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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
- --------------------------------------------------------------------------------
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-11608
WILLIAMS COAL SEAM GAS ROYALTY TRUST
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 75-6437433
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)
TRUST DIVISION 75202
ROYALTY TRUST GROUP (ZIP CODE)
BANK OF AMERICA, N.A.
901 MAIN STREET, 17TH FLOOR
DALLAS, TEXAS
(Address of principal executive offices)
Registrant's telephone number, including area code:
(214) 209-2400
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE
------------------- ON WHICH REGISTERED
Units of Beneficial Interest -------------------
New York Stock Exchange, Inc.
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT
NONE
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 disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities and Exchange Act of 1934). Yes [___] No
[X]
The aggregate market value of the registrant's units of beneficial interest
outstanding (based on the closing sale price on the New York Stock Exchange and
number of shares reported by the Williams Companies Inc. in its Schedule 13D/A
filed on April 2, 2002) held by non-affiliates of the registrant as of the last
business day of the registrant's most recently completed second fiscal quarter
was approximately $67,023,438.
At March 1, 2003, there were 9,700,000 units of beneficial interest
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Listed below are documents parts of which are incorporated herein by
reference and the part of this report into which the document is incorporated:
NONE.
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<Table>
<Caption>
TABLE OF CONTENTS
Page
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PART I............................................................................................................1
Item 1. Business........................................................................................1
GLOSSARY........................................................................................1
DESCRIPTION OF THE TRUST........................................................................4
Creation and Organization of the Trust ................................................4
Assets of the Trust....................................................................5
Liabilities of the Trust...............................................................5
Duties and Limited Powers of the Trustee...............................................6
Liabilities of the Delaware Trustee and the Trustee....................................6
Termination and Liquidation of the Trust...............................................7
DESCRIPTION OF UNITS............................................................................8
Distributions and Income Computations..................................................8
Transfer of Royalty Interests..........................................................8
Possible Divestiture of Units..........................................................9
Periodic Reports to Unitholders........................................................9
Voting Rights of Unitholders...........................................................9
Liability of Unitholders..............................................................10
Transfer Agent........................................................................10
FEDERAL INCOME TAXATION........................................................................10
Summary of Certain Federal Income Tax Consequences....................................11
ERISA CONSIDERATIONS...........................................................................16
STATE TAX CONSIDERATIONS.......................................................................16
REGULATION AND PRICES..........................................................................16
Regulation of Natural Gas.............................................................16
Environmental Regulation..............................................................17
Competition, Markets and Prices.......................................................18
Item 2. Properties.....................................................................................19
THE ROYALTY INTERESTS..........................................................................19
The Underlying Properties.............................................................20
The NPI...............................................................................22
Reserve Report........................................................................23
Historical Gas Sales Prices and Production............................................25
NPI Percentage Reduction..............................................................25
Gas Purchase Contract.................................................................25
Gas Gathering Contract................................................................27
Federal and Indian Lands..............................................................28
Sale and Abandonment of Underlying Properties.........................................30
The Infill NPI........................................................................30
Williams' Performance Assurances .....................................................30
Title to Properties...................................................................31
Item 3. Legal Proceedings..............................................................................32
Item 4. Submission of Matters to a Vote of Security Holders............................................32
PART II..........................................................................................................32
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters..........................32
Item 6. Selected Financial Data........................................................................33
Item 7. Trustee's Discussion and Analysis of Financial Condition and Results of Operations.............33
Item 7A. Quantitative and Qualitative Disclosure About Market Risk......................................36
Item 8. Financial Statements and Supplementary Data....................................................36
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...........45
PART III.........................................................................................................45
Item 10. Directors and Executive Officers of the Registrant.............................................45
Item 11. Executive Compensation.........................................................................46
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................46
Williams's Voting Authority Over Units................................................47
Item 13. Certain Relationships and Related Transactions.................................................48
Administrative Services Agreement.....................................................48
Potential Conflicts of Interest.......................................................48
Item 14. Controls and Procedures........................................................................48
PART IV..........................................................................................................48
Item 15. Exhibits, Financial Statement Schedules and Reports On Form 8-K................................48
</Table>
PART I
ITEM 1. BUSINESS.
The following is a glossary of certain defined terms used in this
Annual Report on Form 10-K.
GLOSSARY
"Administrative Services Agreement" means the Administrative Services
Agreement, dated effective December 1, 1992, between Williams and the Trust, a
copy of which is filed as an exhibit to this Form 10-K.
"Aftertax Cash Flow per Unit" means the sum of the following amounts
that a hypothetical purchaser of a Unit in the Public Offering would have
received or been allocated if such Unit were held through the date of such
determination: (a) total cash distributions per Unit plus (b) total tax credits
available per Unit under Section 29 of the IRC less (c) the net taxes payable
per Unit (assuming a Federal income tax rate of 31 percent, which at the time of
the formation of the Trust was the highest Federal income tax rate applicable to
individuals).
"Bcf" means billion cubic feet of natural gas. Natural gas volumes are
stated herein at the legal pressure base of 14.73 pounds per square inch
absolute at 60 degrees Fahrenheit.
"Blanco Hub Spot Price" means the posted index price of spot gas
delivered to pipelines per MMBtu (dry basis) as published in the first issue of
the month during which gas is delivered or such determination is made, as the
case may be, in Inside FERC's Gas Market Report for "El Paso Natural Gas
Company, San Juan," or in the event a Blanco Hub posted index price is at some
time in the future reported by Inside FERC's Gas Market Report, then the Blanco
Hub posted index price will be substituted in place of the "El Paso Natural Gas
Company, San Juan" posted index price.
"Btu" means British Thermal Unit, the common unit of gross heating
value measurement.
"Citibank's Base Rate" means a fluctuating interest rate per annum
(compounded quarterly) as shall be in effect from time to time which rate per
annum shall at all times be equal to the rate of interest announced publicly by
Citibank, N.A. in New York, New York, from time to time, as its base rate.
"Confirmation Agreement" means the Confirmation Agreement dated
effective as of May 1, 1995, by and among WPC, Williams and the Trust, a copy of
which is filed as an exhibit to this Form 10-K.
"Conveyance" means the Net Profits Conveyance dated effective as of
October 1, 1992, by and among Williams, WPC, the Trustee and the Delaware
Trustee, a copy of which is filed as an exhibit to this Form 10-K.
"December 31, 2002 Reserve Report" means the Reserve Report, dated
February 10, 2003, on the estimated reserves, estimated future net revenues and
the discounted estimated future net revenues attributable to the Royalty
Interests and the Underlying Properties as of December 31, 2002, prepared by
Miller and Lents, Ltd., independent petroleum engineers, a copy of which is
filed as an exhibit to this Form 10-K.
"Delaware Code" means the Delaware Business Trust Act, Title 12,
Chapter 38 of the Delaware Code, Sections 3801 et seq.
"Delaware Trustee" means Chemical Bank Delaware, in its capacity as a
trustee of the Trust.
"Enhanced recovery or similar operations" means operations conducted
for the purpose of maintaining, sustaining or enhancing production from the
Underlying Properties. These operations may include additional compression, the
injection of carbon dioxide or other gases or hydraulic fracturing.
"Farmout Properties" means the 5,348 gross acres in La Plata County,
Colorado on which Quatro Finale owns a 35 percent net profits interest, also
referred to as the PLA-9 Properties.
"Gas Gathering Contract" means the Gas Gathering and Treating
Agreement, dated October 1, 1992, as amended, between WPX Gas Resources (as
successor in interest to WGM) and WFS, a copy of which is filed as an exhibit to
this Form 10-K.
1
"Gas Purchase Contract" means the Gas Purchase Agreement, dated October
1, 1992, as amended, between WPX Gas Resources (as successor in interest to WGM)
and Quatro Finale (as successor to WPC), a copy of which is filed as an exhibit
to this Form 10-K.
"Grantor trust" means a trust as to which the grantor, or its
successor, has retained an interest in the income from the trust.
"Gross acres" means the total number of surface acres of land without
regard to ownership.
"Gross wells" means the total whole number of gas wells without regard
to ownership interest.
"Index Price" means 97 percent of the Blanco Hub Spot Price as of the
date the determination is made.
"Infill Net Proceeds" consists generally of the aggregate proceeds
based on the price at the Wellhead of gas produced from WPC's net revenue
interest in any possible Infill Wells less (a) Quatro Finale's working interest
share of property and production taxes on such Infill Wells; (b) WPC's working
interest share of operating costs on such Infill Wells; (c) WPC's working
interest share of capital costs on such Infill Wells, including costs of
drilling and completing such Infill Wells and the costs of associated surface
facilities; and (d) interest on the unrecovered portion, if any, of the
foregoing costs at Citibank's Base Rate.
"Infill NPI" refers to one of the net profits interests conveyed to the
Trust, consisting of a 20 percent interest in WPC's Infill Net Proceeds.
"Infill Wells" means any possible additional well drilled on a
producing drilling block when well spacing rules are effectively modified from
the existing 320 acre spacing.
"IRC" means the Internal Revenue Code of 1986, as amended.
"IRR" means the annual discount rate (compounded quarterly) that
equates the present value of the Aftertax Cash Flow per Unit to the initial
price to the public of the Units in the Public Offering (which was $20.00 per
Unit).
"Mcf" means thousand cubic feet of natural gas.
"Minimum Purchase Price" means 97 percent of $1.75 per MMBtu (dry
basis).
"MMBtu" means million Btu.
"MMcf" means million cubic feet of natural gas.
"Net profits interest" generally refers to a real property interest
entitling the owner to receive a specified percentage of the net proceeds from
the sale of production attributable to the properties burdened thereby, the
amount of which is based on a revenue formula specified in such net profits
interest.
"NPI" refers to one of the net profits interests conveyed to the Trust,
generally entitling the Trust to receive 81 percent (subject to reduction as
described below) of the NPI Net Proceeds attributable to (i) Quatro Finale's net
revenue interest (working interest less lease burdens) in the WI Properties and
(ii) the revenue stream received by WPC attributable to its 35 percent net
profits interest in the Farmout Properties. The percentage of the NPI Net
Proceeds to which the Trust is entitled was subject to permanent reduction to 60
percent under certain conditions, and such a reduction occurred in the fourth
quarter of 2000 as described under "Item 2--The Royalty Interests--NPI
Percentage Changes."
"NPI Net Proceeds" consists generally of the aggregate proceeds
attributable to (i) Quatro Finale's net revenue interest based on the sale at
the Wellhead of gas produced from the WI Properties and (ii) the revenue stream
received by Quatro Finale from its 35 percent net profits interest in the
Farmout Properties, less (a) Quatro Finale's working interest share of property
and production taxes on the WI Properties; (b) Quatro Finale's working interest
share of actual operating costs on the WI Properties to the extent in excess of
those agreed to be paid by Quatro Finale as described herein; (c) Quatro
Finale's working interest share of capital costs on the WI Properties to the
extent in excess of those agreed to be paid by WPC as described herein; and (d)
interest on the unrecovered portion, if any, of the foregoing costs at
Citibank's Base Rate.
2
"Net wells" and "net acres" are calculated by multiplying gross wells
or gross acres by the interest in such wells or acres.
"October 1, 1992 Reserve Report" means the Reserve Report, dated
November 21, 1992, on the estimated reserves, estimated future net revenues and
the discounted estimated future net revenues attributable to the Royalty
Interests and the Underlying Properties as of October 1, 1992, prepared by
Miller and Lents, Ltd., independent petroleum engineers, a copy of which is
filed as an exhibit to this Form 10-K.
"Price Credit" means the credit received by WPX Gas Resources from WPC
for each MMBtu of natural gas purchased by WFS Gas Resources when the Index
Price is less than the Minimum Purchase Price on or after January 1, 1994, equal
to the difference between the Minimum Purchase Price and the Index Price.
"Price Credit Account" means the account established by WPC containing
the accrued and unrecouped amount of any Price Credits.
"Price Differential" means 50 percent of the excess of the Index Price
over $1.94 per MMBtu.
"Public Offering" has the meaning assigned to such term herein under
"Item 1--Description of the Trust--Creation and Organization of the Trust."
"Public Offering Prospectus" has the meaning assigned to such term
herein defined under "Item 1--Federal Income Taxation."
"Quatro Finale" means (a) with respect to the period May 1, 1997 until
February 28, 2001, Quatro Finale LLC, a Delaware limited liability company
(which entity acquired and owned the Underlying Properties from May 1, 1997
until February 1, 2001), and (b) with respect to the period from and after March
1, 2001, Quatro Finale V LLC, a Delaware limited liability company (which entity
acquired and has owned the Underlying Properties effective and since March 1,
2001).
"QFIV" means Quatro Finale IV LLC, a Delaware limited liability
company, which purchased the remaining Units owned by Williams in a transaction
effective August 11, 2000.
"Royalty Interests" means the NPI and Infill NPI conveyed to the Trust.
"Section 29 tax credit" means the tax credits for federal income tax
purposes pursuant to Section 29 of the IRC to an owner of coal seam gas
production, which tax credits are generated upon the sale of such production.
"Trust" means Williams Coal Seam Gas Royalty Trust, a Delaware business
trust formed pursuant to the Trust Agreement.
"Trust Agreement" means the Trust Agreement, dated as of December 1,
1992, among Williams, WPC, as grantor, Chemical Bank Delaware, as the Delaware
Trustee, and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.),
as the Trustee, as amended by the First Amendment thereto effective as of
December 15, 1992 and by the Second Amendment thereto effective as of January
12, 1993, a copy of each of which is filed as an exhibit to this Form 10-K.
"Trustee" means Bank of America, N.A. (as successor to NationsBank,
N.A.), in its capacity as a trustee of the Trust.
"Underlying Properties" means certain proved properties in the
Fruitland coal formation in the San Juan Basin of New Mexico and Colorado as
specified in the Conveyance in which Quatro Finale has certain net revenue
interests (working interests less lease burdens) and net profits interests.
"Units" means the 9,700,000 units of beneficial interest issued by, and
evidencing the entire beneficial interest in, the Trust.
"Wellhead" means at or in the vicinity of the wellhead of gas produced.
"WFS" means Williams Field Services Company, a wholly-owned indirect
subsidiary of Williams Energy Services (formerly known as Williams Energy Group)
(a wholly-owned subsidiary of Williams).
3
"WGM" means Williams Gas Marketing Company, formerly a wholly-owned
subsidiary of Williams Field Services Group, Inc. (a wholly-owned subsidiary of
Williams) which has been merged into another affiliate of Williams Field
Services Group, Inc.
"WGM Gas Resources Payment Obligations" has the meaning assigned to
such term under "Item 2--The Royalty Interests--Williams' Performance
Assurances."
"WHD" means Williams Holdings of Delaware, Inc., a wholly-owned
subsidiary of Williams. On July 31, 1999, WHD was merged into Williams and
Williams assumed all assets, liabilities and obligations of WHD.
"Williams" means The Williams Companies, Inc., a Delaware corporation.
"WI Properties" means the net revenue interests (working interests less
lease burdens) of Quatro Finale in the Underlying Properties including Quatro
Finale's interests in 12 Federal producing units in New Mexico.
"Working interest" generally refers to a real property interest
entitling the owner to receive a specified percentage of the proceeds from the
sale of oil and gas production or a percentage of such production, but requiring
the owner of such working interest to bear the costs to explore for, develop and
produce such oil and gas.
"WPC" means Williams Production Company, a wholly-owned indirect
subsidiary of Williams.
"WPC Payment Obligations LLC" has the meaning assigned to such term
under "Item 2--The Royalty Interests--Williams' Performance Assurances."
"WPX Gas Resources" means WPX Gas Resources Company (formerly known as
WFS Gas Resources Company), a Delaware corporation and a wholly-owned subsidiary
of WPC and Williams.
DESCRIPTION OF THE TRUST
Williams Coal Seam Gas Royalty Trust (the "Trust") was formed as a
Delaware business trust under the Delaware Business Trust Act, Title 12, Chapter
38 of the Delaware Code, Sections 3801 et seq. (the "Delaware Code"). The
following information is subject to the detailed provisions of (i) the Trust
Agreement of Williams Coal Seam Gas Royalty Trust (as amended, the "Trust
Agreement") entered into effective as of December 1, 1992, by and among Williams
Production Company, a Delaware corporation ("WPC"), as trustor, The Williams
Companies, Inc., a Delaware corporation ("Williams"), Chase Bank (as successor
to Chemical Bank Delaware), a Delaware banking corporation (the "Delaware
Trustee"), and Bank of America, N.A. (as successor to NationsBank of Texas,
N.A.), a national banking association (the "Trustee"), as trustees, and (ii) the
Net Profits Conveyance (the "Conveyance") dated effective as of October 1, 1992,
by and among WPC, Williams, the Trustee and the Delaware Trustee. Copies of the
Trust Agreement and of the Conveyance are filed as exhibits to this Form 10-K.
The provisions governing the Trust are complex and extensive and no attempt has
been made below to describe or reference all of such provisions. The following
is a general description of the basic framework of the Trust and a summary of
the material terms of the Trust Agreement, and detailed provisions concerning
the Trust may be found in the Trust Agreement.
CREATION AND ORGANIZATION OF THE TRUST
All of the authorized units of beneficial interest in the Trust
("Units") were issued to WPC on January 21, 1993. On that date, WPC transferred
its Units to its parent, Williams, by dividend. Williams, in turn, sold, by
means of a prospectus dated January 13, 1993, 5,200,000 Units on January 21,
1993, and an additional 780,000 Units on February 16, 1993, to the public
through various underwriters (the "Public Offering"). In the second quarter of
1993, Williams sold an additional 151,209 Units. During the second quarter of
1995 Williams transferred its Units to Williams Holdings of Delaware, Inc.
("WHD"), a separate holding company for Williams' non-regulated businesses.
Effective July 31, 1999, WHD was merged into Williams and by operation of the
merger Williams assumed all assets, liabilities and obligations of WHD,
including without limitation ownership of WHD's Units. Effective August 11,
2000, Williams sold its Units to Quatro Finale IV LLC, a Delaware limited
liability company ("QFIV"), in a private negotiated transaction. Williams
retained the voting rights and retained a "call" option on the transferred Units
and QFIV was granted a "put" option on the Units. During the period from
December 2001 through December 2002, Williams exercised its option to purchase
690,000 of the QFIV transferred Units and simultaneously sold these Units to the
Public.
4
The Trust has been formed under Delaware law pursuant to the terms of
the Trust Agreement to acquire and hold certain net profits interests (the
"Royalty Interests") in proved natural gas properties located in the San Juan
Basin of New Mexico and Colorado (the "Underlying Properties"). The Royalty
Interests were conveyed to the Trust on January 21, 1993, pursuant to the
Conveyance for the benefit of the Unitholders. The Trustee has powers to collect
and distribute proceeds received by the Trust and to pay Trust liabilities and
expenses. The Delaware Trustee has only such powers as are set forth in the
Trust Agreement and is not empowered to otherwise manage or take part in the
business of the Trust. The Royalty Interests are passive in nature and neither
the Delaware Trustee nor the Trustee has any control over or any responsibility
relating to the operation of the Underlying Properties. Except for the
commitment by WPC to pay the costs incurred to place into production certain
proved nonproducing wells, neither WPC, Quatro Finale nor the operators of the
Underlying Properties has any contractual commitment to the Trust to further
develop the Underlying Properties, to remain as operator with respect to any of
the leases on the Underlying Properties or to maintain their ownership interest
in any of the properties. However, WPC retained an interest in each of the
Underlying Properties immediately after conveyance of the Royalty Interests to
the Trust. As described under "Item 2 --The Royalty Interests," effective May 1,
1997, WPC sold the Underlying Properties subject to and burdened by the Royalty
Interests to Quatro Finale LLC, a non-affiliated Delaware limited liability
company. Ownership of the Underlying Properties reverted back to WPC effective
February 1, 2001, pursuant to the terms of the May 1, 1997 transaction.
Effective March 1, 2001, WPC sold the Underlying Properties subject to and
burdened by the Royalty Interests to Quatro Finale V LLC, a non-affiliated
Delaware limited liability company. The sale of the Underlying Properties is
expressly permitted under the Trust Agreement. Unless otherwise dictated by
context, references herein to Quatro Finale with respect to the ownership of the
Underlying Properties for any period prior to May 1, 1997, and for the period
from February 1 through February 28, 2001, shall be deemed to refer to WPC. For
a description of the Underlying Properties and other information relating to
such properties, see "Item 2--Properties--The Royalty Interests."
The Delaware Trustee and the Trustee may resign at any time or be
removed with or without cause by a vote of not less than a majority of the
outstanding Units. Any successor trustee must be a bank or trust company meeting
certain requirements including having capital, surplus and undivided profits of
at least $20,000,000, in the case of the Delaware Trustee, and $100,000,000, in
the case of the Trustee.
ASSETS OF THE TRUST
The only assets of the Trust, other than cash and temporary investments
being held for the payment of expenses and liabilities and for distribution to
Unitholders, are the Royalty Interests. The Royalty Interests consist primarily
of a net profits interest (the "NPI") in the Underlying Properties. Prior to
2001, the NPI generally entitled the Trust to receive 81 percent of the NPI Net
Proceeds attributable to (i) gas produced and sold from Quatro Finale's net
revenue interests (working interests less lease burdens) in the properties in
which Quatro Finale has a working interest (the "WI Properties") and (ii) the
revenue stream received by Quatro Finale attributable to its 35 percent net
profits interest on 5,348 gross acres in La Plata County, Colorado (the "Farmout
Properties"). However, the percentage of the NPI Proceeds which the Trust is
entitled to receive was subject to permanent reduction to 60 percent under
certain conditions, and such a reduction occurred in the fourth quarter of 2000.
See "Item 2 - Properties--The Royalty Interests--NPI Percentage Reduction." The
Royalty Interests also include a 20 percent interest in the Infill Net Proceeds,
as defined below (the "Infill NPI"), from the sale of production if well spacing
rules are effectively modified and additional wells are drilled on producing
drilling blocks on the WI Properties (the "Infill Wells") during the term of the
Trust. "NPI Net Proceeds" consists generally of the revenue stream received by
Quatro Finale from its 35 percent net profits interest in the Farmout Properties
plus the aggregate proceeds attributable to Quatro Finale's net revenue interest
based on the price paid at or in the vicinity of the wellhead (the "Wellhead")
of gas produced from the WI Properties less Quatro Finale's share of certain
taxes and costs. "Infill Net Proceeds" consists generally of the aggregate
proceeds based on the price at the Wellhead of gas produced from Quatro Finale's
net revenue interest on any Infill Wells less certain taxes and costs. The
complete definitions of NPI Net Proceeds and Infill Net Proceeds are set forth
in the Conveyance. See "Item 2--Properties--The Royalty Interests" for more
information.
LIABILITIES OF THE TRUST
Because of the passive nature of the Trust assets and the restrictions
on the power of the Trustee to incur obligations, the only liabilities the Trust
generally incurs are those for routine administrative expenses, such as the
trustee's fees and accounting, engineering, legal and other professional fees
and the administrative services fee paid to Williams. However, if a court were
to hold that the Trust is taxable as a corporation, then the Trust would incur
substantial Federal income tax liabilities. See "--Federal Income Taxation."
5
DUTIES AND LIMITED POWERS OF THE TRUSTEE
Under the Trust Agreement, the Trustee receives the payments
attributable to the Royalty Interests and pays all expenses, liabilities and
obligations of the Trust. With respect to any liability that is contingent or
uncertain in amount or that otherwise is not currently due and payable, the
Trustee has the discretion to establish a cash reserve for the payment of such
liability. The Trustee is also entitled to cause the Trust to borrow money to
pay expenses, liabilities and obligations that cannot be paid out of cash held
by the Trust. Any such borrowings may be from any source, including from the
entity serving as Trustee or Delaware Trustee, provided that the entity serving
as Trustee or Delaware Trustee shall not be obligated to lend to the Trust. To
secure payment of any such indebtedness (including any indebtedness to the
entity serving as Trustee or Delaware Trustee), the Trustee is authorized to (i)
mortgage and otherwise encumber the entire Trust estate or any portion thereof;
(ii) carve out and convey production payments; (iii) include all terms, powers,
remedies, covenants and provisions it deems necessary or advisable, including
confession of judgment and the power of sale with or without judicial
proceedings; and (iv) provide for the exercise of those and other remedies
available to a secured lender in the event of a default on such loan. The terms
of such indebtedness and security interest, if funds were loaned by the entity
serving as Trustee or Delaware Trustee, must be similar to the terms which such
entity would grant to a similarly situated commercial customer with whom it did
not have a fiduciary relationship, and such entity shall be entitled to enforce
its rights with respect to any such indebtedness and security interest as if it
were not then serving as trustee.
The Trustee is authorized and directed to sell and convey the Royalty
Interests without Unitholder approval in certain instances as described in the
Trust Agreement, including (i) upon termination of the Trust, (ii) commencing
January 1, 2003, if a portion of the NPI ceases to produce or is not capable of
producing in commercially paying quantities (see "Item 2--Properties--The
Royalty Interests--Sale and Abandonment of Underlying Properties") and (iii) in
connection with payment of a purchase price adjustment for uncompleted wells or
successful Southern Ute Indian claims (see "Item 2--Properties--The Royalty
Interests--Purchase Price Adjustments" and "--Title to Properties"). The Trustee
is empowered by the Trust Agreement to employ consultants and agents (including
WPC and Williams) and to make payments of all fees for services or expenses out
of the assets of the Trust. The Trust has no employees. The administrative
functions of the Trust are performed by the Trustee.
The Trust Agreement authorizes the Trustee to take such action as in
its judgment is necessary or advisable to achieve the purposes of the Trust. The
Trustee is authorized to agree to modifications of the terms of the Conveyance
and to settle disputes with respect thereto, so long as such modifications or
settlements do not result in treatment of the Trust as an association taxable as
a corporation for Federal income tax purposes and such modifications or
settlements do not alter the nature of the Royalty Interests as a right to
receive a share of the proceeds of production from the Underlying Properties
which, with respect to the Trust, are free of any operating rights, expense or
cost. The Trust Agreement provides that cash being held by the Trustee as a
reserve for liabilities or for distribution at the next distribution date will
be placed in demand accounts, U.S. government obligations, repurchase agreements
secured by such obligations, or certificates of deposit, but the Trustee is
otherwise prohibited from acquiring any asset other than the Royalty Interests
or engaging in any business or investment activity of any kind whatsoever. The
Trustee may deposit funds awaiting distribution in an account with the Trustee
or Delaware Trustee provided the interest paid equals the amount paid by the
Trustee or Delaware Trustee on similar deposits.
LIABILITIES OF THE DELAWARE TRUSTEE AND THE TRUSTEE
Each of the Delaware Trustee and the Trustee may act in its discretion
and shall be personally or individually liable only for fraud or acts or
omissions in bad faith or which constitute gross negligence and will not be
otherwise liable for any act or omission of any agent or employee unless such
trustee has acted in bad faith or with gross negligence in the selection and
retention of such agent or employee. Each of the Delaware Trustee and the
Trustee will be indemnified from the Trust assets for any liability, expense,
claim, damage or other loss incurred in performing its duties, unless resulting
from gross negligence, fraud or bad faith (the Delaware Trustee or the Trustee
will be indemnified from the Trust assets against its own negligence which does
not constitute gross negligence), and will have a first lien upon the assets of
the Trust as security for such indemnification and for reimbursements and
compensation to which it is entitled. WPC and Williams have agreed to indemnify
each of the Delaware Trustee and the Trustee against certain environmental and
securities laws liabilities, respectively, provided that the Trustee and
Delaware Trustee are generally required to first be indemnified from Trust
assets before seeking indemnification from WPC or Williams. Neither the Delaware
Trustee nor the Trustee shall be entitled to indemnification from Unitholders
(except in connection with lost or destroyed Unit certificates).
6
TERMINATION AND LIQUIDATION OF THE TRUST
The Trust was not permitted to terminate prior to January 1, 2003,
except upon the affirmative vote of the holders of not less than 75 percent of
the outstanding Units to liquidate the Trust. On and after January 1, 2003, the
Trust will terminate upon the first to occur of (i) an affirmative vote of the
holders of not less than a majority of the outstanding Units to liquidate the
Trust; (ii) such time as the ratio of the cash amounts received by the Trust
from the Royalty Interests (excluding deductions for capital expenditures for
enhanced recovery or similar operations on the WI Properties) to administrative
costs of the Trust is less than 1.2 to 1.0 for three consecutive calendar
quarters; (iii) such time as the Royalty Interests held by the Trust have been
sold by the Trust; (iv) March 1 of any calendar year if, based on a reserve
report as of December 31 of the prior year, it is determined that, as of such
date, the net present value (discounted at 10 percent) of the estimated future
net revenues (calculated in accordance with criteria established by the
Securities and Exchange Commission (the "Commission") but using the average
monthly Blanco Hub Spot Price (as defined; see "Item 2--Properties--The Royalty
Interests--Gas Purchase Contract")) of proved reserves attributable to the
Royalty Interests is equal to or less than $30 million; and (v) December 31,
2012 (the date of any such occurrence is referred to herein as the "Termination
Date"). Following termination, the Trustee and the Delaware Trustee will
continue to act as trustees of the Trust until all remaining Trust assets have
been sold and the net proceeds from such sales distributed to Unitholders.
Upon the termination of the Trust, the Trustee will use best efforts
(as defined in the Trust Agreement) to sell any remaining Royalty Interests for
cash pursuant to the procedures described herein. The Trustee will retain an
investment banking firm (the "Advisor") on behalf of the Trust who will assist
the Trustee in selling the remaining Royalty Interests then owned by the Trust.
WPC has the right, but not the obligation, to purchase all remaining Royalty
Interests following termination of the Trust as described in the following
paragraph.
WPC may, within 60 days following the Termination Date, make a cash
offer to purchase all of the remaining Royalty Interests then held by the Trust.
In the event such an offer is made by WPC, the Trustee will decide, based on the
recommendation of the Advisor, to either (i) accept such offer (in which case no
sale to WPC will be made unless a fairness opinion is given by the Advisor that
the purchase price is fair to the Trust and Unitholders) or (ii) defer action on
the offer for approximately 60 days and seek to locate other buyers for the
remaining Royalty Interests. If the Trustee defers action on WPC's offer, the
offer will be deemed withdrawn and the Trustee will then use best efforts (as
defined in the Trust Agreement), assisted by the Advisor, to locate other buyers
for the Royalty Interests. At the end of a 120-day period following the
Termination Date, the Trustee is required to notify WPC of the highest of any
other offers, acceptable to the Trustee (which must be an all cash offer),
received during such period (the "Highest Offer Price"). WPC then has the right
(whether or not it made an initial offer), but not the obligation, to purchase
all remaining Royalty Interests for a cash purchase price computed as follows:
(i) if the Highest Offer Price is more than 105 percent of WPC's original offer
(or if WPC did not make an initial offer), the purchase price will be 105
percent of the Highest Offer Price (net of any commissions or other fees payable
by the Trust), or (ii) if the Highest Offer Price is equal to or less than 105
percent of WPC's original offer, the purchase price will be equal to the Highest
Offer Price. If no other acceptable offers are received for all remaining
Royalty Interests, the Trustee may request WPC to submit another offer for
consideration by the Trustee and may accept or reject such offer.
If a sale of the Royalty Interests is made or a definitive contract for
sale of the Royalty Interests is entered into within a 150-day period following
the Termination Date, the buyer of the Royalty Interests, and not the Trust or
Unitholders, will be entitled to all proceeds of production attributable to the
Royalty Interests following the Termination Date.
In the event that WPC does not purchase the Royalty Interests, the
Trustee may accept any offer for all or any part of the Royalty Interests as it
deems to be in the best interests of the Trust and Unitholders and may continue,
for up to one calendar year after the Termination Date, to attempt to locate a
buyer or buyers of the remaining Royalty Interests in order to sell such
interests in an orderly fashion. If any Royalty Interests have not been sold or
a definitive agreement for sale has not been entered into by the end of such
calendar year, the Trustee is required to sell the remaining Royalty Interests
at public auction, which sale may be to WPC or any of its affiliates.
WPC's purchase rights, as described, may be exercised by WPC and each
of its successors in interest and assigns. WPC's purchase rights are fully
assignable by WPC to any person. The costs of liquidation, including the fees
and expenses of the Advisor, and the Trustee's liquidation fee will be paid by
the Trust.
7
DESCRIPTION OF UNITS
Each Unit represents an equal undivided share of beneficial interest in
the Trust and is evidenced by a transferable certificate issued by the Trustee.
Each Unit entitles its holder to the same rights as the holder of any other
Unit, and the Trust has no other authorized or outstanding class of equity
security. At March 1, 2003, there were 9,700,000 Units outstanding. The Trust
may not issue additional Units.
DISTRIBUTIONS AND INCOME COMPUTATIONS
The Trustee determines for each quarter the amount of cash available
for distribution to Unitholders. Such amount (the "Quarterly Distribution
Amount") is equal to the excess, if any, of the cash received by the Trust, on
or prior to the last day of the month following the end of each calendar quarter
ending prior to the dissolution of the Trust from the Royalty Interests then
held by the Trust, plus, with certain exceptions, any other cash receipts of the
Trust during such quarter (which might include purchase price adjustments paid
by WPC and sales proceeds not sufficient in amount to qualify for special
distribution as described in the next paragraph, and interest), over the
liabilities of the Trust paid during such quarter, subject to adjustments for
changes made by the Trustee during such quarter in any cash reserves established
for the payment of contingent or future obligations of the Trust. Based on the
payment procedures relating to the Royalty Interests, cash received by the
Trustee in a particular quarter from the Royalty Interests generally represents
the sum of (i) proceeds from the sale of gas produced from the WI Properties
during the preceding calendar quarter, plus, (ii) cash received by Quatro Finale
with respect to the Farmout Properties either (a) during the preceding calendar
quarter or (b) if received in sufficient time to be paid to the Trust, in the
month immediately following such preceding calendar quarter. The Trustee
distributes the Quarterly Distribution Amount within 60 days after the end of
each calendar quarter to each person who was a Unitholder of record on the
associated record date (i.e., the 45th day following the end of each calendar
quarter or if such day is not a business day, the next business day thereafter),
together with interest expected to be earned on such Quarterly Distribution
Amount from the date of receipt thereof by the Trustee to the payment date.
The Royalty Interests may be sold under certain circumstances and will
be sold following termination of the Trust. Any purchase price adjustments and
the proceeds from sales of the Royalty Interests, less liabilities and expenses
of the Trust and amounts used for cash reserves, will be distributed, together
with any interest expected to be earned thereon, to Unitholders of record on the
record date established for such distribution. A special distribution will be
made of undistributed sales proceeds, purchase price adjustments and other
amounts received by the Trust aggregating in excess of $9,000,000 (a "Special
Distribution Amount"). The record date for a Special Distribution Amount will be
the 15th day following receipt of amounts aggregating a Special Distribution
Amount by the Trust (unless such day is not a business day in which case the
record date will be the next business day thereafter) unless such day is within
10 days of the record date for a Quarterly Distribution Amount in which case the
record date will be the date as is established for the next Quarterly
Distribution Amount. Distribution to Unitholders will be made no later than 15
days after the Special Distribution Amount record date.
The terms of the Trust Agreement seek to assure, to the extent
practicable, that gross income attributable to cash being distributed will be
reported by the Unitholder who receives such distributions assuming that such
Unitholder is the owner of record on the applicable record date. In certain
circumstances, however, a Unitholder will not receive the cash giving rise to
such income. For example, the Trustee maintains a cash reserve, and is
authorized to borrow money under certain conditions, in order to pay or provide
for the payment of Trust liabilities. Income associated with the cash used to
increase that reserve or to repay any such borrowings must be reported by the
Unitholder, even though that cash is not distributed to him. Likewise, if a
portion of a cash distribution is attributable to a reduction in the cash
reserve maintained by the Trustee, such cash is treated as a reduction to the
Unitholder's basis in his Units and is not treated as taxable income to such
Unitholder (assuming such Unitholder's basis exceeds the amount of the
distribution of cash reserve).
TRANSFER OF ROYALTY INTERESTS
WPC or its assigns may, at any time after January 1, 2003, purchase for
cash all Royalty Interests attributable to Underlying Properties which are
uneconomical to operate. See "Item 2--Properties--The Royalty Interests--Title
to Properties" and "--Sale and Abandonment of Underlying Properties." Upon
termination of the Trust, any remaining Royalty Interests will be sold by the
Trust and any such sales may, and under certain circumstances will, be made to
WPC or Williams or their respective successors or assigns. See "--Description of
the Trust--Termination and Liquidation of the Trust."
8
POSSIBLE DIVESTITURE OF UNITS
The Trust Agreement imposes no restrictions based on nationality or
other status of Unitholders. However, the Trust Agreement provides that in the
event of certain judicial or administrative proceedings seeking the cancellation
or forfeiture of any property in which the Trust has an interest, or asserting
the invalidity of or otherwise challenging any portion of the Royalty Interests,
because of the nationality, citizenship or any other status, of any one or more
Unitholders, the Trustee will give written notice thereof to each Unitholder
whose nationality, citizenship or other status is an issue in the proceeding,
which notice will constitute a demand that such Unitholder dispose of his Units
within 30 days. If any Unitholder fails to dispose of his Units in accordance
with such notice, the Trustee shall have the right to cancel all outstanding
certificates issued in the name of such Unitholder, transfer all Units held by
such Unitholder to the Trustee and sell such Units (including by private sale).
The proceeds of such sale (net of sales expenses), pending delivery of
certificates representing the Units, will be held by the Trustee in a
non-interest bearing account for the benefit of the Unitholder and paid to the
Unitholder upon surrender of such certificates. Cash distributions payable to
such Unitholder will also be held in a non-interest bearing account pending
disposition by the Unitholder of the Units or cancellation of certificates
representing the Units by the Trustee.
PERIODIC REPORTS TO UNITHOLDERS
Within 60 days following the end of each of the first three calendar
quarters of each calendar year, the Trustee mails to each party who was a
Unitholder of record (i) on the quarterly record date for such quarter or (ii)
on a Special Distribution Amount record date occurring during such quarter (if
any), a report which shows in reasonable detail the assets and liabilities and
receipts and disbursements of the Trust for such quarter. Unitholders are also
furnished with comparable quarterly information with respect to the Underlying
Properties. Within 120 days following the end of each fiscal year or such
shorter period of time as may be required by the rules of the New York Stock
Exchange, the Trustee mails to Unitholders of record as of a date to be selected
by the Trustee an annual report containing audited financial statements relating
to the Trust and the Underlying Properties.
The Trustee files such returns for Federal income tax purposes as it is
advised are required to comply with applicable law. The Trustee mails to each
party who was a Unitholder of record (i) on the quarterly record date for such
quarter or (ii) on a Special Distribution Amount record date occurring during
such quarter (if any), a report which shows in reasonable detail the information
necessary to permit each Unitholder to make all calculations reasonably
necessary for tax purposes. The Trustee treats all income, credits and
deductions recognized during each quarter as having been recognized by holders
of record on the quarterly record date established for the distribution unless
otherwise advised by counsel. Available year-end tax information permitting each
Unitholder to make all calculations reasonably necessary for tax purposes is
distributed by the Trustee to Unitholders no later than March 15 of the
following year.
Each Unitholder and his duly authorized agents and attorneys have the
right during reasonable business hours to examine and inspect records of the
Trust and the Trustee.
VOTING RIGHTS OF UNITHOLDERS
Unitholders have only such voting rights as are provided in the Trust
Agreement and such rights are more limited than those of stockholders of most
corporations. Unitholder approval is, however, required to appoint a successor
Trustee or Delaware Trustee. Also, Unitholder approval is required to amend the
Trust Agreement (except for changing the name of the Trust and except to correct
or cure ambiguities in the Trust Agreement which do not adversely affect
Unitholders) and to adopt any amendment to the Gas Gathering Contract relating
to production from the Underlying Properties entered into between WFS (a
subsidiary of Williams Energy Services) and WPX Gas Resources Company (a
subsidiary of WPC (formerly known as WFS Resources Company), "WPX Gas
Resources") as successor in interest to WGM (a former subsidiary of Williams
Field Services Group, Inc., which has been merged into another affiliate of
Williams Field Services Group, Inc.) or to the Gas Purchase Contract relating to
production from the Underlying Properties entered into between WPC and WPX Gas
Resources (as successor in interest to WGM), if such amendment would materially
adversely affect revenues of the Trust. Unitholders may also remove the Trustee
or Delaware Trustee. Unitholders are not entitled to any rights of appraisal or
similar rights in connection with the termination of the Trust.
The Trust Agreement may be amended, the Delaware Trustee and the
Trustee may be removed and the Trust may be terminated by a vote of holders of a
majority of the outstanding Units, but no provision of the Trust Agreement may
be amended that would (i) increase the power of the Delaware Trustee or the
Trustee to engage in business or investment activities, or (ii) alter the rights
of the Unitholders as among themselves. All other actions may be approved
9
by a majority vote of the Units represented at a meeting at which a quorum,
constituting a majority of the outstanding Units, is present or represented
(except that amendment of required voting percentages requires approval of at
least 80 percent of the outstanding Units). The parties to the Trust Agreement
may, without approval of the Unitholders, from time to time, supplement or amend
the Trust Agreement in order to cure any ambiguity or to correct or supplement
any defective or inconsistent provisions, provided such supplement or amendment
is not adverse to the interest of the Unitholders. In addition, Williams may
direct the Trustee to change the name of the Trust which change shall not
require approval of the Unitholders.
Meetings of Unitholders may be called by the Trustee or by Unitholders
owning not less than 10 percent in number of the outstanding Units. All such
meetings shall be held in Dallas, Texas, and written notice of every such
meeting setting forth a time and place of the meeting and the matters proposed
to be acted upon shall be given not more than 60 nor less than 20 days before
such meeting. Each Unitholder shall be entitled to one vote for each Unit owned
by such holder.
LIABILITY OF UNITHOLDERS
Consistent with Delaware law, the Trust Agreement provides that the
Unitholders will have the same limitation on personal liability as is accorded
under the laws of such state to stockholders of a corporation for profit. No
assurance can be given, however, that the courts in jurisdictions outside of
Delaware will give effect to such limitation.
TRANSFER AGENT
The Trustee has appointed Mellon Investor Services, L.L.C. (as
successor to Chemical Shareholder Services Group, Inc.), as transfer agent and
registrar for the Units (the "Transfer Agent").
WEBSITE/SEC FILINGS
The Trust maintains an Internet Website
(www.wtu-williamscoalseamgastrust.com), and as a result provides website access
to its annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and amendments to such reports as soon as reasonably
practicable after it electronically files with or furnishes such material to the
SEC.
FEDERAL INCOME TAXATION
THE TAX CONSEQUENCES TO A UNITHOLDER OF THE OWNERSHIP AND SALE OF UNITS
WILL DEPEND IN PART ON THE UNITHOLDER'S TAX CIRCUMSTANCES. EACH UNITHOLDER
SHOULD THEREFORE CONSULT THE UNITHOLDER'S TAX ADVISOR ABOUT THE FEDERAL, STATE
AND LOCAL TAX CONSEQUENCES TO THE UNITHOLDER OF THE OWNERSHIP OF UNITS.
The sections entitled "Federal Income Tax Consequences" and "Risk
Factors--Tax Considerations" appearing in the Prospectus (the "Public Offering
Prospectus") dated January 13, 1993, which constitutes a part of the
Registration Statement on Form S-3 of Williams (Registration No. 33-53662) filed
in connection with the registration of the Units under the Securities Act of
1933 for offer and sale in the Public Offering, set forth, respectively, a
summary of Federal income tax matters of general application that addresses all
material tax consequences of the ownership and sale of the Units acquired in the
Public Offering and a discussion of certain risk factors associated with matters
of Federal income taxation as applied to the Trust and such Unitholders. A copy
of such sections of the Public Offering Prospectus is filed as an exhibit to
this Form 10-K.
In connection with the registration of the Units for offer and sale in
the Public Offering, Williams and the underwriters of the Units received certain
opinions of counsel to Williams (upon which the Trustee and the Delaware Trustee
were entitled to rely), including, without limitation, opinions as to the
material Federal income tax consequences of the ownership and sale of the Units
acquired in the Public Offering. The opinions of counsel to Williams as to such
Federal income tax consequences were based on provisions of the Internal Revenue
Code of 1986, as amended (the "IRC"), as of January 21, 1993, the date of the
closing of the Public Offering, existing and proposed regulations thereunder and
administrative rulings and court decisions as of January 21, 1993, all of which
are subject to changes that may or may not be retroactively applied. Some of the
applicable provisions of the IRC have not been interpreted by the courts or the
Internal Revenue Service ("IRS"). In addition, such opinions of counsel to
Williams were based on various representations as to factual matters made by
Williams and WPC in connection with the Public Offering. As is typically
10
the case, these opinions were limited in their application to certain investors
purchasing Units in the Public Offering and, as a result, provide no assurance
to investors purchasing Units following the Public Offering.
Neither counsel to the Trust, the Trustee nor the Delaware Trustee,
respectively, has rendered any opinions with respect to any tax matters
associated with the Trust or the Units.
No ruling was requested by Williams, as the sponsor of the Trust, from
the IRS with respect to any matter affecting the Trust or Unitholders. No
assurance can be provided that the opinions of counsel to Williams (which do not
bind the IRS) will not be challenged by the IRS or will be sustained by a court
if so challenged.
SUMMARY OF CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following summary of certain Federal income tax consequences of
acquiring, owning and disposing of Units is based on the opinions of counsel to
Williams on Federal income tax matters, which are set forth in the Public
Offering Prospectus, and is qualified in its entirety by express reference to
the sections of the Public Offering Prospectus identified in the first paragraph
of this "Federal Income Taxation" section. Although the Trust believes that the
following summary contains a description of all of the material matters
discussed in the opinions referenced above, the summary is not exhaustive and
many other provisions of the Federal tax laws may affect individual Unitholders.
Furthermore, the summary does not purport to be complete or to address the tax
issues potentially affecting Unitholders acquiring Units other than by purchase
through the Public Offering. Each Unitholder should consult the Unitholder's tax
advisor with respect to the effects of the Unitholder's ownership of Units on
the Unitholder's personal tax situation.
Classification and Taxation of the
Trust ......................... The Trust is a grantor trust and not an
association taxable as a corporation. As a
grantor trust, the Trust is not subject to
Federal income tax. There can be no
assurance that the IRS will not challenge
this treatment. The tax treatment of the
Trust and Unitholders would be materially
different if the IRS were to successfully
challenge this treatment.
Taxation of Unitholders.......... Each Unitholder is taxed directly on his
proportionate share of income, deductions
and credits of the Trust attributable to the
Royalty Interests consistent with such
Unitholder's taxable year and method of
accounting, and without regard to the
taxable year or method of accounting
employed by the Trust.
Income and Deductions............ The income of the Trust consists primarily
of a specified share of the proceeds from
the sale of coal seam gas produced from the
Underlying Properties. During 2002, the
Trust earned interest income on funds held
for distribution and made adjustments to the
cash reserve maintained for the payment of
contingent or future obligations of the
Trust. The deductions of the Trust consist
of severance taxes and administrative
expenses. In addition, each Unitholder is
entitled to depletion deductions. See
"Unitholder's Depletion Allowance" below.
Individuals may deduct "miscellaneous"
itemized deductions (including, in general,
investment expenses) only to the extent that
such expenses exceed 2 percent of the
individual's adjusted gross income. Although
there are exceptions to the 2 percent
limitation, authority suggests that no
exceptions apply to expenses passed through
from a grantor trust, like the Trust.
Limits on Deductions and Credits.. Generally, a taxpayer is entitled to claim
deductions and tax credits generated by an
investment only if the investment has
economic substance. The application of this
principle in the context of the production
and sale of nonconventional fuels (like coal
seam gas) which generate the Section 29 tax
credit is uncertain because such application
has not been addressed either by a court or
the IRS.
11
An investment has economic substance if the
investor can demonstrate that there is a
reasonable possibility of deriving an
economic profit from the investment in
excess of a de minimis amount, apart from
tax benefits. In many cases, economic profit
has been computed by comparing the
taxpayer's total cash investment to the
total cash reasonably expected to be
received by the taxpayer as a result of the
investment. At the time of the Public
Offering, Williams, after consultation with
its counsel, expressed its belief only in
connection with the Public Offering that the
purchaser of a Unit in the Public Offering,
who did not borrow funds in order to
purchase his Unit, had a reasonable
possibility of deriving an economic profit
in excess of a de minimis amount apart from
tax benefits associated with ownership of
the Unit. No assurance is given either by
the Trustee or counsel to the Trustee to a
purchaser of Units in or following the
Public Offering as to whether (and to what
extent) such purchaser will be entitled to
claim deductions and the Section 29 tax
credit generated with respect to such Units.
Section 29 Tax Credits........... Unitholders are entitled, provided certain
requirements are met, to claim tax credits
pursuant to Section 29 of the IRC with
respect to sales of coal seam gas production
attributable to the NPI, the gross income
from which is included in their taxable
income. The Section 29 tax credit provides
to a taxpayer a dollar-for-dollar reduction
in his regular Federal income tax liability,
and, therefore, generally provides to him a
greater benefit than a deduction which
merely reduces the amount of his taxable
income. For a Unitholder who owned the same
Units of record on all four quarterly record
dates during 2002, the available Section 29
tax credit is approximately $.901258 per
Unit, based on the first estimate of the GNP
implicit price deflator published by the
Bureau of Economic Analysis.
The availability of Section 29 tax credits
is dependent upon meeting a number of
requirements, many of which are factual in
nature. Williams represented only in
connection with the Public Offering that
those factual requirements were met and
Williams expressed its belief in connection
with the Public Offering that substantially
all of the production attributable to the
NPI from the coal seam gas wells identified
in the October 1, 1992 Reserve Report
(defined herein) qualified for Section 29
tax credits. At the time of the Public
Offering, counsel to Williams opined as to
those requirements which are statutory or
legal in nature. If any of the factual
requirements are not met, or the opinion not
followed, some or all of the expected
Section 29 tax credits may not be available.
If any portion of the NPI is treated as a
production payment because the NPI is
reduced due to Quatro Finale's retained
interest, no Section 29 tax credit will be
available to a Unitholder with respect to
production attributable to that portion. In
addition, if the production units or
participating areas are expanded to include
additional production which does not qualify
for the Section 29 tax credit, the amount of
Section 29 tax credits available to a
Unitholder will not be increased even though
his share of production increases. Neither
Quatro Finale, WPC nor the Trust can control
whether a production unit or participating
area is expanded.
12
No Section 29 tax credits will be available
under current law to a Unitholder with
respect to production attributable to the
Infill NPI even if an Infill Well recovers a
portion of the reserves that prior to the
drilling and completion of an Infill Well
were recoverable from a well burdened by the
NPI that qualified for Section 29 tax
credits.
Production from coal seam gas wells drilled
after December 31, 1979 and prior to January
1, 1993, qualifies for the Section 29
credit, so long as the wells are certified
by the Federal Energy Regulatory Commission
("FERC"). This tax credit is calculated
annually based on each year's qualified
production throughout the year 2002. Coal
seam gas produced and sold after December
31, 2002, will no longer generate a Section
29 credit unless the applicability of the
Section 29 credit is extended by Congress.
Legislation currently is proposed to extend
the Section 29 credit retroactively to
January 1, 2003. Of course, there can be no
assurance that such legislation will be
passed and, if passed, will be effective
retroactively to January 1, 2003.
Limits on Unitholder's Use of Section 29
Credits..................... The Section 29 credit is based on the
Unitholder's pro rata share of qualifying
production. It can be used only to the
extent that a Unitholder's regular tax
liability exceeds the Unitholder's tentative
minimum tax liability after the regular tax
liability has been reduced by the foreign
tax credit and certain other nonrefundable
personal credits. Any part of the Section 29
credit not allowed for the tax year solely
because of this alternative minimum tax
limitation is subject to certain carryover
provisions relating to the alternative
minimum tax calculation. Except for the
foregoing, there are no IRC provisions that
allow for the carryback or carryforward of
Section 29 credits in any other
circumstances. As the carryforward of unused
Section 29 credits is related to the
alternative minimum tax calculation for
succeeding years, carryforwards should be
allowed even if the Section 29 credit is not
extended after 2002.
Quarterly Allocations of Section 29
Credits..................... Under the IRC, a Unitholder is entitled to
Section 29 tax credits only to the extent
that he is an owner of the economic interest
at the time the coal seam gas is produced.
The Trustee allocates the income received by
the Trust for a quarter, and the Section 29
tax credit allocable to such income, to
Unitholders of record on the quarterly
record date for such quarter. Such an
allocation may be challenged by the IRS, but
any challenge is likely to have a material
adverse effect only if successful and only
for Unitholders who do not own Units for a
full quarter for each record date,
particularly Unitholders who acquire Units
shortly before a record date and sell
shortly after a record date.
Unitholder's Depletion Each Unitholder is entitled to amortize the
Allowance...................... cost of the Units through cost depletion
over the life of the NPI (or if greater,
through percentage depletion equal to 15
percent of gross income). If any portion of
the NPI is treated as a production payment
or is not treated as an economic interest,
however, a Unitholder will not be entitled
to depletion in respect of such portion.
13
Depletion Recapture ............. If a taxpayer disposes of any "section 1254
property" (certain oil, gas, geothermal or
other mineral property), and if the adjusted
basis of such property includes adjustments
for deductions for depletion under Section
611 of the IRC (discussed above), the
taxpayer generally must recapture the amount
deducted for depletion in ordinary income
(to the extent of gain realized on the
disposition of the property). This depletion
recapture rule applies to any disposition of
property that was placed in service by the
taxpayer after December 31, 1986. Detailed
rules set forth in Sections 1.1254-1 through
1.1254-6 of the United States Treasury
regulations govern dispositions of property
after March 13, 1995. The IRS will likely
take the position that a Unitholder who
purchases a Unit subsequent to December 31,
1986, must recapture depletion upon the
disposition of that Unit.
Non-Passive Activity Income, Credits
and Loss....................... The income, credits and expenses of the
Trust are not taken into account in
computing the passive activity losses and
income under Section 469 of the IRC for a
Unitholder who acquires and holds Units as
an investment and did not acquire them in
the ordinary course of a trade or business.
Section 29 tax credits generated by an
investment in Units can be utilized to
offset regular tax liability on income from
any source, whether active or passive,
subject to other limitations discussed
herein or arising from the individual tax
circumstances of each Unitholder. See
"Limits on Unitholder's Use of Credits"
above.
Unitholder Reporting
Information.................... The Trustee furnishes to Unitholders tax
information concerning royalty income,
depletion and the Section 29 tax credits on
an annual basis. Year-end tax information is
furnished to Unitholders no later than March
15 of the following year. See the second
paragraph under "Description of
Units--Periodic Reports to Unitholders."
Unless the final information issued by the
U.S. Treasury Department at the end of March
regarding the amount of the Section 29
credit for 2002 differs materially from the
Trustee's estimate, the final information
will be contained in the next quarterly
report. However, to the extent the final
information issued by the U.S. Treasury
Department causes the tax credit amounts for
2002 to differ materially from the Trustee's
estimates contained in the 2002 Tax
Information booklet, the Trustee will
promptly mail final tax credit information
to each affected Unitholder.
Tax Shelter Registration......... The Trust is registered as a "tax shelter"
and its tax shelter registration number is
92-364000072. Issuance of a tax shelter
registration number does not indicate that
the investment in Units or the claimed tax
benefits have been reviewed, examined or
approved by the IRS.
Substantial Understatement
Penalty...................... Section 6662 of the IRC imposes a penalty in
certain circumstances for a substantial
understatement of taxes if a taxpayer's tax
liability is understated by more than the
greater of (i) 10 percent of the taxes
required to be shown on the return or (ii)
$5,000 ($10,000 for most corporations). The
penalty (which is not deductible) is 20
percent of the understatement.
14
Except in the case of understatements
attributable to "tax shelter" items, which
are subject to special rules discussed
below, an item of understatement will not
give rise to the penalty if: (i) there is or
was "substantial authority" for the
taxpayer's treatment of the item, (ii) all
the facts relevant to the tax treatment of
the item are adequately disclosed on the
return or on a statement attached to the
return and there is a reasonable basis for
the tax treatment of such item, or (iii)
there is reasonable cause and the taxpayer
acted in good faith.
In the case of understatements attributable
to "tax shelter" items by noncorporate
taxpayers, the substantial understatement
penalty may be avoided only if: (i) the
taxpayer establishes that, in addition to
having substantial authority for his
position, he reasonably believed that the
treatment claimed was more likely than not
the proper treatment of the item, or (ii)
there is reasonable cause and the taxpayer
acted in good faith. In the case of
understatements attributable to "tax
shelter" items by corporate taxpayers,
effective for transactions occurring after
December 8, 1994, the substantial authority
and reasonable belief exception does not
apply. Accordingly, in a transaction
occurring after December 8, 1994, if a
corporate taxpayer has a substantial
understatement attributable to a "tax
shelter" item, penalties apply unless the
corporate taxpayer can show reasonable cause
and good faith. For transactions involving
corporate taxpayers and substantial
understatements attributable to "tax
shelter" items occurring before December 9,
1994, the rules applicable to noncorporate
taxpayers apply. A "tax shelter" item is an
item (e.g., income, gain, loss, deduction,
credit) attributable to a partnership or
other entity, any investment plan or
arrangement, or any other plan or
arrangement, if a significant purpose of
such partnership, entity, plan or
arrangement is the avoidance or evasion of
income tax. For transactions entered into
before August 6, 1997, the relevant standard
is whether tax avoidance or evasion of
income tax was the principal purpose of the
entity, plan, or arrangement.
No assurance is given either by the Trustee
or counsel to the Trustee as to the possible
application of this penalty or any other
penalties, in part because such application
depends largely upon the individual
circumstances under which the Units were
acquired. As a result, purchasers of Units
in and after the Public Offerings should
consult with their personal tax advisors.
15
ERISA CONSIDERATIONS
The section entitled "ERISA Considerations" appearing in the Public
Offering Prospectus sets forth certain information regarding the applicability
of the Employee Retirement Income Security Act of 1974, as amended, and the IRC
to pension, profit-sharing and other employee benefit plans, and to individual
retirement accounts (collectively, "Qualified Plans"). A copy of sections of the
Public Offering Prospectus is filed as our exhibit to this Form 10-K and is
incorporated herein by reference.
Due to the complexity of the prohibited transaction rules and the
penalties imposed upon persons involved in prohibited transactions, it is
important that potential qualified plan investors consult with their counsel
regarding the consequences under ERISA and the IRC of their acquisition and
ownership of Units.
STATE TAX CONSIDERATIONS
THE FOLLOWING IS INTENDED AS A BRIEF SUMMARY OF CERTAIN INFORMATION
REGARDING STATE INCOME TAXES AND OTHER STATE TAX MATTERS AFFECTING THE TRUST AND
THE UNITHOLDERS. UNITHOLDERS SHOULD THEREFORE CONSULT THE UNITHOLDER'S TAX
ADVISOR REGARDING STATE INCOME TAX FILING AND COMPLIANCE MATTERS.
Unitholders should consider state and local tax consequences of holding
Units. The Trust owns Royalty Interests burdening gas properties located in New
Mexico and Colorado. Both New Mexico and Colorado have income taxes applicable
to individuals and corporations (subject to certain exceptions for S
corporations). A Unitholder is generally required to file state income tax
returns and/or pay taxes in those states and may be subject to penalties for
failure to comply with such requirements. In addition, these states may require
the Trust to withhold tax from distributions to Unitholders to the extent such
distributions are attributable to income from properties located in such states.
The Trustee will provide information concerning the Units sufficient to
identify the income from Units that is allocable to each state. Unitholders
should consult their own tax advisors to determine their income tax filing
requirements with respect to their share of income of the Trust allocable to
states imposing an income tax on such income.
The Trust has been structured to cause the Units to be treated for
certain state law purposes essentially the same as other securities, that is, as
interests in intangible personal property rather than as interests in real
property. If the Units are held to be real property or an interest in real
property under the laws of either or both of such states, a Unitholder, even if
not a resident of such state, could be subject to devolution, probate and
administration laws, and inheritance or estate and similar taxes, under the laws
of such state.
REGULATION AND PRICES
REGULATION OF NATURAL GAS
The production, transportation and sale of natural gas from the
Underlying Properties are subject to Federal and state governmental regulation,
including regulation of tariffs charged by pipelines, taxes, the prevention of
waste, the conservation of gas, pollution controls and various other matters.
Legislative Proposals. In the past, Congress has been very active in
the area of gas regulation. Legislation enacted in recent years has repealed
incremental pricing requirements and gas use restraints previously applicable.
Federal and State Regulation of Gas. The Underlying Properties are
subject to the jurisdiction of the Federal Energy Regulatory Commission ("FERC")
and the Department of Energy ("DOE") with respect to various aspects of gas
operations including marketing and production of gas but not the wellhead price
for natural gas. All sales of natural gas produced from the Underlying
Properties are considered under the Natural Gas Policy Act of 1978 ("NGPA") and
the
16
Natural Gas Wellhead Decontrol Act of 1989 to be sold at the wellhead (as
opposed to downstream sales or resales) for purposes of pricing and therefore
are not subject to federal regulation.
The transportation of natural gas in interstate commerce is subject to
Federal regulation by FERC under the Natural Gas Act ("NGA") and the NGPA. FERC
has initiated a number of regulatory policy initiatives that may affect the
transportation of natural gas from the wellhead to the market and thus may
affect the marketing of natural gas. Such initiatives include regulations which
are intended to further open access to interstate pipelines by requiring such
pipelines to unbundle their transportation services from sales services and
allow customers to choose and pay for only the services they require, regardless
of whether the customer purchases natural gas from such pipelines or from other
suppliers. Although these regulations should generally facilitate the
transportation of natural gas produced from the Underlying Properties to natural
gas markets, the impact of these regulations on marketing production from the
Underlying Properties cannot be fully predicted at this time; however, it is
possible such impact could be significant.
Many state jurisdictions have at times imposed limitations on the
production of gas by restricting the rate of flow for gas wells below their
actual capacity to produce and by imposing acreage limitations for the drilling
of a well. Most states regulate the production of gas, including requirements
for obtaining drilling permits, the method of developing new fields, provisions
for the unitization or pooling of gas properties, the spacing, operation,
plugging and abandonment of wells and the prevention of waste of gas resources.
The rate of production may be regulated and the maximum daily production
allowable from gas wells may be established on a market demand or conservation
basis or both.
Several states have in past years enacted or proposed regulations
intended to revise significantly current systems of prorationing gas production.
The modified rules may decrease the total amount of gas produced in New Mexico
or Colorado, and could result in an increase in market prices for gas. The
foregoing developments have fostered debate regarding the purpose and effect of
the new prorationing rules, with opponents of such rules arguing that the
primary purpose thereof is to increase gas prices by withholding supplies from
the market.
At the present time, it is impossible to predict what proposals, if
any, might actually be enacted by Congress or the various state legislatures or
regulatory entities, including proration rules and what effect, if any, such
proposals might have on the Underlying Properties gas or oil prices and the
Trust.
ENVIRONMENTAL REGULATION
General. Activities on the Underlying Properties are subject to
existing Federal, state and local laws (including case law), rules and
regulations governing health, safety, environmental quality and pollution
control. It is anticipated that, absent the occurrence of an extraordinary
circumstance or event, compliance with existing Federal, state and local laws,
rules and regulations regulating health, safety, the release of materials into
the environment or otherwise relating to the protection of the environment will
not have a material adverse effect upon the Trust or Unitholders. The Trustee
cannot predict what effect additional regulation or legislation, enforcement
policies thereunder, and claims for damages to property, employees, other
persons and the environment resulting from operations on the Underlying
Properties could have on the Trust or Unitholders. However, pursuant to the
terms of the Conveyance, any costs or expenses incurred by WPC in connection
with environmental liabilities arising out of or relating to activities
occurring on, in or in connection with, or conditions existing on or under, the
Underlying Properties before October 1, 1992, will be borne by WPC and not the
Trust and will not be deducted in calculating NPI Net Proceeds or Infill Net
Proceeds. Any environmental costs or expenses that are attributable to Quatro
Finale's working interest share of the WI Properties that do not fall within the
preceding sentence will be paid by Quatro Finale but will be deducted in
calculating NPI Net Proceeds or Infill Net Proceeds, as the case may be, and
will, therefore, reduce amounts payable to the Trust. Environmental costs or
expenses that are attributable to the Farmout Properties that arise after
October 1, 1992, could reduce the revenue paid to WPC (on behalf of Quatro
Finale) and, therefore, the amount of NPI Net Proceeds.
Solid and Hazardous Waste. The Royalty Interests are carved out of
Quatro Finale's interests in certain properties that have produced gas from
other formations for many years. Quatro Finale has never operated any of the
coal seam gas wells related to the Underlying Properties. WPC, the previous
owner of the Underlying Properties, has acted as operator for only a small
number of the coal seam gas wells, and for a relatively short period of time.
Williams and WPC have advised the Trustee that to their knowledge, although WPC
and the other operators have utilized
17
operating and disposal practices that were standard in the industry at the time,
hydrocarbons or other solid or hazardous wastes may have been disposed or
released on or under the Underlying Properties by the current or previous
operators. Federal, state and local laws applicable to gas-related wastes and
properties have become increasingly more stringent. Under these laws, WPC or an
operator of the Underlying Properties could be required to remove or remediate
previously disposed wastes or property contamination (including groundwater
contamination) or to perform remedial plugging operations to prevent future
contamination.
The operations of the Underlying Properties may generate wastes that
are subject to the Federal Resource Conservation and Recovery Act ("RCRA") and
comparable state statutes. The Environmental Protection Agency (the "EPA") has
limited the disposal options for certain hazardous wastes and may adopt more
stringent disposal standards for nonhazardous wastes.
Superfund. The Comprehensive Environmental Response, Compensation and
Liability Act ("CERCLA"), also known as the "superfund" law, imposes liability,
regardless of fault or the legality of the original conduct, on certain classes
of persons that contributed to the release of a "hazardous substance" into the
environment. These persons include the current or previous owner and the current
or previous operator of a site and companies that disposed or arranged for the
disposal of, the hazardous substance found at a site. CERCLA also authorizes the
EPA and, in some cases, private parties to take actions in response to threats
to the public health or the environment and to seek recovery from such
responsible classes of persons of the costs of such action. In the course of
their operations, the operators of the Underlying Properties have generated and
will generate wastes that may fall within CERCLA's definition of "hazardous
substances." Quatro Finale, WPC or an operator of the Underlying Properties may
be responsible under CERCLA for all or part of the costs to clean up sites at
which such substances have been disposed.
Air Emissions. The operations of the Underlying Properties are subject
to Federal, state and local regulations concerning the control of emissions from
sources of air contaminants. Administrative enforcement actions for failure to
comply strictly with air regulations or permits are generally resolved by
payment of a monetary penalty and correction of any identified deficiencies.
Regulatory agencies could require the operators to forego or modify construction
or operation of certain air emission sources.
OSHA/Right-to-know. The operations of the Underlying Properties are
subject to the requirements of the Federal Occupational Safety and Health Act
("OSHA") and comparable state statutes. The OSHA hazard communication standard,
the EPA community right-to-know regulations under Title III of the Federal
Superfund Amendment and Reauthorization Act and similar state statutes require
that information be organized and maintained about hazardous materials used or
produced in the operations. Certain of this information must be provided to
employees, state and local government authorities and citizens.
COMPETITION, MARKETS AND PRICES
The revenues of the Trust and the amount of cash distributions to
Unitholders depend upon, among other things, the effect of competition and other
factors in the market for natural gas. The gas industry is highly competitive in
all of its phases. Quatro Finale and WPC encounter competition from major oil
and gas companies, independent oil and gas concerns, and individual producers
and operators. Many of these competitors have greater financial and other
resources than Quatro Finale or WPC. Competition is also presented by
alternative fuel sources, including heating oil and other fossil fuels.
Demand for natural gas has decreased recently after spiking up during
the winter months. This was in response to weakened strong domestic economic
conditions, relatively lower prices for alternative energy sources, and other
factors. Decreased demand has recently resulted in lower prices for natural gas
after spiking up during the winter months. In addition, in the recent short
term, demand for natural gas production in the United States has generally
resulted in increased competitive pressure and significantly higher natural gas
prices. The existence or effect of any shortages or excesses of natural gas
production capacity as may exist in the future cannot be predicted with
certainty. See "Item 2--Properties--The Royalty Interests--Historical Gas Sales
Prices and Production."
Demand for natural gas production has historically been seasonal in
nature and prices for gas fluctuate accordingly. Consequently, the amount of
cash distributions by the Trust may vary substantially on a seasonal basis.
18
Generally, gas production volumes and prices tend to be higher during the first
and fourth quarters of the calendar year. Because of the lag between the receipt
of revenues related to the Underlying Properties and the dates on which
distributions are made to Unitholders, however, any seasonality that affects
production and prices generally should be reflected in distributions that are
made to Unitholders in later periods. See "--Description of Units--Distributions
and Income Computations."
Prices for natural gas are subject to wide fluctuations in response to
relatively minor changes in supply, market uncertainty and a variety of
additional factors that are beyond the control of the Trust, Quatro Finale,
Williams and WPC. These factors include political conditions in the Middle East,
the price and quantity of imported oil and gas, the level of consumer product
demand, the severity of weather conditions, government regulations, the price
and availability of alternative fuels and overall economic conditions. In view
of the many uncertainties affecting the supply and demand for natural gas and
natural gas prices, the Trust and Williams are unable to make reliable
predictions of future gas prices, production, or demand or the overall effect
they will have on the Trust.
ITEM 2. PROPERTIES.
THE ROYALTY INTERESTS
The Royalty Interests conveyed to the Trust consist of net profits
interests in the Underlying Properties. The Royalty Interests were conveyed to
the Trust by means of a single instrument of conveyance. The Conveyance was
recorded in the appropriate real property records in each county in New Mexico
and Colorado where the Underlying Properties are located so as to give notice of
the Royalty Interests to creditors and transferees, who would take an interest
in the Underlying Properties subject to the Royalty Interests. The Conveyance
was intended to convey the Royalty Interests as real property interests under
applicable state law.
On May 7, 1997, effective as of May 1, 1997, WPC transferred the
Underlying Properties to Quatro Finale LLC, a Delaware limited liability
company, pursuant to the terms of a Purchase and Sale Agreement dated as of May
1, 1997 ("1997 Transaction"). Prior to the 1997 Transaction, WPC had owned the
Underlying Properties, subject to and burdened by the Royalty Interests owned by
the Trust, since the inception of the Trust. The sale of the Underlying
Properties is expressly permitted under the Trust Agreement. Neither the Trustee
nor the Delaware Trustee has any control over or responsibility relating to the
operation of the Underlying Properties. Under the terms of the 1997 Transaction,
ownership of the Underlying Properties reverted back to WPC effective February
1, 2001. Pursuant to a Purchase and Sale Agreement dated March 14, 2001 (the
"2001 Transaction Agreement") and effective March 1, 2001, WPC transferred the
Underlying Properties to Quatro Finale V LLC, a Delaware limited liability
company (the "2001 Transaction"). With respect to the ownership of the
Underlying Properties for any period prior to May 1, 1997, and for the period
from February 1 through February 28, 2001, references herein to Quatro Finale
should be deemed to refer to WPC.
Concurrently with the 2001 Transaction, WPC and Quatro Finale entered
into a Management Services Agreement dated March 1, 2001 (the "Management
Services Agreement"), whereby WPC agreed, among other things, to continue to
manage and operate the Underlying Properties and to handle the receipt and
payment of funds with respect thereto. Prior to the 2001 Transaction, WPC
received all payments relating to the Underlying Properties and, pursuant to the
Conveyance, paid to the Trust the portion thereof attributable to the Royalty
Interests. Following the 2001 Transaction, under the Management Services
Agreement, WPC continues to collect all revenues on behalf of Quatro Finale and
remains obligated to pay to the Trust on behalf of Quatro Finale the amounts
payable with respect to the Royalty Interests.
Under the Conveyance, the amounts payable with respect to the Royalty
Interests are computed with respect to each calendar quarter ending prior to
termination of the Trust, and such amounts are to be paid to the Trust not later
than the last day of the calendar month next following the end of each calendar
quarter. The amount paid to the Trust does not include interest on any amounts
payable with respect to the Royalty Interests that are held by WPC prior to
payment to the Trust. WPC is entitled to retain any amounts attributable to the
Underlying Properties that are not required to be paid to the Trust with respect
to the Royalty Interests.
Concurrently with the 2001 Transaction, WPC, Williams, the Trust and
Quatro Finale entered into an Agreement dated March 1, 2001 (the "Performance
Acknowledgement Agreement"), pursuant to which (i) the parties acknowledged
19
that, although WPC was selling the Underlying Properties to Quatro Finale, WPC
retained all of its duties and obligations under the Trust Agreement, Conveyance
and related documents (the "Trust Documents"), subject to the terms and
conditions set forth in the 2001 Transaction Agreement and the agreements
entered into pursuant to the 2001 Transaction Agreement, (ii) Williams and WPC
each confirmed and agreed that, notwithstanding the sale of the Underlying
Properties to Quatro Finale, Williams and WPC would continue to perform their
respective obligations to the Trust pursuant to the Trust Documents, including
without limitation the performance assurances of Williams set forth in the
Conveyance, and (iii) Quatro Finale acknowledged and agreed that it was
purchasing the Underlying Properties burdened by the Royalty Interests owned by
the Trust.
The following description contains a summary of the material terms of
the Conveyance and is subject to and qualified by the more detailed provisions
of the Conveyance, a copy of which is filed as an exhibit to this Form 10-K.
THE UNDERLYING PROPERTIES
The Royalty Interests were conveyed by WPC to the Trust from its net
revenue interest (working interest less lease burdens) in the WI Properties and
its net profits interest in the Farmout Properties. Substantially all of the
production from the Underlying Properties is from the Fruitland coal formation
in the San Juan Basin. The San Juan Basin (the "Basin"), one of the largest gas
producing basins in the United States, encompasses approximately 12,000 square
miles in northwest New Mexico and southwest Colorado, just east of the common
corner of the states of Utah, Arizona, New Mexico and Colorado known as the Four
Corners. It covers parts of La Plata and Archuleta counties in Colorado, as well
as parts of San Juan, Rio Arriba, McKinley and Sandoval counties in New Mexico.
The Basin has been an active area for coal seam gas development within the
Fruitland coal formation.
Williams acquired its interests in the Underlying Properties in 1983
through the acquisition of Northwest Pipeline Corporation ("Northwest"), and
such Underlying Properties were transferred to WPC on December 31, 1990.
Northwest originally owned working interests which were burdened by overriding
royalty interests in the Underlying Properties. The overriding royalty interests
resulted in excessive burdens and Northwest negotiated settlements with the
owners of the overriding royalty interests. Pursuant to one of these
settlements, Northwest and Amoco Production Company ("Amoco") entered into a
joint venture under which Northwest agreed to assign to Amoco certain oil and
gas properties in two exploratory areas, one of which (the PLA-9 properties)
comprises the Farmout Properties. In consideration for such assignment,
Northwest received an overriding royalty interest in the Farmout Properties.
Northwest's rights under the joint venture agreement were subsequently assigned
to WPC, which elected, effective as of October 1, 1992, to convert the
overriding royalty interest in the Farmout Properties to a 35 percent net
profits interest. Effective May 1, 1997, WPC conveyed its rights in the
Underlying Properties to Quatro Finale.
Development of the Fruitland coal formation acreage has resulted in the
drilling of 627 gross coal seam gas wells in the Underlying Properties, 22 of
which are in the Farmout Properties. Quatro Finale owns mineral rights in the
Fruitland coal formation under 214 oil and gas leases. Under the terms of these
leases, Quatro Finale has the right to extract oil and gas from the lease
properties. Quatro Finale holds either a record title interest, operating right
interest or net profits interest in the leases. Record title and operating right
interests are commonly referred to as working interests. The Underlying
Properties constitute substantially all of Quatro Finale's proved reserves in
the Fruitland coal formation. Neither Quatro Finale nor WPC operate any of the
coal seam gas wells on the Underlying Properties.
Unitized Areas. Approximately 90 percent of the Fruitland coal
formation proved developed coal seam gas wells on the WI Properties are located
within the boundaries of New Mexico Federal Units (as defined herein). Pursuant
to the Federal Mineral Leasing Act of 1920, as amended, and applicable state
regulations, owners of oil and gas leases in New Mexico created large unitized
areas consisting of several contiguous sections for the orderly development and
conservation of oil and gas reserves. The WI Properties participate in
production from the 12 unitized areas in New Mexico referred to in the following
table (the "Federal Units"). Operation and development of the Federal Units is
governed by unit agreements and unit operating agreements (collectively, the
"Unit Agreement"). Under the Unit Agreement and applicable government
regulations, the Federal Unit operators request regulatory approval from the New
Mexico Commission of Public Lands, the New Mexico Oil Conservation Commission
and the Bureau of Land Management to establish or expand participating areas
which produce oil and gas in paying quantities from designated formations. The
interests of participants in a participating area are based on the surface
acreage included in the
20
participating area. Under the terms of the Unit Agreements, the operators,
selected by a vote of the respective working interest owners, perform all
operating functions.
In all of the Federal Units, participating areas have been formed for
the Fruitland coal formation. After the wells capable of producing gas in paying
quantities from the Fruitland coal formation are drilled on the undeveloped
drill blocks included within a Federal Unit, such wells are added to the
participating area if approved in accordance with the appropriate Unit
Agreement. A delay of at least 18-36 months is usually incurred after a well is
completed and producing before it is added to a participating area. As
participating areas are created and expanded, such modification (which will be
effective retroactively to the date production commenced from the wells causing
such expansion) results in a participant owning undivided interests in all of
the producing wells within the participating area. Therefore, Quatro Finale's
working interest and net revenue interest in the wells in a Federal Unit or
participating area may be modified retroactively, which could affect
significantly the amount of NPI Net Proceeds with respect to production from
October 1, 1992. If any well(s) that produced or may have produced marketable
quantities of coal seam gas prior to 1980 is included in or added to a
participating area in which the WI Properties participate, the Conveyance
provides that such well(s) will be treated as, and the Trust will own, a
separate Net profits interest in such well(s) (the "Pre-80 Production NPI"). The
net proceeds for such Pre-80 Production NPI would be calculated in a manner
similar to the calculation of Infill Net Proceeds, and the Trust's share of such
net proceeds will be 81 percent, subject to decrease upon the same terms as the
NPI. If a participating area expansion includes production from wells that do
not qualify for Section 29 tax credits, the tax credit available to Unitholders
in respect of production attributable to the NPI from such Federal Unit could be
reduced. See "Item 1 -- Federal Income Taxation." As discussed in "Item 1 --
Federal Income Taxation", coal seam gas produced and sold after December 31,
2002, will no longer generate a Section 29 credit unless applicability of the
Section 29 credit is extended by Congress.
The following table reflects certain information from the Reserve
Report as of December 31, 2002 prepared by Miller and Lents, Ltd. dated February
10, 2003 (the "December 31, 2002 Reserve Report") regarding the Federal Units in
which the WI Properties participate. At December 31, 2002, the WI Properties
covered 627 gross (72 net) coal seam gas wells with working interests ranging
from .0589 percent to 100 percent, with an average working interest of
approximately 11.5 percent. The Royalty Interests participate in each Federal
Unit and participating area in which the WI Properties participate based on the
acreage containing wells with proved reserves on December 31, 2002.
<Table>
<Caption>
UNDERLYING PROPERTIES
-----------------------------
ESTIMATED
DISCOUNTED
FUTURE NET
NET PROVED REVENUES
RESERVES (DISCOUNTED
FEDERAL UNIT FEDERAL UNIT OPERATOR (Bcf) AT 10%)
------------ --------------------------------- ----- -------
(IN THOUSANDS)
San Juan 32-9...................... Meridian Oil Inc. 12.1 19,669
San Juan 32-7...................... Conoco Phillips 12.9 19,463
San Juan 30-5...................... Conoco Phillips 12.9 18,811
San Juan 30-6...................... Meridian Oil Inc. 11.4 17,864
San Juan 32-8...................... Conoco Phillips 11.3 17,192
San Juan 29-6...................... Conoco Phillips 6.3 9,735
San Juan 31-6...................... Conoco Phillips 5.4 7,980
San Juan 29-7...................... Meridian Oil Inc. 2.8 4,074
Huerfano........................... Meridian Oil Inc. 3.0 3,321
Northeast Blanco................... Blackwood & Nichols Co., Ltd. 1.8 2,928
San Juan 29-5...................... Conoco Phillips .7 937
San Juan 28-6...................... Meridian Oil Inc. .6 608
San Juan 28-5...................... Meridian Oil Inc. .8 60
</Table>
Meridian Oil Inc. is a subsidiary of Burlington Resources Inc. and
Blackwood & Nichols Co., Ltd. is a subsidiary of Devon Energy Corporation.
21
Well Count and Acreage Summary. The following table shows as of December
31, 2000, 2001, and 2002, the gross and net wells and acreage by proved
producing and nonproducing categories for the WI Properties.
<Table>
<Caption>
NUMBER OF
WELLS ACRES
----- -----
GROSS NET GROSS NET
----- --- ----- ---
DECEMBER 31,
------------
2000
Producing................. 600 68 150,988 20,681
Nonproducing.............. 0 0 0 0
------- ------- ------- -------
Total................ 600 68 150,988 20,681
======= ======= ======= =======
2001
Producing................. 631 73 150,988 20,681
Nonproducing.............. 0 0 0 0
------- ------- ------- -------
Total................ 631 73 150,988 20,681
======= ======= ======= =======
2002
Producing................. 627 72 150,988 20,681
Nonproducing.............. 0 0 0 0
------- ------- ------- -------
Total................ 627 72 150,988 20,681
</Table>
Of the total gross wells described above at December 31, 2002, 582
gross wells are located in unitized areas. In addition to the above, the Farmout
Properties have 22 gross wells.
Properties Outside Unitized Areas. The WI Properties also include
interests held by Quatro Finale in 23 proved developed Fruitland formation coal
seam gas wells held in areas outside of Federal Units that are not reflected in
the foregoing table. As of December 31, 2002, Quatro Finale's working interest
and net revenue interests in these wells averaged 0.9 percent and 7.3 percent,
respectively.
The Farmout Properties consist of a 35 percent Net profits interest on
a property farmed out to Amoco in La Plata County, Colorado. Such properties are
not within any Federal Unit boundary. The Farmout Properties are owned, and most
of the wells thereon are operated, by Amoco. Neither Quatro Finale, Williams,
WPC, the Delaware Trustee, the Trustee nor the Unitholders are able to influence
or control the operation or future development of the Farmout Properties. WPC
has advised the Trustee that it believes that a majority of the production from
the Farmout Properties is sold by Amoco under short-term marketing arrangements
at spot market prices and qualifies for the Section 29 tax credit (to the extent
the Section 29 credit is available). No assurance can be given, however, that
Amoco will not in the future subject production from the Farmout Properties to
long-term sales contracts at non-market responsive prices. A portion of the
production from the Farmout Properties is gathered by WFS pursuant to a
gathering contract at rates and subject to other terms that were negotiated on
an arms-length basis. As of December 31, 2002, 22 gross wells had been drilled
on the Farmout Properties. For a further description of the Farmout Properties,
see " -- The NPI."
THE NPI
Prior to 2001, the NPI generally entitled the Trust to receive 81
percent of the NPI Net Proceeds, subject to permanent reduction under certain
conditions as described under "--NPI Percentage Changes." The percentage of NPI
Net Proceeds which the Trust is entitled to receive was permanently reduced to
60 percent in the fourth quarter of 2000. NPI Net Proceeds consists generally of
the aggregate proceeds attributable to (i) Quatro Finale's net revenue interest
based on the sale at the Wellhead of gas produced from the WI Properties and
(ii) the revenue stream received by Quatro Finale from its 35 percent Net
profits interest in the Farmout Properties, less (a) Quatro Finale's working
interest share of property and production taxes on the WI Properties; (b) Quatro
Finale's working interest share of actual operating costs on the WI Properties
to the extent in excess of those agreed to be paid by Quatro Finale (as
successor to WPC)
22
as described herein; (c) Quatro Finale's working interest share of capital costs
on the WI Properties to the extent in excess of those agreed to be paid by
Quatro Finale (as successor to WPC) as described herein; and (d) interest on the
unrecovered portion, if any, of the foregoing costs at Citibank's Base Rate.
Most of the wells reflected in the December 31, 2002 Reserve Report
were drilled prior to 1994. Significant additional capital expenditures were not
incurred during the early years of the production lives of such wells, and it is
not anticipated that further significant capital expenditures will be incurred.
Consequently, the December 31, 2002 Reserve Report was prepared on the basis
that there will be no capital expenditures borne by the Royalty Interests.
Nevertheless, the operators and working interest owners of the wells could elect
at any time to implement measures to increase the producible reserves. These
measures, if implemented, could involve additional compression or enhanced or
secondary recovery operations requiring substantial capital expenditures that
would be proportionately borne by the Royalty Interests.
Exhibit B to the Conveyance reflects estimated annual operating
expenses for wells on the WI Properties. No operating expenses in respect of the
WI Properties will be deducted in calculating NPI Net Proceeds except when the
actual cumulative operating expenses attributable to Quatro Finale's working
interests in the WI Properties exceed the estimated cumulative operating
expenses reflected in Exhibit B to the Conveyance as of the close of a calendar
quarter (less the estimated operating costs in such Exhibit that are allocable
to two wells that were repurchased effective as of January 1, 1994, by WPC as a
purchase price adjustment or to any wells that are reconveyed to WPC as
uneconomic). The amount by which such actual cumulative operating expenses
exceed estimated cumulative operating expenses reflected in such Exhibit will be
deducted in calculating NPI Net Proceeds and, therefore, will reduce the amounts
payable to the Trust.
If, during any period, costs and expenses deductible in calculating the
NPI Net Proceeds exceed gross proceeds, neither the Trust nor Unitholders will
be liable for such excess, but the Trust will receive no payments for
distribution to Unitholders with respect to the NPI until future gross proceeds
exceed future costs and expenses plus the cumulative excess of such costs and
expenses plus interest thereon at Citibank's Base Rate. However, if the excess
costs are the result of capital costs incurred for enhanced recovery or similar
operations on the WI Properties, the Trust will receive no less than 20 percent
of the NPI Net Proceeds (calculated before such capital costs are deducted)
until such excess costs plus interest thereon at Citibank's Base Rate are
recovered by Quatro Finale unless such capital costs are $3,000,000 or more, in
which event the Trust will only receive payments equal to the administrative
costs of the Trust until such unrecovered costs plus interest thereon at
Citibank's Base Rate are less than $3,000,000.
The calculation of NPI Net Proceeds includes amounts received by Quatro
Finale in respect of its 35 percent net profits interest in the Farmout
Properties. Quatro Finale's net profits interest in the Farmout Properties is
calculated on a total operations basis and is defined as lease revenues less
burdens, operating expenses (including overhead as defined in the applicable
operating agreement) and all taxes related to the value of reserves, production,
property and equipment (e.g., severance and ad valorem taxes).
WPC has advised the Trustee that the majority of the coal seam gas from
the Farmout Properties is sold by Amoco under short-term marketing arrangements
at spot market prices and the remainder is marketed by the other operators of
the wells in the Farmout Properties. Neither the Gas Purchase Contract nor the
Gas Gathering Contract covers the volumes produced from the Farmout Properties.
RESERVE REPORT
The following table summarizes net proved reserves estimated as of
December 31, 2002, and certain related information for the Royalty Interests and
Underlying Properties from the December 31, 2002 Reserve Report prepared by
Miller and Lents, Ltd., independent petroleum engineers. A summary of the
December 31, 2002 Reserve Report is filed as an exhibit to this Form 10-K and
incorporated herein by reference. See Note 9 to "Item 8--Financial Statements
and Supplementary Data--Notes to Financial Statements" for additional
information regarding the net proved reserves of the Trust.
A Net profits interest does not entitle the Trust to a specific
quantity of gas but to a portion of the net proceeds derived therefrom.
Ordinarily and in the case of the Farmout Properties, proved reserves
attributable to a Net profits
23
interest are calculated by deducting an amount of gas sufficient, if sold at the
prices used in preparing the reserve estimates for such net profits interest, to
pay the future estimated costs and expenses deducted in the calculation of the
net proceeds of such interest. Because Quatro Finale (as successor to WPC) has
agreed to pay certain operating and capital costs with respect to the WI
Properties, no amount of gas in respect of such costs has been deducted from the
amount of reserves attributable to the WI Properties in determining the amount
of reserves attributable to the Royalty Interests. Accordingly, the reserves
presented for the Royalty Interests reflect quantities of gas that are free of
future costs and expenses (other than production, severance and ad valorem taxes
in respect of the WI Properties) if the price and cost assumptions set forth in
the December 31, 2002 Reserve Report occur. The December 31, 2002 Reserve Report
was prepared in accordance with criteria established by the Commission and,
accordingly, is based upon a contractual price for gas for December 2002, of
$3.125 per MMBtu before transportation charges. The December 31, 2002 Reserve
Report is also based on the percentage share of NPI Net Proceeds payable to the
Trust continuing at 60 percent (permanently reduced from 81 percent since the
fourth quarter of 2000) for the remaining life of the reserves.
<Table>
<Caption>
ROYALTY UNDERLYING
INTERESTS PROPERTIES
--------- ----------
Net Proved Gas Reserves (Bcf)(a)(b). . . . . . . . . . . . . . . . . . . . . . . . . 39.7 117.5
Estimated Future Net Revenues (in millions)(c) . . . . . . . . . . . . . . . . . . . 65.3 246.1
Discounted Estimated Future Net Revenues (in millions)(c) . . . . . . . . . . . . . . 46.0 167.0
</Table>
- ----------
(a) Although the prices utilized in preparing the estimates in this table
are in accordance with criteria established by the Commission, such
prices were influenced by seasonal demand for natural gas and other
factors and may not be the most representative prices for estimating
future net revenues or related reserve data.
(b) The gas reserves were estimated by Miller and Lents, Ltd. by applying
decline curve analyses utilizing type curves for the various areas in
the Basin. The bases for the consideration of type curves are the
production histories, the water and gas production rates and the
initial reservoir pressures of the wells in the separate areas.
(c) Estimated future net revenues are defined as the total revenues
attributable to the Underlying Properties and Royalty Interests less
royalties, severance and ad valorem taxes, operating costs and future
capital expenditures in excess of estimated amounts to be paid by
Quatro Finale. Overhead costs (beyond the standard overhead charges for
the nonoperated properties) have not been included, nor have the
effects of depreciation, depletion and Federal income tax. Estimated
future net revenues and discounted estimated future net revenues are
not intended and should not be interpreted as representing the fair
market value for the estimated reserves.
As discussed in "Item 1 -- Federal Income Taxation," coal seam gas
produced and sold after December 31, 2002, will no longer generate a Section 29
credit unless applicability of the Section 29 credit is extended by Congress.
There are many uncertainties inherent in estimating quantities and
values of proved reserves and in projecting future rates of production and the
timing of development expenditures. The reserve data set forth herein, although
prepared by independent petroleum engineers in a manner customary in the
industry, are estimates only, and actual quantities and values of natural gas
are likely to differ from the estimated amounts set forth herein. In addition,
the reserve estimates for the Royalty Interests will be affected by future
changes in sales prices for natural gas produced and costs that are deducted in
calculating NPI Net Proceeds and Infill Net Proceeds. Further, the discounted
present values shown herein were prepared using guidelines established by the
Commission for disclosure of reserves and should not be considered
representative of the market value of such reserves or the Units. A market value
determination would include many additional factors.
Information concerning historical changes in net proved reserves
attributable to the Underlying Properties, and the calculation of the
standardized measure of discounted future net revenues related thereto, are
contained in Note 9 to "Item 8--Financial Statements and Supplementary
Data--Notes to Financial Statements." Williams has not filed reserve estimates
covering the Underlying Properties with any Federal authority or agency other
than the Commission.
24
HISTORICAL GAS SALES PRICES AND PRODUCTION
The following table sets forth the actual net production volumes from
the WI Properties, weighted average lifting costs and information regarding
historical gas sales prices for each of the years ended December 31, 2002, 2001
and 2000:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
2002 2001 2000
---- ---- ----
Production from the WI Properties (MMcf) .................................. 11,295 15,937 12,967
Weighted average lifting costs (dollars per Mcf) ......................... $ 0.33 $ 0.24 $ 0.37
Weighted average sales price of gas produced from the WI Properties
(dollars per Mcf) $ 1.65 $ 1.91 $ 0.37
Average Blanco Hub Spot Price (dollars per MMBtu) ......................... $ 2.58 $ 3.75 $ 3.53
</Table>
The published Blanco Hub Spot Price for December 2002 was $3.64 per
MMBtu. Information regarding average wellhead sales prices for production from
the Farmout Properties is not available to WPC (as manager of Quatro Finale's
interests in the Underlying Properties on behalf of Quatro Finale), although WPC
has advised the Trustee that it believes production from such properties is
currently sold by Amoco under short-term marketing arrangements at spot market
prices.
NPI PERCENTAGE REDUCTION
As described above under "--The NPI," since the Trust's inception, the
NPI has generally entitled the Trust to receive 81 percent of NPI Net Proceeds.
However, under the terms of the Conveyance, at the point that (i) cumulative gas
production since October 1, 1992, from the Underlying Properties has exceeded
178.5 Bcf and (ii) the internal rate of return of the "Aftertax Cash flow per
Unit" (as defined below) has equaled or exceeded 12 percent, the percentage of
NPI Net Proceeds payable to the Trust in respect of the NPI is automatically and
permanently reduced to 60 percent. In such event, Quatro Finale's retained
percentage of NPI Net Proceeds is correspondingly increased from 19 percent to
40 percent. For purposes hereof, "Aftertax Cash Flow per Unit" is equal to the
sum of the following amounts that a hypothetical purchaser of a Unit in the
Public Offering would have received or been allocated if such Unit were held
through the date of such determination: (a) total cash distributions per Unit
plus (b) total tax credits available per Unit under Section 29 of the IRC less
(c) the net taxes payable per Unit (assuming a Federal income tax rate of 31
percent, which at the time of the formation of the Trust was the highest Federal
income tax rate applicable to individuals). IRR is the annual discount rate
(compounded quarterly) that equates the present value of the Aftertax Cash Flow
per Unit to the initial price to the public of the Units in the Public Offering
(which was $20.00 per Unit).
Cumulative production since October 1, 1992, from the Underlying
Properties has been in excess of 178.5 since 1999. The 12 percent internal rate
of return of Aftertax Cash Flow per Unit was reached in during the fourth
quarter of 2000. Consequently, beginning in the fourth quarter of 2000, the
percentage of NPI Net Proceeds the Trust is entitled to receive under the NPI
has been permanently reduced from 81 percent to 60 percent. Quatro Finale's
retained percentage of NPI Net proceeds has been correspondingly increased from
19 percent to 40 percent.
GAS PURCHASE CONTRACT
Under the terms of the Gas Purchase Contract, WPX Gas Resources (as
successor in interest to WGM) purchased the natural gas produced from the WI
Properties (except for certain small volumes) at the Wellhead. The Gas Purchase
Contract commenced October 1, 1992, and expires on the termination of the Trust.
The Gas Purchase Contract provides for a pricing mechanism during an initial
5-year period ("Primary Term") which expired on December 31, 1997. Following the
expiration of the Primary Term, the pricing mechanism continues for one or more
consecutive additional one-year terms (each such term a "Contract Year") unless
and until WPX Gas Resources exercises its annual option, exercisable 15 days
prior to the end of each Contract Year, to discontinue purchasing gas from
Quatro Finale (as successor to WPC) under the pricing provision of the Gas
Purchase Contract and instead purchase gas at a monthly price equal to the
"Index Price" as described hereafter. For each of the Contract Years 2000, 2001
and 2002, WPX Gas Resources did not exercise this option and therefore the
pricing mechanism of the Primary Term remained in effect for each of those past
years and will continue to remain in effect through at least December 31, 2003.
Under this mechanism,
25
the monthly price to be paid by WPX Gas Resources for natural gas purchased
pursuant to the Gas Purchase Contract shall be (a) the $1.70 Minimum Purchase
Price, less (b) any costs paid by WPX Gas Resources to gather, treat and process
the gas and deliver it to specified delivery points and plus (c) under certain
circumstances, additional amounts determined as described below:
(i) If the Index Price in any month during any Contract Year, including
2003, is greater than $1.94 per MMBtu, then WPX Gas Resources will pay
Quatro Finale (as successor to WPC) an amount for gas purchased equal
to $1.94 per MMBtu, less the costs paid by WPX Gas Resources to gather
and process such gas and deliver it to specified delivery points, plus
50 percent of the excess of the Index Price over $1.94 per MMBtu (the
"Price Differential"), provided WPX Gas Resources has no accrued Price
Credits (see below) in the Price Credit Account, as defined below. If
WPX Gas Resources has accrued Price Credits in the Price Credit
Account, then WPX Gas Resources will be entitled to reduce the amount
in excess of the Minimum Purchase Price (before deducting gathering and
processing costs and costs to deliver the gas to specified delivery
points) that otherwise would be payable by any accrued and unrecouped
Price Credits in the Price Credit Account, and WPX Gas Resources will
not be obligated to pay Quatro Finale any amounts in excess of the
Minimum Purchase Price until such time as all accrued Price Credits
have been recouped and a zero balance exists in the Price Credit
Account.
(ii) If the Index Price in any month during any Contract Year,
including 2003, is greater than the Minimum Purchase Price but less
than or equal to $1.94 per MMBtu, then WPX Gas Resources will pay
Quatro Finale an amount for each MMBtu purchased equal to the Index
Price less the costs paid by WPX Gas Resources to gather and process
such gas and deliver it to specified delivery points, provided WPX Gas
Resources has no accrued Price Credits in the Price Credit Account. If
WPX Gas Resources has accrued Price Credits in the Price Credit
Account, then WPX Gas Resources will be entitled to reduce the amount
in excess of the Minimum Purchase Price (before deducting, gathering
and processing costs and costs to deliver to specified delivery points)
that otherwise would be payable by any accrued and unrecouped Price
Credits in the Price Credit Account, and WPX Gas Resources will not be
obligated to pay WPC any amounts in excess of the Minimum Purchase
Price until such time as all accrued Price Credits have been recouped
and a zero balance exists in the Price Credit Account.
(iii) If the Index Price in any month during any Contract Year,
including 2003, is less than the Minimum Purchase Price, then WPX Gas
Resources will pay for each MMBtu of gas purchased the Minimum Purchase
Price less the costs paid by WPX Gas Resources to gather and process
such gas and deliver it at specified delivery points, and WPX Gas
Resources will receive a credit (the "Price Credit") from Quatro Finale
for each MMBtu of gas purchased by WPX Gas Resources equal to the
difference between the Minimum Purchase Price and the Index Price.
Quatro Finale is required to establish and maintain the Price Credit
Account containing the accrued and unrecouped amount of such Price
Credits. No Price Credits were accrued in respect of production
purchased by WPX Gas Resources prior to January 1, 1994.
For the year ended December 31, 2002, which is based on production
volumes and natural gas prices for the twelve months ended September 30, 2002,
the Index Price exceeded the Minimum Purchase Price for each month during the
year except for October 2001. As of December 31, 2002 and 2001, there were no
remaining unrecouped Price Credits in the Price Credit Account.
To the extent there may in the future be a balance in the Price Credit
Account, the entitlement to recoup Price Credits means that if and when the
Index Price is above the Minimum Purchase Price, future royalty income paid to
the Trust would be reduced until such time as such Price Credits have been fully
recouped. Corresponding cash distributions to Unitholders would also be reduced.
Subsequent to the expiration of the Primary Term of the pricing
provision of the Gas Purchase Contract, which occurred on December 31, 1997, WPX
Gas Resources has an annual option (which can be exercised only once during the
term of the Gas Purchase Contract) to discontinue purchasing gas under the
pricing provision of the Gas Purchase Contract by giving written notice of its
election to pay solely the Index Price (less the costs paid by WPX Gas Resources
to gather, treat and process such gas and deliver it to specified points). If
WPX Gas Resources so elects to discontinue paying under the pricing provision,
WPX Gas Resources will no longer be entitled to retain the Price Differential
when
26
the Index Price exceeds $1.94 per MMBtu and any accrued and unrecouped Price
Credits will be extinguished. Since there is no published price in the San Juan
Basin for wellhead deliveries, the wellhead price in the Gas Purchase Contract
is determined by utilizing a published price which is inclusive of gathering,
treating and processing costs. As used in this "Item 2. Properties - Reserve
Report," "Index Price" means 97 percent of the first of month El Paso Natural
Gas Co. -- San Juan Spot Price. The El Paso Natural Gas Co. -- San Juan Spot
Price is a posted index price per MMBtu (dry basis) published in Inside
F.E.R.C.'s Gas Market Report, which is a bi-monthly publication by The
McGraw-Hill Companies, Inc. The Gas Purchase Contract provides WPX Gas Resources
a one-time option to convert the Index Price from the first of month posting of
El Paso Natural Gas Co. -- San Juan Spot Price to the average of the bi-monthly
postings for that same index. The Gas Purchase Contract further provides for an
alternative indexing mechanism in the event the Inside F.E.R.C.'s Gas Market
Report indices are modified or discontinued. All prices used as index prices are
delivered prices at the specified point of delivery and are, therefore, before
deducting gathering and/or transportation charges, taxes, treating costs or
other costs payable prior to the delivery points. During periods when there is a
Price Differential, WPX Gas Resources will absorb a portion of the gathering
charges based on a formula specified within the Gas Purchase Contract.
A small volume of gas produced from the WI Properties (less than 5
percent) is sold by the operators of certain wells under gas purchase contracts
with other buyers.
The prices paid to Quatro Finale pursuant to the Gas Purchase Contract
are prices payable for the value of gas purchased for production at the
Wellhead. Title to the gas purchased pursuant to the Gas Purchase Contract
passes to WPX Gas Resources at the Wellhead. WPX Gas Resources is responsible
for gathering, treating, processing and marketing all gas purchased pursuant to
the Gas Purchase Contract. Approximately 90 percent of the production from the
WI Properties is gathered by WPX on behalf of WPX Gas Resources. The balance of
the production is gathered on behalf of WPX Gas Resources by third parties. See
"--Gas Gathering Contract." The price paid to Quatro Finale pursuant to the Gas
Purchase Contract is after deducting the costs incurred by WPX Gas Resources to
gather, treat and process such gas (including costs incurred by WPX Gas
Resources under the Gas Gathering Contract). Payments to Quatro Finale for gas
purchased pursuant to the Gas Purchase Contract are made by WPX Gas Resources on
or before the last day of the first calendar month next following the end of
each calendar quarter.
NPI Net Proceeds and Infill Net Proceeds are calculated on an
entitlements or entitled volume basis, whereby the aggregate proceeds from the
sale of gas under applicable gas sales contracts (excluding production from the
Farmout Properties) are determined by WPC as agent for Quatro Finale as if
Quatro Finale had produced and sold its working interest share of production
from the WI Properties, even if the actual volumes delivered to and sold by
Quatro Finale are different than the entitlement volumes. The effect of such an
"entitlements basis" calculation is that NPI Net Proceeds or Infill Net Proceeds
and, therefore, the amount thereof paid to the Trust, may include amounts in
respect of production not taken by Quatro Finale because of a so-called
imbalance (that is, where a working interest owner is delivered more or less
than the actual share of production to which it is entitled).
The Gas Purchase Contract may not be amended in a manner that would
materially adversely affect the revenues to the Trust without the approval of
the holders of a majority of the Units present or represented at a meeting of
Unitholders at which a quorum (consisting of a majority of the outstanding
Units) is present or represented. As noted elsewhere herein, the Units held by
Williams (or an affiliate) immediately after the Public Offering may not be
voted on any such amendment nor will such Units be counted for quorum purposes
so long as such Units are held by Williams (or an affiliate). Effective August
11, 2000, Williams sold all of its remaining holdings of Units to QFIV. A copy
of the Gas Purchase Contract is filed as an exhibit to this Form 10-K. The
foregoing summary of the material provisions of the Gas Purchase Contract is
qualified in its entirety by reference to the terms of such agreement as set
forth in such exhibit.
GAS GATHERING CONTRACT
In accordance with the Confirmation Agreement, effective May 1, 1995,
WGM assigned to WPX Gas Resources all of its right, title, interest, duties and
obligations under the Gas Gathering Contract, and WPX Gas Resources assumed all
of WGM's right, title, interest, duties and obligations thereunder.
The Gas Gathering Contract, which will be in effect until December 31,
2022, subject to annual extensions thereafter, covers approximately 90 percent
of the production from the WI Properties and commits WFS on behalf of
27
WPX Gas Resources to gather such production (except production from 19 wells in
the San Juan 29-7 unit as described below), at rates starting at $.35 per Mcf
(plus a fuel reimbursement estimated to be 6.2 percent to 7.3 percent of
gathered volumes on a Btu equivalent basis, and subject to increase if the CO2
content of the gas exceeds 10 percent) and adjusted annually based on average
annual price comparisons determined on the basis of the Blanco Hub Spot Price,
provided that the gathering rate will be no less than $.35 per Mcf increased or
decreased on the basis of an increase or decrease in a published index measuring
the gross domestic product. A significant portion of the gas to be gathered
pursuant to the Gas Gathering Contract must first be gathered from the Wellhead
to a Federal Unit central delivery point by Burlington Resources Gathering Inc.
("Burlington"). WPX Gas Resources has been assigned a one-year gathering
contract (with a monthly evergreen provision) whereby Burlington provides
interruptible gathering service at the price of $.06 per Mcf which escalates
annually at 3 percent, plus actual fuel used (historically averaging
approximately .5 percent). It is anticipated that WPX Gas Resources will be able
to extend the term of this agreement. [CONFIRM]
The remainder of the production on the WI Properties is not physically
connected to the WFS system and is not covered by the Gas Gathering Contract.
This gas is gathered either by Burlington or El Paso Field Services ("EFS") for
delivery at the Blanco Hub or by WFS for delivery at the outlet of the Ignacio
Plant in La Plata County, Colorado. WPC has existing long-term gathering
agreements with EFS and short-term gathering agreements with Burlington with
rates and terms generally comparable to the Gas Gathering Contract.
The Gas Gathering Contract may not be amended in a manner that would
materially adversely affect the revenues to the Trust without the approval of
the holders of a majority of the Units present or represented at a meeting of
Unitholders at which a quorum (consisting of a majority of the outstanding
Units) is present or represented. As noted elsewhere herein, the Units held by
Williams (or an affiliate) immediately after the Public Offering may not be
voted on any such amendment nor will such Units be counted for quorum purposes
so long as such Units are held by Williams (or an affiliate).
The Gas Gathering Contract was twice amended, each effective as of
October 1, 1993, with respect to 19 wells located in the San Juan 29-7 unit. WFS
is obligated to gather production from such wells at a rate of $.36 per Mcf
(plus a fuel reimbursement of 5.5 percent of the gas received at the Wellhead
Receipt Points (as defined)), fixed for a 10 year term. In connection with these
amendments to the Gas Gathering Contract, the Trustee received an opinion of
counsel to Williams that such amendments need not be submitted for approval by
vote of the Unitholders.
The Gas Gathering Contract was further amended effective as of April 1,
1997, for the purpose of increasing the field rights held by the Trust on the
Manzanares gathering system. The increase accommodates incremental gas flow that
will occur due to WFS's expansion and enhancement of gathering facilities.
A copy of the Gas Gathering Contract is filed as an exhibit to this
Form 10-K. The foregoing summary of the material provisions of the Gas Gathering
Contract is qualified in its entirety by reference to the terms of such
agreement as set forth in such exhibit.
FEDERAL AND INDIAN LANDS
Approximately 80 percent of the Underlying Properties are burdened by
Royalty Interests held by the Federal government or the Southern Ute Indian
Tribe. Royalty payments due to the U.S. Government for gas produced from Federal
and Indian lands included in the Underlying Properties must be calculated in
conformance with its interpretation of regulations issued by the Minerals
Management Service ("MMS"), a subagency of the U.S. Department of the Interior
which administers and receives revenues from Federal and Indian royalties on
behalf of the U.S. Government and as agent for the Indian tribes. The MMS
regulations cover both valuation standards which establish the basis for placing
a value on production and cost allowances which define those post-production
costs that are deductible by the lessee.
Where gas is sold by a lessee to a marketing affiliate such as WPX Gas
Resources, the MMS regulations essentially ignore the lessee-affiliate
transaction and consider the arm's-length sale by the affiliate as the point of
valuation for royalty purposes. Accordingly, Quatro Finale is required to
calculate royalty payments based on the price WPX Gas Resources receives when it
markets the gas production ("Resale Price"), notwithstanding the price payable
by WPX Gas Resources to Quatro Finale pursuant to the Gas Purchase Contract.
With respect to the Farmout Properties, Amoco pays royalties based on the price
it receives for production from such properties as long as the gas is purchased
28
by nonaffiliates. The NPI Net Proceeds, a portion of which is payable to the
Trust, reflects the deduction of all royalty and overriding royalty burdens. The
ratio of royalties paid on Federal and Indian lands to the NPI Net Proceeds
increases as the Resale Price exceeds the price under the Gas Purchase Contract.
The MMS regulations permit a lessee to deduct from its gross proceeds
its reasonable actual costs of transportation and processing to transport the
gas from the lease to the point of sale in calculating the market value of its
production. Although WPX Gas Resources deducts the gathering charges paid by it
to WFS, Burlington, EFS and Northwest in calculating the wellhead price it pays
to Quatro Finale, the MMS could disallow the deduction of some portion of the
gathering charges after review of such charges on audit of Quatro Finale's
royalty as discussed below. If some portion of the gathering charges is
disallowed, the MMS will likely demand additional royalties plus interest on the
amount of the underpayment.
The Trustee has been advised by WPC that the MMS has from time to time
considered the inclusion of the value of the Section 29 tax credits attributable
to coal seam gas production in the calculation of gross proceeds for purposes of
calculating the royalty that is payable to the MMS. On August 30, 1993, the U.S.
Office of the Inspector General (the "OIG") issued an audit report stating that
Section 29 tax credits should be included in the calculation of gross proceeds
and recommending that the MMS pursue collection of additional royalties with
respect to past and future production. On December 8, 1993, however, the Office
of the Solicitor of the U.S. Department of the Interior gave its opinion to the
MMS that the report of the OIG was incorrect and that Section 29 tax credits are
not part of gross proceeds for the purpose of federal royalty calculations. WPC
believes that any such inclusion of the value of Section 29 tax credits for
purposes of calculating royalty payments required to be made on Federal and
Indian lands would be inappropriate since all mineral interest owners, including
royalty owners, are entitled to Section 29 tax credits for their proportionate
share of qualifying coal seam gas production (to the extent that the Section 29
credit is available). WPC has advised the Trustee that it would vigorously
oppose any attempt by the MMS to require the inclusion of the value of Section
29 tax credits in the calculation of gross proceeds. However, if regulations
providing for the inclusion of such value were adopted and upheld, royalty
payments would be increased which would decrease NPI Net Proceeds and,
therefore, the amounts payable to the Trust. The reduction in amounts payable to
the Trust would cause a corresponding reduction in associated Section 29 tax
credits available to Unitholders. As discussed in "Item 1 -- Federal Income
Taxation," coal seam gas produced and sold after December 31, 2002, will no
longer generate a Section 29 credit unless applicability of the Section 29
credit is extended by Congress.
The MMS generally audits royalty payments within a six-year period.
Although WPC, on behalf of Quatro Finale, calculates royalty payments in
accordance with its interpretation of the then applicable MMS regulations, WPC
does not know whether the royalty payments made to the U.S. Government are
totally in conformance with MMS standards until the payments are audited. If an
MMS audit, or any other audit by a Federal or state body, results in additional
royalty charges, together with interest, relating to production from and after
October 1, 1992, in respect of the Underlying Properties, such charges and
interest will be deducted in calculating NPI Net Proceeds for the quarter in
which the charges are billed and in each quarter thereafter until the full
amount of the additional royalty charges and interest have been recovered.
On January 5, 2001, the State of New Mexico, acting under authority of
the MMS, presented WPC with an Audit Issue Letter for the alleged underpayment
of royalties in the amount of $948,501, on gas produced from the Underlying
Properties due to Federal royalty owners during the time period from January
1992 through December 1996. MMS regulations permit a lessee to deduct from its
gross proceeds its reasonable actual costs of transportation and processing to
transport the gas from the lease to the point of sale in calculating the market
value of its production. The State of New Mexico claims that certain costs of
removing and transporting carbon dioxide gas are not deductible. On March 22,
2001, WPC responded to the Audit Issue Letter and contested the State of New
Mexico's claim for additional royalties as being contrary to law. In early
November 2001, WPC received from the MMS an Order to Report and Pay Additional
Royalties and Perform Restructured Accounting on subsequent periods. The order
was dated October 30, 2001. The order requires WPC (1) to pay additional
royalties of $943,964 on production related to the audit period of January 1,
1992 through December 31, 1996; (2) to pay an estimated incremental royalty
amount of $991,549 for production covering January 1, 1997 through March 31,
2001; and (3) to perform a restructured accounting and pay an additional royalty
for months after March 2001. On January 30, 2002, WPC filed its Statement of
Reasons in support of its earlier appeal of the audit issue letter. While WPC
has informed the Trustee that it believes that its past computations have been
appropriately stated,
29
applying the MMS methodology asserted by the State of New Mexico could
potentially result in negative adjustments to amounts previously paid to the
Trust of approximately $3,000,000.
SALE AND ABANDONMENT OF UNDERLYING PROPERTIES
Quatro Finale (and any transferees) has the right to abandon any well
or working interest included in the Underlying Properties if, in its opinion,
such well or property ceases to produce or is not capable of producing in
commercially paying quantities. Since Quatro Finale does not operate any of the
wells on the Underlying Properties, Quatro Finale does not normally control the
timing of plugging and abandoning wells. The Conveyance provides that Quatro
Finale's working interest share of the costs of plugging and abandoning
uneconomic wells will be deducted in calculating NPI Net Proceeds.
Just as WPC sold the Underlying Properties to Quatro Finale, Quatro
Finale may sell the Underlying Properties, subject to and burdened by the
Royalty Interests, without the consent of the Unitholders. Under the Trust
Agreement, WPC has certain rights (but not the obligation) to purchase the
Royalty Interests upon termination of the Trust. See "Item 1--Description of the
Trust--Termination and Liquidation of the Trust."
WPC has retained the right to repurchase from the Trust, commencing
January 1, 2003, any portion of the NPI conveyed to the Trust if WPC's interest
in the Underlying Properties burdened by such portion of the NPI ceases to
produce or is not capable of producing in commercially paying quantities
(ignoring for purposes of such determination the NPI and the Infill NPI). The
purchase price payable by WPC will be the fair market value at the date of
repurchase of the portion of the NPI or Infill NPI so purchased, as established
on the basis of an appraisal provided by an independent expert.
THE INFILL NPI
The Royalty Interests include the Infill NPI, a net profits interest on
any Infill Wells completed on the WI Properties. In October 2002, the field
rules for the Basin Fruitland Coal (Gas) Pool were revised to allow an optional
second infill well on the standard 320-acre spacing unit in certain designated
areas of the pool. The Working Interest Properties contain 288 potential infill
locations of which 199 are evaluated as containing proved undeveloped reserves
according to SEC guidelines. As of December 31, 2002, proved undeveloped
reserves associated with the Working Interest Properties estimated by
independent petroleum engineers were approximately 2,490 MMcf. As of December
31, 2002, only one infill well was drilled and producing. The Infill NPI will
entitle the Trust to receive 20 percent of the Infill Net Proceeds.
WILLIAMS' PERFORMANCE ASSURANCES
Pursuant to the Conveyance and the Performance Acknowledgement
Agreement, Williams has agreed to pay each of the following to the extent not
paid by Quatro Finale (as successor to WPC) when due and payable: (i) all
liabilities and operating and capital expenses that Quatro Finale is required
under the Conveyance to pay as owner of the Underlying Properties, including
without limitation, Quatro Finale's obligation to pay operating expenses with
respect of the WI Properties up to the cumulative amounts specified in Exhibit B
to the Conveyance and the capital costs incurred in respect of the WI Properties
to the extent specified in the Conveyance, including amounts which Quatro Finale
is obligated to pay with respect to environmental liabilities; (ii) all NPI Net
Proceeds, Infill Net Proceeds and other amounts which Quatro Finale is obligated
to pay to the Trust under the Conveyance, including amounts which Quatro Finale
is obligated to pay with respect to environmental liability; and (iii) any
proceeds from a sale of any remaining Royalty Interests that Quatro Finale may
elect to purchase upon termination of the Trust ((i) through (iii) collectively,
the "WPC Payment Obligations"). Williams has also agreed, to the extent not paid
by WPX Gas Resources when due and payable, to pay all amounts which WPX Gas
Resources is required to pay to Quatro Finale (as successor to WPC) in respect
of production attributable to the Royalty Interests pursuant to the terms of the
Gas Purchase Contract between WPC and WPX Gas Resources (the "WPX Gas Resources
Payment Obligations"). In the Confirmation Agreement, Williams expressly
confirmed that its agreement to cause the WPX Gas Resources Payment Obligations
to be paid in full when due shall continue in full force and effect
notwithstanding the assignments by WGM of the Gas Purchase Contract and the Gas
Gathering Contract.
30
In the event and to the extent that WPC or Quatro Finale, as
applicable, does not pay any of the WPC Payment Obligations in full when due
and, in the event and to the extent that WPX Gas Resources does not pay any of
the WFS Gas Resources Payment Obligations in full when due, the Trustee (but not
Unitholders) is entitled, following notice to Williams and demand for payment by
the Trustee and after a 10-day cure period, to enforce payment by Williams.
Williams' assurance obligations terminate upon the earlier of (i) dissolution of
the Trust, (ii) with respect to the WPC Payment Obligations, upon sale or other
transfer by Quatro Finale of all or substantially all of the Underlying
Properties, (iii) with respect to the WPC Payment Obligations, upon one or more
sales or other transfers of a majority or more of Williams' ownership interests
in WPC and (iv) with respect to the WPX Gas Resources Payment Obligations, upon
one or more sales or other transfers of a majority or more of Williams'
ownership interests in WPX Gas Resources; provided that, with respect to (ii),
(iii) and (iv) above, only if the transferee has, at the time of transfer, a
rating assigned to outstanding unsecured long-term debt from Moody's Investor
Services of at least Baa3 or from Standard & Poor's Corporation of at least BBB-
(or an equivalent rating from at least one nationally-recognized statistical
rating organization), or such transferee is approved by holders of a majority of
outstanding Units, and in any case, the transferee unconditionally agrees in
writing, to assume and be bound by Williams' remaining assurance obligations.
TITLE TO PROPERTIES
Williams has advised the Trustee that it believes that Quatro Finale's
title to the Underlying Properties (as successor to WPC), and the Trust's title
to the Royalty Interests, are good and defensible in accordance with standards
generally accepted in the gas industry, subject to such exceptions which, in the
opinion of Williams, are not so material as to detract substantially from the
use or value of such Underlying Properties or Royalty Interests. As is customary
in the gas industry, only a perfunctory title examination is performed as a
lease is acquired, except leases covering proved reserves. Generally, prior to
drilling a well, a more thorough title examination of the drill site tract is
conducted and curative work is performed with respect to significant title
defects, if any, before proceeding with operations. However, prior to the sale
of the Underlying Properties to Quatro Finale, WPC (or its predecessor) had
owned the leases covering the Underlying Properties since 1974, and conventional
gas has been produced from formations other than the Fruitland formation covered
by all of the leases since the 1950s. Under these circumstances, WPC conducted
an internal review of its title records prior to the drilling of the coal seam
gas wells within the 12 Federal Units, but did not conduct title examinations.
In addition to its internal review, WPC, when requested by the operator,
participated in title examinations prior to the drilling of a few coal seam gas
wells located outside the Federal Units.
The Underlying Properties are typically subject, in one degree or
another, to one or more of the following: (i) royalties and other burdens and
obligations, expressed and implied, under gas leases; (ii) overriding royalties
and other burdens created by WPC or its predecessors in title; (iii) a variety
of 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;
(iv) 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; (v) pooling, unitization and
communitization agreements, declarations and orders; and (vi) easements,
restrictions, rights-of-way and other matters that commonly affect property. To
the extent that such burdens and obligations affect Quatro Finale's 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 value of the reserves attributable to the Royalty Interests. Except
as noted below, Williams believes that the burdens and obligations affecting the
Underlying Properties and Royalty Interests are conventional in the industry for
similar properties, do not, in the aggregate, materially interfere with the use
of the Underlying Properties and will not materially and adversely affect the
value of the Royalty Interests.
Although the matter is not entirely free from doubt, Williams has
advised the Trustee that it believes (based upon the opinions of local counsel
to WPC with respect to matters of Colorado law and New Mexico law) that the
Royalty Interests should constitute real property interests under applicable
state law. Consistent therewith, the Conveyance states that the Royalty
Interests constitute real property interests and it was recorded in the
appropriate real property records of Colorado and New Mexico, the states in
which the Underlying Properties are located in accordance with local recordation
provisions. If, during the term of the Trust, Quatro Finale (as successor to
WPC) becomes involved as a debtor in bankruptcy proceedings, it is not entirely
clear that all of the Royalty Interests would be treated as real property
interests under the laws of Colorado and New Mexico. If in such a proceeding a
determination were made that the Royalty Interests constitute real property
interests, the Royalty Interests should be unaffected in
31
any material respect by such bankruptcy proceeding. If in such a proceeding a
determination were made that a Royalty Interest constitutes an executory
contract (a term used, but not defined, in the United States Bankruptcy Code to
refer to a contract under which the obligations of both the debtor and the other
party to such contract are so unsatisfied that the failure of either to complete
performance would constitute a material breach excusing performance by the
other) and not a real property interest under applicable state law, and if such
contract were not to be assumed in a bankruptcy proceeding involving Quatro
Finale (as successor to WPC), the Trust would be treated as an unsecured
creditor of Quatro Finale with respect to such Royalty Interest in the pending
bankruptcy. Although no assurance is given, Williams has advised the Trustee
that it does not believe that the Royalty Interests should be subject to
rejection in a bankruptcy proceeding as executory contracts.
ITEM 3. LEGAL PROCEEDINGS.
There are no material pending proceedings to which the Trust is a party
or of which any of its property is the subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Units are listed and traded on the New York Stock Exchange under
the symbol "WTU." The following table sets forth, for the periods indicated, the
high and low sales prices per Unit and the amount of quarterly cash
distributions per Unit made by the Trust.
<Table>
<Caption>
SALES PRICE
------------------------- DISTRIBUTION
2002 HIGH LOW PER UNIT
- -------------- ----------- --------- ------------
First Quarter $ 14.10 $ 11.00 $ .199148
Second Quarter $ 11.95 $ 6.72 $ .111184
Third Quarter $ 8.85 $ 5.00 $ .221029
Fourth Quarter $ 10.35 $ 6.57 $ .356223
2001
First Quarter $ 16.20 $ 8.06 $ .588028
Second Quarter $ 21.99 $ 11.30 $ .893012
Third Quarter $ 17.20 $ 12.89 $ .658096
Fourth Quarter $ 16.33 $ 12.69 $ .366405
</Table>
At March 1, 2003, there were 9,700,000 Units outstanding and
approximately 1,783 Unitholders of record.
The Trust does not maintain any equity compensation plans.
32
ITEM 6. SELECTED FINANCIAL DATA.
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------
2002 2001 2000 1999 1998
----------- ----------- ----------- ----------- -----------
Royalty Income $ 9,296,774 $24,864,317 $16,817,935 $12,242,379 $16,452,220
Distributable Income $ 8,634,497 $24,293,901 $16,319,731 $11,754,647 $15,968,274
Distributable Income per Unit $ .89 $ 2.50 $ 1.68 $ 1.21 $ 1.65
Distributions per Unit $ .89 $ 2.50 $ 1.68 $ 1.21 $ 1.63
Total Assets at Year End $18,240,451 $22,621,529 $30,743,274 $40,272,316 $49,863,338
Total Corpus at Year End $18,165,048 $22,544,752 $30,670,266 $40,198,727 $49,769,352
</Table>
ITEM 7. TRUSTEE'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The trust's financial statements reflect the selection and application of
accounting policies that require the Trust to make significant estimates and
assumptions. The following are some of the more critical judgement areas in the
application of accounting policies that currently affect the Trust's financial
condition and results of operations.
Revenue Recognition. Revenues from Royalty Interests are recognized in the
period in which amounts are received by the Trust. Royalty income received by
the Trust in a given calendar year will generally reflect the proceeds, on an
entitlements basis, from natural gas produced for the 12-month period ended
September 30th in that calendar year.
Reserve Recognition. Independent petroleum engineers estimate the net
proved reserves attributable to the Royalty Interest. In accordance with
Statement of Financial Standards No. 69, "Disclosures About Oil and Gas
Producing Activities," estimates of future net revenues from proved reserves
have been prepared using year-end contractual gas prices and related costs.
Numerous uncertainties are inherent in estimating volumes and the value of
proved reserves and in projecting future production rates and the timing of
development of non-producing reserves. 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
reserve estimates.
Contingencies. Contingencies related to the Underlying Properties that are
unfavorably resolved would generally be reflected by the Trust as reductions to
future royalty income payments to the Trust with corresponding reductions to
cash distributions to Unitholders.
LIQUIDITY AND CAPITAL RESOURCES
As stipulated in the Trust Agreement, the Trust is intended to be passive
in nature and neither the Delaware Trustee nor the Trustee has any control over
or any responsibility relating to the operation of the Underlying Properties.
The Trustee has powers to collect and distribute proceeds received by the Trust
and pay Trust liabilities and expenses and its actions have been limited to
those activities. The Trust is a passive entity and other than the Trust's
ability to periodically borrow money as necessary to pay expenses, liabilities
and obligations of the Trust that cannot be paid out of cash held by the Trust,
the Trust is prohibited from engaging in borrowing transactions. As a result,
other than such borrowings, if any, the Trust has no source of liquidity or
capital resources other than the Royalty Interests.
Royalty income to the Trust is attributable to the sale of depleting
assets. All of the Underlying Properties burdened by the Royalty Interests
consist of producing properties. Accordingly, the proved reserves attributable
to Quatro Finale's interest in the Underlying Properties are expected to decline
substantially during the term of the Trust and a portion of each cash
distribution made by the Trust will, therefore, be analogous to a return of
capital. Accordingly, cash yields attributable to the Units are expected to
decline over the term of the Trust.
RESULTS OF OPERATIONS
The Trust makes quarterly cash distributions to Unitholders. The only
assets of the Trust, other than cash and cash equivalents being held for the
payment of expenses and liabilities and for distribution to Unitholders, are the
Royalty Interests. The Royalty Interests owned by the Trust burden the
Underlying Properties, which are owned by Quatro Finale and not the Trust.
33
Distributable income of the Trust consists of the excess of royalty income
plus interest income over the general and administrative expenses of the Trust.
Upon receipt by the Trust, royalty income is invested in short-term investments
in accordance with the Trust Agreement until its subsequent distribution to
Unitholders.
The amount of distributable income of the Trust for any calendar year may
differ from the amount of cash available for distribution to the Unitholders in
such year due to differences in the treatment of the expenses of the Trust in
the determination of those amounts. The financial statements of the Trust are
prepared on a modified cash basis pursuant to which the expenses of the Trust
are recognized when incurred. Consequently, the reported distributable income of
the Trust for any year is determined by deducting from the income received by
the Trust the amount of expenses incurred by the Trust during such year. The
amount of cash available for distribution to Unitholders, however, is determined
in accordance with the provisions of the Trust Agreement and reflects the
deduction from the income actually received by the Trust of the amount of
expenses actually paid by the Trust and adjustment for changes in reserves for
unpaid liabilities. See Note 5 to "Item 8--Financial Statements and
Supplementary Data--Notes to Financial Statements" for additional information
regarding the determination of the amount of cash available for distribution to
Unitholders.
For 2002, royalty income received by the Trust amounted to $9,296,774 as
compared to $24,864,317 and $16,817,935 for 2001 and 2000, respectively. The
decrease in royalty income in 2002 compared to 2001, and compared to 2000 was
primarily due to lower prices for gas in addition to lower net production from
the Underlying Properties as compared to 2001 and 2000. Net production related
to the royalty income received by the Trust in 2002 was approximately 7,981,349
MMBtu as compared to 10,056,329 MMBtu and 12,636,517 MMBtu in 2001 and 2000,
respectively. The average net natural gas priced received for royalty income in
2002 was $1.16 per MMBtu as compared to $2.47 MMBtu and $1.34 MMBtu in 2001 and
2000, respectively. Interest income for 2002 was $7,807 as compared to $70,444
and $73,352 for 2001 and 2000. The decrease in interest income for 2002 reflects
lower interest rates and decrease in funds available for investment.
General and administrative expenses for 2002 were $670,084, as compared to
$640,860 and $571,556 for 2001 and 2000, respectively. The increase in these
expenses in 2002 was primarily due to higher administrative expenses in 2002
than 2001 and 2000.
Distributable income for 2002 was $8,634,497 or $.89 per Unit, compared to
$24,293,901, or $2.50 per Unit for 2001, and $16,319,731, or $1.68 per Unit, for
2000. This decrease resulted from lower production and lower gas prices than in
2001 and 2000.
Reserve values at December 31, 2002 and December 31, 2001 were impacted by
significant changes in natural gas prices used to value the reserves and the
permanent reduction in the percentage of NPI Net Proceeds to which the Trust is
entitled from 81 percent to 60 percent that occurred during the fourth quarter
of 2000. See "Item 2 -- Properties -- The Royalty Interests -- NPI Percentage
Reduction." The year end prices required to be utilized in such valuations were
$3.125 per Mcf, $2.24 per Mcf and $6.35 per Mcf as at December 31, 2002, 2001
and 2000 respectively.
Because the Trust incurs administrative expenses throughout a quarter but
receives its royalty income only once in a quarter, the Trustee established in
the first quarter of 1993 a cash reserve for the payment of expenses and
liabilities of the Trust. The Trustee thereafter has adjusted the amount of such
reserve in certain quarters as required for the payment of the Trust's expenses
and liabilities, in accordance with the provisions of the Trust Agreement. The
Trustee anticipates that it will maintain for the foreseeable future a cash
reserve that will fluctuate as expenses are paid and royalty income is received.
Royalty income to the Trust is attributable to the sale of depleting
assets. All of the Underlying Properties burdened by the Royalty Interests
consist of producing properties. Accordingly, the proved reserves attributable
to Quatro Finale's interest in the Underlying Properties are expected to decline
substantially during the term of the Trust and a portion of each cash
distribution made by the Trust will, therefore, be analogous to a return of
capital. Accordingly, cash yields attributable to the Units are expected to
decline over the term of the Trust.
Royalty income received by the Trust in a given calendar year will
generally reflect the sum of (i) proceeds from the sale of gas produced from the
WI Properties (as defined in Note 1 to the financial statements of the Trust
appearing
34
elsewhere herein ("Note 1")) during the first 3 quarters of that year and the
fourth quarter of the preceding calendar year, plus (ii) cash received by WPC
(on behalf of Quatro Finale) with respect to the Farmout Properties (as defined
in Note 1) during the first 3 quarters of that year (or in the month immediately
following the third quarter, if received by WPC in sufficient time to be paid to
the Trust) and the fourth quarter of the preceding calendar year.
Accordingly, the royalty income included in distributable income for the
years ended December 31, 2002, 2001 and 2000, was based on production volumes
and natural gas prices for the 12 months ended in September 30, 2002, 2001 and
2000, respectively, as shown in the table below. The production volumes included
in the table are for production attributable to the Underlying Properties, and
not production attributable to the Royalty Interests owned by the Trust, and are
net of the amount of production attributable to Quatro Finale's royalty
obligations to third parties, which are determined by contractual arrangement
with such parties.
<Table>
<Caption>
TWELVE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------
2002 2001 2000
-------------- -------------- --------------
Production, Net (MMBtu)(1)
WI Properties 11,142,065 14,037,604 12,160,658
Farmout Properties(2) 2,160,187 2,722,945 3,439,980
Average Blanco Hub Spot Price ($/MMBtu) $ 2.31 $ 4.48 $ 2.89
Average Net Wellhead Price WI Properties ($/MMBtu) $ 1.12 $ 2.16 $ 1.28
</Table>
- ----------
(1) Million British Thermal Units.
(2) Includes previously reported estimated amounts for certain months.
(3) Total Gross Proceeds divided by Entitled W.I. Dry MMBtu for 12 mounts
ending in September 30.
Production from the WI Properties is generally sold pursuant to the Gas
Purchase Contract. For more information regarding the Gas Purchase Contract and
the right of WFS Gas Resources to recoup certain Price Credits, see "Item 2 --
Properties -- The Royalty Interests -- Gas Purchase Contract" in this Form 10-K
of the Trust.
The information herein concerning production and prices relating to the
Underlying Properties is based on information prepared and furnished by WPC (on
behalf of Quatro Finale) to the Trustee. The Trustee has no control over and no
responsibility relating to the operation of the Underlying Properties.
OFF-BALANCE SHEET ARRANGEMENTS.
As stipulated in the Trust Agreement, the Trust is intended to be passive
in nature and neither the Delaware Trustee nor the Trustee has any control over
or any responsibility relating to the operation of the Underlying Properties.
The Trustee has powers to collect and distribute proceeds received by the Trust
and pay Trust liabilities and expenses and its actions have been limited to
those activities. Therefore, the Trust has not engaged in any off-balance sheet
arrangements.
TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.
<Table>
<Caption>
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD
-------------------------------------------------------------------
LESS THAN 1 MORE THAN 5
TOTAL YEAR 1 - 3 YEARS 3-5 YEARS YEARS
---------------- ---------------- ---------------- ----------------
Long-Term Debt Obligations 0 0 0 0 0
Capital Lease Obligations 0 0 0 0 0
Operating Lease Obligations 0 0 0 0 0
Purchase Obligations 0 0 0 0 0
Other Long-Term Liabilities 0 0 0 0 0
Reflected on the Trusts Balance
Sheet under GAAP
Total 0 0 0 0 0
</Table>
35
FORWARD-LOOKING STATEMENTS
This Annual Report includes "forward-looking statements" within the
meaning of Section 21E of the Securities Exchange Act of 1934, which are
intended to be covered by the safe harbor created thereby. All statements other
than statements of historical fact included in this Annual Report are
forward-looking statements. Such statements include, without limitation, factors
affecting the price of oil and natural gas contained in Item 1, "Business,"
certain reserve information and other statements contained in Item 2,
"Properties," and certain statements regarding the Trust's financial position,
industry conditions and other matters contained in this Item 7. Although the
Trustee believes that the expectations reflected in such forward-looking
statements are reasonable, such expectations are subject to numerous risks and
uncertainties and the Trustee can give no assurance that they will prove
correct. There are many factors, none of which is within the Trustee's control,
that may cause such expectations not to be realized, including, among other
things, factors identified in this Annual Report affecting oil and gas prices
and the recoverability of reserves, general economic conditions, actions and
policies of petroleum-producing nations and other changes in the domestic and
international energy markets.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The only assets of and sources of income to the Trust are the Royalty
Interests, which generally entitle the Trust to receive a share of the net
profits from natural gas production from the Underlying Properties.
Consequently, the Trust's financial results can be significantly affected by
fluctuations in natural gas prices and the Trust has commodity price risk
exposure associated with the natural gas markets in the United States. The
Royalty Interests do not entitle the Trust to control or influence the operation
of the Underlying Properties or the sale of gas produced therefrom. Natural gas
produced from the WI Properties, which comprises the majority of production
attributable to the Royalty Interests, is currently sold by Quatro Finale
pursuant to the terms of the Gas Purchase Contract. Although the Trust is not a
party to the Gas Purchase Contract, the Gas Purchase Contract may significantly
impact revenues to the Trust. Although the Gas Purchase Contract mitigates the
risk to the Trust of low gas prices, it also limits the ability of the Trust to
benefit from the effects of higher gas prices, particularly to the extent a
balance exists in the Price Credit Account. See "Item 2 -- Properties -- The
Royalty Interests -- Gas Purchase Contract" for detailed information about the
Gas Purchase Contract and its impact on the Trust and Unitholders.
The Trust is a passive entity and other than the Trust's ability to
periodically borrow money as necessary to pay expenses, liabilities and
obligations of the Trust that cannot be paid out of cash held by the Trust, the
Trust is prohibited from engaging in borrowing transactions. The amount of any
such borrowings is unlikely to be material to the Trust. The Trust periodically
holds short term investments acquired with funds held by the Trust pending
distribution to Unitholders and funds held in reserve for the payment of Trust
expenses and liabilities. Because of the short-term nature of these borrowings
and investments and certain limitations upon the types of such investments which
may be held by the Trust, the Trustee believes that the Trust is not subject to
any material interest rate risk. The Trust does not engage in transactions in
foreign currencies which could expose the Trust or Unitholders to any foreign
currency related market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Audited Statements of Assets, Liabilities and Trust Corpus of the Trust
as of December 31, 2002 and 2001, and the related Statements of Distributable
Income and Changes in Trust Corpus for each of the 3 years in the period ended
December 31, 2002, are included in this Form 10-K.
36
REPORT OF INDEPENDENT AUDITORS
THE TRUSTEE
WILLIAMS COAL SEAM GAS ROYALTY TRUST
We have audited the accompanying statements of assets, liabilities and
trust corpus of Williams Coal Seam Gas Royalty Trust as of December 31, 2002 and
2001, and the related statements of distributable income and changes in trust
corpus for each of the three years in the period ended December 31, 2002. These
financial statements are the responsibility of the Trust's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 statements. 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.
As described in Note 2 to the financial statements, these financial
statements have been prepared on a modified cash basis of accounting, which is a
comprehensive basis of accounting other than accounting principles generally
accepted in the United States.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the assets, liabilities and trust corpus of
Williams Coal Seam Gas Royalty Trust at December 31, 2002 and 2001, and its
distributable income and its changes in trust corpus for each of the three years
in the period ended December 31, 2002, on the basis of accounting described in
Note 2.
/s/ ERNST & YOUNG LLP
Tulsa, Oklahoma
March 24, 2003
37
FINANCIAL STATEMENTS
WILLIAMS COAL SEAM GAS ROYALTY TRUST
STATEMENTS OF ASSETS, LIABILITIES AND TRUST CORPUS
<Table>
<Caption>
DECEMBER 31,
--------------------------------
2002 2001
--------------- ---------------
ASSETS
Current assets - cash and cash equivalents................................... $ 115,051 $ 91,492
Royalty interests in oil and gas properties (less accumulated
amortization of $120,441,263 and $116,036,626 at December 31,
2002 and 2001, respectively) (Note 2)..................................... 18,125,400 22,530,037
--------------- ---------------
Total ....................................................................... $ 18,240,451 $ 22,621,529
=============== ===============
LIABILITIES AND TRUST CORPUS
Current liabilities:
Payable to The Williams Companies, Inc. (Note 4) ................... $ 65,238 $ 63,338
Other accounts payable.............................................. 10,165 13,439
--------------- ---------------
Current liabilities.......................................................... 75,403 76,777
Trust corpus (9,700,000 units of beneficial interest authorized and
outstanding) (Note 2)..................................................... 18,165,048 22,544,752
--------------- ---------------
Total........................................................................ $ 18,240,451 $ 22,621,529
=============== ===============
</Table>
STATEMENTS OF DISTRIBUTABLE INCOME
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------------------------------
2002 2001 2000
----------------- --------------- --------------
Royalty income............................................ $ 9,296,774 $ 24,864,317 $ 16,817,935
Interest income........................................... 7,807 70,444 73,352
----------------- --------------- --------------
Total.................................................... $ 9,304,581 $ 24,934,761 $ 16,891,287
General and administrative expenses (Note 4).............. (670,084) (640,860) (571,556)
----------------- -------------- --------------
Distributable income...................................... $ 8,634,497 $ 24,293,901 $ 16,319,731
================= ============== ==============
Distributable income per Unit (9,700,000 units) (Note 2).. $ .89 $ 2.50 $ 1.68
================ ============== ==============
Distributions per Unit (Note 5)........................... $ .89 $ 2.50 $ 1.68
================ ============== ==============
</Table>
STATEMENTS OF CHANGES IN TRUST CORPUS
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
2002 2001 2000
------------ ------------ ------------
Trust corpus, beginning of year.......................... $ 22,544,752 $ 30,670,266 $ 40,198,727
Amortization of royalty interests......................... (4,404,637) (8,115,668) (9,521,918)
Distributable income...................................... 8,634,497 24,293,901 16,319,731
Distributions to Unitholders (Note 5)..................... (8,609,564) (24,303,747) (16,326,274)
------------ ------------ ------------
Trust corpus, end of year................................. $ 18,165,048 $ 22,544,752 $ 30,670,266
============ ============ ============
</Table>
- -----------------------
See accompanying notes
38
NOTES TO FINANCIAL STATEMENTS
1. TRUST ORGANIZATION AND PROVISIONS
Williams Coal Seam Gas Royalty Trust (the "Trust") was formed as a
Delaware business trust pursuant to the terms of the Trust Agreement of Williams
Coal Seam Gas Royalty Trust (as amended, the "Trust Agreement") entered into
effective as of December 1, 1992, by and among Williams Production Company, a
Delaware corporation ("WPC"), as trustor, The Williams Companies, Inc., a
Delaware corporation ("Williams"), and Bank of America, N.A. (as successor to
NationsBank of Texas, N.A.), a national banking association (the "Trustee"), and
Chemical Bank Delaware, a Delaware banking corporation (the "Delaware Trustee"),
as trustees. The trustees are independent financial institutions.
The Trust was formed to acquire and hold certain net profits interests
(the "Royalty Interests") in proved natural gas properties located in the San
Juan Basin of New Mexico and Colorado (the "Underlying Properties") owned by
WPC. The Trust was initially created effective as of December 1, 1992, with a
$100 contribution by WPC. On January 21, 1993, the Royalty Interests were
conveyed to the Trust by WPC pursuant to the Net Profits Conveyance (the
"Conveyance") dated effective as of October 1, 1992, by and among WPC, Williams,
the Trustee and the Delaware Trustee, in consideration for all the 9,700,000
authorized units of beneficial interest in the Trust ("Units"). WPC transferred
its Units by dividend to its parent, Williams, which sold an aggregate of
6,131,209 Units to the public through various underwriters in January and
February 1993 (the "Public Offering"). During the second quarter of 1995
Williams transferred its remaining Units to Williams Holdings of Delaware, Inc.
("WHD"), a separate holding company for Williams' non-regulated businesses.
Effective July 31, 1999, WHD was merged into Williams and by operation of the
merger Williams assumed all assets, liabilities and obligations of WHD,
including without limitation ownership of WHD's Units. Effective August 11,
2000, Williams sold its Units to Quatro Finale IV LLC, a Delaware limited
liability company ("QFIV"), in a privately negotiated transaction. Williams
retained the voting rights and a "call" option on the transferred Units and QFIV
was granted a "put" option on the Units. Substantially all of the production
attributable to the Underlying Properties is from the Fruitland coal formation
and constitutes "coal seam" gas that entitles the owners of such production,
provided certain requirements are met, to tax credits for Federal income tax
purposes pursuant to Section 29 of the Internal Revenue Code of 1986, as
amended, for coal seam gas produced and sold before 2003 (unless extended by
Congress). Effective May 1, 1997, WPC transferred the Underlying Properties to
Quatro Finale, LLC, a non-affiliated Delaware limited liability company ("Quatro
Finale"). Ownership of the Underlying Properties reverted back to WPC effective
February 1, 2001, pursuant to the terms of the May 1, 1997 transaction.
Effective March 1, 2001, WPC sold the Underlying Properties subject to and
burdened by the Royalty Interest to Quatro Finale V. LLC, a non-affiliated
Delaware limited liability company.
The Trustee has the power to collect and distribute the proceeds
received by the Trust and to pay Trust liabilities and expenses. The Delaware
Trustee has only such powers as are set forth in the Trust Agreement and is not
empowered to otherwise manage or take part in the business of the Trust. The
Royalty Interests are passive in nature and neither the Delaware Trustee nor the
Trustee has any control over or any responsibility relating to the operation of
the Underlying Properties.
The Trust will terminate no later than December 31, 2012, subject to
earlier termination under certain circumstances described in the Trust Agreement
(the "Termination Date"). Cancellation of the Trust will occur on or following
the Termination Date when all Trust assets have been sold and the net proceeds
thereof distributed to Unitholders.
The only assets of the Trust, other than cash and cash equivalents
being held for the payment of expenses and liabilities and for distribution to
Unitholders, are the Royalty Interests. The Royalty Interests consist primarily
of a net profits interest (the "NPI") in the Underlying Properties. Prior to
2001, the NPI generally entitled the Trust to receive 81 percent of the NPI Net
Proceeds, as defined below, attributable to (i) gas produced and sold from
Quatro Finale's net revenue interests (working interests less lease burdens) in
the properties in which Quatro Finale has a working interest (the "WI
Properties") and (ii) the revenue stream received by Quatro Finale attributable
to its 35 percent net profits interest in 5,348 gross acres in La Plata County,
Colorado (the "Farmout Properties"). However, the percentage of NPI Proceeds
which the Trust is entitled to receive was subject to permanent reduction to 60
percent under certain conditions, and such a reduction occurred in the fourth
quarter of 2000. The Royalty Interests also include a 20 percent interest in
Quatro Finale's Infill Net Proceeds, as defined below, from the sale of
production if well spacing rules are effectively modified
39
and additional wells are drilled on producing drilling blocks on the WI
Properties (the "Infill Wells") during the term of the Trust. As of December 31,
2002, only one infill well was drilled and producing. "NPI Net Proceeds"
consists generally of the revenue stream received by Quatro Finale from its 35
percent net profits interest in the Farmout Properties, plus the aggregate
proceeds attributable to Quatro Finale's net revenue interest, based on the
price paid at or in the vicinity of the wellhead (the "Wellhead"), of gas
produced from the WI Properties, less Quatro Finale's share of certain taxes and
costs. "Infill Net Proceeds" consists generally of the aggregate proceeds, based
on the price at the Wellhead, of gas produced from Quatro Finale's net revenue
interest in any Infill Wells less certain taxes and costs. The complete
definitions of NPI Net Proceeds and Infill Net Proceeds are set forth in the
Conveyance.
2. BASIS OF ACCOUNTING
The financial statements of the Trust are prepared on a modified cash
basis and are not intended to present financial position and results of
operations in conformity with accounting principles generally accepted in the
United States ("GAAP"). Preparation of the Trust's financial statements on such
basis includes the following:
o Revenues are recognized in the period in which amounts are received by
the Trust. General and administrative expenses are recognized on an
accrual basis.
o Amortization of the Royalty Interests is calculated on a
unit-of-production basis and charged directly to trust corpus.
o Distributions to Unitholders are recorded when declared by the Trustee
(see Note 5).
The financial statements of the Trust differ from financial statements
prepared in accordance with GAAP because royalty income is not accrued in the
period of production and amortization of the Royalty Interests is not charged
against operating results.
3. FEDERAL INCOME TAXES
The Trust is a grantor trust for Federal income tax purposes. As a
grantor trust, the Trust will not be required to pay Federal or state income
taxes. Accordingly, no provision for income taxes has been made in these
financial statements.
Because the Trust will be treated as a grantor trust, and because a
Unitholder will be treated as directly owning an interest in the Royalty
Interests, each Unitholder will be taxed directly on his per Unit pro rata share
of income attributable to the Royalty Interests consistent with the Unitholder's
method of accounting and without regard to the taxable year or accounting method
employed by the Trust.
Production from the coal seam gas wells drilled after December 31, 1979
and prior to January 1, 1993, qualifies for the Federal income tax credit for
producing nonconventional fuels under Section 29 of the Internal Revenue Code.
This tax credit is calculated annually based on each year's qualified production
through the year 2002. Williams provides the Trustee with Section 29 credit
information related to the Underlying Properties. Coal seam gas produced and
sold after December 31, 2002, will no longer generate a Section 29 credit unless
the applicability of the Section 29 credit is extended by Congress. Legislation
currently is proposed to extend the Section 29 credit retroactively to January
1, 2003. Of course there can be no assurance that such legislation will be
passed, and if passed, will be effective retroactively to January 1, 2003.
The Section 29 credit is based on the Unitholder's pro rata share of
qualifying production. It can be used only to the extent that a Unitholder's
regular tax liability exceeds the Unitholder's tentative minimum tax liability
after the regular tax liability has been reduced by the foreign tax credit and
certain nonrefundable personal credits. Any part of the Section 29 credit not
allowed for the tax year solely because of this alternative minimum tax
limitation is subject to certain carryover provisions relating to the
alternative minimum tax calculation. Except for the foregoing, there are no IRC
provisions that allow for the carryback or carryforward of Section 29 credits in
any other circumstances. As the
40
carryforward of unused Section 29 credits is related to the alternative minimum
tax calculation for succeeding years, carryforwards should be allowed even if
the Section 29 credit is not extended after 2002.
Each Unitholder should consult his tax advisor regarding Trust tax
compliance matters.
4. RELATED PARTY TRANSACTIONS
Williams provides accounting, bookkeeping and informational services to
the Trust in accordance with an Administrative Services Agreement effective
December 1, 1992. The fee is $50,000 per quarter, escalating 3 percent each
October 1 commencing October 1, 1993. Amounts payable by the Trust to Williams
at December 31, 2002 and 2001 represent the fourth quarter fees. Aggregate fees
incurred by the Trust to Williams in 2002, 2001 and 2000 were $260,955, $256,318
and $249,514, respectively.
Aggregate fees paid by the Trust to the trustees in 2002, 2001 and 2000
were $48,452, $48,713 and $47,473, respectively.
5. DISTRIBUTIONS TO UNITHOLDERS
The Trustee determines for each quarter the amount of cash available
for distribution to Unitholders. Such amount (the "Quarterly Distribution
Amount") is an amount equal to the excess, if any, of the cash received by the
Trust, on or prior to the last day of the month following the end of each
calendar quarter from the Royalty Interests, plus, with certain exceptions, any
other cash receipts of the Trust during such quarter, over the liabilities of
the Trust paid during such quarter, subject to adjustments for changes made by
the Trustee during such quarter in any cash reserves established for the payment
of contingent or future obligations of the Trust.
The Trustee distributes the Quarterly Distribution Amount within 60
days after the end of each calendar quarter to each person who was a Unitholder
of record on the associated record date (i.e. the 45th day following the end of
each calendar quarter or if such day is not a business day, the next business
day thereafter), together with interest estimated to be earned on such amount
from the date of receipt thereof by the Trustee to the payment date.
In addition to the regular quarterly distributions, under certain
circumstances specified in the Trust Agreement (such as upon a purchase price
adjustment, if any, or pursuant to the sale of a Royalty Interest) the Trust
would make a special distribution (a "Special Distribution Amount"). A Special
Distribution Amount would be made when amounts received by the Trust under such
circumstances aggregated in excess of $9,000,000. The record date for a Special
Distribution Amount will be the 15th day following receipt of amounts
aggregating a Special Distribution Amount by the Trust (unless such day is not a
business day in which case the record date will be the next business day
thereafter) unless such day is within 10 days of the record date for a Quarterly
Distribution Amount in which case the record date will be the date as is
established for the next Quarterly Distribution Amount. Distribution to
Unitholders of a Special Distribution Amount will be made no later than 15 days
after the Special Distribution Amount record date.
6. CONTINGENCIES
WPX Gas Resources Company ("WPX Gas Resources," as successor in
interest to Williams Gas Marketing Company) purchases natural gas produced from
the WI Properties (except for certain small volumes) at the wellhead under the
terms of a gas purchase contract dated October 1, 1992, as amended (the "Gas
Purchase Contract"). The Gas Purchase Contract provides for a pricing mechanism
during an initial 5-year period, which expired on December 31, 1997, and
continuing for one or more consecutive additional one-year terms unless and
until WPX Gas Resources exercises its annual option, exercisable 15 days prior
to the end of each contract year, to discontinue purchasing gas under the
pricing mechanism of the Gas Purchase Contract and instead purchase gas at a
monthly market-based price. WPX Gas Resources has not exercised this option and
therefore the pricing mechanism will continue to remain in effect through at
least December 31, 2003.
41
Under the pricing mechanism of the Gas Purchase Contract, when the
market price is less than $1.70 per MMBtu (the "Minimum Purchase Price"), the
Trust will be paid the Minimum Purchase Price for the gas and an account (the
"Price Credit Account") will be maintained to identify the accrued and
unrecouped amount of payments made to the Trust in excess of the market price.
Any amounts in the Price Credit Account are subject to future recoupment when
the market price exceeds the Minimum Purchase Price. As of December 31, 2002,
2001 and 2000, there were no remaining unrecouped Price Credits in the Price
Credit Account. During 2000, WPX Gas Resources recouped approximately $5.5
million of Price Credits in the Price Credit account, which, based on the
Trust's 81 percent interest in the WI Properties, represented an offset of
approximately $4.5 million against royalty income the Trust would have otherwise
received during the year. To the extent there may in the future be a balance in
the Price Credit Account, the entitlement to recoup Price Credits means that if
and when the Index Price is above the Minimum Purchase Price, future royalty
income paid to the Trust would be reduced until such time as such Price Credit
Account is once again reduced to zero. Corresponding cash distributions to
Unitholders would also be reduced.
While the terms of the Gas Purchase Agreement pricing mechanism remain
in place and no balance exists in the Price Credit Account at December 31, 2002,
when the market price for natural gas exceeds $1.94 per MMBtu (as was the case
during 11 months in 2002), the Trust receives only 50 percent of the excess of
the market price over the $1.94 price per MMBtu.
The majority of the production attributable to the Trust is within
Federal units. Unit participating areas are formed by pooling production from
the participating area. Entitlement to the pooled production is based on each
party's acreage in the participating area divided by the total participating
acreage. Wells drilled outside the participating area may create an enlargement
to the participating area and a revision of the Unit ownership entitlement. The
Bureau of Land Management ("BLM") must approve Unit participating area
expansions. The effective date for Unit expansions is retroactive to the date
the well creating the expansion was tested. The revenues presented in the
accompanying statements of distributable income are on an entitlement basis and
reflect the most recent BLM participating area approvals at December 31, 2002,
2001, and 2000, respectively. There are pending or anticipated applications or
approvals for additional participating area enlargements. WPC has advised the
Trustee that it does not believe that final approval of these Unit participating
area enlargements and the resulting retroactive adjustments, if any, will have a
material impact on the revenues as presented in these statements.
The Trustee has been advised by WPC that the Minerals Management
Service ("MMS"), a subagency of the U.S. Department of the Interior, has from
time to time considered the inclusion of the value of the Section 29 tax credits
attributable to coal seam gas production in the calculation of gross proceeds
for purposes of calculating the royalty that is payable to the MMS. On August
30, 1993, the U.S. Office of the Inspector General (the "OIG") issued an audit
report stating that Section 29 tax credits should be included in the calculation
of gross proceeds and recommending that the MMS pursue collection of additional
royalties with respect to past and future production. On December 8, 1993,
however, the Office of the Solicitor of the U.S. Department of the Interior gave
its opinion to the MMS that the report of the OIG was incorrect and that Section
29 tax credits are not part of gross proceeds for the purpose of Federal royalty
calculations. WPC believes that any such inclusion of the value of Section 29
tax credits for the purposes of calculating royalty payments required to be made
on Federal and Indian lands would be inappropriate since all mineral interest
owners, including royalty owners, are entitled to Section 29 tax credits for
their proportionate share of qualifying coal seam gas production (to the extent
that the Section 29 credit is available). WPC has advised the Trustee that it
would vigorously oppose any attempt by the MMS to require the inclusion of the
value of Section 29 tax credits in the calculation of gross proceeds. However,
if such regulations were adopted and upheld, royalty payments would be increased
which would decrease NPI Net Proceeds and, therefore, the amounts payable to the
Trust. The reduction in amounts payable to the Trust would cause a corresponding
reduction in associated Section 29 tax credits available to Unitholders. As
discussed in Note 3, coal seam gas produced and sold after December 31, 2002,
will no longer generate a Section 29 credit unless applicability of the Section
29 credit is extended by Congress.
On January 5, 2001, the State of New Mexico, acting under authority of
the MMS, presented WPC with an Audit Issue Letter for the alleged underpayment
of royalties in the amount of $948,501, on gas produced from the Underlying
Properties due to federal royalty owners during the time period from January
1992 through December 1996. MMS regulations permit a lessee to deduct from its
gross proceeds its reasonable actual costs of transportation and processing to
transport the gas from the lease to the point of sale in calculating the market
value of its production. The State of New Mexico claims that certain costs of
removing and transporting carbon dioxide gas are not deductible. On March 22,
2001, WPC responded to the Audit Issue Letter and contested the State of New
Mexico's claim for additional royalties as being
42
contrary to law. In early November 2001, WPC received from the MMS an Order to
Report and Pay Additional Royalties and Perform Restructured Accounting on
subsequent periods. The order was dated October 30, 2001. The order requires WPC
(1) to pay additional royalties of $943,964 on production related to the audit
period of January 1, 1992 through December 31, 1996; (2) to pay an estimated
incremental royalty amount of $991,549 for production covering January 1, 1997
through March 31, 2001; and (3) to perform a restructured accounting and pay an
additional royalty for months after March 2001. On January 30, 2002, WPC filed
its Statement of Reasons in support of its earlier appeal of the audit issue
letter. While WPC has informed the Trustee that it believes that its past
computations have been appropriately stated, applying the MMS methodology
asserted by the State of New Mexico could potentially result in negative
adjustments to amounts previously paid to the Trust of approximately $3,000,000.
7. SUBSEQUENT EVENT
Subsequent to December 31, 2002, the Trust declared the following
distribution:
<Table>
<Caption>
QUARTERLY RECORD DATE PAYMENT DATE DISTRIBUTION PER UNIT
February 5, 2003... February 28, 2003 $.211473
</Table>
The Trustee has estimated the Section 29 tax credit associated with the
February 5, 2003 quarterly distribution to be $.15 per Unit.
8. QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table sets forth the royalty income, distributable income
and distributable income per Unit of the Trust for each quarter in the years
ended December 31, 2002 and 2001 (in thousands, except per Unit amounts):
<Table>
<Caption>
CALENDAR QUARTER ROYALTY INCOME DISTRIBUTABLE INCOME DISTRIBUTION PER UNIT
- ------------------------------ ---------------------------- --------------------------- ----------------------------
2002
First...................... $ 2,055 $ 1,824 $ 0.19
Second..................... 1,297 1,113 0.11
Third...................... 2,342 2,226 0.23
Fourth..................... 3,603 3,472 0.36
------- ------- --------
TOTAL............... $ 9,297 $ 8,635 $ 0.89
======= ======= ========
2001
First...................... $ 5,819 $ 5,627 $ 0.58
Second..................... 8,824 8,674 0.89
Third...................... 6,548 6,426 0.66
Fourth..................... 3,673 3,567 0.37
------- ------- --------
TOTAL $24,864 $24,294 $ 2.50
======= ======= ========
</Table>
43
Selected 2002 fourth quarter data are as follows (in thousands except
per Unit amounts):
<Table>
Royalty income............................................ $ 3,603
Interest income........................................... 3
General and administrative expenses....................... (134)
-------------
Distributable income...................................... $ 3,472
Distributable income per Unit (9,700,000 units)........... $ .36
=============
Distribution per Unit..................................... $ .36
=============
</Table>
9. SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)
The net proved reserves attributable to the Royalty Interests have been
estimated as of December 31, 2002, 2001 and 2000, 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 contractual gas prices and related costs. The standardized measure of
future net revenues from the gas reserves is calculated based on discounting
such future net revenues at an annual rate of 10 percent. The Blanco Hub Spot
Price for December 2002 of $4.25 per MMBtu, after adjustments for certain costs
and provisions of the Gas Purchase Contract, resulted in a weighted average
wellhead price of $2.89 per Mcf. The standardized measure of discounted future
net revenues below has been reduced by operating and development costs which are
paid by Williams and are included in computing the royalty income of the Trust.
The standardized measure has not been reduced for income taxes as no income
taxes are paid by the Trust (Note 3).
Numerous uncertainties are inherent in estimating volumes and value 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 reserve
estimates.
Based on inception to date experience in estimating reserves,
production history and other information with regard to the status of the
interest in the NPI, the reserve estimates as of January 1, 2000, for Royalty
Interests were based on a percentage share of NPI Net Proceeds payable to the
Trust of 81 percent, adjusted to reflect possible reduction of the NPI upon
meeting certain production targets and certain rates of return expected to be
met in the future. The reserve estimates as of December 31, 2000, 2001 and 2002,
are based on a percentage share of NPI Net Proceeds payable to the Trust reduced
to 60 percent.
<Table>
<Caption>
NATURAL GAS(MMcf)
Proved reserves at January 1, 2000 ......................................... 64,790
Production ................................................................. (13,660)
Revisions of previous estimates ............................................ (11,654)
-------
Proved reserves at December 31, 2000 ....................................... 39,476
Production ................................................................. (11,449)
Revisions to computed net profits volumes .................................. 17,312
-------
Proved reserve at December 31, 2001 ........................................ 45,339
Production ................................................................. (8,136)
Extensions and revisions of previous estimates ............................. 2,519
-------
Proved reserves at December 31, 2002 ....................................... 39,722
=======
Proved developed reserves at December 31, 2002 ............................. 37,232
=======
</Table>
All proved reserve estimates presented above at December 31, 2001,
2000, and January 1, 2000, are proved developed.
Proved reserves are estimated quantities of natural gas which
geological and engineering data indicate with reasonable certainty to be
recoverable in future years from known reservoirs under existing economic and
operating
44
conditions. Proved developed reserves are proved reserves which can be expected
to be recovered through existing wells with existing equipment and operating
methods. Proved undeveloped reserves are the reserves which are expected to be
recovered from infill wells on the standard 320 acre spacing unit in certain
designated areas of the fruitland coal formation.
The following table sets forth the standardized measure of discounted
future net revenues at December 31, 2002, 2001 and 2000 relating to proved
developed reserves (in thousands):
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
2002 2001 2000
---------- ---------- ----------
Future cash inflows $ 78,299 $ 62,005 $ 170,785
Future production taxes (9,549) (13,083) (32,499)
Future development costs (3,441) -- --
---------- ---------- ----------
Future net cash flows 65,309 48,922 138,286
10% discount factor (19,270) (14,484) (43,189)
---------- ---------- ----------
Standardized measure of discounted future net revenues $ 46,039 $ 34,438 $ 95,097
========== ========== ==========
</Table>
The following table sets forth the changes in the aggregate
standardized measure of discounted future net revenues from proved reserves
during the years ended December 31, 2002, 2001 and 2000 (in thousands):
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Balance at January 1 ......................................................... $ 34,438 $ 95,097 $ 44,119
Increase (decrease) due to:
Net sales of coal seam gas ................................................ (10,299) (21,425) (18,948)
Net changes in prices and costs ........................................... 15,503 (60,274) 91,202
Development costs incurred ................................................ (629) (323) (240)
Changes in estimated future development cost .............................. 2,812 323 240
Extensions and revisions of previous quantity estimates ................... 2,915 13,150 (27,788)
Accretion of discount ..................................................... 3,444 9,510 4,411
Other ..................................................................... (2,145) (1,620) 2,101
-------- -------- --------
11,601 60,659 50,978
-------- -------- --------
Balance at December 31 ...................................................... $ 46,039 $ 34,438 $ 95,097
======== ======== ========
</Table>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The Trust has no directors or executive officers. Each of the Trustee
and the Delaware Trustee is a corporate trustee that may be removed as trustee
under the Trust Agreement, with or without cause, at a meeting duly called and
held by the affirmative vote of Unitholders of not less than a majority of all
the Units then outstanding. Any such removal of the Delaware Trustee shall be
effective only at such time as a successor Delaware Trustee fulfilling the
requirements of Section 3807(a) of the Delaware Code has been appointed and has
accepted such appointment, and any such removal of the Trustee shall be
effective only at such time as a successor Trustee has been appointed and has
accepted such appointment.
45
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange At of 1934 requires the
Trust's directors, officers or beneficial owners of more than ten percent of a
registered class of the Trust's equity securities to file reports of ownership
and changes in ownership with the SEC and to furnish the Trust with copies of
all such reports.
The Trust has no directors or officers and based solely on its review
of the reports received by it, the Trust believes that during the fiscal year of
2002, no person who was a beneficial owner of more than ten percent the Trust's
Units failed to file on a timely basis any report required by Section 16(a).
ITEM 11. EXECUTIVE COMPENSATION.
The following is a description of certain fees and expenses anticipated
to be paid or borne by the Trust, including fees expected to be paid to
Williams, the Trustee, the Delaware Trustee, the Transfer Agent, or their
affiliates.
Ongoing Administrative Expenses. The Trust is responsible for paying
all legal, accounting, engineering and stock exchange fees, printing costs and
other administrative and out-of-pocket expenses incurred by or at the direction
of the Trustee or Delaware Trustee and the out-of-pocket expenses of the
Transfer Agent.
Compensation of the Trustee, Delaware Trustee and Transfer Agent. The
Trust Agreement provides for compensation to the Trustee and the Delaware
Trustee for administrative services, out of the Trust assets. The Trustee was
paid a 2002 base amount of $43,840, plus an hourly charge for services in excess
of a combined total of 300 hours annually at the Trustee's then standard rate.
The Delaware Trustee is paid a fixed annual amount which was initially set at
$5,000. The Trustee and the Delaware Trustee received total compensation for
2002 of $43,840 and $4,612, respectively. The base amount of the Trustee's fee
and the amount of the Delaware Trustee's fee for administrative services
escalate at the rate of 3 percent per year. The Trustee and the Delaware Trustee
are each entitled to reimbursement for out-of-pocket expenses. Upon termination
of the Trust, the Trustee will receive, in addition to its out-of-pocket
expenses, a termination fee in the amount of $8,000.
The Transfer Agent receives a transfer agency fee of $5.50 annually per
account (minimum of $15,000 annually), subject to change each December, based
upon the change in the Producers' Price Index as published by the Department of
Labor, Bureau of Labor Statistics, plus $1.00 for each certificate issued in
excess of 10,000 annually. The total fees paid by the Trust to the Transfer
Agent in 2002 were $23,460.
Fees to Williams. Williams will receive, throughout the term of the
Trust, an administrative services fee for accounting, bookkeeping and
informational services relating to the Royalty Interests as described below in
"Item 13--Administrative Services Agreement."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) Security Ownership of Certain Beneficial Owners. The following
table sets forth as of March 1, 2003 information with respect to the only
Unitholder who was known to the Trustee to be a beneficial owner of more than 5
percent of the outstanding Units.
<Table>
<Caption>
NUMBER OF UNITS PERCENT
NAME AND ADDRESS OF BENEFICIAL OWNER BENEFICIALLY OWNED OF CLASS
------------------------------------ ------------------ --------
Quatro Finale IV LLC(1) 2,608,791 26.9%
245 Park Avenue
New York, NY 10167
</Table>
46
(1) This information was provided to the Securities and Exchange
Commission and to the Trust in a Schedule 13D/A filed with the
Securities and Exchange Commission on December 9, 2002, on behalf of
the Bear Stearns Companies Inc. and Quatro Finale IV, LLC. Such
Schedule 13D/A reports that Quatro Finale IV, LLC is a subsidiary of
Bear Stearns Companies Inc. and that each entity has shared
dispositive and voting power with regard to such units
The Schedule 13D/A filed with the Securities and Exchange Commission
on behalf of The Bear Stearns Companies Inc. and Quatro Finale IV,
LLC may be reviewed for more detailed information concerning the
matters summarized herein.
WILLIAMS'S VOTING AUTHORITY OVER UNITS
Although Williams sold all of its remaining Units to QFIV effective
August 11, 2000, Williams contractually retained the voting rights for those
Units irrespective of the sale and acquired a call option, to purchase, in one
or more lots of 10,000 units, the Subject Units (as reported in Form 4 filed
September 26, 2000) and Quatro Finale IV, LLC acquired an option to require
Williams to purchase the Subject Units. This information was provided to the
Securities and Exchange Commission and to the Trust in a Schedule 13D/A filed
with the Securities and Exchange Commission on January 25, 2002, on behalf of
Williams. Such Schedule 13D/A also reflects the fact that Williams owns
beneficial interest in the units owned by Quatro Finale IV, LLC in the form of
derivative securities and the fact that Williams has sold underlying Trust Units
that it acquired pursuant to exercises of its call option. Except as noted
below, Williams (or its affiliate) has the same voting rights under the Trust
Agreement as other Unitholders. Accordingly, so long as Williams (or its
affiliate) continues to possess voting control of 26.9 percent of the Units, on
any matters brought to a vote of Unitholders requiring the approval of the
holders of a majority of Units present or represented at a meeting where a
majority of outstanding Units are represented, Williams will likely be able to
control the vote with respect to such matters if not less than the 14 percent of
additional Units necessary for quorum purposes are represented at such meeting.
With respect to the vote on any amendment to the Gas Purchase Contract or the
Gas Gathering Contract, the Units held by Williams (or its affiliate)
immediately after the Public Offering (and now held by QFIV) may not be voted
nor will such Units be counted for purposes of determining if a quorum is
present so long as such Units continue to be held by Williams (or its
affiliate). This voting limitation will not be applicable to Units Williams (or
its affiliate) may acquire, if any, after the date of the Public Offering.
In addition, as noted below, certain potential conflicts of interest
exist between Williams and its subsidiaries and the interests of the Trust and
the Unitholders (see "Item 13 -- Certain Relationships and Related Transactions
- -- Potential Conflicts of Interest"). To the extent that any matters are brought
to a vote of Unitholders where the interests of Williams conflict, or
potentially conflict, with the interests of the Trust or Unitholders, Williams
(or its affiliate) can be expected to vote in its own self-interest and under
certain circumstances as noted above, may have sufficient votes to control the
outcome.
The Schedule 13D/A filed with the Securities and Exchange Commission on
behalf of Williams may be reviewed for more detailed information concerning the
matters summarized herein.
(b) Security Ownership of Management. The Trust has no directors or
executive officers. As of March 1, 2003, Bank of America, N.A., the Trustee,
held an aggregate of 42,444 Units in various fiduciary capacities, with no
investment or voting powers. As of March 1, 2003, Chase Bank (as successor to
Chemical Bank Delaware), the Delaware Trustee, did not beneficially own any
Unit.
(c) Changes in Control. Subject to the discussion above in this Item 12
under "Williams's Voting Authority Over Units," the Trustee knows of no
arrangements the operation of which may at a subsequent date result in a change
in control of the Trust.
47
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ADMINISTRATIVE SERVICES AGREEMENT
Pursuant to the Trust Agreement, Williams and the Trust entered into an
Administrative Services Agreement effective December 1, 1992. A copy of the
Administrative Services Agreement is filed as an exhibit to this Form 10-K.
The Administrative Services Agreement obligates the Trust to pay to
Williams each quarter an administrative services fee for accounting, bookkeeping
and informational services relating to the Royalty Interests. The administrative
services fee was $51,500 per calendar quarter commencing October 1, 1993,
through and including the quarter ended September 30, 1994, and increases 3
percent each October 1. Accordingly, the total of the administrative services
fees paid by the Trust to Williams in 2002 was $260,955.
POTENTIAL CONFLICTS OF INTEREST
The interests of Quatro Finale and of Williams and its subsidiaries and
the interests of the Trust and the Unitholders with respect to the Underlying
Properties could at times be different. As a working interest owner in the WI
Properties, Quatro Finale could have interests that conflict with the interests
of the Trust and Unitholders. For example, such conflicts could be due to a
number of factors including, but not limited to, future budgetary considerations
and the absence of any contractual obligation on the part of Quatro Finale to
spend for development of the WI Properties, except as noted herein. Such
decisions may have the effect of changing the amount or timing of future
distributions to Unitholders. Quatro Finale's interests may also conflict with
those of the Trust and Unitholders in situations involving the sale or
abandonment of Underlying Properties. Quatro Finale has the right at any time to
sell any of the Underlying Properties subject to the Royalty Interests and under
certain circumstances may abandon any of the WI Properties. Such sales or
abandonment may not be in the best interest of the Trust. In addition, WPX Gas
Resources has the right, exercisable in its sole discretion, to terminate its
Minimum Purchase Price commitment under the Gas Purchase Contract. Williams'
interests could conflict with those of the Trust and Unitholders to the extent
the interests of WPX Gas Resources, under the Gas Purchase Contract, or WFS and
WPX Gas Resources, under the Gas Gathering Contract, differ from the interests
of the Trust and the Unitholders. Except for amendments to the Gas Gathering
Contract or Gas Purchase Contract that must be approved by the vote of a
majority of the Unitholders present at a meeting at which a quorum is present if
such amendment would materially adversely affect Trust revenues, no mechanism or
procedure has been included to resolve potential conflicts of interest between
the Trust and Quatro Finale, Williams, WPC or their affiliates.
ITEM 14. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this report, the Trustee
carried out an evaluation of the effectiveness of the design and operation of
the Trust's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Trustee concluded that the Trust's
disclosure controls and procedures are effective in timely alerting the trustee
to material information relating to the Trust required to be included in the
Trust's periodic filings with the Securities and Exchange Commission. In its
evaluation of disclosure controls and procedures, the Trustee has relied, to the
extent considered reasonable, on information provided by WPC. No significant
changes in the Trust's internal controls or other factors that could affect
these controls have occurred subsequent to the date of such evaluation.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this report:
1. Financial Statements (included in Item 8 of this report)
48
<Table>
<Caption>
PAGE IN THIS
REPORT
------
Report of Independent Auditors 37
Statements of Assets, Liabilities and Trust Corpus as of December 31, 2001 and 2000 38
Statements of Distributable Income for each of the three years in the period ended
December 31, 2002 38
Statements of Changes in Trust Corpus for each of the three years in the period ended
December 31, 2002 38
Notes to Financial Statements 39
</Table>
2. Financial Statement Schedules
Financial statement schedules are omitted because of the absence of
conditions under which they are required or because the required information is
included in the financial statements and notes thereto.
3. Exhibits
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
- ------- -------
3.1 -- Certificate of Trust of Williams Coal Seam Gas Royalty Trust (filed as Exhibit 3.1 to the
Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.1 -- Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of December 1, 1992, by and
among Williams Production Company, The Williams Companies, Inc. and Chemical Bank Delaware and
Bank of America, N.A. (as successor to NationsBank of Texas, N.A.), as trustees (filed as Exhibit
4.1 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by
reference).
4.2 -- First Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of
December 15, 1992, by and among Williams Production Company, The Williams Companies, Inc.,
Chemical Bank Delaware and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.)
(filed as Exhibit 4.2 to the Registrant's Form 10-K for the year ended December 31, 1992 and
incorporated herein by reference).
4.3 -- Second Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of
January 12, 1993, by and among Williams Production Company, The Williams Companies, Inc.,
Chemical Bank Delaware and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.)
(filed as Exhibit 4.3 to the Registrant's Form 10-K for the year ended December 31, 1992 and
incorporated herein by reference).
4.4 -- Net Profits Conveyance effective as of October 1, 1992, by and among Williams Production
Company, The Williams Companies, Inc., and Bank of America, N.A. (as successor to NationsBank of
Texas, N.A.), and Chemical Bank Delaware (filed as Exhibit 4.4 to the Registrant's Form 10-K for
the year ended December 31, 1992 and incorporated herein by reference).
10.1 -- Administrative Services Agreement effective December 1, 1992, by and between The Williams
Companies, Inc. and Williams Coal Seam Gas Royalty Trust (filed as Exhibit 10.1 to the
Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by
reference).
10.2 -- Gas Purchase Agreement dated October 1, 1992, by and between Williams Gas Marketing Company and
Williams Production Company (filed as Exhibit 10.2 to the Registrant's Form 10-K for the year
ended December 31, 1992 and incorporated herein by reference).
10.3 -- First Amendment to the Gas Purchase Agreement effective January 12, 1993, by and between
Williams Gas Marketing Company and Williams Production Company (filed as Exhibit 10.3 to the
Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein by
reference).
</Table>
49
<Table>
<Caption>
EXHIBIT
NUMBER EXHIBIT
- ------- -------
10.4 -- Gas Gathering and Treating Agreement effective October 1, 1992, by and between Williams Field
Services Company and Williams Gas Marketing Company (filed as Exhibit 10.4 to the Registrant's
Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
10.5 -- First Amendment to the Gas Gathering and Treating Agreement effective as of January 12, 1993, by
and between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit
10.5 to the Registrant's Form 10-K for the year ended December 31, 1992 and incorporated herein
by reference).
10.6 -- Amendment #2 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and
between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit
10.6 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein
by reference).
10.7 -- Amendment #3 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and
between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit
10.7 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein
by reference).
23.1 -- Consent of Ernst & Young LLP.
23.2 -- Consent of Miller and Lents, Ltd.
99.1 -- The information under the section captioned "Tax Considerations" on pages 20-21, and the
information under the sections captioned "Federal Income Tax Consequences" and "ERISA
Considerations" on pages 45-52 of the Prospectus dated January 13, 1993, which constitutes a
part of the Registration Statement on Form S-3 of The Williams Companies, Inc. (Registration No.
33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the year ended December 31,
1992 and incorporated herein by reference).
99.2 -- Reserve Report, dated November 21, 1992, on the estimated reserves, estimated future net
revenues and the discounted estimated future net revenues attributable to the Royalty Interests
and the Underlying Properties as of October 1, 1992, prepared by Miller and Lents, Ltd.,
independent petroleum engineers, included as Exhibit A of the Prospectus dated January 13, 1993,
which constitutes a part of the Registration Statement on Form S-3 of The Williams Companies,
Inc. (Registration No. 33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference).
99.3 -- Reserve Report, dated February 10, 2003, on the estimated reserves, estimated future net
revenues and the discounted estimated future net revenues attributable to the Royalty Interests
and the Underlying Properties as of December 31, 2002, prepared by Miller and Lents, Ltd.,
independent petroleum engineers.
99.4 -- Certificate by Bank of America, Trustee of Williams Coal Seam Gas Royalty Trust, dated March 28,
2003 as required by 10 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
</Table>
(b) Reports on Form 8-K. No report on Form 8-K was filed by the
Registrant during the last quarter of the period covered by this report.
50
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) 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.
WILLIAMS COAL SEAM GAS ROYALTY TRUST
By: BANK OF AMERICA, N.A., TRUSTEE
By: /S/ RON E. HOOPER
-----------------------------------
RON E. HOOPER
Senior Vice President and Administrator
Date: March 28, 2003
(The Registrant has no directors or executive officers.)
51
CERTIFICATION
I, Ron Hooper, certify that:
1. I have reviewed this Annual Report on Form 10-K of Williams
Coal Seam Gas Royalty Trust, for which Bank of America, N.A.,
acts as Trustee;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
distributable income and changes in trust corpus of the
registrant as of, and for, the periods presented in this
annual report;
4. I am responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14), or for causing such procedures to be
established and maintained, for the registrant and I have:
a) designed such disclosure controls and procedures, or
caused such controls and procedures to be designed,
to ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to me by others within those entities,
particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c) presented in this quarterly report my conclusions
about the effectiveness of the disclosure controls
and procedures based on my evaluation as of the
Evaluation Date;
5. I have disclosed, based on my most recent evaluation, to the
registrant's auditors:
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
persons who have a significant role in the
registrant's internal controls; and
6. I have indicated in this annual report whether or not there
were significant changes in internal controls or in other
factors that could significantly affect internal controls
subsequent to the date of my most recent evaluation, including
any corrective actions with regard to significant deficiencies
and material weaknesses.
In giving the certifications in paragraphs 4, 5 and 6 above, I
have relied to the extent I consider reasonable on information
provided to me by Williams Production Company.
Date: March 28, 2003 By: /s/ Ron Hooper
----------------------------------------
Ron Hooper
Senior Vice President and Administrator
Bank of America, N.A.,
52
INDEX TO EXHIBITS
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
3.1 -- Certificate of Trust of Williams Coal Seam Gas Royalty Trust (filed as Exhibit 3.1 to the Registrant's
Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.1 -- Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of December 1, 1992, by and among Williams
Production Company, The Williams Companies, Inc. and Chemical Bank Delaware and Bank of America, N.A. (as
successor to NationsBank of Texas, N.A.), as trustees (filed as Exhibit 4.1 to the Registrant's Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference).
4.2 -- First Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of December 15,
1992, by and among Williams Production Company, The Williams Companies, Inc., Chemical Bank Delaware and
Bank of America, N.A. (as successor to NationsBank of Texas, N.A.) (filed as Exhibit 4.2 to the Registrant's
Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.3 -- Second Amendment to the Trust Agreement of Williams Coal Seam Gas Royalty Trust effective as of January 12,
1993, by and among Williams Production Company, The Williams Companies, Inc., Chemical Bank Delaware and
Bank of America, N.A. (as successor to NationsBank of Texas, N.A.) (filed as Exhibit 4.3 to the Registrant's
Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
4.4 -- Net Profits Conveyance effective as of October 1, 1992, by and among Williams Production Company, The
Williams Companies, Inc., and Bank of America, N.A. (as successor to NationsBank of Texas, N.A.), and Chemical
Bank Delaware (filed as Exhibit 4.4 to the Registrant's Form 10-K for the year ended December 31, 1992 and
incorporated herein by reference).
10.1 -- Administrative Services Agreement effective December 1, 1992, by and between The Williams Companies, Inc.
and Williams Coal Seam Gas Royalty Trust (filed as Exhibit 10.1 to the Registrant's Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference).
10.2 -- Gas Purchase Agreement dated October 1, 1992, by and between Williams Gas Marketing Company and Williams
Production Company (filed as Exhibit 10.2 to the Registrant's Form 10-K for the year ended December 31, 1992
and incorporated herein by reference).
10.3 -- First Amendment to the Gas Purchase Agreement effective January 12, 1993, by and between Williams Gas
Marketing Company and Williams Production Company (filed as Exhibit 10.3 to the Registrant's Form 10-K for
the year ended December 31, 1992 and incorporated herein by reference).
10.4 -- Gas Gathering and Treating Agreement effective October 1, 1992, by and between Williams Field Services
Company and Williams Gas Marketing Company (filed as Exhibit 10.4 to the Registrant's Form 10-K for the year
ended December 31, 1992 and incorporated herein by reference).
10.5 -- First Amendment to the Gas Gathering and Treating Agreement effective as of January 12, 1993, by and between
Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit 10.5 to the Registrant's
Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).
</Table>
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.6 -- Amendment #2 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and
between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit
10.6 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein
by reference).
10.7 -- Amendment #3 to the Gas Gathering and Treating Agreement dated as of October 1, 1993, by and
between Williams Field Services Company and Williams Gas Marketing Company (filed as Exhibit
10.7 to the Registrant's Form 10-K for the year ended December 31, 1993 and incorporated herein
by reference).
23.1 -- Consent of Ernst & Young LLP.
23.2 -- Consent of Miller and Lents, Ltd.
99.1 -- The information under the section captioned "Tax Considerations" on pages 20-21, and the
information under the sections captioned "Federal Income Tax Consequences" and "ERISA
Considerations" on pages 45-52 of the Prospectus dated January 13, 1993, which constitutes a
part of the Registration Statement on Form S-3 of The Williams Companies, Inc. (Registration No.
33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the year ended December 31,
1992 and incorporated herein by reference).
99.2 -- Reserve Report, dated November 21, 1992, on the estimated reserves, estimated future net
revenues and the discounted estimated future net revenues attributable to the Royalty Interests
and the Underlying Properties as of October 1, 1992, prepared by Miller and Lents, Ltd.,
independent petroleum engineers, included as Exhibit A of the Prospectus dated January 13, 1993,
which constitutes a part of the Registration Statement on Form S-3 of The Williams Companies,
Inc. (Registration No. 33-53662) (filed as Exhibit 28.1 to the Registrant's Form 10-K for the
year ended December 31, 1992 and incorporated herein by reference).
99.3 -- Reserve Report, dated February 10, 2003, on the estimated reserves, estimated future net
revenues and the discounted estimated future net revenues attributable to the Royalty Interests
and the Underlying Properties as of December 31, 2002, prepared by Miller and Lents, Ltd.,
independent petroleum engineers.
99.4 -- Certificate by Bank of America, Trustee of Williams Coal Seam Gas Royalty Trust, dated March 28,
2003 as required by 10 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
</Table>