10-Q 1 tenq1q05.txt SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended January 31, 2005 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________ to ___________ . Commission file number 1-8245 NORTH EUROPEAN OIL ROYALTY TRUST ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 22-2084119 ----------------------- -------------------------- (State of organization) (I.R.S. Employer I.D. No.) Suite 19A, 43 West Front Street, Red Bank, New Jersey 07701 ------------------------------------------------------------- (Address of principal executive offices) (732) 741-4008 ---------------------------------------------------- (Registrant's telephone number, including area 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 whether the registrant is an accelerated filer (as defined in Rule 126-2 of the Exchange Act). Yes X No ----- ----- Class Outstanding at January 31, 2005 ----- ------------------------------- Units of Beneficial Interest 8,933,316 -2- PART I -- FINANCIAL INFORMATION ------------------------------- Item 1. Financial Statements -------------------- STATEMENTS OF REVENUE COLLECTED AND EXPENSES PAID (NOTE 1) ----------------------------------------------------------- FOR THE THREE MONTHS ENDED JANUARY 31, 2005 AND 2004 ----------------------------------------------------- 2005 2004 -------------- ------------- (unaudited) German gas, oil and sulfur royalties received $ 5,154,811 $ 4,360,730 ----------- ----------- Interest income 5,320 6,393 ----------- ----------- Trust expenses ( 325,017) ( 233,010) ----------- ----------- Net income on a cash basis $ 4,835,114 $ 4,134,113 =========== =========== Net income per unit on a cash basis $ .54 $ .46 ====== ====== Cash distributions paid or to be paid: Distributions per unit to be paid to unit owners $ .54 $ .46 ====== ====== STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS (NOTE 1) ----------------------------------------------------------- JANUARY 31, 2005 AND OCTOBER 31, 2004 ------------------------------------- 2005 2004 -------------- ------------- (unaudited) Current assets - - Cash and cash equivalents (Note 1) $ 4,901,508 $ 3,014,386 Producing gas and oil royalty rights, net of amortization (Notes 1 and 2) 1 1 ----------- ----------- Total Assets $ 4,901,509 $ 3,014,387 =========== =========== Current liabilities - - Cash distributions payable to unit owners $ 4,823,991 $ 2,947,992 Contingent liability (Note 3) Trust corpus (Notes 1 and 2) 1 1 Undistributed earnings 77,517 66,394 ----------- ----------- Total Liabilities and Trust Corpus $ 4,901,509 $ 3,014,387 =========== =========== The accompanying notes to financial statements should be read in conjunction with these statements. -3- STATEMENTS OF CHANGES IN CASH AND CASH EQUIVALENTS (NOTE 1) ----------------------------------------------------------- FOR THE THREE MONTHS ENDED JANUARY 31, 2005 AND 2004 ---------------------------------------------------- 2005 2004 -------------- ------------- (unaudited) Sources of cash and cash equivalents: German gas, oil and sulfur royalties $ 5,154,811 $ 4,360,730 Interest income 5,320 6,393 ----------- ----------- $ 5,160,131 $ 4,367,123 =========== =========== Uses of cash and cash equivalents: Payment of Trust expenses 325,017 233,010 Distributions and dividends paid (Note 3) 2,947,992 4,019,156 ----------- ----------- 3,273,009 4,252,166 ----------- ----------- Net increase in cash and cash equivalents during the period 1,887,122 114,957 Cash and cash equivalents, beginning of period 3,014,386 4,063,766 ----------- ----------- Cash and cash equivalents, end of period $ 4,901,508 $ 4,178,723 =========== =========== STATEMENTS OF UNDISTRIBUTED EARNINGS (NOTE 1) --------------------------------------------- FOR THE THREE MONTHS ENDED JANUARY 31, 2005 AND 2004 ---------------------------------------------------- 2005 2004 ------------- ------------- (unaudited) Balance, beginning of period $ 66,394 $ 44,630 Net income on a cash basis 4,835,114 4,134,113 ----------- ----------- 4,901,508 4,178,743 ----------- ----------- Less: Current year distributions paid or to be paid to unit owners (Note 3) 4,823,991 4,108,470 ----------- ----------- 4,823,991 4,108,470 ----------- ----------- Balance, end of period $ 77,517 $ 70,273 =========== =========== The accompanying notes to financial statements should be read in conjunction with these statements. -4- NORTH EUROPEAN OIL ROYALTY TRUST -------------------------------- NOTES TO FINANCIAL STATEMENTS ----------------------------- (Unaudited) ----------- (1) Summary of significant accounting policies: ------------------------------------------- Basis of accounting - ------------------- The accompanying financial statements present financial statement balances and financial results on a cash basis of accounting, which is a comprehensive basis of accounting other than accounting principles generally accepted in the United States ("GAAP basis"). Cash basis financial statements report income when cash is received and expenses when cash is paid. GAAP basis financial statements report income as earned and expenses as incurred, without regard to receipts or payments. The sole exception to the use of the cash basis of accounting is the accrual for distributions to be paid to unit owners (those distributions approved by the Trustees for the Trust). The Trust's distributable income represents royalty income received by the Trust during the period plus interest income less any expenses incurred by the Trust, all on a cash basis. In the opinion of the Trustees, the use of the cash basis provides a more meaningful presentation to unit owners of the results of operations of the Trust. Producing gas and oil royalty rights - --------------------- The rights to certain gas and oil royalties in Germany were transferred to the Trust at their net book value by North European Oil Company (the "Company") (see Note 2). The net book value of the royalty rights has been reduced to one dollar ($1) in view of the fact that the remaining net book value of royalty rights is de minimis relative to annual royalties received and distributed by the Trust and does not bear any meaningful relationship to the fair value of such rights or the actual amount of proved producing reserves. Federal income taxes - ------------------------------ The Trust, as a grantor trust, is exempt from federal income taxes under a private letter ruling issued by the Internal Revenue Service. Cash and cash equivalents - ------------------------- Included in cash and cash equivalents are amounts deposited in bank accounts and amounts invested in certificates of deposit and U. S. Treasury bills with maturities of three months or less from the date of purchase. -5- Net income per unit on the cash basis - ------------------- Net income per unit on the cash basis is based upon the number of units outstanding at the end of the period (see Note 3). As of January 31, 2005 and 2004, there were 8,933,316 and 8,931,414 units of beneficial interest outstanding, respectively. (2) Formation of the Trust: ----------------------- The Trust was formed on September 10, 1975. As of September 30, 1975, the Company was liquidated and the remaining assets and liabilities of the Company, including its royalty rights, were transferred to the Trust. The Trust on behalf of the owners of beneficial interest in the Trust holds overriding royalty rights covering gas and oil production in certain concessions or leases in the Federal Republic of Germany. These rights are held under contracts with local German exploration and development subsidiaries of ExxonMobil Corp. and the Royal Dutch/Shell Group of Companies. Under these contracts, the Trust receives various percentage royalties on the proceeds of the sales of certain products from the areas involved. At the present time, royalties are received for sales of gas well gas, oil well gas, crude oil, distillate and sulfur. (3) Contingent liability: --------------------- The Trust serves as fiduciary for certain unlocated or unknown shareholders of the Trust's corporate predecessors North European Oil Corporation (the "Corporation") and North European Oil Company. From the liquidation of the Company to October 31, 2004, 723,260 Trust units were issued in exchange for Corporate or Company shares and dividends of $355,166 and distributions of $4,319,084 were paid to former unlocated Corporation and Company shareholders. For the three month period ended January 31, 2005, there were 6 units issued in exchanges and $265.40 in distributions were paid to former unlocated Corporation and Company shareholders. On February 26, 1996 the settlement of litigation between the Trust and the Delaware State Escheator ("Delaware Escheator") was approved by the Delaware Court of Chancery. As of that date, there were a total of 875,748 authorized but unissued units representing the unexchanged shares of the Trust's corporate predecessors. Out of this total 760,560 units were subject to the settlement. Under the settlement 380,280 units were issued to the Delaware Escheator on April 17, 1996. Of the Trust units remaining to be issued to the Delaware Escheator, approximately 50% (190,128 units) had been issued to the Delaware Escheator as of June 30, 2000 and the remaining balance will be issued by June 30, 2005. Through June 30, 2000 claims by unlocated or unknown shareholders of the Trust's corporate predecessors for units and past dividends and distributions thereon ("subsequent claims") were paid by the Delaware Escheator and the Trust on a 50:50 basis. From July 1, 2000 to June 30, 2005 subsequent claims will be paid by the Delaware Escheator and the Trust on a 75:25 basis. Any subsequent claims will reduce the number of units to be issued to the Delaware Escheator in 2005. Following the -6- final issuance of units to the Delaware Escheator in 2005, the Trust's contingent liability for past dividends and distributions attributable to all unexchanged Corporation and Company shares subject to the settlement will be completely eliminated. Under the terms of the settlement, the maximum liability of the Delaware Escheator for subsequent claims is limited to the value of the units received, plus current distributions on units retained, less the Delaware Escheator's share of subsequent claims. As of the receipt of the February 2005 distribution, the maximum liability of the Delaware Escheator will be $13,752,245. As of the record date for the February distribution, the Delaware Escheator continues to own 35,995 units of the 570,408 units previously issued to it as part of the settlement. In addition to the agreement reached with the Delaware Escheator, on December 4, 2001 the Trust reached a parallel agreement with the Administrator of Unclaimed Property, Office of the New York State Comptroller (the "New York Administrator") covering units for which owners were unlocated but for whom New York state addresses were shown in predecessor corporation records. The New York Settlement Agreement (the "Settlement Agreement") covers 89,220 units attributable to stock ownership by unlocated shareholders of predecessor corporate entities. Of the units covered by the Settlement Agreement, 44,610 were issued to the New York Administrator on December 21, 2001 and the balance of 44,610 will be issued on or before June 30, 2005. The Settlement Agreement provides for processing of claims in the period until June 30, 2005 and the sharing on a 50:50 basis of any costs relating to any claims which are allowed. Any subsequent claims will reduce the number of units to be issued to the New York Administrator in 2005. Following the final issuance of units to the New York Administrator in 2005, the Trust's contingent liability for past dividends and distributions attributable to all unexchanged Corporation and Company shares subject to the Settlement Agreement will be completely eliminated. Under the terms of the Settlement Agreement, the maximum liability of the New York Administrator for subsequent claims is limited to the value of the units received, plus current distributions on units retained, less the New York Administrator's share of subsequent claims. As of the receipt of the February 2005 distribution, the maximum liability of the New York Administrator will be $1,104,544. As of the record date for the February distribution, the New York Administrator continues to own all of the 44,610 units previously issued to it as part of the settlement. Under the Trust Agreement, as deemed amended by the February 26, 1996 Delaware Court Order, the Trust is not required to make payments of arrearages of Company dividends or Trust distributions with respect to units issued or to be issued to the Delaware Escheator or the New York Administrator. As of January 31, 2005, there remained a total of 253,200 units that could be issued to unlocated or unknown Corporation and Company shareholders. Of this total, 234,732 units are subject to the settlements and remain to be issued to the Delaware Escheator or the New York Administrator. If all shares represented by the units already issued as well as the units remaining to be issued were presented for exchange, $485,958 in dividends and $31,169,425 in distributions would be payable. In the opinion of the Trustees, based in part on the history of exchanges during the last ten fiscal years, the maximum liability of the Delaware Escheator and the New York Administrator would not be less than their respective share of any -7- subsequent claims. In any event, the Trust's contingent liability for all claims for arrearages will be eliminated in 2005. (4) Related party transactions: --------------------------- John R. Van Kirk, the Managing Director of the Trust, provides office space and office services to the Trust at cost. During the first quarter of fiscal 2005 the Trust reimbursed him a total of $5,007.31 for such office space and office services. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. ------------------------------------------------- The Trust is a passive fixed investment trust which holds overriding royalty rights, receives income under those rights from certain operating companies, pays its expenses and distributes the remaining net funds to its unit owners. The Trust does not engage in any business or extractive operations of any kind in the areas over which it holds royalty rights and is precluded from any such involvement by the Trust Agreement. There are no requirements, therefore, for capital resources with which to make capital expenditures or investments in order to continue the receipt of royalty revenues by the Trust. Seasonal demand factors affect the income from royalty rights insofar as they relate to energy demands and increases or decreases in prices, but on average they are not material to the regular annual income received under the royalty rights. The operating companies, subsidiaries of ExxonMobil Corp. and the Royal Dutch/Shell Group of Companies, pay monthly royalties to the Trust based on their sales of natural gas, sulfur and oil. The Oldenburg concession is the primary area from which these products are extracted and provides nearly 100% of all the royalties received by the Trust. Natural gas provides approximately 98% of the total royalties. Within the Oldenburg concession there are two overriding royalty rates in effect on sales of natural gas. The Trust receives a 4% royalty from the western portion of the concession. The Trust also receives a 0.6667% royalty (adjusted to account for an agreed portion of costs), which covers the entire concession. The royalties are initially paid in Euros and are converted into U.S. dollars at the then current Euro/dollar exchange rate just prior to their transfer from Germany. The gas that is produced by the operating companies from the Oldenburg concession is sold to various distributors under long term contracts which delineate, among other provisions, the timing, manner, volume and price of the gas sold. Although the Trust itself does not have access to the specific sales contracts under which the Oldenburg gas is sold, a third party contractor, retained by the Trust, examines these contracts periodically. For the Trust there are two elements of these contracts that are significant. The first element is the utilization of the price of light heating oil in Germany as the primary pricing factor in many of these contracts. The price of light heating oil in Germany is affected by the price of oil expressed in dollars on the international market. The second element is a three to six month delay before changes in pricing factors are translated into changes in the price of gas. Since Germany must import a -8- large percentage of its energy requirements, the U.S. dollar price of oil on the international market has a significant, although delayed, impact on the price of gas. A strong Euro would tend to reduce the cost of oil being imported into Germany and likely result in a lower price for light heating oil. This lower price would likely impact the price of gas after the three to six month delay and possibly result in a reduction in the amount of royalties paid to the Trust in Germany. However, a strong Euro would also result in an increase in the amount of royalties received when the royalties, originally received in Euros, are converted into dollars and transferred to the Trust's bank account in the U.S. A weak Euro would have the opposite effect. However, it is important to note that the price of imported oil and the Euro/dollar relationship are only two of the numerous factors that can affect the price of light heating oil and through it the price of gas. Net Trust income for the first quarter of fiscal 2005 was $4,835,114 as compared to $4,134,113 for the first quarter of fiscal 2004. This level of income permitted a distribution of 54 cents per unit which was paid on February 23, 2005 to owners of record as of February 11, 2005. Gross royalty income of $5,154,811 for the quarter ended January 31, 2005 increased by 18.2% from gross royalty income of $4,360,730 received during last year's equivalent period. This royalty income was based on sales of gas, oil and sulfur from the Trust's overriding royalty areas in Germany during the fourth calendar quarter of 2004. In comparison to the first quarter of fiscal 2004, the combination of higher gas prices and higher average exchange rates (applied to the royalty transfers from Germany) more than offset the decline in the volume of gas sales. It appears that the operating companies' efforts to increase gas sales are beginning to have some effect although the volume of gas sales still fell from the prior year's equivalent quarter. Gas sales under the higher royalty rate agreement covering western Oldenburg declined by 4.6% from 18.17 billion cubic feet ("Bcf") to 17.33 Bcf compared to the first quarter of fiscal 2004. Overall gas sales throughout the Oldenburg concession covered under the lower royalty rate agreement declined 5.1% from 46.59 Bcf to 44.21 Bcf compared to the first quarter of fiscal 2004. The decline in gas sales was almost evenly spread through both the eastern and western halves of the Oldenburg concession. For the quarter just ended the average price of gas sold under the higher royalty rate agreement increased 9.9% from 1.1836 Eurocents/Kwh ("Ecents/Kwh") to 1.3010 Ecents/Kwh. For the same period, the average price of gas sold under the lower royalty rate area increased 16.9% from 1.2120 Ecents/Kwh to 1.4169 Ecents/Kwh. The immediate impact of the exchange rates occurs when they are applied to provide the equivalent value in dollars to the royalties paid to the Trust when those royalties are transferred to the U.S. Based on the conversion and transfer of all the royalties during the quarter, the weighted average value for the Euro increased by 7.7% from a dollar equivalent of 1.2269 for the first quarter of fiscal 2004 to 1.3213 for the quarter just ended. If we apply this weighted average value to the average price of gas during the quarter just ended, we can convert the average gas prices into more familiar terms. For the first quarter of fiscal 2005 the average gas price for gas sold under both the higher and lower royalty rate agreements was $5.09/Mcf as compared to $4.18/Mcf for the first quarter of fiscal 2004. With the end of the first quarter of fiscal 2005, quarterly gas sales for western Oldenburg have posted declines in quarterly comparisons for nine consecutive quarters. In a corresponding comparison, overall gas sales -9- for the entire Oldenburg concession have posted quarterly declines for five consecutive quarters and for seven quarters out of the preceding nine. From comments made by the operating companies it appears that the decline in gas sales seems to be directly related to a drop in production capacity, which in turn was caused by a general decline in wellhead pressure. The decline in wellhead pressure is a natural occurrence as wells age and fields mature. Individual wells begin their production cycle with different initial pressure levels and, depending upon the rate at which the gas is withdrawn and the underlying geological structure, the decline in pressure and the amount of recoverable gas will vary from well to well. In an actively operated concession there is a mix of newer and older wells along with an active exploration and drilling program. Prior to 2004, the operating companies have only had a limited drilling program averaging perhaps two wells per year over the prior ten years. It appears that the primary reason behind the limited exploration and drilling program has been the high state royalty imposed on gas sales by the State of Lower Saxony, where the Oldenburg concession is located. The high state royalty consumes a large portion of funds that would otherwise be available for exploration and drilling. Following the merger of Exxon and Mobil in 1999, the newly formed corporation began a worldwide re-evaluation of potential exploration and development in order to decide where best to make future investments. We believe the Trust is seeing the benefits of this analysis with the accelerating drilling program that began in 2004 and continues in 2005. As the additional wells come fully on-line, the mix of new and old wells are anticipated to reach a healthier ratio. The installation of the new compressor systems has helped to increase production capacity on an immediate basis. In the future, the compressors are expected to allow the complete exploitation of the reserves in not only the wells currently connected but additional wells as residual pressures continue to drop over time. It is our hope that the completion of the wells already drilled in 2004 and the drilling efforts planned by the operating companies for 2005 will help return gas sales to the higher levels experienced in prior years and that the operating companies will continue a more active drilling and exploration program in the future. The Trust does not conduct any active business operations and has only limited need of funds for its own administrative services. These funds are used to pay Trustees' fees (computed under the Trust Agreement and based upon a percentage of royalties and interest income received), the remuneration fixed by the Trustees for the Managing Trustee, the Managing Director and the Audit Committee Chairman, expenses associated with the Trustees' meetings, professional fees paid to consultants, legal advisors and auditors, transfer agent fees, and secretarial and other general office expenses. Trust expenses for the first quarter of fiscal 2005 were $325,017, an increase of $92,007 or 39.5% from the prior year. A cumulative bill from Delaware counsel for legal services during 2004 was paid during the first quarter of fiscal 2005. There was no corresponding fee paid in the first quarter of fiscal 2004. Additionally, the Trust's consultant in Germany chose to defer his compensation for fiscal 2004 and the lump sum was paid out during the first quarter of fiscal 2005. The 2005 listing fee for the New York Stock Exchange was paid during the first quarter of fiscal 2005, while the 2004 fee was paid during the second quarter of fiscal 2004. Interest income declined, reflecting the reduced funds available for investment and the continuing low interest rates on those funds. -10- The current Statement of Assets, Liabilities and Trust Corpus of the Trust at January 31, 2005 compared to that at fiscal year end (October 31, 2004) shows an increase in assets due to higher royalty receipts during the quarter. As mandated by the Trust Agreement, distributions of income are made on a quarterly basis. These distributions, as determined by the Trustees, constitute substantially all the funds on hand after provision is made for Trust expenses then anticipated. As permitted by the Trust Agreement, no provision is made for the retention of reserve funds of any kind. If funds are required for payments to owners of units not previously presented for issuance, quarterly distributions would be reduced to the extent required to provide funds for such payments. ----------------------------------- This report on Form 10-Q contains forward looking statements concerning business, financial performance and financial condition of the Trust. Many of these statements are based on information provided to the Trust by the operating companies or by consultants using public information sources. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in any forward looking statements. These include uncertainties concerning levels of gas production and gas prices, general economic conditions and currency exchange rates. Actual results and events may vary significantly from those discussed in the forward looking statements. Item 3. Quantitative and Qualitative Disclosures About Market Risk. ---------------------------------------------------------- The Trust does not engage in any trading activities with respect to possible foreign exchange fluctuations. The Trust does not use any financial instruments to hedge against possible risks related to foreign exchange fluctuations. The market risk is negligible because standing instructions at its German bank require the bank to process conversions and transfers of royalty payments as soon as possible following their receipt. Item 4. Controls and Procedures. ----------------------- As of the end of the period covered by this report, an evaluation was carried out under the supervision and with the participation of the Trust's management, which consists of the Managing Trustee and the Managing Director, of the effectiveness of the design and operation of the Trust's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Managing Trustee and the Managing Director concluded that the Trust's disclosure controls and procedures were effective, in all material respects, with respect to the recording, processing, summarizing and reporting, within the time periods specified in the Securities and Exchange Commission's rules and forms, of information required to be disclosed by the Trust's management in the reports that are filed or submitted under the Exchange Act. -11- There have been no changes in our internal control over financial reporting identified in connection with the evaluation described above that occurred during the first quarter of fiscal 2005 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting. Part II -- OTHER INFORMATION ---------------------------- Item 4. Submission of Matters to a Vote of Security Holders. ---------------------------------------------------- (a) The Annual Meeting of Unit Owners was held on February 9, 2005. (b) The following persons were elected as Trustees of the Trust to serve until the 2005 Annual Meeting of Unit Owners: Robert P. Adelman (7,519,155 votes for; 112,692 withheld) Samuel M. Eisenstat (7,551,000 votes for; 80,847 withheld) Willard B. Taylor (7,553,447 votes for; 78,400 withheld) John H. Van Kirk (7,355,835 votes for; 276,012 withheld) Rosalie J. Wolf (7,376,183 votes for; 255,664 withheld) Item 5. Other Information. ------------------ There have been no changes to the procedures by which unit owners may recommend nominees for Trustees of the Trust since those disclosed in our proxy statement on Schedule 14A dated January 10, 2005. Item 6. Exhibits. -------- Exhibit 3. Amended and Restated Trustees' Regulations amended as of February 9, 2005 Exhibit 31.1. Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 31.2. Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32. Certification of Chief Executive and Chief Financial Officers pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -12- SIGNATURE --------- 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 hereunto duly authorized. NORTH EUROPEAN OIL ROYALTY TRUST /s/ John R. Van Kirk --------------------------------- John R. Van Kirk Managing Director Dated: February 27, 2004