and which taxes have been paid by the Operator for the benefit of the Parties. If the ad valorem taxes are based in whole or in part upon separate valuations of each party's interest, then notwithstanding anything to the contrary herein, charges to the Joint Account shall be made and paid by the Parties hereto in accordance with the tax value generated by each party's interest. 12. Insurance Net premiums paid for insurance required to be carried for the Joint Operations for the protection of the Parties. In the event Joint Operations are conducted in a state in which Operator may act as self-insurer for Worker's Compensation and/or Employers Liability under the respective state's laws, Operator may, at its election, include the risk under its self-insurance program and in that event, Operator shall include a charge at Operator's cost not to exceed manual rates. 13. Abandonment and Reclamation Costs incurred for abandonment of the Joint Property, including costs required by governmental or other regulatory authority. 14. Communications Cost of acquiring, leasing, installing, operating, repairing and maintaining communication systems, including radio and microwave facilities or any form of telephonic equipment or service used in serving the Joint Property. In the event communication facilities/systems serving the Joint Property are Operator owned, charges to the Joint Account shall be made as provided in Paragraph 8 of this Section II. 15. Other Expenditures Any other expenditure not covered or dealt with in the foregoing provisions of this Section II, or in Section III and which is of direct benefit to the Joint Property and is incurred by the Operator in the necessary and proper conduct of the Joint Operations. III. OVERHEAD 1. Overhead - Drilling and Producing Operations i. As compensation for administrative, supervision, office services and warehousing costs, Operator shall charge drilling and producing operations on a Fixed Rate Basis, Paragraph 1A. Such charge shall be in lieu of costs and expenses of all offices and salaries or wages plus applicable burdens and expenses of all personnel, except those directly chargeable under Paragraph 3A, Section II. The cost and expense of services from outside sources in connection with matters of taxation, traffic, accounting or matters before or involving governmental agencies shall not be considered as included in the overhead rates. ii. The salaries, wages and Personal Expenses of Technical Employees and/or the cost of professional consultant services and contract services of technical personnel directly employed on the Joint Property shall not be covered by the overhead rates. iii. The salaries, wages and Personal Expenses of Technical Employees and/or costs of professional consultant services and contract services of technical personnel either temporarily or permanently assigned to and directly employed in the operation of the Joint Property shall not be covered by the overhead rates. 4 A. Overhead - Fixed Rate Basis (1) Operator shall charge the Joint Account at the following rates per well per month: For wells located in the Hugoton Field Drilling Well Rate $2,350.00 (Prorated for less than a full month) Producing Well Rate $235.00 For wells located in all other areas Drilling Well Rate $4,760.00 (Prorated for less than a full month) Producing Well Rate $476.00 (2) Application of Overhead - Fixed Rate Basis shall be as follows: (a) Drilling Well Rate (1) Charges for drilling wells shall begin on the date the well is spudded and terminate on the date the drilling rig, completion rig, or other units used in completion of the well is released, whichever is later, except that no charge shall be made during suspension of drilling or completion operations for fifteen (15) or more consecutive calendar days. (2) Charges for wells undergoing any type of workover or recompletion or swabbing shall be made at the drilling well rate. Such charges shall be applied for the period from date such operations, with rig or other units used, commence through date of rig or other unit release, except that no charge shall be made during suspension of operations for fifteen (15) or more consecutive calendar days. (b) Producing Well Rates (1) An active well either produced or injected into for any portion of the month shall be considered as a one-well charge for the entire month. (2) Each active completion in a multi-completed well in which production is not commingled down hole shall be considered as a one-well charge providing each completion is considered a separate well by the governing regulatory authority. (3) An inactive gas well shut in because of overproduction or failure of purchaser to take the production shall be considered as a one-well charge providing the gas well is directly connected to a permanent sales outlet. (4) A one-well charge shall be made for the month in which plugging and abandonment operations are completed on any well. This one-well charge shall be made whether or not the well has produced except when drilling well rate applies. (5) All other inactive wells (including but not limited to inactive wells covered by unit allowable, lease allowable, transferred allowable, etc.) shall not qualify for an overhead charge. (3) The well rates shall be adjusted as of the first day of April each year beginning in 1999. The adjustment shall be computed by multiplying the rate currently in use by the percentage increase or decrease in the average weekly earnings of Crude Petroleum and Gas Production Workers for the last calendar year compared to the calendar year preceding as shown by the index of average weekly earnings of Crude Petroleum and Gas Production Workers as 5 published by the United States Department of Labor, Bureau of Labor Statistics. The adjusted rates shall be the rates currently in use, plus or minus the computed adjustment. 2. Overhead - Major Construction To compensate Operator for overhead costs incurred in the construction and installation of fixed assets, the expansion of fixed assets, and any other project clearly discernable as a fixed asset required for the development and operation of the Joint Property, Operator shall charge the Joint Account for overhead based on the following rates for any Major Construction project in excess of $25,000.00: A. 5% of first $100,000 or total cost if less, plus B. 3% of costs in excess of $100,000 but less than $1,000,000, plus C. 2% of costs in excess of $1,000,000. Total cost shall mean the gross cost of any one project. For the purpose of this paragraph, the component parts of a single project shall not be treated separately and the cost of drilling and workover wells and artificial lift equipment shall be excluded. 3. Catastrophe Overhead To compensate Operator for overhead costs incurred in the event of expenditures resulting from a single occurrence due to oil spill, blowout, explosion, fire, storm, hurricane, or other catastrophes as agreed to by the Parties, which are necessary to restore the Joint Property to the equivalent condition that existed prior to the event causing the expenditures, Operator shall charge the Joint Account for overhead based on the following rates: A. 5% of total costs through $100,000; plus B. 3% of total costs in excess of $100,000 but less than $1,000,000; plus C. 2% of total costs in excess of $1,000,000. Expenditures subject to the overheads in this Section 3 above will not be reduced by insurance recoveries, and no other overhead provisions of this Section III shall apply. IV. PRICING OF JOINT ACCOUNT MATERIAL PURCHASES, TRANSFERS AND DISPOSITIONS Operator is responsible for Joint Account Materials and shall make proper and timely charges and credits for all Material movements affecting the Joint Property. Operator shall provide all Material for use on the Joint Property. Operator shall make timely disposition of idle and/or surplus Material, such disposal being made either through sale to Operator, or sale to outsiders. Operator may purchase, but shall be under no obligation to purchase, interest of the Trust in surplus condition A or B Material at the prices defined below. 1. Purchases Material purchased shall be charged at the price paid by Operator after deduction of all discounts, adjustments or rebates received. In case of Material found to be defective or returned to vendor for any other reasons, credit shall be passed to the Joint Account when adjustment has been received by the Operator. 2. Transfers and Dispositions Material furnished to the Joint Property and Material transferred from the Joint Property or disposed of by the Operator shall be priced on the following basis exclusive of cash discounts: A. New Material (Condition A) (1) Tubular Goods Other than Line Pipe 6 (a) Tubular goods, sized 2-3/8 inches OD and larger, except line pipe, shall be priced at Eastern mill published carload prices effective as of date of movement plus transportation cost using the 80,000 pound carload weight basis to the railway receiving point nearest the Joint Property for which published rail rates for tubular good exist. If the 80,000 pound rail rate is not offered, the 70,000 pound or 90,000 pound rail rate may be used. Freight charges for tubing will be calculated from Lorain, Ohio and casing from Youngstown, Ohio. (b) For grades which are special to one mill only, prices shall be computed at the mill base of that mill plus transportation cost from that mill to the railway receiving point nearest the Joint Property as provided above in Paragraph 2.a.(1)(a). For transportation cost from points other than Eastern mills, the 30,000 pound Oil Field Haulers Association interstate truck rate shall be used. (c) Special end finish tubular goods shall be priced at the lowest published out-of-stock price, f.o.b. Houston, Texas, plus transportation cost, using Oil Field Haulers Association interstate 30,000 pound truck rate, to the railway receiving point nearest the Joint Property. (d) Macaroni tubing (size less than 2-3/8 inch OD) shall be priced at the lowest published out-of-stock prices f.o.b. the supplier plus transportation costs, using the Oil Field Haulers Association interstate truck rate per weight of tubing transferred, to the railway receiving point nearest the Joint Property. (2) Line Pipe (a) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) 30,000 pounds or more shall be priced under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (b) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) less than 30,000 pounds shall be priced at Eastern mill published carload base prices effective as of date of shipment, plus 20 percent, plus transportation costs based on freight rates as set forth under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (c) Line pipe 24 inch OD and over and 3/4 inch wall and larger shall be priced f.o.b. the point of manufacture at current new published prices plus transportation cost to the railway receiving point nearest the Joint Property. (d) Line pipe, including fabricated line pipe, drive pipe and conduit not listed on published price lists shall be priced at quoted prices plus freight to the railway receiving point nearest the Joint Property or at prices agreed to by the Parties. (3) Other Material shall be priced at the current new price, in effect at date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. (4) Unused new Material, except tubular goods, moved from the Joint Property shall be priced at the current new price, in effect on date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. Unused new tubulars will be priced as provided above in Paragraph 2 A (1) and (2). B. Good Used Material (Condition B) Material in sound and serviceable condition and suitable for reuse without reconditioning: (1) Material moved to the Joint Property At seventy-five percent (75%) of current new price, as determined by Paragraph A. 7 (2) Material used on and moved from the Joint Property (a) At seventy-five percent (75%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as new Material. (b) At sixty-five percent (65%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as used Material. (3) Material not used on and moved from the Joint Property At seventy-five percent (75%) of current new price as determined by Paragraph A. The cost of reconditioning, if any, shall be absorbed by the transferring property. C. Other Used Material (1) Condition C Material which is not in sound and serviceable condition and suitable for its original function until after reconditioning shall be priced at fifty percent (50%) of current new price as determined by Paragraph A. The cost of reconditioning shall be charged to the receiving property, provided Condition C value plus cost of reconditioning does not exceed Condition B value. (2) Condition D Material, excluding junk, no longer suitable for its original purpose, but usable for some other purpose shall be priced on a basis commensurate with its use. Operator may dispose of Condition D Material under procedures normally used by Operator without prior approval of the Assignee. (a) Casing, tubing or drill pipe used as line pipe shall be priced as Grade A and B seamless line pipe of comparable size and weight. Used casing, tubing or drill pipe utilized as line pipe shall be priced at used line pipe prices. (b) Casing, tubing or drill pipe used as higher pressure service lines than standard line pipe, e.g. power oil lines, shall be priced under normal pricing procedures for casing, tubing, or drill pipe. Upset tubular goods shall be priced on a non upset basis. (3) Condition E Junk shall be priced at prevailing prices. Operator may dispose of Condition E Material under procedures normally utilized by Operator without prior approval of Non-Operators. D. Obsolete Material Material which is serviceable and usable for its original function but condition and/or value of such Material is not equivalent to that which would justify a price as provided above may be specially priced as reasonably determined by Operator. Such price should result in the Joint Account being charged with the value of the service rendered by such Material. E. Pricing Conditions (1) Loading and unloading costs related to the movement of the Material to the Joint Property shall be charged in accordance with the methods specified in COPAS Bulletin 21. (2) Material involving erection costs shall be charged at applicable percentage of the current knocked-down price of new Material. 8 3. Premium Prices Whenever Material is not readily obtainable at published or listed prices because of national emergencies, strikes or other unusual causes over which the Operator has no control, the Operator may charge the Joint Account for the required Material at the Operator's actual cost incurred in providing such Material, in making it suitable for use, and in moving it to the Joint Property. 4. Warranty of Material Furnished by Operator Operator does not warrant the Material furnished. In case of defective Material, credit shall not be passed to the Joint Account until adjustment has been received by Operator from the manufacturers or their agents. V. INVENTORIES The Operator shall maintain detailed records of Controllable Material. 1. Periodic Inventories, Notice and Representation At reasonable intervals, inventories shall be taken by Operator of the Joint Account Controllable Material. 2. Reconciliation and Adjustment of Inventories Adjustments to the Joint Account resulting from the reconciliation of a physical inventory shall be made within six months following the taking of the inventory. Inventory adjustments shall be made by Operator to the Joint Account for overages and shortages, but Operator shall be held accountable only for shortages due to lack of reasonable diligence. 3. Special Inventories Special inventories may be taken whenever there is any sale, change of interest, or change of Operator in the Joint Property. It shall be the duty of the party selling to notify all other Parties as quickly as possible after the transfer of interest takes place. In such cases, both the seller and the purchaser shall be governed by such inventory. In cases involving a change of Operator, all Parties shall be governed by such inventory. 4. Expense of Conducting Inventories A. The expense of conducting periodic inventories shall not be charged to the Joint Account. B. The expense of conducting special inventories shall be charged to the Parties requesting such inventories, except inventories required due to change of Operator shall be charged to the Joint Account. 9 EX-10.3 8 FORM OF 80% NET OVERRIDING ROYALTY CONVEYANCE-WY EXHIBIT 10.3 NET OVERRIDING ROYALTY CONVEYANCE Hugoton Royalty Trust STATE OF WYOMING (S) (S) KNOW ALL MEN BY THESE PRESENTS: COUNTIES OF LINCOLN, (S) SUBLETTE AND SWEETWATER (S) THAT CROSS TIMBERS OIL COMPANY, a corporation formed under the laws of the State of Delaware ("Assignor"), for and in consideration of the sum of Ten Dollars ($10.00) and other good and valuable consideration to Assignor paid by NATIONSBANK, N.A., a bank organized under the laws of the United States, acting not in its individual corporate capacity but solely as trustee under that certain Trust Indenture establishing the Hugoton Royalty Trust dated as of December 1, 1998 ("Assignee"), the receipt and sufficiency of which are hereby acknowledged, has bargained, sold, granted, conveyed, transferred, assigned, set over and delivered, and by these presents does bargain, sell, grant, convey, transfer, assign, set over and deliver unto Assignee a net overriding royalty interest ("the Royalty Interest") in and to the Subject Hydrocarbons in and under, and if, as and when produced, saved and sold from, the Subject Lands during the term of the Subject Interests equal to eighty percent (80%) of the Net Proceeds attributable to the Subject Interests, as each of the above capitalized words is defined in Article I hereof and all as more fully provided herein. TO HAVE AND TO HOLD the Royalty Interest, together with all and singular the rights and appurtenances thereto in anywise belonging, unto Assignee, its successors and assigns, subject, however, to the terms and provisions of this Conveyance; and Assignor does by these presents bind and obligate itself, its successors and assigns, to WARRANT and FOREVER defend all and singular the Royalty Interest unto the said Assignee, its successors and assigns, against every person whomsoever lawfully claiming or to claim the same or any part thereof by, through or under Assignor, but not otherwise. ARTICLE I DEFINITIONS As used herein, the following words, terms or phrases have the following meanings: SECTION 1.01. "Affiliate" means, as to the party specified, any Person controlling, controlled by or under common control with such party, with the concept of control in such context meaning the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of another, whether through the ownership of voting securities, by contract or otherwise. The Trust shall not be deemed an Affiliate of Assignor. SECTION 1.02. "Assignor" means the Assignor named herein while Assignor owns all or any part of or interest in the Subject Interests and any other Person or Persons (excluding Assignee) who hereafter may acquire all or any part of or interest in the Subject Interests. SECTION 1.03. "Assignee" means the Assignee named herein (and any successor Trustee under the Trust Indenture) while it owns all or any part of or interest in the Royalty Interest and any other Person or Persons who may acquire legal title to all or any part of or interest in the Royalty Interest. SECTION 1.04. "Computation Period" means (i) initially, the period commencing on the Effective Date and ending on February 28, 1999, and (ii) each calendar month thereafter. SECTION 1.05. "Conveyance" means this Net Overriding Royalty Conveyance. SECTION 1.06. "Effective Date" means 7:00 o'clock A.M., local time in effect at the location of each Subject Interest, on December 1, 1998. SECTION 1.07. "Excess Production Costs" means, for any Computation Period, an amount equal to the excess, if any, of Production Costs for such Computation Period over Gross Proceeds for such Computation Period. SECTION 1.08. "Existing Sales Contracts" means all contracts and agreements in effect as of the Effective Date between or among Assignor and any Affiliate of Assignor, or between or among any Affiliates of Assignor, for the Sale, Processing, treatment, compression, gathering or transportation of Subject Hydrocarbons. SECTION 1.09. "Gross Proceeds" means, for any Computation Period, and subject to Section 2.01 (i) during the term of the Existing Sales Contracts, the proceeds received by Assignor under the Existing Sales Contracts attributable to the Sale of Subject Hydrocarbons Sold during such Computation Period by Assignor after the Effective Date, and (ii) as to Subject Hydrocarbons Sold by Assignor during such Computation Period after the Effective Date other than under the Existing Sales Contracts (A) if Sold under a Sales Contract with a Non-Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract, or (B) if Sold under a Sales Contract with an Affiliate of Assignor, the proceeds received by Assignor under such Sales Contract but in no event less than 98% of the proceeds received by such Affiliate upon the resale of such Subject Hydrocarbons to a Non-Affiliate of Assignor, and (iii) the proceeds received by Assignor in respect of underproduced gas imbalances attributable to the Subject Interests as of the Effective Date, but in all instances, subject to the following: 2 (a) There shall be excluded from Gross Proceeds all Property Taxes that are deducted or excluded from proceeds of Sale received by Assignor. (b) There shall be excluded any amount for Subject Hydrocarbons attributable to nonconsent operations conducted with respect to the Subject Interests (or any portion thereof) as to which Assignor shall be a nonconsenting party and which is dedicated to the recoupment or reimbursement of costs and expenses of the consenting party or parties by the terms of the relevant operating agreement, unit agreement, contract for development or other instrument providing for such nonconsent operations. Assignor agrees that its election not to participate in such operations shall be made in conformity with the provisions of Section 6.01 of this Conveyance, but third persons shall not be under any duty to determine that such election so conformed. (c) There shall be excluded any amount which Assignor shall receive as any of the following: consideration for transfer or sale of any of the Subject Interests (subject to the Royalty Interest) or equipment or other personal property or fixtures on the Subject Lands; payments for gas not taken, when such payments are made (but to the extent such payments are allocated to gas taken in the future such payments shall be included without interest in Gross Proceeds when such gas is taken); damages arising from any cause other than drainage or reservoir injury; rental for reservoir use; payments made to Assignor in connection with the drilling of any well on any of the Subject Lands or lands in the vicinity thereof (such exclusion including dry and bottom hole payments, provided that if such well is drilled on the Subject Lands and Assignor incurs Production Costs in connection therewith such payments shall reduce Production Costs) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; provided there shall be included in Gross Proceeds advance or prepaid payments for future production received by Assignor to the extent not subject to repayment in the event of insufficient subsequent production (and to the extent so subject to repayment shall be included without interest in Gross Proceeds when the Subject Hydrocarbons on which such payment was so advanced or prepaid are actually produced) and payments made to Assignor in connection with the deferring of drilling of any well on any of the Subject Lands (including payments from an operator in the vicinity for refraining from drilling an offset well). (d) There shall be excluded any amount for Subject Hydrocarbons lost in the production or marketing thereof or used by Assignor in conformity with ordinary or prudent practices for drilling, production and plant operations (including gas injection, secondary recovery, pressure maintenance, repressuring, cycling operations, plant fuel or shrinkage) conducted for the purpose of drilling for, producing or Processing Subject Hydrocarbons or for operations on any unit or plant to which the Subject Interests are committed, but only so long as such Subject Hydrocarbons are so used. 3 (e) Amounts received as a loan by Assignor from a purchaser of Subject Hydrocarbons, whether with or without interest, shall not be considered to be derived from the sale of Subject Hydrocarbons. (f) If a controversy or possible controversy exists (whether by reason of any statute, order, decree, rule, regulation, contract or otherwise) between Assignor and any purchaser as to the correct sales price of any Subject Hydrocarbons or, for any other reason, as to Assignor's right to receive or collect the proceeds of sale of any Subject Hydrocarbons, then (i) amounts withheld by the purchaser or deposited by it with an escrow agent shall not be considered to be received by Assignor until actually collected by Assignor, but the amounts received by Assignor shall include any interest, penalty or other amount paid to Assignor in respect thereof; (ii) amounts received by Assignor and promptly deposited by it with an escrow agent shall not be considered to have been received by Assignor, but all amounts thereafter paid to Assignor by such escrow agent shall be considered to be amounts received from the Sale of Subject Hydrocarbons; and (iii) amounts received by Assignor and not deposited with an escrow agent shall be considered to be received for purposes of this Section 1.09. SECTION 1.10. "Hydrocarbons" means oil, gas (which term includes coal bed gas, coal seam gas and methane) and all other minerals produced in association with oil or gas (including, but not limited to, helium, sulphur and carbon dioxide), but excluding all other minerals, whether similar or dissimilar. SECTION 1.11. "Monthly Record Date" for each month means the close of business on the last day of such month which is not a Saturday, Sunday or other day on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law, unless Assignee determines that a different date is required to comply with applicable law or the rules of a securities exchange or quotation system pursuant to the terms of the Trust Indenture, in which event it means such different date. SECTION 1.12. "Net Proceeds" means, for any Computation Period, the excess of Gross Proceeds for such Computation Period over Production Costs for such Computation Period. SECTION 1.13. "Non-Affiliate" means, as to the party specified, any Person who is not an Affiliate of such party. SECTION 1.14. "Person" means any individual, corporation, partnership, limited liability company, trust, estate or other entity, organization or association. 4 SECTION 1.15. "Prime Interest Rate" means the variable rate of interest most recently announced by NationsBank, N.A. as its "prime rate." SECTION 1.16. "Process" or "Processing" means to extract or otherwise recover natural gas liquids from natural gas included in the Subject Hydrocarbons through the processes of absorption, condensation, adsorption, cryogenic or other methods in a manner that does not constitute Separation. SECTION 1.17. "Processing Costs" means the costs to Assignor or any Affiliate of Assignor to Process Subject Hydrocarbons before the Sale thereof, which costs for purposes hereof shall consist of the sum of (a) any such Processing charges paid to Non-Affiliates, (b) the charges by Affiliates of Assignor under Existing Sales Contracts, and (c) the charges by Affiliates of Assignor other than under Existing Sales Contracts so long as such charges do not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges. If Assignor (or its Affiliates) receives a share of the production of others or of plant products therefrom (or proceeds of sale thereof) for Processing such production of others, such share shall not be included in Subject Hydrocarbons (or Gross Proceeds). If Assignor (or its Affiliates) does not bear any Processing Costs but the owners or operators of a plant receive a share of the Subject Hydrocarbons (or proceeds of sale thereof) for Processing them, such share (or proceeds) shall be excluded from the Subject Hydrocarbons (and Gross Proceeds). SECTION 1.18. "Production Costs" means, for any Computation Period, to the extent not excluded for purposes of calculating Gross Proceeds, whether capital or non-capital in nature, (a) the sum of (i) all amounts paid by Assignor or any Affiliate of Assignor as any of the following: royalty, overriding royalty or other presently existing burden against production or the proceeds of Sale of production attributable to the Subject Interests; delay rental; shut-in gas well royalty or payment; minimum royalty; payments to lessors or others in the area in connection with the drilling or deferring of drilling of any well on any of the Subject Lands or lands in the vicinity thereof (including dry and bottom hole payments and payments made to others for refraining from drilling an offset well) or in connection with any adjustment of any well and leasehold equipment upon unitization of any of the Subject Interests; and rent and other consideration paid for use of or damage to the surface; (ii) the Property Tax Accrual; (iii) the overhead costs paid by Assignor or any Affiliate of Assignor under any joint operating agreement applicable to any of the Subject Interests to which 5 Assignor and one or more Non-Affiliates of Assignor are parties and where Assignor or any Affiliate of Assignor is not the operator of such Subject Interest; (iv) the overhead rate provided for in any joint operating agreement applicable to any of the Subject Interests where Assignor or any Affiliate of Assignor is the operator of such Subject Interests, less the portion, if any, of the overhead rate due from Non-Affiliates of Assignor; (v) with respect to any Subject Interests operated by Assignor or any of its Affiliates and not subject to a joint operating agreement, an overhead fee as shown on Schedule B attached hereto and subject to adjustment as provided in Schedule B attached hereto; (vi) all other costs, expenses and liabilities (including Processing Costs) paid or incurred by Assignor or any Affiliate of Assignor for investigating, exploring, prospecting, drilling and mining for, operating and producing Subject Hydrocarbons and sale and marketing thereof, including without implied limitation: costs for equipping, plugging back, reworking, completing, recompleting and plugging and abandoning of any well on the Subject Lands and of making the Subject Hydrocarbons ready or available for market; costs for construction and operation of gathering lines, tanks, transmission lines, meters and other production and delivery facilities; costs, whether paid in cash or by a share of Subject Hydrocarbons, of transporting, compressing, dehydrating, separating, treating, storing and marketing the Subject Hydrocarbons and disposing of extraneous substances produced in association with Subject Hydrocarbons (provided that such costs, if paid to or incurred by an Affiliate of Assignor other than pursuant to an Existing Sales Contract, shall not materially exceed charges prevailing in the area for similar services at the time of contracting for such charges); costs for secondary recovery, pressure maintenance, repressuring, cycling and other operations conducted for the purpose of enhancing production; costs or expenses (whether paid in cash or by delivery of gas) incurred in resolving overproduced gas imbalances attributable to the Subject Interests as of the Effective Date and thereafter; and costs for litigation concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests; and costs for litigation or regulatory proceedings concerning title to or operation of the Subject Interests and any other acts or omissions of Assignor consistent herewith or brought by Assignor to protect the Subject Interests or to protect or enforce any rights, contractual or otherwise, of Assignor to produce or market Subject Hydrocarbons therefrom; (vii) Excess Production Costs for the preceding Computation Period (including any remaining Excess Production Costs carried forward from any preceding Computation Period); 6 (viii) interest on the amount of Excess Production Costs at the beginning of any Computation Period, calculated from the first day to the last day of the Computation Period, at the Prime Interest Rate in effect at the beginning of such Computation Period; (ix) any amounts paid by Assignor or any Affiliate of Assignor whether as refund, interest or penalty, to a purchaser or any governmental agency or other Person because the amount initially received by Assignor (or Affiliate of Assignor) as sales price for Sales after the Effective Date was more or allegedly more than permitted by the terms of any applicable contract, statute, regulation, order, decree or other obligation; provided such amounts (in the case of a refund), or the amounts with respect to which the interest or penalty was paid, were previously included in Gross Proceeds; (x) any other amounts paid by Assignor or any Affiliate of Assignor with respect to ownership or operation of the Subject Interests after the Effective Date or Sales of production therefrom after the Effective Date, whether as refund, fine, interest or penalty, pursuant to litigation or settlement of threatened litigation or order of governmental agency, provided that Assignor has not breached Section 6.01 hereof; (xi) all consideration hereafter paid and costs and expenses hereafter incurred by Assignor or any Affiliate of Assignor for any renewals or extensions of leases or other rights acquired after the Effective Date which are included in the definition herein of Subject Interests; and (xii) any accrual or reserve which Assignor or any Affiliate of Assignor shall have the right, at its election, to charge to Production Costs for operations (other than day-to-day operations) budgeted under an operating agreement or approved under an authorization for expenditures ("AFE"), which accrual or reserve may be based on the reasonably expected time of performing such operation or on an estimated percentage of completion of the operation or on any other reasonable method, and which accrual is in lieu of charging the cost of such operation when paid for by Assignor (or Affiliate of Assignor) but which shall be adjusted if and to the extent actual costs differ from such accrual or reserve; (b) but excluding (i) costs which would otherwise be treated as Production Costs (but which shall not be so treated for purposes hereof until the following amounts have been fully credited against such costs) equal to amounts reimbursed or credited to Assignor by insurance from damage to property, by sales of property or transfers of 7 property off the leases included in the Subject Interests or by proceeds from unitization or other disposition of property; and (ii) except for resolution of gas imbalances which are included in Section 1.18(a)(vi) above, any amounts which would otherwise be Production Costs but which are attributable to periods before the Effective Date; and (iii) costs that otherwise would be treated as Production Costs but which have already been excluded or deducted from Gross Proceeds under Section 1.09; and (iv) costs incurred by any Affiliate of Assignor for which such Affiliate has received a fee, reimbursement or other payment from Assignor, where such payment by Assignor constitutes a Production Cost; and (v) costs paid or accrued by Assignor during the month of December 1998 for the drilling, equipping, reworking, plugging back, completing or recompleting of any well on the Subject Lands. SECTION 1.19. "Property Taxes" means the sum of all general property (ad valorem), production, severance, sales, gathering and excise taxes and other taxes (whether state, federal or otherwise), except income taxes, assessed or levied on or in connection with the Subject Interests, the Royalty Interest or the production therefrom or equipment on the Subject Lands, or against Assignor as owner of the Subject Interests or Assignee as owner of the Royalty Interest. SECTION 1.20. "Property Tax Accrual" means, for any Computation Period, an amount that may be set aside by Assignor as an accrual to be applied against Property Taxes other than those that are deducted or excluded from Gross Proceeds pursuant to Section 1.09(a) above, which accruals shall be adjusted to the extent actual Property Taxes differ. SECTION 1.21. "Sale" and "Sold" mean all forms of dispositions of Subject Hydrocarbons for value, including exchanges and other dispositions for value. SECTION 1.22. "Sales Contracts" means all contracts and agreements for the sale of Subject Hydrocarbons. SECTION 1.23. "Separation" means liquid separation operations in the vicinity of the well using a conventional mechanical liquid gas separator but excluding operations involving heat exchange, adiabatic cooling, absorption, adsorption or refrigeration principles. SECTION 1.24. "Subject Hydrocarbons" means all Hydrocarbons in and under, and which may be produced, saved and sold from, and which shall accrue and be attributable to, the Subject Interests, including plant products attributable thereto from Processing gas or casinghead gas included 8 in the Subject Hydrocarbons before sale thereof (but not including products derived from processing oil). SECTION 1.25. "Subject Interests" means, subject to the exclusions stated below, each kind and character of right, title, claim or interest which Assignor has on the Effective Date in or under each oil, gas or mineral lease, unitization or pooling agreement (and the units created thereby), royalty interests, overriding royalty interests, fee mineral interests and net profits interests and any other agreements, conveyances, assignments or instruments which are described or referred to in Schedule A, and all the right, title, claim or interest which Assignor has on the Effective Date in and to the Subject Lands, whether such right, title, claim or interest be under and by virtue of a lease, a unitization or pooling agreement or order, an operating agreement, a division order, a transfer order or any other type of agreement, conveyance, assignment or instrument or under any other type of claim or title, legal or equitable, recorded or unrecorded, even though Assignor's interests be incorrectly or incompletely described in, or a description thereof be omitted from, Schedule A, all as the same shall be enlarged by the discharge of any payments out of production or by the removal of any charges or encumbrances to which any of the same are subject and any and all renewals and extensions of any of the same, but subject to all burdens to which Assignor's such right, title, claim or interest is subject (while same remains so subject), limited, however, if Assignor's interest in any Subject Interest should terminate at any time, to the period to which Assignor's interest in such Subject Interest is limited. There shall be excluded from the term "Subject Interests" any interest hereafter acquired by Assignor in and to any of the Subject Lands, except any interest acquired pursuant to existing agreements for no new consideration and renewals or extensions of existing leases and other such agreements. For purposes of this Conveyance "renewals or extensions" of any lease or other such agreement shall be limited to renewals or extensions of an existing lease or other such agreement obtained by the present owner thereof (or such owner's successors in interest) while such lease is in force or within six months after such lease or other such agreement terminates. Assignor shall be under no duty to seek renewals or extensions of any lease or other such agreement. SECTION 1.26. "Subject Lands" means the lands which are described in and which are subject to the oil, gas or mineral leases, unitization or pooling agreements or orders, operating agreements, division orders, transfer orders or other type of agreement, conveyance, assignment or instrument described in Schedule A attached hereto, provided that, where the description in Schedule A excepts land or refers to an instrument insofar only as it covers certain land or certain depths in certain land, no interest in such excepted land or depths or in land other that to which such reference is limited shall be included in the terms "Subject Lands" or "Subject Interests". SECTION 1.27. "Trust" means the Hugoton Royalty Trust established by the Trust Indenture. SECTION 1.28. "Trust Indenture" means the Royalty Trust Indenture by and between Cross Timbers Oil Company and NationsBank, N.A. dated as of December 1, 1998, establishing the Hugoton Royalty Trust, an express Texas Trust under the Texas Trust Code. 9 ARTICLE II MARKETING OF SUBJECT HYDROCARBONS SECTION 2.01. Sales Contracts. Assignor, to the extent it has the right to do so, shall market or cause to be marketed the Subject Hydrocarbons and Assignee shall have no authority to market the Subject Hydrocarbons or to take in-kind any Subject Hydrocarbons. For such purpose, Sales of Subject Hydrocarbons may continue to be made pursuant to Existing Sales Contracts. Assignor may amend such Existing Sales Contracts and may enter into one or more Sales Contracts in the future at the prices and on the terms Assignor shall deem proper in Assignor's sole and absolute discretion, which may include sales to Affiliates of Assignor. Further, Assignor may commit any of the Subject Interests (including the Royalty Interest attributable thereto) to one or more agreements for Processing pursuant to which, by way of example and not by way of limitation, the plant owner or operator (which may be an Affiliate of Assignor) receives a portion of the Subject Hydrocarbons or plant products derived therefrom or proceeds of the Sale thereof as a fee for Processing. Gross Proceeds of Subject Hydrocarbons shall be determined on the basis of amounts actually received by Assignor (and not, except as provided in Section 1.09, proceeds received by any of Assignor's Affiliates) from Sales under Sales Contracts regardless of whether at the time of production or Sale market value should be different from proceeds of Sale. In no event shall Gross Proceeds or Production Costs include any revenues, expenses, gains or losses resulting from option transactions or other futures or hedging transactions (other than forward Sales of the Subject Hydrocarbons) which, if engaged in by Assignor or any of its Affiliates in respect of Subject Hydrocarbons, shall be solely for the account of Assignor or such Affiliate. SECTION 2.02. Delivery of Subject Hydrocarbons. All Subject Hydrocarbons Sold by Assignor, whether pursuant to Sales Contracts or otherwise, shall be delivered, by Assignor to the purchasers thereof, into the pipelines to which the wells producing such Subject Hydrocarbons may be connected or to such other point of purchase as is reasonably required in the marketing of such Subject Hydrocarbons. SECTION 2.03. Reliance by Third Party. As to any party, the acts of Assignor shall be binding on Assignee. It shall not be necessary for Assignee to join with Assignor in any division or transfer order, lease extension or Sales Contract, and proceeds of Sale of the Subject Hydrocarbons shall be paid by the purchasers thereof (or others disbursing proceeds) directly to Assignor without necessity of joinder by or consent of Assignee. ARTICLE III PAYMENTS SECTION 3.01. Payment. On or before each Monthly Record Date, beginning with the Monthly Record Date for March, 1999, Assignor shall pay to Assignee as an overriding royalty 10 hereunder an amount equal to eighty percent (80%) of the Net Proceeds for the preceding Computation Period. SECTION 3.02. Interest on Past Due Payments. Except as otherwise provided in Section 9.05 hereof, any amount not paid by Assignor to Assignee when due shall bear, and Assignor will pay, interest determined at the end of each month, from such due date until such amount is paid, at the rate of the lesser of (a) the Prime Interest Rate plus 4% or (b) the maximum lawful contract rate of interest permitted by the applicable usury laws, now or hereafter enacted, which interest rate (the "Maximum Rate") shall change when and as said laws change, effective at the close of business on the day such change in said laws becomes effective; but, if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). SECTION 3.03. Overpayment. If at any time Assignor pays Assignee more than the amount due, Assignee shall not be obligated to return any such overpayment, but the amount or amounts otherwise payable to Assignee for any subsequent period or periods shall be reduced by such overpayment, plus an amount equal to interest during the period of such overpayment at the rate of the lesser of (a) the Prime Interest Rate or (b) the Maximum Rate; but if there shall be no Maximum Rate, then the rate shall be as specified in the foregoing clause (a). ARTICLE IV RECORDS AND REPORTS SECTION 4.01. Books and Records. Assignor shall at all times maintain true and correct books and records sufficient to determine the amounts payable to Assignee hereunder, including, but not limited to, a Net Proceeds account to which Gross Proceeds and Production Costs are credited and charged. SECTION 4.02. Inspections. The books and records referred to in Section 4.01 shall be open for inspection by Assignee and its agents and representatives at the office of Assignor during normal business hours and after reasonable advance notice. SECTION 4.03. Quarterly Statements. Within thirty (30) days next following the close of each calendar quarter, Assignor shall deliver to Assignee a statement showing the computation of Net Proceeds attributable to such quarter. SECTION 4.04. Assignee's Exceptions to Quarterly Statements. If Assignee shall take exception to any item or items included in the quarterly statements rendered by Assignor, Assignee shall notify Assignor in writing within 180 days after the receipt of the report and annual audit furnished pursuant to Section 4.07 hereof, setting forth in such notice the specific charges complained of and to which exception is taken or the specific credits which should have been made and allowed; and, with respect to such complaints and exceptions as are justified, adjustment shall be made. If Assignee shall fail to give Assignor notice of such complaints and exceptions prior to the expiration 11 of such 180 day period, then the statements for such calendar year as originally rendered by Assignor shall be deemed to be correct as rendered. SECTION 4.05. Geological and Other Data. Upon request by Assignee, Assignor shall, subject to the limitations of confidentiality or nondisclosure obligations to co-owners or other third parties, furnish to Assignee access to all geological, well and production data which Assignor has on hand relating to operations on the Subject Interests. Assignor will use reasonable efforts to obtain waivers of any such confidentiality or nondisclosure obligations that prevent it from providing to Assignee any requested information, but Assignor shall not be obligated to incur any expense or detriment above a nominal amount to obtain such waiver. Assignor shall also furnish to Assignee, upon request by Assignee, reports showing the status of development, producing and other operations conducted by Assignor on the Subject Interests. Assignor shall, upon request by Assignee, furnish to Assignee all reserve reports or studies in the possession of Assignor from time to time relating to the Subject Interests, whether prepared by Assignor or by third party consulting engineers; provided, it is agreed that Assignor makes no representations or warranties as to the accuracy or completeness of any such reports or studies and shall have no liability to Assignee or any other Person resulting from their use of such reports or studies, and Assignee agrees not to attribute to Assignor or such third-party consulting engineers any such reports or studies or the contents thereof in any securities filings or reports to owners or holders of "Beneficial Interests" in the Trust. All information furnished to Assignee pursuant to this section is confidential and for the sole benefit of Assignee and shall not be shown by Assignee to any other Person, except that this provision shall not prohibit the disclosure by Assignee of any information that (i) at the time of disclosure is generally available to the public (other than as a result of a disclosure by Assignee), (ii) was available to Assignee on a nonconfidential basis from a source other than Assignor, provided that such source is not known by Assignee to be bound by a confidentiality obligation owed to Assignor, or (iii) Assignee is legally required to disclose, provided that Assignee has given to Assignor notice of such requirement and a reasonable opportunity to seek, at Assignor's expense, a protective order and other appropriate relief from such requirement. SECTION 4.06. Monthly Estimates. On or before ten days (excluding Saturdays, Sundays and other days on which national banking institutions in the City of Fort Worth, Texas, are closed as authorized or required by law) before each Monthly Record Date (beginning with the Monthly Record Date for March, 1999), Assignor shall deliver to Assignee a statement of Assignor's best estimate of the amount payable to Assignee on or before such Monthly Record Date. SECTION 4.07. Annual Audits and Reports. Within 90 days after the end of the calendar year, Assignor shall deliver to Assignee a statement which has been audited by a nationally recognized firm of independent public accountants selected by Assignor, which shall show the information provided for in Section 4.03 on an annual basis. Assignee shall bear the cost of each such audit. 12 SECTION 4.08. Reserve Reports. Assignor may, but is not obligated to, provide an annual reserve report for the Royalty Interest prepared by independent consulting reservoir engineers. If such reserve report is provided by Assignor, Assignee will reimburse Assignor for the cost thereof. ARTICLE V LIABILITY OF ASSIGNEE In no event shall Assignee be liable or responsible in any way for any Production Costs (including Excess Production Costs) or other costs or liabilities incurred by Assignor or others attributable to the Subject Interests or to the Hydrocarbons produced therefrom. ARTICLE VI OPERATION OF SUBJECT INTERESTS SECTION 6.01. Prudent Operator Standard. Assignor agrees, to the extent it has the legal right to do so under the terms of any lease, operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof), that it will conduct and carry on the maintenance and operation of the Subject Interests with reasonable and prudent business judgment and in accordance with good oil and gas field practices, and that it will drill such wells as a reasonably prudent operator would drill from time to time in order to protect the Subject Interests from drainage. However, nothing contained in this Section 6.01 shall be deemed to prevent or restrict Assignor from electing not to participate in any operation which is to be conducted under the terms of any operating agreement, contract for development or similar instrument affecting or pertaining to the Subject Interests (or any portion thereof) and allowing consenting parties to conduct nonconsent operations thereon, if such election is made by Assignor in good faith. Notwithstanding anything elsewhere herein to the contrary, Assignor shall never be liable to Assignee for the manner in which Assignor performs its duties hereunder as long as Assignor has acted in good faith. SECTION 6.02. Abandonment of Properties. Nothing herein contained shall obligate Assignor to continue to operate any well or to operate or maintain in force or attempt to maintain in force any of the Subject Interests when, in Assignor's opinion, such well or Subject Interest ceases to produce or is not capable of producing Hydrocarbons in paying quantities. The expiration of a Subject Interest in accordance with the terms and conditions applicable thereto shall not be considered to be a voluntary surrender or abandonment thereof. SECTION 6.03. Insurance. Although Assignor is permitted to carry policies of insurance covering the property upon the Subject Interests and risks incident to the operation thereof and to charge premiums therefor to the Net Proceeds account, Assignor shall not be required to carry insurance on such property or covering any of such risks unless it elects to do so. In no event shall Assignor be liable to Assignee on account of any losses sustained which are not covered by insurance. 13 SECTION 6.04. Certain Rights to Manage the Subject Interests. Notwithstanding anything in this Conveyance to the contrary, Assignor shall have the right and power, acting in good faith and as a reasonably prudent oil and gas operator, to execute, deliver, and perform operating agreements, oil and gas leases, farmout agreements, exploration agreements, participation agreements, drilling agreements, acreage contribution agreements, dry-hole agreements, bottom-hole agreements, joint venture agreements, partnership agreements, and other similar instruments and agreements that cover or affect the Subject Interests and to make all decisions or elections required thereunder, including, but not limited to, decisions to consent or non-consent to drilling and other operations. The applicable Royalty Interest shall in each case be bound by such instrument or agreement (and decisions or elections thereunder), without the necessity of any execution, consent, joinder, or ratification by Assignee, and the Royalty Interest shall thereafter be calculated and paid with respect to the interests reserved, obtained, or modified by Assignor in such transaction, not by reference to the Subject Interests that existed before such transaction. For example, but not by way of limitation, (a) Assignor may farm out any Subject Interest that is an oil and gas lease, and the Subject Interest therein shall subsequently be the overriding royalty interest, reversionary working interest, and/or other rights and interests reserved by Assignor in the farmout, not the original leasehold interest, or (b) Assignor may execute an oil and gas lease to cover any Subject Interest that is a mineral interest, and the Subject Interest shall subsequently be the royalty and other lease benefits obtained or reserved by Assignor in such lease, not the original mineral interest. ARTICLE VII POOLING AND UNITIZATION SECTION 7.01. Pooled Subject Interests. To the extent any of the Subject Interests have been heretofore pooled and unitized for the production of Hydrocarbons, such Subject Interests are and shall be subject to the terms and provisions of such pooling and unitization agreements, and the Royalty Interest in each such Subject Interest shall apply to and affect only the production from such units which accrues to such Subject Interest under and by virtue of the applicable pooling and unitization agreements. SECTION 7.02. Right to Pool and Unitize. Assignor shall have the exclusive right and power (as between Assignor and Assignee), exercisable only during the period provided in Section 7.03 hereof, to pool or unitize any of the Subject Interests and to alter, change or amend or terminate any pooling or unitization agreements heretofore or hereafter entered into, as to all or any part of the Subject Lands, as to any one or more of the formations or horizons thereunder, and as to any one or more Hydrocarbons, upon such terms and provisions as Assignor shall in its sole and absolute discretion determine. If and whenever through the exercise of such right and power, or pursuant to any law hereafter enacted or any rule, regulation or order of any governmental body or official hereafter promulgated, any of the Subject Interests are pooled or unitized in any manner, the Royalty Interest insofar as it affects such Subject Interest shall also be pooled and unitized, and in any such event such Royalty Interest in such Subject Interest shall apply to and affect only the production which accrues to such Subject Interest under and by virtue of the pooling and unitization, and it shall 14 not be necessary for Assignee to agree to, consent to, ratify, confirm or adopt any exercise of such right and power by Assignor. SECTION 7.03. Applicable Period. Assignor's power and rights in Section 7.02 shall be exercisable only during the period of the life of the last survivor of the descendants of the signers of the Declaration of Independence living on the date of execution hereof, plus twenty-one (21) years after the death of such last survivor, or the term of this Conveyance, whichever period shall first expire. ARTICLE VIII GOVERNMENT REGULATION All obligations of Assignor hereunder shall be subject to all present and future valid federal, state and local laws, statutes, codes and orders; and all applicable rules, orders, regulations and decisions of every court, governmental agency, body or authority having jurisdiction over the Hydrocarbons in and under and that may be produced from the Subject Interests. Assignor's obligations are specifically, but not by way of limitation, subject, to the extent in effect, to all applicable provisions of the Emergency Petroleum Allocation Act of 1973, the Department of Energy Organization Act, the Natural Gas Act, the Natural Gas Policy Act of 1978, the Natural Gas Wellhead Decontrol Act of 1989 and each other statute purporting to provide regulation of the Sale of Hydrocarbons or establishing maximum prices at which the same may be Sold and all applicable laws, orders, rules and regulations thereunder of the Federal Energy Regulatory Commission, the Department of Energy and each other legislative or governmental body, agency, board or commission having jurisdiction. If maximum rates permitted under such statutes, rules and regulations for the Subject Hydrocarbons are lower than prices established in Sales Contracts, then the lower regulated prices received by Assignor shall control. Assignor shall be entitled to use its reasonable discretion in making filings, for itself and on behalf of Assignee, with the Federal Energy Regulatory Commission, the Department of Energy or any other governmental body, agency, board or commission having jurisdiction, affecting the price or prices at which Subject Hydrocarbons may be Sold, and with purchasers of production, operators or others with respect to any excise tax. ARTICLE IX ASSIGNMENTS SECTION 9.01. Assignment by Assignor. Assignor shall have the right to assign, sell, transfer, convey, mortgage or pledge the Subject Interests, or any part thereof, subject to the Royalty Interest and the terms and provisions of this Conveyance. From and after the effective date of any such assignment, sale, transfer or conveyance by Assignor, the assignee thereunder shall succeed to all the requirements upon and responsibilities of Assignor hereunder, as to the interests in the Subject Interests so acquired by such assignee, and, from and after the said effective date, Assignor shall be 15 relieved of such requirements and responsibilities, excepting only those accrued or due for performance prior to such effective date. SECTION 9.02. Partial Assignment. If Assignor assigns its interest under the Subject Interests as to some of such Subject Interests or as to some part thereof, then, effective as of the date of such assignment, in determining the Royalty Interest payable with respect to production from such assigned Subject Interests or parts thereof, the Gross Proceeds, Production Costs and Net Proceeds attributable to such assigned interests will be computed and determined by the assignee of such assigned interests in the aggregate as to the assigned interests owned by such assignee, but separate from and not aggregated with the computation and determination made by Assignor as to Subject Interests that have not been assigned by Assignor. SECTION 9.03. Assignment by Assignee. Assignee has the right to assign the Royalty Interest in whole or in part only as authorized by the Trust Indenture. However, no such assignment will affect the method of computing Net Proceeds, and if more than one Person becomes entitled to participate in the Royalty Interest, Assignor may withhold from such other Person payments to which such Person would otherwise be entitled hereunder and the furnishing of any data or information which Assignor is required by the terms hereof to furnish Assignee until Assignor is furnished a recordable instrument executed by or binding upon all Persons interested in the Royalty Interest designating one Person who is to receive such payments, data and information. In making conveyances or assignments of any of the Subject Interests (to the extent permitted hereunder), Assignee need not vest in its grantee or assignee all of the rights of Assignee hereunder with respect to the interest in the Subject Interests so conveyed or assigned. SECTION 9.04. Certain Sales of Subject Interests. Subject to the limitations set forth in Section 3.02(b) of the Trust Indenture, Assignor may cause the sale of certain Subject Interests, including the appurtenant Royalty Interest from time to time and Assignee will join in such sales as provided in the Trust Indenture. The proceeds of any such sale shall be apportioned and paid as provided in the Trust Indenture, but the purchasers of such Subject Interests (inclusive of the appurtenant Royalty Interest) may pay the full amount of the purchase price therefor to Assignor and shall have no responsibility to see to the proper allocation thereof between Assignor and Assignee. SECTION 9.05. Change in Ownership. No change of ownership or right to receive payment of the Royalty Interest, or of any part thereof, however accomplished, shall be binding upon Assignor until notice thereof shall have been furnished by the Person claiming the benefit thereof, and then only with respect to payments thereafter made. Notice of sale or assignment shall consist of a certified copy of the recorded instrument accomplishing the same; notice of change of ownership or right to receive payment accomplished in any other manner (for example by reason of incapacity, death or dissolution) shall consist of certified copies of recorded documents and complete proceedings legally binding and conclusive of the rights of all parties. Until such notice accompanied by such documentation shall have been furnished Assignor as above provided, the payment or tender of all sums payable on the Royalty Interest may be made in the manner provided herein precisely as if no such change in interest or ownership or right to receive payment had occurred, or (at Assignor's 16 election) Assignor shall have the right to suspend payment of such sums without interest in the event of such change until such documentation is furnished. The kind of notice herein provided shall be exclusive, and no other kind, whether actual or constructive, shall be binding on Assignor. SECTION 9.06. Rights of Mortgagee or Trustee. If Assignee shall at any time execute a mortgage or deed of trust covering all or part of the Royalty Interest, the mortgagee(s) or trustee(s) therein named or the holder of any obligation secured thereby shall be entitled, to the extent such mortgage or deed of trust so provides, to exercise all the rights, remedies, powers and privileges conferred upon Assignee by the terms of this Conveyance and to give or withhold all consents required to be obtained hereunder by Assignee, but the provisions of this Section 9.06 shall in no way be deemed or construed to impose upon Assignor any obligation or liability undertaken by Assignee under such mortgage or deed of trust or under the obligation secured thereby. ARTICLE X MISCELLANEOUS SECTION 10.01. Proportionate Reduction. In the event of failure or deficiency in title to any of the Subject Interests, the portion of the production from such Subject Interest out of which the Royalty Interest attributable to such Subject Interest shall be payable shall be reduced in the same proportion that such Subject Interest is reduced. Notwithstanding the foregoing, if any Person claims that this Conveyance gives rise to a preferential right of such Person to acquire any portion of the Royalty Interest (or any of the Subject Interests), then Assignor shall indemnify Assignee and the trustee of the Trust against any liability, expense, damage or loss in regard to such claim and the provisions of Section 6.05 of the Trust Indenture shall apply with respect to such indemnity obligation. If such claim results in the acquisition of any portion of the Royalty Interest by the Person claiming the preferential right then, subject to the proviso below, Assignor shall pay to Assignee the amount determined by multiplying (i) the product of 40,000,000 multiplied by the initial public offering price of the Trust's units of beneficial interest by (ii) a fraction, the numerator of which is the value of the portion of the Royalty Interest acquired by the Person claiming the preferential right, as determined by reference to the most recent Reserve Report (as defined in the Trust Indenture) of the Trust and the denominator of which is the value of all the Royalty Interest as determined by reference to such Reserve Report; provided, however, that if the Person claiming such preferential right makes any payment to the Trust in connection with the acquisition of a portion of the Royalty Interest, then the amount of such payment shall be credited against Assignor's payment obligation set forth above, but not to create a negative number. SECTION 10.02. Term. This Conveyance shall remain in force as long as any of the Subject Interests are in effect. SECTION 10.03. Further Assurances. Should any additional instruments of assignment and conveyance be required to describe more specifically any interests subject hereto, Assignor agrees to execute and deliver the same. Also, if any other or additional instruments are required in 17 connection with the transfer of State, Federal or Indian lease interests in order to comply with applicable laws, regulations or agreements, Assignor will execute and deliver the same. SECTION 10.04. Notices. All notices, statements, payments and communications between the parties hereto shall be deemed to have been sufficiently given and delivered if enclosed in a post paid wrapper and deposited in the United States Mails directed, or if personally delivered, to the party to whom the same is directed or to be furnished or made at the respective addresses, as follows: If to Assignor: Cross Timbers Oil Company 810 Houston Street, Suite 2000 Fort Worth, Texas 76102 Attention: Corporate Secretary If to Assignee: NationsBank, N.A. 17th Floor 901 Main Street NationsBank Plaza Dallas, Texas 75202 Attention: Trust Department Either party or the successors or assignees of the interest or rights or obligations of either party hereunder may change its address or designate a new or different address or addresses for the purposes hereof by a similar notice given or directed to all parties interested hereunder at the time. SECTION 10.05. Binding Effect. This Conveyance shall bind and inure to the benefit of the successors and assigns of Assignor and Assignee. SECTION 10.06. Governing Law. The validity, effect and construction of this Conveyance shall be governed by the laws of the State of Texas. SECTION 10.07. Headings. Article and Section headings used in this Conveyance are for convenience only and shall not affect the construction of this Conveyance. SECTION 10.08. Substitution of Warranty. This instrument is made with full substitution and subrogation of Assignee in and to all covenants of warranty by others heretofore given or made with respect to the Subject Interests or any part thereof or interest therein. 18 SECTION 10.09. Counterpart Execution. This Conveyance may be executed in multiple counterparts, each of which shall be an original. Certain counterparts may have descriptions relating to different recording jurisdictions omitted from Schedule A. A counterpart with all such descriptions is being filed for record in Lincoln County, Wyoming. Where a description covers an interest located in more than one county, such description may be included in counterparts recorded in each county but such inclusion of the same description in more than one counterpart does not have any cumulative effect as to the interests covered by such description. IN WITNESS WHEREOF, each of the parties hereto has caused this Conveyance to be executed in its name and behalf and delivered as of the Effective Date. ATTEST: CROSS TIMBERS OIL COMPANY /s/ VIRGINIA ANDERSON - ---------------------------- Virginia Anderson, Secretary of Cross Timbers Oil Company By: /s/ VAUGHN O. VENNERBERG, II ----------------------------- Vaughn O. Vennerberg, II Senior Vice President - Land ATTEST: NATIONSBANK, N.A., acting not in its individual capacity but solely as the /s/ DONALD A. YUCHS Trustee of the Hugoton Royalty Trust - ---------------------------- By: /s/ RON E. HOOPER ----------------------------- Ron E. Hooper, Vice President 19 STATE OF TEXAS (S) (S) COUNTY OF TARRANT (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Vaughn O. Vennerberg II, Senior Vice President - Land of Cross Timbers Oil Company, on behalf of said corporation. Commission Expires: /s/ KIM FIELDS RHOADS 11-13-99 ---------------------------------- - ------------------ Notary Public State of Texas [NOTARY SEAL APPEARS HERE] THE STATE OF TEXAS (S) (S) COUNTY OF DALLAS (S) This instrument was acknowledged before me on this 14th day of January, 1999, by Ron E. Hooper, Vice President of NationsBank, N.A., Trustee of the Hugoton Royalty Trust, on behalf of said Bank as Trustee of the Hugoton Royalty Trust. Commission Expires: /s/ JANA L. EGELER 10-22-02 ---------------------------------- - ------------------ Notary Public State of Texas [NOTARY SEAL APPEARS HERE] 20 SCHEDULE A [Description of Subject Interests - Omitted] 21 SCHEDULE B Attached to and made a part of that certain Net Overriding Royalty Conveyance (Hugoton Royalty Trust) dated effective December 1, 1998 (the "Conveyance") ACCOUNTING PROCEDURE I. GENERAL PROVISIONS 1. Definitions "Joint Property" shall mean the real and personal property subject to the Conveyance. "Joint Operations" shall mean all operations necessary or proper for the development, operation, protection and maintenance of the Joint Property. "Joint Account" shall mean the account showing the charges paid and credits received in the conduct of the Joint Operations and which are used in the calculation of Gross Proceeds, Net Proceeds, Processing Costs and Production Costs, as said terms are defined in the Conveyance. "Operator" shall mean Cross Timbers Oil Company or any of its affiliates that conduct Joint Operations on the Joint Property. "Parties" shall mean Operator and the Hugoton Royalty Trust (herein referred to as the "Trust"). "First Level Supervisors" shall mean those employees whose primary function in Joint Operations is the direct supervision of other employees and/or contract labor directly employed on the Joint Property in a field operating capacity. "Technical Employees" shall mean those employees having special and specific engineering, geological or other professional skills, and whose primary function in Joint Operations is the handling of specific operating conditions and problems for the benefit of the Joint Property. "Personal Expenses" shall mean travel and other reasonable reimbursable expenses of Operator's employees. "Material" shall mean personal property, equipment or supplies acquired or held for use on the Joint Property. "Controllable Material" shall mean Material which at the time is so classified in the Material Classification Manual as most recently recommended by the Council of Petroleum Accountants Societies. 2. Designation and Responsibilities of Operator Cross Timbers Oil Company shall be the Operator of the Joint Property, and shall, to the extent it has the legal right to do so, conduct and direct and have full control of all operations on the Joint Property as permitted and required by, and within the limits of the Conveyance. 3. Payments and Accounting Except as herein otherwise specifically provided, Operator shall promptly pay and discharge expenses incurred in the development and operation of the Joint Property and shall charge the Joint Account with the appropriate proportionate share upon the expense basis provided herein. Operator shall keep an accurate record of the expenses incurred and charges and credits made and received. 4. Application of Agreement This Accounting Procedure will apply to Joint Properties where Cross Timbers Oil Company is the Operator and the Operator owns all or a portion of the leasehold interest in the Joint Properties. In the event there is an existing Accounting Procedure or related instrument governing the operations of the Joint Properties, this Accounting Procedure will control except as to the overhead rate stated in the existing Accounting Procedure or related instrument. 1 5. Conflicts In the event there exists any conflict between the terms of this Accounting Procedure or any Accounting Procedure that applies to the Joint Properties and the Conveyance to which it is attached, the Conveyance will control. II. DIRECT CHARGES Operator shall charge the Joint Account with the following items, which shall be allocated to Processing Costs or Production Costs as appropriate: 1. Ecological and Environmental Costs incurred for the benefit of the Joint Property as a result of governmental or regulatory requirements to satisfy environmental considerations applicable to the Joint Operations. Such costs may include surveys of an ecological or archaeological nature and pollution control procedures as required by applicable laws and regulations, and costs related to employees of Operator performing any environmental work involving the Joint Property. 2. Rentals and Royalties Lease rentals and royalties paid by Operator for the Joint Operations. 3. Labor A. (1) Salaries and wages of Operator's field employees employed on the Joint Property in the conduct of Joint Operations. (2) Salaries of First Level Supervisors in the field. (3) Salaries and wages of Technical Employees directly employed on the Joint Property. (4) Salaries and wages of Technical Employees either temporarily or permanently assigned to and directly employed in the operation of the Joint Property. (5) Salaries and wages of support employees whose duties are primarily field related in connection with the Joint Operations, regardless of their location (e.g., field superintendents and clerical employees located in the field). B. Operator's cost of holiday, vacation, sickness and disability benefits and other customary allowances paid to employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. Such costs under this Paragraph 3B may be charged on a "when and as paid basis" or by "percentage assessment" on the amount of salaries and wages chargeable to the Joint Account under Paragraph 3A of this Section II. If percentage assessment is used, the rate shall be based on the Operator's cost experience. C. Expenditures or contributions made pursuant to assessments imposed by governmental authority which are applicable to Operator's costs chargeable to the Joint Account under Paragraphs 3A and 3B of this Section II. D. Personal Expenses of those employees whose salaries and wages are chargeable to the Joint Account under Paragraph 3A of this Section II. 4. Employee Benefits Operator's current costs of established plans for employees' group life insurance, hospitalization, pension, retirement, stock purchase, thrift, bonus, and other benefit plans of a like nature, applicable to Operator's labor cost chargeable to the Joint Account under 2 Paragraph 3A and 3B of this Section II shall be Operator's actual cost not to exceed the percent most recently recommended by the Council of Petroleum Accountants Societies. 5. Material Material purchased or furnished by Operator for use on the Joint Property as provided under Section IV. Only such Material shall be purchased for or transferred to the Joint Property as may be required for immediate use and is reasonably practical and consistent with efficient and economical operations. The accumulation of surplus stocks shall be avoided. 6. Transportation Transportation of employees and Material necessary for the Joint Operations but subject to the following limitations: A. If Material is moved to the Joint Property from the Operator's warehouse or other properties, no charge shall be made to the Joint Account for a distance greater than the distance from the nearest reliable supply store where like material is normally available or railway receiving point nearest the Joint Property. B. If surplus Material is moved to Operator's warehouse or other storage point, no charge shall be made to the Joint Account for a distance greater than the distance to the nearest reliable supply store where like material is normally available, or railway receiving point nearest the Joint Property. No charge shall be made to the Joint Account for moving Material to other properties belonging to Operator. C. In the application of subparagraphs A and B above, the option to equalize or charge actual trucking cost is available when the actual charge is $400 or less excluding accessorial charges. The $400 will be adjusted to the amount most recently recommended by the Council of Petroleum Accountants Societies. 7. Services The cost of contract services, equipment and utilities provided by outside sources, except services excluded by Paragraph 10 of Section II and Paragraph i, ii, and iii, of Section III. The cost of professional consultant services and contract services of technical personnel directly engaged on the Joint Property if such charges are excluded from the overhead rates. 8. Equipment and Facilities Furnished By Operator A. Operator shall charge the Joint Account for use of equipment and facilities owned by Operator or any of its affiliates at rates commensurate with costs of ownership and operation. Such rates shall include costs of maintenance, repairs, other operating expense, insurance, taxes, depreciation, and interest on gross investment less accumulated depreciation not to exceed twelve percent (12%) per annum. Such rates shall not exceed average commercial rates currently prevailing in the immediate area of the Joint Property. B. In lieu of charges in paragraph 8A above, Operator may elect to use average commercial rates prevailing in the immediate area of the Joint Property less 20%. For automotive equipment, Operator may elect to use rates published by the Petroleum Motor Transport Association. C. This Paragraph 8 shall not affect any current charges made by Operator to the Joint Account related to transportation, gathering, treating, compression or processing or related charges by an affiliate of Operator. 9. Damages and Losses to Joint Property All costs or expenses necessary for the repair or replacement of Joint Property made necessary because of damages or losses incurred by fire, flood, storm, theft, accident, or other cause, except those resulting from Operator's gross negligence or willful misconduct. 10. Legal Expense Expense of handling, investigating and settling litigation or claims, discharging of liens, payment of judgments and amounts paid for settlement of claims incurred in or resulting from operations under the Conveyance or necessary to protect or recover the Joint 3 Property, and the costs and expenses incurred in connection with hearings and other matters before governmental bodies and agencies and costs and expenses incurred in curing title to the Joint Property. Costs incurred by Operator in procuring abstracts and fees paid outside attorneys for title examination (including preliminary, supplemental, shut-in gas royalty opinions and division order title opinions) shall be borne by the Joint Account. Operator shall make no charge for services rendered by its staff attorneys or other personnel in the performance of the above functions. All other legal expense is considered to be covered by the overhead provisions of Section III. 11. Taxes All taxes of every kind and nature assessed or levied upon or in connection with the Joint Property, the operation thereof, or the production therefrom, and which taxes have been paid by the Operator for the benefit of the Parties. If the ad valorem taxes are based in whole or in part upon separate valuations of each party's interest, then notwithstanding anything to the contrary herein, charges to the Joint Account shall be made and paid by the Parties hereto in accordance with the tax value generated by each party's interest. 12. Insurance Net premiums paid for insurance required to be carried for the Joint Operations for the protection of the Parties. In the event Joint Operations are conducted in a state in which Operator may act as self-insurer for Worker's Compensation and/or Employers Liability under the respective state's laws, Operator may, at its election, include the risk under its self-insurance program and in that event, Operator shall include a charge at Operator's cost not to exceed manual rates. 13. Abandonment and Reclamation Costs incurred for abandonment of the Joint Property, including costs required by governmental or other regulatory authority. 14. Communications Cost of acquiring, leasing, installing, operating, repairing and maintaining communication systems, including radio and microwave facilities or any form of telephonic equipment or service used in serving the Joint Property. In the event communication facilities/systems serving the Joint Property are Operator owned, charges to the Joint Account shall be made as provided in Paragraph 8 of this Section II. 15. Other Expenditures Any other expenditure not covered or dealt with in the foregoing provisions of this Section II, or in Section III and which is of direct benefit to the Joint Property and is incurred by the Operator in the necessary and proper conduct of the Joint Operations. III. OVERHEAD 1. Overhead - Drilling and Producing Operations i. As compensation for administrative, supervision, office services and warehousing costs, Operator shall charge drilling and producing operations on a Fixed Rate Basis, Paragraph 1A. Such charge shall be in lieu of costs and expenses of all offices and salaries or wages plus applicable burdens and expenses of all personnel, except those directly chargeable under Paragraph 3A, Section II. The cost and expense of services from outside sources in connection with matters of taxation, traffic, accounting or matters before or involving governmental agencies shall not be considered as included in the overhead rates. ii. The salaries, wages and Personal Expenses of Technical Employees and/or the cost of professional consultant services and contract services of technical personnel directly employed on the Joint Property shall not be covered by the overhead rates. iii. The salaries, wages and Personal Expenses of Technical Employees and/or costs of professional consultant services and contract services of technical personnel either temporarily or permanently assigned to and directly employed in the operation of the Joint Property shall not be covered by the overhead rates. 4 A. Overhead - Fixed Rate Basis (1) Operator shall charge the Joint Account at the following rates per well per month: For wells located in the Hugoton Field Drilling Well Rate $2,350.00 (Prorated for less than a full month) Producing Well Rate $235.00 For wells located in all other areas Drilling Well Rate $4,760.00 (Prorated for less than a full month) Producing Well Rate $476.00 (2) Application of Overhead - Fixed Rate Basis shall be as follows: (a) Drilling Well Rate (1) Charges for drilling wells shall begin on the date the well is spudded and terminate on the date the drilling rig, completion rig, or other units used in completion of the well is released, whichever is later, except that no charge shall be made during suspension of drilling or completion operations for fifteen (15) or more consecutive calendar days. (2) Charges for wells undergoing any type of workover or recompletion or swabbing shall be made at the drilling well rate. Such charges shall be applied for the period from date such operations, with rig or other units used, commence through date of rig or other unit release, except that no charge shall be made during suspension of operations for fifteen (15) or more consecutive calendar days. (b) Producing Well Rates (1) An active well either produced or injected into for any portion of the month shall be considered as a one-well charge for the entire month. (2) Each active completion in a multi-completed well in which production is not commingled down hole shall be considered as a one-well charge providing each completion is considered a separate well by the governing regulatory authority. (3) An inactive gas well shut in because of overproduction or failure of purchaser to take the production shall be considered as a one-well charge providing the gas well is directly connected to a permanent sales outlet. (4) A one-well charge shall be made for the month in which plugging and abandonment operations are completed on any well. This one-well charge shall be made whether or not the well has produced except when drilling well rate applies. (5) All other inactive wells (including but not limited to inactive wells covered by unit allowable, lease allowable, transferred allowable, etc.) shall not qualify for an overhead charge. (3) The well rates shall be adjusted as of the first day of April each year beginning in 1999. The adjustment shall be computed by multiplying the rate currently in use by the percentage increase or decrease in the average weekly earnings of Crude Petroleum and Gas Production Workers for the last calendar year compared to the calendar year preceding as shown by the index of average weekly earnings of Crude Petroleum and Gas Production Workers as 5 published by the United States Department of Labor, Bureau of Labor Statistics. The adjusted rates shall be the rates currently in use, plus or minus the computed adjustment. 2. Overhead - Major Construction To compensate Operator for overhead costs incurred in the construction and installation of fixed assets, the expansion of fixed assets, and any other project clearly discernable as a fixed asset required for the development and operation of the Joint Property, Operator shall charge the Joint Account for overhead based on the following rates for any Major Construction project in excess of $25,000.00: A. 5% of first $100,000 or total cost if less, plus B. 3% of costs in excess of $100,000 but less than $1,000,000, plus C. 2% of costs in excess of $1,000,000. Total cost shall mean the gross cost of any one project. For the purpose of this paragraph, the component parts of a single project shall not be treated separately and the cost of drilling and workover wells and artificial lift equipment shall be excluded. 3. Catastrophe Overhead To compensate Operator for overhead costs incurred in the event of expenditures resulting from a single occurrence due to oil spill, blowout, explosion, fire, storm, hurricane, or other catastrophes as agreed to by the Parties, which are necessary to restore the Joint Property to the equivalent condition that existed prior to the event causing the expenditures, Operator shall charge the Joint Account for overhead based on the following rates: A. 5% of total costs through $100,000; plus B. 3% of total costs in excess of $100,000 but less than $1,000,000; plus C. 2% of total costs in excess of $1,000,000. Expenditures subject to the overheads in this Section 3 above will not be reduced by insurance recoveries, and no other overhead provisions of this Section III shall apply. IV. PRICING OF JOINT ACCOUNT MATERIAL PURCHASES, TRANSFERS AND DISPOSITIONS Operator is responsible for Joint Account Materials and shall make proper and timely charges and credits for all Material movements affecting the Joint Property. Operator shall provide all Material for use on the Joint Property. Operator shall make timely disposition of idle and/or surplus Material, such disposal being made either through sale to Operator, or sale to outsiders. Operator may purchase, but shall be under no obligation to purchase, interest of the Trust in surplus condition A or B Material at the prices defined below. 1. Purchases Material purchased shall be charged at the price paid by Operator after deduction of all discounts, adjustments or rebates received. In case of Material found to be defective or returned to vendor for any other reasons, credit shall be passed to the Joint Account when adjustment has been received by the Operator. 2. Transfers and Dispositions Material furnished to the Joint Property and Material transferred from the Joint Property or disposed of by the Operator shall be priced on the following basis exclusive of cash discounts: A. New Material (Condition A) (1) Tubular Goods Other than Line Pipe 6 (a) Tubular goods, sized 2-3/8 inches OD and larger, except line pipe, shall be priced at Eastern mill published carload prices effective as of date of movement plus transportation cost using the 80,000 pound carload weight basis to the railway receiving point nearest the Joint Property for which published rail rates for tubular good exist. If the 80,000 pound rail rate is not offered, the 70,000 pound or 90,000 pound rail rate may be used. Freight charges for tubing will be calculated from Lorain, Ohio and casing from Youngstown, Ohio. (b) For grades which are special to one mill only, prices shall be computed at the mill base of that mill plus transportation cost from that mill to the railway receiving point nearest the Joint Property as provided above in Paragraph 2.a.(1)(a). For transportation cost from points other than Eastern mills, the 30,000 pound Oil Field Haulers Association interstate truck rate shall be used. (c) Special end finish tubular goods shall be priced at the lowest published out-of-stock price, f.o.b. Houston, Texas, plus transportation cost, using Oil Field Haulers Association interstate 30,000 pound truck rate, to the railway receiving point nearest the Joint Property. (d) Macaroni tubing (size less than 2-3/8 inch OD) shall be priced at the lowest published out-of-stock prices f.o.b. the supplier plus transportation costs, using the Oil Field Haulers Association interstate truck rate per weight of tubing transferred, to the railway receiving point nearest the Joint Property. (2) Line Pipe (a) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) 30,000 pounds or more shall be priced under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (b) Line pipe movements (except size 24 inch OD and larger with walls 3/4 inch and over) less than 30,000 pounds shall be priced at Eastern mill published carload base prices effective as of date of shipment, plus 20 percent, plus transportation costs based on freight rates as set forth under provisions of tubular goods pricing in Paragraph A.(1)(a) as provided above. Freight charges shall be calculated from Lorain, Ohio. (c) Line pipe 24 inch OD and over and 3/4 inch wall and larger shall be priced f.o.b. the point of manufacture at current new published prices plus transportation cost to the railway receiving point nearest the Joint Property. (d) Line pipe, including fabricated line pipe, drive pipe and conduit not listed on published price lists shall be priced at quoted prices plus freight to the railway receiving point nearest the Joint Property or at prices agreed to by the Parties. (3) Other Material shall be priced at the current new price, in effect at date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. (4) Unused new Material, except tubular goods, moved from the Joint Property shall be priced at the current new price, in effect on date of movement, as listed by a reliable supply store nearest the Joint Property, or point of manufacture, plus transportation costs, if applicable, to the railway receiving point nearest the Joint Property. Unused new tubulars will be priced as provided above in Paragraph 2 A (1) and (2). B. Good Used Material (Condition B) Material in sound and serviceable condition and suitable for reuse without reconditioning: (1) Material moved to the Joint Property At seventy-five percent (75%) of current new price, as determined by Paragraph A. 7 (2) Material used on and moved from the Joint Property (a) At seventy-five percent (75%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as new Material. (b) At sixty-five percent (65%) of current new price, as determined by Paragraph A, if Material was originally charged to the Joint Account as used Material. (3) Material not used on and moved from the Joint Property At seventy-five percent (75%) of current new price as determined by Paragraph A. The cost of reconditioning, if any, shall be absorbed by the transferring property. C. Other Used Material (1) Condition C Material which is not in sound and serviceable condition and suitable for its original function until after reconditioning shall be priced at fifty percent (50%) of current new price as determined by Paragraph A. The cost of reconditioning shall be charged to the receiving property, provided Condition C value plus cost of reconditioning does not exceed Condition B value. (2) Condition D Material, excluding junk, no longer suitable for its original purpose, but usable for some other purpose shall be priced on a basis commensurate with its use. Operator may dispose of Condition D Material under procedures normally used by Operator without prior approval of the Assignee. (a) Casing, tubing or drill pipe used as line pipe shall be priced as Grade A and B seamless line pipe of comparable size and weight. Used casing, tubing or drill pipe utilized as line pipe shall be priced at used line pipe prices. (b) Casing, tubing or drill pipe used as higher pressure service lines than standard line pipe, e.g. power oil lines, shall be priced under normal pricing procedures for casing, tubing, or drill pipe. Upset tubular goods shall be priced on a non upset basis. (3) Condition E Junk shall be priced at prevailing prices. Operator may dispose of Condition E Material under procedures normally utilized by Operator without prior approval of Non-Operators. D. Obsolete Material Material which is serviceable and usable for its original function but condition and/or value of such Material is not equivalent to that which would justify a price as provided above may be specially priced as reasonably determined by Operator. Such price should result in the Joint Account being charged with the value of the service rendered by such Material. E. Pricing Conditions (1) Loading and unloading costs related to the movement of the Material to the Joint Property shall be charged in accordance with the methods specified in COPAS Bulletin 21. (2) Material involving erection costs shall be charged at applicable percentage of the current knocked-down price of new Material. 8 3. Premium Prices Whenever Material is not readily obtainable at published or listed prices because of national emergencies, strikes or other unusual causes over which the Operator has no control, the Operator may charge the Joint Account for the required Material at the Operator's actual cost incurred in providing such Material, in making it suitable for use, and in moving it to the Joint Property. 4. Warranty of Material Furnished by Operator Operator does not warrant the Material furnished. In case of defective Material, credit shall not be passed to the Joint Account until adjustment has been received by Operator from the manufacturers or their agents. V. INVENTORIES The Operator shall maintain detailed records of Controllable Material. 1. Periodic Inventories, Notice and Representation At reasonable intervals, inventories shall be taken by Operator of the Joint Account Controllable Material. 2. Reconciliation and Adjustment of Inventories Adjustments to the Joint Account resulting from the reconciliation of a physical inventory shall be made within six months following the taking of the inventory. Inventory adjustments shall be made by Operator to the Joint Account for overages and shortages, but Operator shall be held accountable only for shortages due to lack of reasonable diligence. 3. Special Inventories Special inventories may be taken whenever there is any sale, change of interest, or change of Operator in the Joint Property. It shall be the duty of the party selling to notify all other Parties as quickly as possible after the transfer of interest takes place. In such cases, both the seller and the purchaser shall be governed by such inventory. In cases involving a change of Operator, all Parties shall be governed by such inventory. 4. Expense of Conducting Inventories A. The expense of conducting periodic inventories shall not be charged to the Joint Account. B. The expense of conducting special inventories shall be charged to the Parties requesting such inventories, except inventories required due to change of Operator shall be charged to the Joint Account. 9 EX-15.1 9 AWARENESS LETTER OF ARTHUR ANDERSEN LLP EXHIBIT 15.1 AWARENESS LETTER--UNAUDITED INTERIM FINANCIAL INFORMATION Cross Timbers Oil Company Fort Worth, Texas We are aware that our reports dated April 20, 1998, July 22, 1998, and October 21, 1998, which were included in the Cross Timbers Oil Company's Quarterly Report on Form 10-Q for the quarters ended March 31, 1998, June 30, 1998, and September 30, 1998, are being incorporated by reference in the Company's Amendment No. 1 to Registration Statement on Form S-3, Registration Number 333-68441. We also are aware that the aforementioned reports, pursuant to Regulation C under the Securities Act of 1933, are not considered a part of the Registration Statement prepared or certified by our firm within the meaning of Sections 7 and 11 of that Act. ARTHUR ANDERSEN LLP Fort Worth, Texas January 25, 1999 EX-23.1 10 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.1 INDEPENDENT PUBLIC ACCOUNTANTS' CONSENT As independent public accountants, we hereby consent to the use of our reports in this Registration Statement Amendment No. 1 on Form S-1 of Hugoton Royalty Trust and on Form S-3 of Cross Timbers Oil Company (the Company), Registration No. 333-68441, dated January 22, 1999 and January 25, 1999, and to the incorporation by reference of our report dated March 18, 1998 included in the Company's Form 10-K for the year ended December 31, 1997, our report dated February 11, 1998 included in the Company's Form 8-K/A Amendment No. 1 dated December 1, 1997 and our report dated April 17, 1998 included in the Company's Form 8-K and Form 8-K/A Amendment No.1 dated April 24, 1998, and to all references to our firm included in or made a part of this Registration Statement. ARTHUR ANDERSEN LLP Fort Worth, Texas January 25, 1999 EX-23.5 11 CONSENT OF MILLER AND LENTS EXHIBIT 23.5 [LETTERHEAD OF MILLER AND LENTS, LTD. APPEARS HERE] January 25, 1999 Hugoton Royalty Trust 901 Main St., 17th Floor Dallas, Texas 75202 Cross Timbers Oil Company 810 Houston Street, Suite 2000 Forth Worth, Texas 76102 Re: Securities and Exchange Commission Form S-1/Form S-3 Registration Statement No. 333-68441 Gentlemen: The firm of Miller and Lents, Ltd., consents to the incorporation of its estimated Proved Reserves, Future Net Revenues, and Present Values of Future Net Revenues in the Hugoton Royalty Trust and Cross Timbers Oil Company Form S-1/S-3 Registration Statement, No. 333-68441, and to references to our Firm in such registration statement. Miller and Lents, Ltd. has no interests in Hugoton Royalty Trust or Cross Timbers Oil Company or any of its affiliated companies or subsidiaries and is not to receive any such interest as payment for such reports and has no director, officer, or employee, or otherwise, connected with Hugoton Royalty Trust or Cross Timbers Oil Company. We are not employed by Hugoton Royalty Trust or Cross Timbers Oil Company on a contingent basis. Yours very truly, Miller and Lents, Ltd. By: /s/ Karen Loving -------------------------------- Karen Loving Vice President EX-27.1 12 FINANCIAL DATA SCHEDULE
5 0000862022 HUGOTON ROYALTY TRUST 1,000 OTHER DEC-31-1998 DEC-31-1998 1 0 0 0 0 0 247,067 0 247,068 0 0 0 0 0 247,068 247,068 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
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