10-Q 1 q0304-10q.txt 3Q 2004 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC. 20549 FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from __________ to __________ For the Quarterly Period Ended September 30, 2004 Commission file number 000-50175 DORCHESTER MINERALS, L.P. (Exact name of Registrant as specified in its charter) Delaware 81-0551518 (State or other jurisdiction of (I.R.S. Employer Identification No.) Incorporation or organization) 3838 Oak Lawn Avenue, Suite 300, Dallas, Texas 75219 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (214) 559-0300 Dorchester Minerals, L.P. 3738 Oak Lawn Avenue, Suite 300, Dallas, Texas 75219 (Former address of principal executive offices) (Zip Code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No As of November 5, 2004, 28,240,431 common units of partnership interest were outstanding. 1 TABLE OF CONTENTS DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS................................3 PART I - FINANCIAL INFORMATION.................................................3 ITEM 1. FINANCIAL STATEMENTS................................................3 CONDENSED BALANCE SHEETS AS OF SEPTEMBER 30, 2004 (UNAUDITED) AND DECEMBER 31, 2003......................................................4 CONDENSED STATEMENTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003 (UNAUDITED)................................5 CONDENSED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30,2004 AND 2003 (UNAUDITED).................................6 NOTES TO THE CONDENSED FINANCIAL STATEMENTS...............................7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............................................9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.........14 ITEM 4. CONTROLS AND PROCEDURES............................................14 PART II - OTHER INFORMATION...................................................15 ITEM 1. LEGAL PROCEEDINGS..................................................15 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS........15 ITEM 3. DEFAULTS UPON SENIOR SECURITIES....................................15 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS................15 ITEM 5. OTHER INFORMATION..................................................15 ITEM 6. EXHIBITS...........................................................15 SIGNATURES....................................................................15 INDEX TO EXHIBITS.............................................................16 CERTIFICATIONS................................................................17 2 DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS Statements included in this report which are not historical facts (including any statements concerning plans and objectives of management for future operations or economic performance, or assumptions or forecasts related thereto), are forward-looking statements. These statements can be identified by the use of forward-looking terminology including "may," "believe," "will," "expect," "anticipate," "estimate," "continue" or other similar words. These statements discuss future expectations, contain projections of results of operations or of financial condition or state other "forward-looking" information. In this report, the term "Partnership", as well as the terms "us," "our," "we," and "its," are sometimes used as abbreviated references to Dorchester Minerals, L.P. itself or Dorchester Minerals, L.P. and its related entities. These forward-looking statements are made based upon management's current plans, expectations, estimates, assumptions and beliefs concerning future events impacting us and therefore involve a number of risks and uncertainties. We caution that forward-looking statements are not guarantees and that actual results could differ materially from those expressed or implied in the forward-looking statements for a number of important reasons. Examples of such reasons include, but are not limited to, changes in the price or demand for oil and natural gas, changes in the operations on or development of the Partnership's properties, changes in economic and industry conditions and changes in regulatory requirements (including changes in environmental requirements) and the Partnership's financial position, business strategy and other plans and objectives for future operations. These and other factors are set forth in the Partnership's filings with the Securities and Exchange Commission. You should read these statements carefully because they discuss our expectations about our future performance, contain projections of our future operating results or our future financial condition, or state other "forward-looking" information. Before you invest, you should be aware that the occurrence of any of the events herein described in this report could substantially harm our business, results of operations and financial condition and that upon the occurrence of any of these events, the trading price of our common units could decline, and you could lose all or part of your investment. PART I-FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Dorchester Minerals, L.P. is a publicly traded Delaware limited partnership that commenced operations on January 31, 2003, upon the combination of Dorchester Hugoton, Ltd., which was a publicly traded Texas limited partnership, and Republic Royalty Company and Spinnaker Royalty Company, L.P., both of which were privately held Texas partnerships. The amounts and results of operations of Dorchester Minerals included in these financial statements as historical amounts prior to February 1, 2003 reflect the results of operations of Dorchester Hugoton. The effect of the combination is reflected in the balance sheet and in the results of operations and cash flows since January 31, 2003. The combination was accounted for using the purchase method of accounting. 3 DORCHESTER MINERALS, L.P. (A Delaware Limited Partnership) CONDENSED BALANCE SHEETS (Dollars in Thousands) September 30, December 31, 2004 2003 ------------ ----------- (unaudited) ASSETS Current assets: Cash and cash equivalents....................... $ 14,450 $ 10,881 Trade receivables............................... 9,048 7,658 Note receivable - related party................. 167 205 Prepaid expenses................................ 27 69 --------- --------- Total current assets........................ 23,692 18,813 Oil and natural gas properties - at cost (full cost method)..................................... 291,804 268,189 Less accumulated depletion................... (103,477) (88,051) --------- --------- Net oil and natural gas properties............ 188,327 180,138 --------- --------- Total assets................................ $212,019 $198,951 ========= ========= LIABILITIES AND PARTNERSHIP CAPITAL Current liabilities: Accounts payable and other current liabilities.. $ 1,293 $ 512 --------- --------- Total current liabilities.................. 1,293 512 Commitments and contingencies - - Partnership capital: General partner ................................ 7,958 8,246 Unitholders..................................... 202,768 190,193 --------- --------- Total partnership capital.................. 210,726 198,439 --------- --------- Total liabilities and partnership capital............ $212,019 $198,951 ========= ========= The accompanying condensed notes are an integral part of these financial statements. 4 DORCHESTER MINERALS, L.P. (A Delaware Limited Partnership) CONDENSED STATEMENTS OF OPERATIONS (Dollars in Thousands) (Unaudited) Three Months Ended Nine Months Ended September 30, September 30, ----------------- ------------------ 2004 2003 2004 2003 ------- --------- -------- --------- Net operating revenues: Net profits interest.................. $ 5,775 $ 5,583 $18,061 $ 15,789 Natural gas sales..................... - - - 2,401 Royalties............................. 7,822 6,936 21,677 19,392 Other................................. 836 29 1,516 222 ------- --------- -------- --------- Total net operating revenues.......... 14,433 12,548 41,254 37,804 Cost and expenses: Operating, including production taxes. 687 592 1,767 1,908 Depreciation, depletion and amort..... 5,103 6,600 15,426 18,243 Impairment of full cost properties.... - 21,590 - 43,804 General and administrative expenses... 800 590 2,390 2,184 Management fees....................... - - - 524 Combination costs and related expenses - - - 3,080 ------- --------- -------- -------- Total costs and expenses.............. 6,590 29,372 19,583 69,743 ------- --------- -------- --------- Operating income .......................... 7,843 (16,824) 21,671 (31,939) Other income (expense) Investment income..................... 33 83 69 108 Other income (expense), net........... 17 55 112 160 ------- --------- -------- --------- Total other income (expense).......... 50 138 181 268 Net earnings (loss)........................ $ 7,893 $(16,686) $21,852 $(31,671) ======= ========= ======== ========= Allocation of net earnings: General partner....................... $ 211 $ (425) $ 557 $ (773) ======= ========= ======== ========= Unitholders........................... $ 7,682 $(16,261) $21,295 $(30,898) ======= ========= ======== ========= Net earnings per common unit (in dollars)......................... $ 0.29 $ (0.60) $ .79 $ (1.22) ======= ========= ======== ========= Wtd. avg. common units outstanding (000's) 27,053 27,040 27,044 25,230 ======= ========= ======== ========= The accompanying condensed notes are an integral part of these financial statements. 5 DORCHESTER MINERALS, L.P. (A Delaware Limited Partnership) CONDENSED STATEMENTS OF CASH FLOWS (Dollars in Thousands) (Unaudited) Nine Months Ended September 30, ---------------------- 2004 2003 --------- --------- Net cash provided by operating activities. ........... $ 36,836 $ 28,216 --------- --------- Cash flows from investing activities: Adjustment related to acquistion of royalty interests............................. 1,068 68 Capital expenditures........................... (446) (5) --------- --------- Net cash provided by (used in) investing activities... 622 63 --------- --------- Cash flows from financing activities: Distributions paid to Partners................ (33,889) (39,072) --------- --------- Increase (decrease) in cash and cash equivalents...... 3,569 (10,793) Cash and cash equivalents at January 1................ 10,881 23,129 --------- --------- Cash and cash equivalents at September 30............. $ 14,450 $ 12,336 ========= ========= Non cash investing and financing activities: Acquisition of assets for units Oil and gas properties...................... $ 24,324 $233,466 Receivables................................. - 3,660 Payables.................................... - - Cash........................................ - 68 --------- --------- Value assigned to assets acquired........... $ 24,324 $237,194 ========= ========= The accompanying condensed notes are an integral part of these financial statements. 6 DORCHESTER MINERALS, L.P. (A Delaware Limited Partnership) NOTES TO THE CONDENSED FINANCIAL STATEMENTS (Unaudited) 1. BASIS OF PRESENTATION: Dorchester Minerals, L.P. (the "Partnership") is a publicly traded Delaware limited partnership that was formed in December 2001 in connection with the combination, which was completed on January 31, 2003, of Dorchester Hugoton, Ltd., which was a publicly traded Texas limited partnership, and Republic Royalty Company (Republic) and Spinnaker Royalty Company, L.P. (Spinnaker) both of which were privately held Texas partnerships. The condensed financial statements reflect all adjustments (consisting only of normal and recurring adjustments unless indicated otherwise) that are, in the opinion of management, necessary for the fair presentation of the Partnership's financial position and operating results for the interim period. Interim period results are not necessarily indicative of the results for the calendar year. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional information. Per-unit information is calculated by dividing the income applicable to holders of the Partnership's common units by the weighted average number of units outstanding. The accompanying financial statements reflect the combination completed on January 31, 2003 and accounted for using the purchase method of accounting. In accordance with the purchase method of accounting, Dorchester Hugoton was designated as the accounting acquiror. Under the purchase method of accounting, the Partnership used the market price of Dorchester Hugoton's partnership units on the last day of trading, adjusted for the liquidating distribution to Dorchester Hugoton Unitholders, to determine the value of the Republic and Spinnaker oil and gas properties merged into the Partnership. Such method increased the historic book values of the oil and gas properties of Republic and Spinnaker by approximately $192,000,000, which increased the Partnership's quarterly depletion. See the Partnership's Form 8-K filed on April 15, 2003 and Note 3 and Critical Accounting Policies for more details. Prior to January 31, 2003, the Partnership had no combined operations. In these circumstances, the Partnership is required to present, discuss and analyze the financial condition and results of operations of our Partnership for the three and nine month periods ended September 30, 2004 and 2003 by including the financial condition and results of Dorchester Hugoton, the accounting acquiror, for the one month period ended January 31, 2003. Effective September 30, 2004, the Partnership through Dorchester Minerals Acquisition LP, its wholly owned subsidiary, acquired assets related to oil and gas properties consisting of producing and perpetual mineral and royalty interests located in 104 counties and parishes in six states. As consideration, an aggregate of 1,200,000 common units of Dorchester Minerals, L.P. were issued. Consequently, the Condensed Balance Sheets presented include $23,256,000 in property additions. 2. CONTINGENCIES: In January 2002, some individuals and an association called Rural Residents for Natural Gas Rights, referred to as RRNGR, sued Dorchester Hugoton, Ltd., Anadarko Petroleum Corporation, Conoco, Inc., XTO Energy Inc., ExxonMobil Corporation, Phillips Petroleum Company, Incorporated and Texaco Exploration and Production, Inc. Dorchester Minerals Operating LP, owned directly and indirectly by our general partner, now owns and operates the properties formerly owned by Dorchester Hugoton. These properties contribute a major portion of the Net Profits Interests amounts paid to the Partnership. The suit is currently pending in the District Court of Texas County, Oklahoma and discovery is underway by the plaintiffs and defendants. The individuals and RRNGR consist primarily of Texas County, Oklahoma residents who, in residences located on leases use natural gas from gas wells located on the same leases, at their own risk, free of cost. The plaintiffs seek declaration that their domestic gas use is not limited to stoves and inside lights and is not limited to a principal dwelling as provided in the oil and gas lease agreements with defendants in the 1930s to the 1950s. Plaintiffs' claims against defendants include failure to prudently operate wells, violation of rights to free domestic gas, violation of irrigation gas contracts, underpayment of royalties, a request for accounting, and fraud. Plaintiffs also seek certification of class action against defendants. In July 2002, the defendants were granted a motion for summary judgment removing RRNGR as a plaintiff. On October 1, 2004, the plaintiffs severed claims against Dorchester Minerals Operating LP regarding royalty underpayments. Dorchester Minerals Operating LP believes plaintiffs' claims, including severed claims, are completely without merit. Based upon past measurements of such domestic gas usage, Dorchester Minerals Operating LP believes the domestic gas damages sought by plaintiffs to be minimal. An 7 adverse decision could reduce amounts the Partnership receives from the Net Profits Interests. The Partnership and Dorchester Minerals Operating LP are involved in other legal and/or administrative proceedings arising in the ordinary course of their businesses, none of which have predictable outcomes and none of which are believed to have any significant effect on financial position or operating results. 3. COMBINATION TRANSACTIONS: On January 31, 2003, Dorchester Hugoton transferred certain assets to Dorchester Minerals Operating LP in exchange for a net profits interest, contributed the net profits interest and other assets to the Partnership and subsequently liquidated. Republic and Spinnaker transferred certain assets to Dorchester Minerals Operating LP in exchange for net profits interests and subsequently merged with the Partnership. For accounting purposes Dorchester Hugoton is deemed the acquiror. The value assigned to the assets of Republic and Spinnaker was based on the market capitalization of Dorchester Hugoton and the share of the total common units of the Partnership received by the former partners of Republic (10,953,078 common units) and Spinnaker (5,342,973 common units). The assets of Republic and Spinnaker were valued at $237,194,000 which was allocated as follows: Cash.................................. $ 68,000 Oil and gas properties................ 233,466,000 Receivables........................... 3,660,000 ------------- Total................................. $ 237,194,000 The following reflects unaudited pro forma data related to the combination discussed herein. The unaudited pro forma data assumes the combination had taken place as of the beginning of each period. The pro forma amounts are not necessarily indicative of the results that may be reported in the future. Pro forma adjustments have been made to depletion, depreciation, and amortization to reflect the new basis of accounting for the assets of Spinnaker and Republic as of January 31, 2003, and to January 2003 revenues to reflect the revenues of Dorchester Hugoton as Net Profits Interests. Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2003 2003 ------------------ ----------------- Revenues $ 12,548,000 $ 39,693,000 Depletion $ 6,600,000 $ 19,994,000 Impairment $ 21,590,000 $ 43,804,000 Net earnings (loss) $ (16,686,000) $ (31,820,000) Earnings (loss) per common unit $ (0.60) $ (1.14) Nonrecurring items: Severance and related costs --- $ 3,003,000 Combination-related costs $ --- $ 670,000 On September 30, 2004, we acquired through Dorchester Minerals Acquisition LP assets shown on our current balance sheet at $24,324,000 in exchange for 1,200,000 common units of Dorchester Minerals. See Note 1 for additional information. 4. IMPAIRMENT OF OIL AND GAS PROPERTIES: During the second and third quarter of 2003, the Partnership recorded non-cash charges against earnings of $43,804,000. The write-downs represent impairment of assets that results primarily from the difference between the discounted present value of the Partnership's proved natural gas and oil reserves using quarter ended gas and oil prices as compared to the book value assigned to former Republic and Spinnaker assets in accordance with purchase accounting rules which value significantly exceeded historic book value. The write-downs were a function of such increased value and changes in prevailing oil and gas prices since the consummation of the combination transaction. Cash flow from operations and cash distributions to unitholders were not affected by the write-downs. See Note 1 and Note 3 and Critical Accounting Policies. 8 5. DISTRIBUTION TO HOLDERS OF COMMON UNITS: Since the Partnership's combination on January 31, 2003, unitholder cash distributions per common unit have been: Year Quarter Record Date Payment Date Amount ------ ------------ ---------------- ----------------- --------- 2003 1st (partial) April 28, 2003 May 8, 2003 $0.206469 2003 2nd July 28, 2003 August 7, 2003 $0.458087 2003 3rd October 31, 2003 November 10, 2003 $0.422674 2003 4th January 26, 2004 February 5, 2004 $0.391066 2004 1st April 30, 2004 May 10, 2004 $0.415634 2004 2nd July 26, 2004 August 5, 2004 $0.415315 2004 3rd October 25, 2004 November 4, 2004 $0.476196 Third quarter 2004 distributions were paid on 28,240,431 units; previous distributions were paid on 27,040,431 units. The next cash distribution will be paid by February 15, 2005. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Dorchester Minerals, L.P. is a publicly traded Delaware limited partnership that was formed in December 2001 in connection with the combination, which was completed on January 31, 2003, of Dorchester Hugoton, which was a publicly traded Texas limited partnership, and Republic and Spinnaker, both of which were privately held Texas partnerships. Dorchester Minerals Operating LP, a Delaware limited partnership owned directly and indirectly by our general partner, holds the working interest properties previously owned by Dorchester Hugoton and a minor portion of mineral interest properties previously owned by Republic and Spinnaker. We refer to Dorchester Minerals Operating LP by the term "operating partnership". Our Partnership directly and indirectly holds a 96.97% net profits overriding royalty interest in these properties. We refer to our net profits overriding royalty interest in these properties as the Net Profits Interests. After the close of each month, we receive a payment equaling 96.97% of the net proceeds actually received during that month from the properties subject to the Net Profits Interests. In addition to the Net Profits Interests, we also hold producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests, which we acquired as part of the combination upon the mergers of Republic and Spinnaker into our Partnership and by merger of one of our subsidiaries effective September 30. We currently own Royalty Properties in 571 counties and parishes in 25 states. BASIS OF PRESENTATION In the combination completed on January 31, 2003 and accounted for as a purchase, Dorchester Hugoton was designated as the accounting acquiror. Prior to January 31, 2003, our Partnership had no combined operations. IN THESE CIRCUMSTANCES, WE ARE REQUIRED TO PRESENT, DISCUSS AND ANALYZE THE FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF OUR PARTNERSHIP FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2004 AND 2003 BY INCLUDING THE FINANCIAL CONDITION AND RESULTS OF DORCHESTER HUGOTON, THE ACCOUNTING ACQUIROR, FOR THE ONE MONTH PERIOD ENDED JANUARY 31, 2003. FOR THE PURPOSES OF THIS PRESENTATION, THE TERM COMBINATION MEANS THE TRANSACTIONS CONSUMMATED IN CONNECTION WITH THE COMBINATION OF THE BUSINESS AND PROPERTIES OF DORCHESTER HUGOTON, REPUBLIC AND SPINNAKER. Effective September 30, 2004, the Partnership through Dorchester Minerals Acquisition LP, its wholly owned subsidiary, acquired assets related to oil and gas properties consisting of producing and non-producing perpetual mineral and royalty interests located in 104 counties and parishes in six states. As consideration an aggregate of 1,200,000 common units of Dorchester Minerals, L.P. were issued. Consequently, the Condensed Balance Sheets presented include $23,256,000 in property additions. No income statement impact was recorded during this period. COMMODITY PRICE RISKS Our profitability is affected by volatility in prevailing oil and natural gas prices. Oil and natural gas prices have been subject to significant volatility in recent years in response to changes in the supply and demand for oil and natural gas in the market and general market volatility. 9 RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AS COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2003 Normally, our period-to-period changes in net earnings and cash flows from operating activities are principally determined by changes in natural gas and crude oil sales volumes and prices. Our portion of gas and oil sales and weighted average prices were: Three Months Ended Nine Months Ended -------------------- ----------------- June September 30, 30, September 30, ------------ ------ ------- ------ ACCRUAL BASIS SALES VOLUMES: 2004 2003 2004 2004 2003 ----- ----- ------ ------- ------ Dorchester Hugoton Gas Sales (mmcf)(1) -- -- -- -- 448 Net Profits Interests Gas Sales(mmcf) 1,343 1,441 1,352 4,042 3,586 Net Profits Interests Oil Sales (mbbls) 2 2 2 6 5 Royalty Props. Gas Sales(mmcf) 831 897 822 2,541 2,372 Royalty Props. Oil Sales (mbbls 73 83 67 220 224 WEIGHTED AVERAGE SALES PRICE: Dorchester Hugoton Gas Sales ($/mcf) -- -- -- -- $ 5.20 Net Profits Interests Gas Sales($/mcf) $ 5.42 $ 4.94 $ 5.81 $ 5.56 $ 5.55 Net Profits Interests Oil Sales ($/bbl) $38.14 $29.51 $35.25 $34.16 $29.32 Royalty Properties Gas Sales ($/mcf) $ 5.89 $ 5.08 $ 5.28 $ 5.40 $ 5.46 Royalty Properties Oil Sales ($/bbl) $40.10 $28.68 $36.90 $36.17 $28.75 Production Costs Deducted Under the Net Profits Interests ($/mcfe)(2) $ 1.21 $ 1.12 $ 1.23 $ 1.18 $ 1.21 ______________________________________ (1) For purposes of comparison the January 2003 Dorchester Hugoton volumes have been reduced to reflect our 96.97% Net Profits Interest in production from the underlying properties. (2) Provided to assist in determination of revenues; applies only to Net Profits Interests sales volumes and prices. Oil sales volumes attributable to our Royalty properties during the third quarter decreased 12% from 83,000 bbls during 2003 to 73,000 bbls during 2004 as a result of our receipt of retroactive volume adjustments in the third quarter of 2003. Gas sales volumes attributable to our Royalty Properties during the third quarter decreased 7.4% from 897 mmcf during 2003 to 831 mmcf during 2004. Oil sales volumes attributable to our Net Profits Interests during the third quarter were unchanged from 2003. Gas sales volumes attributable to our Net Profits Interests during the third quarter decreased 6.8% from 1,441 mmcf during 2003 to 1,343 mmcf during 2004 due to initial increased production resulting from 2003 start-up of additional field compression on the Oklahoma properties previously owned by Dorchester Hugoton. New activity on the Net Profits Interest properties contributed minor amounts to third quarter 2004 production volumes. Weighted average oil sales prices attributable to the Partnership's interest in Royalty Properties increased 39.8% from $28.68 per bbl during the third quarter 2003 to $40.10 per bbl during the third quarter 2004. Similarly, third quarter weighted average Partnership natural gas sales prices from Royalty Properties increased 15.9% from $5.08 per mcf during 2003 to $5.89 per mcf during 2004. Both oil and gas price increases resulted from changing market conditions. Third quarter weighted average oil sales prices from the Net Profits Interests' properties increased 29.2% from $29.51 per bbl in 2003 to $38.14 per bbl in 2004. Third quarter weighted average natural gas sales prices from the Net Profits Interests' properties increased 9.7% from $4.94 per mcf in 2003 to $5.42 per mcf in 2004. Such oil and gas price increases are due to changing market conditions. Oil and natural gas sales volumes attributable to the Royalty Properties and oil and natural gas sales volumes attributable to the Net Profits Interests from Republic and Spinnaker are included in our results for the nine month period ended September 30, 2004 and are included for only the eight months ended September 30, 2003. See "Basis of Presentation" and Note 1 of the Notes to the Condensed Financial Statements. Weighted average prices for oil and natural gas sales volumes attributable to the Royalty Properties and also to the Net Profits Interests from Republic and Spinnaker are included in our results for the nine months ended September 30, 2004 and are included for only the eight months ended September 30, 2003. See "Basis of Presentation" and Note 1 of the Notes to the Condensed Financial Statements. Our third quarter net operating revenues increased 15% from $12,548,000 during 2003 to $14,433,000 during 2004 due primarily to increased natural gas prices and crude oil prices. Comparing the nine month periods, net operating revenue rose 9.1% from $37,804,000 during 2003 to $41,254,000 during 2004, primarily as a result of improvement of natural gas and crude oil prices as well as significant lease bonus income. Management cautions 10 the reader in the comparison of results for the nine month periods because operations attributable to properties formerly owned by Republic and Spinnaker are not included for January in the nine-month period ending September 30, 2003. See "Basis of Presentation" and Note 1 of the Notes to the Condensed Financial Statements. Costs and expenses during the third quarter of 2004 decreased 77.6% from $29,372,000 during the third quarter of 2003 to $6,590,000. Similarly, costs and expenses during the nine months ended September 30, 2004 of $19,583,000 were 71.9% lower than costs in the nine months ended September 30, 2003 of $69,743,000. Such decrease in costs is primarily due to second and third quarter 2003 non-cash charges against earnings of $43,804,000 representing an impairment of assets during 2003. See Note 4 of the Notes to the Condensed Financial Statements. Several categories of costs during the first nine months of 2004 were lower than the first nine months of 2003 due to non-recurring expenses associated with the 2003 liquidation of Dorchester Hugoton. Such 2003 costs are mostly combination and related expenses of $2,907,000, consisting primarily of $2,500,000 in severance payments and related costs. Similarly, management fees in 2003 include a one-time $496,000 charge. Other income during the three and nine month period ended September 30 decreased from $138,000 and $268,000, respectively, during 2003 to $50,000 and $181,000, respectively, during the same periods in 2004. Through September 30 we have received partial payments including interest of a legal judgment in the amount $107,000 and accrued an additional $78,000 including interest attributable to the same matter. The first nine months of 2004 include expenses of $87,000 attributable to unsuccessful property acquisition attempts in the first quarter. Note that lease bonus revenue is included in Other net operating revenue and is not reflected as Other income. Depletion, depreciation and amortization during the three and nine month period ended September 30 decreased from $6,600,000 and $18,243,000, respectively, during 2003 to $5,103,000 and $15,426,000, respectively, during 2004, primarily as a result of a reduced depletable asset base, mainly due to impairments and prior quarterly depletion. The recent asset acquisition, while included in the current balance sheet, will not be depleted until fourth quarter 2004. Management cautions the reader in the comparison of results for these periods, because operations of the properties formerly owned by Republic and Spinnaker are not included for January in the nine-month period ending September 30, 2003 and due to the application of purchase accounting methods. See "Basis of Presentation," "Critical Accounting Policies," and Notes 1, 3 and 4 of the Notes to the Condensed Financial Statements. We received cash payments in the amount of $931,000 from various sources during the third quarter of 2004 including lease bonus attributable to seven leases and four pooling elections located in ten counties in three states. Each of the leases reflected royalty terms of 25% and lease bonuses ranging up to $500/acre. We retained the option in two of the leases to convert a portion of our royalty interest to a working interest at payout, and in the event subsequent wells are drilled on such lands, we retain the right to participate in each such well with as much as 50% of our original interest. We retained the option in one of the leases which covered multiple tracts to participate for as much as 10% of our original interest in all wells drilled on lands in which we own an interest. This option may be exercised after the initial well on each tract is drilled, logged and the operator thereof recommends attempting a completion. In each instance in which we retain the option to participate, or to convert a portion of our royalty interest to a working interest, we intend to assign that option to the operating partnership subject to our reservation of a 96.97% net profits interest. We received division orders for, or otherwise identified 60 new wells completed on our Royalty Properties and Net Profits Interests in 26 counties and parishes in six states during the third quarter of 2004. Selected new wells and the royalty interests owned therein by us and the working interests and net revenue interests owned therein by the operating partnership are summarized in the following table: Test Rates per day ------------ Ownership County/ ------------ Gas Oil State Parish Operator Well Name WI(1) NRI(1) mcf bbls ------ --------- --------- ----------------- ----- ----- ------ ------ Royalty Properties --------------------- Louisiana Claiborne Marathon Seegers 1-11 Alt -- 8.0% 2,400 140 Texas Starr Ascent Garza-Hitchcock #5 -- 2.6% 4,103 110 Texas Hidalgo Shell Woods Christian #45 -- 2.7% 7,833 183 Net Profits Interests --------------------- Oklahoma Roger Mills Bravo Perry 1-30 1.5% 1.5% 1,447 22 Oklahoma Roger Mills JMA Hutson Farms 1-18 1.6% 1.6% 3,608 9 Oklahoma Washita Cimarex Kamphaus 7-2 BPO(2) 7.0% 8.8% 1,000 0 ____________________________________ (1) WI and NRI mean working interest and net revenue interest, respectively. (2) BPO and APO mean before payout and after payout, respectively. 11 Third quarter net earnings allocable to common units increased from a $16,261,000 loss during 2003 to $7,682,000 during 2004, due primarily to increased quarterly natural gas and crude oil sales prices and due to the non-cash charge against earnings during 2003. Generally for the same reasons, net earnings allocable to common units during the first nine months of 2004 were $21,295,000 compared to a $30,898,000 loss in the same period in 2003. Net cash provided by operating activities increased 11.6% from $11,930,000 during the third quarter 2003 to $13,318,000 during the third quarter 2004, principally due to timing of collection of accounts receivable along with improved oil and natural gas sales prices. Net cash provided by operating activities increased 30.6% from $28,216,000 during the nine months ended September 30, 2003 to $36,836,000 during the nine months ended September 30, 2004 as a result of the combination along with improved oil sales prices. Management cautions the reader in the comparison of results for the nine month periods because operations of the properties formerly owned by Republic and Spinnaker are not included for January in the nine-month period ending September 30, 2003. See "Basis of Presentation" and Notes 1 and 3 of the Notes to the Condensed Financial Statements. LIQUIDITY AND CAPITAL RESOURCES CAPITAL RESOURCES Our primary sources of capital are our cash flow from the Net Profits Interests and the Royalty Properties. Our only cash requirements are the distributions to our unitholders, the payment of oil and gas production and property taxes not otherwise deducted from gross production revenues and general and administrative expenses incurred on our behalf and properly allocated in accordance with our partnership agreement. Since the distributions to our unitholders are, by definition, determined after the payment of all expenses actually paid by us, the only cash requirements that may create liquidity concerns for us are the payments of expenses. Since most of these expenses vary directly with oil and natural gas prices and sales volumes, we anticipate that sufficient funds will be available at all times for payment of these expenses. See Note 5 of the Notes to the Condensed Financial Statements for the amounts and dates of cash distributions to unitholders. We are not directly liable for the payment of any exploration, development or production costs. We do not have any transactions, arrangements or other relationships that could materially affect our liquidity or the availability of capital resources. We have not guaranteed the debt of any other party, nor do we have any other arrangements or relationships with other entities that could potentially result in unconsolidated debt. Pursuant to the terms of our Partnership Agreement, we cannot incur indebtedness other than trade payables, (i) in excess of $50,000 in the aggregate at any given time or (ii) which would constitute "acquisition indebtedness" (as defined in Section 514 of the Internal Revenue Code of 1986, as amended). EXPENSES AND CAPITAL EXPENDITURES During the third quarter 2004, for $200,000, the operating partnership acquired two of fourteen overriding royalty interests in three wells it owns and operates near Guymon, Oklahoma. The overriding royalty interests receive approximately 75% of the working interest and bear 100% of the costs. The operating partnership believes the undeveloped Council Grove formation underlying the existing wells to be excluded from the overriding royalty interests. The operating partnership filed a declaratory judgment in Texas County, Oklahoma seeking a finding on this matter. The operating partnership does not currently anticipate drilling additional wells as a working interest owner in the Fort Riley zone or the Council Grove formation or elsewhere in the Oklahoma properties previously owned by Dorchester Hugoton. Successful activities by others in these formations or other developments could prompt a reevaluation of this position. Any such drilling is estimated to cost $250,000 to $300,000 per well. Such activities by the operating partnership could influence the amount we receive from the Net Profits Interests. Activities, including legal costs, by the operating partnership influence the amount we receive from the Net Profits Interests. The operating partnership anticipates continuing additional fracture treating in the Oklahoma properties previously owned by Dorchester Hugoton. During the third quarter of 2004, two wells were fracture treated at a cost of $55,000 and $37,000. The wells increased production from 154 to 250 mcf per day and from 107 to 138 mcf per day, respectively. The operating partnership owns and operates the wells, pipelines and gas compression and dehydration facilities located in Kansas and Oklahoma previously owned by Dorchester Hugoton. The operating partnership anticipates gradual increases in expenses as repairs to these facilities become more frequent, and anticipates gradual 12 increases in field operating expenses as reservoir pressure declines. The operating partnership does not anticipate incurring significant expense to replace these facilities at this time. These capital and operating costs are reflected in the Net Profits Interests payments we receive from the operating partnership. In 1998, Oklahoma regulations removed production quantity restrictions in the Guymon-Hugoton field, and did not address efforts by third parties to persuade Oklahoma to permit infill drilling in the Guymon-Hugoton field. Both infill drilling and removal of production limits could require considerable capital expenditures. The outcome and the cost of such activities are unpredictable. Such activities by the operating partnership could influence the amount we receive from the Net Profits Interests. No additional compression affecting the wells formerly owned by Dorchester Hugoton has been installed since 2000 by operators on adjoining acreage. The operating partnership believes it now has sufficient field compression to remain competitive with adjoining operators for the foreseeable future. LIQUIDITY AND WORKING CAPITAL Cash and cash equivalents totaled $14,450,000 at September 30, 2004 and $10,881,000 at December 31, 2003. CRITICAL ACCOUNTING POLICIES We utilize the full cost method of accounting for costs related to our oil and gas properties. Under this method, all such costs (productive and nonproductive) are capitalized and amortized on an aggregate basis over the estimated lives of the properties using the units-of-production method. These capitalized costs are subject to a ceiling test however, which limits such pooled costs to the aggregate of the present value of future net revenues attributable to proved oil and gas reserves discounted at 10% plus the lower of cost or market value of unproved properties. In accordance with applicable accounting rules, Dorchester Hugoton was deemed to be the accounting acquiror of the Republic and Spinnaker assets. Our Partnership's acquisition of these assets was recorded at a value based on the closing price of Dorchester Hugoton's common units immediately prior to consummation of the combination transaction, subject to certain adjustments. Consequently, the acquisition of these assets was recorded at values that exceed the historical book value of these assets prior to consummation of the combination transaction. Our Partnership did not assign any book or market value to unproved properties, including non-producing royalty, mineral and leasehold interests. The full cost ceiling is evaluated at the end of each quarter. For 2003, our unamortized costs of oil and gas properties exceeded the ceiling test. As a result, in 2003, our Partnership recorded full cost write-downs of $43,804,000. No additional impairments have been recorded since the quarter ended September 30, 2003. The discounted present value of our proved oil and gas reserves is a major component of the ceiling calculation and requires many subjective judgments. Estimates of reserves are forecasts based on engineering and geological analyses. Different reserve engineers may reach different conclusions as to estimated quantities of natural gas reserves based on the same information. Our reserve estimates are prepared by independent consultants. The passage of time provides more qualitative information regarding reserve estimates, and revisions are made to prior estimates based on updated information. However, there can be no assurance that more significant revisions will not be necessary in the future. Significant downward revisions could result in an impairment representing a non-cash charge to earnings. In addition to the impact on calculation of the ceiling test, estimates of proved reserves are also a major component of the calculation of depletion. While the quantities of proved reserves require substantial judgment, the associated prices of oil and gas reserves that are included in the discounted present value of our reserves are objectively determined. The ceiling test calculation requires use of prices and costs in effect as of the last day of the accounting period, which are generally held constant for the life of the properties. As a result, the present value is not necessarily an indication of the fair value of the reserves. Oil and gas prices have historically been volatile and the prevailing prices at any given time may not reflect our Partnership's or the industry's forecast of future prices. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. For example, estimates of uncollected revenues and unpaid expenses from royalties and net profits interests in properties operated by non-affiliated entities are particularly subjective due to inability to gain accurate and timely information. Therefore, actual results could differ from those estimates. 13 NEW ACCOUNTING STANDARDS In July 2001, the Financial Accounting Standards Board issued SFAS No. 143, "Accounting for Asset Retirement Obligations". SFAS No. 143 requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. We adopted SFAS No. 143 on January 1, 2003, which did not have a material effect on our financial statements. The FASB's Emerging Issues Task Force (EITF) reached a consensus that mineral rights are tangible assets in EITF Issue 04-2, "Whether Mineral Assets Are Tangible or Intangible Assets". The FASB ratified the EITF consensus, subject to amendment of SFAS No. 141 and No. 142 through a FASB Staff Position (FSP). Therefore, no changes would be required in the way the Partnership classifies its mineral rights. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The following information provides quantitative and qualitative information about our potential exposures to market risk. The term "market risk" refers to the risk of loss arising from adverse changes in oil and natural gas prices, interest rates and currency exchange rates. The disclosures are not meant to be precise indicators of expected future losses, but rather indicators of reasonably possible losses. MARKET RISK RELATED TO OIL AND NATURAL GAS PRICES Essentially all of our assets and sources of income are from the Net Profits Interests and the Royalty Properties, which generally entitle us to receive a share of the proceeds based on oil and natural gas production from those properties. Consequently, we are subject to market risk from fluctuations in oil and natural gas prices. Pricing for oil and natural gas production has been volatile and unpredictable for several years. We do not anticipate entering into financial hedging activities intended to reduce our exposure to oil and natural gas price fluctuations. ABSENCE OF INTEREST RATE AND CURRENCY EXCHANGE RATE RISK We do not anticipate having a credit facility or incurring any debt, other than trade debt. Therefore, we do not expect interest rate risk to be material to us. We do not anticipate engaging in transactions in foreign currencies which could expose us to foreign currency related market risk. ITEM 4. CONTROLS AND PROCEDURES EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES As of the end of the period covered by this report, our Partnership's principal executive officer and principal financial officer carried out an evaluation of the effectiveness of our disclosure controls and procedures. Based on their evaluation, they have concluded that our Partnership's disclosure controls and procedures effectively ensure that the information required to be disclosed in the reports the Partnership files with the Securities and Exchange Commission is recorded, processed, summarized and reported, within the time periods specified by the Securities and Exchange Commission. CHANGES IN INTERNAL CONTROLS There were no changes in our Partnership's internal controls or in other factors that have materially affected, or are reasonably likely to materially affect, our Partnership's internal controls subsequent to the date of their evaluation of our disclosure controls and procedures. 14 PART II Item 1. LEGAL PROCEEDINGS None. Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS None. Item 3. DEFAULTS UPON SENIOR SECURITIES None. Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. Item 5. OTHER INFORMATION None. Item 6. EXHIBITS Exhibits: See the attached Index to Exhibits. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. DORCHESTER MINERALS, L.P. By: Dorchester Minerals Management LP its General Partner, By: Dorchester Minerals Management GP LLC, its General Partner /s/ William Casey McManemin ------------------------------------------------ William Casey McManemin Date: November 5, 2004 Chief Executive Officer /s/ H.C. Allen, Jr. ------------------------------------------------ H.C. Allen, Jr. Date: November 5, 2004 Chief Financial Officer PAGE 15 INDEX TO EXHIBITS Number Description 3.1 Certificate of Limited Partnership of Dorchester Minerals, L.P. (incorporated by reference to Exhibit 3.1 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.2 Amended and Restated Agreement of Limited Partnership of Dorchester Minerals, L.P. (incorporated by reference to Exhibit 3.2 to Dorchester Minerals' Report on Form 10-K filed for the year ended December 31, 2002) 3.3 Certificate of Limited Partnership of Dorchester Minerals Management LP (incorporated by reference to Exhibit 3.4 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.4 Amended and Restated Agreement of Limited Partnership of Dorchester Minerals Management LP (incorporated by reference to Exhibit 3.4 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.5 Certificate of Formation of Dorchester Minerals Management GP LLC (incorporated by reference to Exhibit 3.7 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.6 Amended and Restated Limited Liability Company Agreement of Dorchester Minerals Management GP LLC (incorporated by reference to Exhibit 3.6 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002). 3.7 Certificate of Formation of Dorchester Minerals Operating GP LLC (incorporated by reference to Exhibit 3.10 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.8 Limited Liability Company Agreement of Dorchester Minerals Operating GP LLC (incorporated by reference to Exhibit 3.11 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.9 Certificate of Limited Partnership of Dorchester Minerals Operating LP (incorporated by reference to Exhibit 3.12 to Dorchester Minerals' Registration Statement on Form S-4, Registration Number 333-88282) 3.10 Amended and Restated Agreement of Limited Partnership of Dorchester Minerals Operating LP. (incorporated by reference to Exhibit 3.10 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.11 Certificate of Limited Partnership of Dorchester Minerals Oklahoma LP (incorporated by reference to Exhibit 3.11 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.12 Agreement of Limited Partnership of Dorchester Minerals Oklahoma LP (incorporated by reference to Exhibit 3.12 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.13 Certificate of Incorporation of Dorchester Minerals Oklahoma GP, Inc. (incorporated by reference to Exhibit 3.13 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.14 Bylaws of Dorchester Minerals Oklahoma GP, Inc. (incorporated by reference to Exhibit 3.14 to Dorchester Minerals' Report on Form 10-K for the year ended December 31, 2002) 3.15 Certificate of Limited Partnership for Dorchester Minerals Acquisition LP 3.16 Agreement of Limited Partnership of Dorchester Minerals Acquisition LP 3.17 Certificate of Incorporation of Dorchester Minerals Acquisition GP, Inc. 3.18 Bylaws of Dorchester Minerals Acquisition GP, Inc. 10.1 Agreement and Plan of Merger among Dorchester Minerals, L.P., Dorchester Minerals Acquisition LP and Bradley Royalty Partners LLC dated September 24, 2004 10.2 Form of Registration Rights Agreement dated September 30, 2004 31.1 Certification of Chief Executive Officer of the Partnership pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934 31.2 Certification of Chief Financial Officer of the Partnership pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 32.1 Certification of Chief Executive Officer of the Partnership pursuant to 18 U.S.C. Sec. 1350 32.2 Certification of Chief Financial Officer of the Partnership pursuant to 18 U.S.C. Sec. 1350 PAGE 16