3
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
x Quarterly report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1998
or
o Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 000-23701
SOUTHWEST ROYALTIES, INC. SOUTHWEST
ROYALTIES
(Exact Name of Registrant as HOLDINGS, INC.
Specified in Its Charter) (Exact
Name of Registrant as
Specified in Its Charter)
Delaware Delaware
(State or Other Jurisdiction of (State or
Other Jurisdiction of
Incorporation or Organization)
Incorporation or Organization)
75-1917432 75-2724264
(I.R.S. Employer (I.R.S.
Employer
Identification Number) Identification Number)
407 North Big Spring, Suite 300
Midland, Texas 79701
(Address of Principal Executive Offices) (Zip
Code)
(915) 686-9927
Registrants' Telephone Number, Including Area Code:
Not Applicable
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check 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 ___
Number of shares of common stock outstanding as of September 30,
1998 for Southwest Royalties, Inc........................100.
Number of shares of common stock outstanding as of September 30,
1998 for Southwest Royalties Holdings, Inc...1,075,868.
<PAGE>
SOUTHWEST ROYALTIES, INC.
SOUTHWEST ROYALTIES HOLDINGS, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 1998
(unaudited)
and December 31, 1997 3
Consolidated Statements of Operations for the three and
nine months ended
September 30, 1998 and 1997 (unaudited) 5
Consolidated Statements of Cash Flows for the three and nine
months ended
September 30, 1998 and 1997 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and
Results of Operations 18
PART II - OTHER INFORMATION
Item 6. Reports on
Form 8-K and Exhibits 24
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
September 30,December
31,
ASSETS 1998
1997
- -----------------------------------------------------------------
- ---------------------------------------------------------------
(unaudited)
Current assets
Cash and cash equivalents $20,027 $27,365
Accounts receivable, net of allowance of $265 and $254,
respectively 6,813 8,376
Receivables from related parties 673 2,556
Other current assets 1,778 1,209
----------
- ----------
Total current assets 29,291 39,506
----------
- ----------
Oil and gas properties, using the full cost method of accounting
Proved 193,344 188,432
Unproved 4,735 4,554
----------
- ----------
198,079 192,986
Less accumulated depletion, depreciation and amortization
79,877 42,240
----------
- ----------
Oil and gas properties, net 118,202 150,746
----------
- ----------
Rental property, net 109,577 81,373
----------
- ----------
Other property and equipment, net 5,916 5,556
----------
- ----------
Other assets
Restricted cash 6,502 8,064
Equity investment in subsidiaries 2,443 2,443
Real estate investments 4,013 4,203
Deferred debt costs, net of accumulated amortization of
$2,542 and $903, respectively 8,585 9,382
Noncompete covenants, net of accumulated amortization
of $196 1,407 -
Other, net 2,338 4,170
----------
- ----------
Total other assets 25,288 28,262
----------
- ----------
Total assets $288,274 $305,443
====== ======
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share data)
LIABILITIES, MINORITY INTEREST, REDEEMABLE September 30,December
31,
COMMON STOCK AND STOCKHOLDERS' DEFICIT 1998 1997
- -----------------------------------------------------------------
- ------------------------------- ----------------------
- --------
(unaudited)
Current liabilities
Current maturities of long-term debt $78,450 $1,878
Accounts payable 4,087 7,119
Accounts payable to related parties - 64
Accrued expenses 7,680 4,049
Accrued interest payable 10,808 5,401
Deferred income taxes - 254
----------
- ----------
Total current liabilities 101,025 18,765
----------
- ----------
Long-term debt 233,168 281,764
----------
- ----------
Other long-term liabilities 1,795 1,809
----------
- ----------
Deferred income taxes - 2,094
----------
- ----------
Minority interest 864 1,861
----------
- ----------
Redeemable common stock of subsidiary 2,777 2,666
----------
- ----------
Redeemable common stock 8,290 8,290
----------
- ----------
Stockholders' deficit
Preferred stock - $1 par value; 5,000,000 shares authorized;
none issued - -
Common stock - $.10 par value; 5,000,000 shares authorized;
1,161,037 issued 116 116
Additional paid-in capital 2,196 2,196
Accumulated deficit (57,181) (9,321)
Note receivable from an officer and stockholder (1,686)
(1,707)
Less: treasury stock - at cost; 214,215 shares (3,090)
(3,090)
----------
- ----------
Total stockholders' deficit (59,645) (11,806)
---------
- ---------
Total liabilities, minority interest, redeemable common stock
and stockholders' deficit $288,274 $305,443
====== ======
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Operating revenues
Oil and gas $ 7,357 $7,073 $26,188 $24,919
Well servicing - - - 7,789
Real estate 6,965 1,899 17,759 5,029
Other 366 347 1,155 888
------------ ------------
- ------------ ------------
Total operating revenues 14,688 9,319
45,102 38,625
------------ ------------
- ------------ ------------
Operating expenses
Oil and gas production 4,234 4,005 14,896 12,166
Well servicing - - - 5,600
Real estate 3,534 685 8,786 1,907
General and administrative, net of related
party management and administrative
fees of $905, $695, $2,752 and
$3,000, respectively 1,106 912 3,708 3,850
Depreciation, depletion and amortization 1,707 2,215
11,195 8,093
Impairment of oil and gas properties - -
29,000 -
Other 325 352 1,052 1,003
------------ ------------
- ------------ ------------
Total operating expenses 10,906 8,169 68,637
32,619
------------ ------------
- ------------ ------------
Operating income (loss) 3,782 1,150 (23,535) 6,006
------------ ------------
- ------------ ------------
Other income (expense)
Interest and dividend income 346 156 1,143
545
Interest expense (9,584) (4,131) (26,502) (10,950)
Other 26 59 306 (66)
------------ ------------
- ------------ ------------
(9,212) (3,916) (25,053) (10,471)
------------ ------------
- ------------ ------------
(conti
nued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
(in thousands, except per share data)
(unaudited)
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Loss before income taxes, minority interest,
equity loss and extraordinary item $ (5,430) $(2,766)
$ (48,588) $ (4,465)
Income tax benefit - 1,022 2,348 1,526
------------ ------------
- ------------ ------------
Loss before minority interest, equity loss and
extraordinary item (5,430) (1,744) (46,240) (2,939)
Minority interest in subsidiaries, net of tax 290
100 489 322
Equity in loss of subsidiary, net of tax (1,028) -
(2,109) -
------------ ------------
- ------------ ------------
Loss before extraordinary item (6,168) (1,644) (47,860)
(2,617)
Extraordinary item, net of tax - - -
(490)
------------ ------------
- ------------ ------------
Net loss $(6,168) $(1,644) $(47,860) $
(3,107)
======= ======= ======= =======
Loss per common share before extraordinary
item $(5.74) $(1.53) $(44.49) $(2.43)
Extraordinary loss from early extinguishment
of debt - - - (.45)
------------ ------------
- ------------ ------------
Loss per common share $(5.74) $(1.53) $(44.49) $(2.88)
======= ======= ======= =======
Weighted average shares outstanding 1,075,868
1,075,868 1,075,868 1,078,454
======= ======= ======= =======
The accompanying notes are an integral part of these consolidated
financial statements
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Cash flows from operating activities
Net loss $(6,168) $(1,644) $(47,860) $
(3,107)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation, depletion and amortization 1,707 2,215
11,195 8,093
Impairment of oil and gas properties - -
29,000 -
Noncash interest expense 800 1,117 2,025
1,660
Extraordinary loss from early extingushment
of debt - - - 490
Loss (gain) on sale of assets (23) (6) (284)
119
Equity loss of subsidiary 1,028 - 2,109
- -
Other noncash items 97 (341) 174 (169)
Bad debt expense 32 - 187 -
Deferred income taxes - (813) (2,348) (1,284)
Minority interest in loss of subsidiary (290) (100)
(489) (322)
Changes in operating assets and liabilities-
Accounts receivable 909 (560) 3,279 (6,048)
Other current assets 46 (27) (207) (613)
Accounts payable and accrued expenses 1,177 876
5,408 6,723
Accrued interest payable 5,430 3,917 534
4,230
Income taxes payable - 5 - (25)
------------ ------------
- ------------ ------------
Net cash provided by operating activities 4,745 4,639
2,723 9,747
------------ ------------
- ------------ ------------
Cash flows from investing activities
Proceeds from sale of oil and gas properties 738
1,064 3,796 1,146
Purchase of oil and gas properties (2,323) (7,432)
(8,889) (26,522)
Purchase of other property and equipment
and rental property (3,211) (18,535) (29,662) (34,944)
Purchase of other assets (1,095) - (3,242)
(2,660)
Purchase of noncompete covenants - - (1,602)
-
Proceeds from sale of real estate investments -
- 764 -
Proceeds from sale of other assets 77 -
1,137 -
Proceeds from sale of other property and
equipment and rental property 27 - 51
-
Purchase of real estate investments (328) (4)
(328) (57)
Change in restricted cash 506 (2,369) 1,562
(4,828)
Purchase of treasury stock by subsidiary - -
- (1,174)
Other 7 (543) 15 306
------------ ------------
- ------------ ------------
Net cash used by investing activities (5,602) (27,819)
(36,398) (68,733)
------------ ------------ ---
--------- ------------
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(unaudited)
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Cash flows from financing activities
Proceeds from borrowings $ 2,330$ 27,087 $29,295
$ 87,119
Payments on debt (869) (2,174) (1,706) (31,987)
Payments on other long-term liabilities - (58)
(57) (101)
Increase in other long-term liabilities 21 96
43 724
Cash received on subscriptions receivable - -
- - 2,807
Purchase of treasury stock - (30) -
(582)
Issuance of redeemable common stock,
net of issue costs - - - 33
Deferred debt cost (61) (529) (841) (1,464)
Dividends paid to minority interest owners (28)
(29) (89) (91)
Purchase of minority interest in subsidiary -
- - (305) -
Net proceeds from sale of minority interest -
904 - 904
Prepayment penalty on early extinguishment
of debt - (336) - (336)
Other - (5) (3) -
------------ ------------
- ------------ ------------
Net cash provided by financing activities 1,393 24,926
26,337 57,026
------------ ------------
- ------------ ------------
Net increase (decrease) in unrestricted cash and
cash equivalents 536 1,746 (7,338) (1,960)
Unrestricted cash and cash equivalents -
beginning of period 19,491 4,578 27,365 8,284
------------ ------------
- ------------ ------------
Unrestricted cash and cash equivalents -
end of period $20,027 $6,324 $20,027 $6,324
======= ======= ======= =======
Supplemental disclosures of cash flow information
Interest paid $ 3,390 $2,806 $19,106 $8,704
Income taxes received $ - $(162) $ - $ (74)
The accompanying notes are and integral part of these
consolidated financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Business
Southwest Royalties Holdings, Inc. ("SRH"), a Delaware
corporation was formed in June 1997 to serve as a holding company
for Southwest Royalties Inc. ("Southwest"), Sierra Well Service
Inc. ("Sierra") and Midland Red Oak Realty, Inc. ("Red Oak")
(collectively, the "Company"). Each shareholder of Southwest was
issued one share in SRH for each share of Southwest stock held.
Prior to the formation of SRH, Red Oak and Sierra were
subsidiaries of Southwest. Southwest paid a dividend of the
shares it owned in Red Oak and Sierra to SRH. After the
formation of SRH, Southwest and Red Oak became subsidiaries of
SRH and, as of July 1, 1997, Sierra was deconsolidated.
Southwest is principally involved in the business of oil and
gas development and production. Southwest is the general partner
of Southwest Partners II and III, which own common stock in
Sierra. Southwest sells its oil and gas production to a variety
of purchasers, with the prices it receives being dependent upon
oil and gas commodity prices. Red Oak is principally involved in
real estate investment and development. Sierra is principally
involved in the business of oil and gas well services.
Principles of Consolidation
The consolidated financial statements include the accounts of
SRH and its subsidiaries, each of which are wholly owned, except
for Red Oak, Sierra, Midland Southwest Software ("Software") and
Threading Products International, LLC ("TPI"). Software and TPI
are subsidiaries of Southwest. As of September 30, 1998, the
Company owned approximately 81% of Red Oak, 39% of Sierra, 99% of
Software and 98% of TPI. Effective July 1, 1997, Sierra was
deconsolidated and is accounted for using the equity method. The
consolidated financial statements include the Company's
proportionate share of the assets, liabilities, income and
expenses of oil and gas limited partnerships for which it serves
as managing general partner. The Company accounts for its
investments in Sierra, Southwest Partners II and III using the
equity method. All significant intercompany transactions have
been eliminated.
Commodity Hedging and Derivative Financial Instruments
The financial instruments that the Company accounts for as
hedging contracts must meet the following criteria: the
underlying asset must expose the Company to price risk that is
not offset in another asset or liability, the hedging contract
must reduce that price risk, and the instrument must be
designated as a hedge at the inception of the contract and
throughout the contract period. In order to qualify as a hedge,
there must be a clear correlation between changes in the fair
value of the financial instrument and the fair value of the
underlying asset such that changes in the market value of the
financial instrument will be offset by the effect of price
changes on the exposed items.
Since the contracts are accounted for as hedges, premiums
paid for such contracts are amortized to oil and gas sales over
the term of the agreements. Unamortized premiums are included in
other assets in the consolidated balance sheet. Amounts
receivable under the commodity option contracts are accrued as an
increase in oil and gas sales for the applicable periods.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies -
continued
Noncompete covenants
Noncompete covenants are carried at cost less accumulated
amortization. The covenants are being amortized over their
contractual lives, generally three to five years.
Reporting Comprehensive income
In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 130 "Reporting Comprehensive Income"
("SFAS 130") which establishes standards for reporting and
display of comprehensive income and its components in a full set
of general-purpose financial statements. Specifically, SFAS 130
requires that an enterprise (i) classify items of other
comprehensive income by their nature in a financial statement and
(ii) display the accumulated balance of other comprehensive
income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial
position. This statement has no effect on the Company.
Segment Reporting
In June 1997, the FASB issued Statement of Financial
Accounting Standards No. 131 "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131") which
establishes standards for public business enterprises for
reporting information about operating segments in annual
financial statements and requires that such enterprises report
selected information about operating segments in interim
financial reports issued to shareholders. This statement also
establishes standards for related disclosures about products and
services, geographic areas, and major customers. The Company
implemented SFAS 131 during 1997.
Interim Financial Statements
In the opinion of management, the unaudited consolidated
financial statements of the Company as of September 30, 1998 and
1997 include all adjustments and accruals, consisting only of
normal recurring accrual adjustments, which are necessary for a
fair presentation of the results for the interim periods. These
interim results are not necessarily indicative of results for a
full year. Certain amounts in the prior period financial
statements have been reclassified to conform with the current
period presentation.
Certain information and footnote disclosures normally
included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or
omitted in this Report pursuant to the rules and regulations of
the Securities and Exchange Commission. These consolidated
financial statements should be read in conjunction with the
consolidated financial statements and notes thereto included in
the 1997 Form 10-K of the Company.
2. Subsidiaries, Acquisitions and Dispositions
During the nine months ended September 30, 1998, Red Oak
acquired four office buildings one real estate fee management and
brokerage company, two retail shopping malls and two retail pad
sites for approximately $28 million. The transactions were
accounted for using the purchase method. The results of
operations of the acquired properties and the real estate fee
management and brokerage company are included in the Consolidated
Statements of Operations as of the close of each acquisition.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. Property and Equipment
Property and equipment, including oil and gas, well servicing,
rental property and other, consists of the following (in
thousands):
September 30, 1998December 31,
----------------------------------
(unaudited) 1997 1996
------ ------
Land $ 2,287 $ 2,157 $ 2,157
Building and improvements 1,419 1,413
1,326
Machinery and equipment 2,952 2,277 7,365
Furniture and fixtures 2,365 1,743 1,714
Equipment under capital lease 56 614
1,000
Rental property 113,675 83,696 30,287
---------- --------
- --------
122,754 91,900 43,849
Less accumulated depreciation 7,261 4,971
5,171
---------- --------
- --------
$115,493 $ 86,929 $ 38,678
====== ===== =====
4. Long-term Debt
Long-term debt consists of the following (in thousands):
September 30, 1998December 31,
----------------------------------
(unaudited) 1997 1996
------ ------
10.5% Senior Notes, interest payable
semi-annually due October 15, 2004,
net of discount of $2,182 and $2,346,
respectively $197,818 $197,654 $ -
13% Notes payable, due April 2000.
Cash interest of 10% payable monthly
with additional interest payable based
on excess cash flow or through
the issuance of additional notes.
Collateralized by real estate. 71,927 70,628
- -
Revolving line of credit with variable-
rate interest, due February 1999.
Collateralized by oil and gas properties 40
100 28,125
9% Notes payable, with variable
quarterly payments including interest,
due December 2003. - - 27,649
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Long-term Debt - continued
September 30, 1998December 31,
----------------------------------
(unaudited) 1997 1996
------ ------
10% Note payable, interest payable monthly,
due June 1998. - - 9,000
12% Note payable, interest payable
semi-annually due November 2001. - -
7,143
Capital lease obligations 286 473
352
Note payable at 3-year U.S. Treasury plus
3.875%, monthly payments of $41
including interest, due February 2002 -
- - 4,428
Note payable at 3-year U.S. Treasury plus
3.5%, monthly payments of $46
including interest, due November 2002 -
- - 4,954
Note payable, at prime plus 1.5%, monthly
payments of $68 including interest,
due September 2003.. - - 7,106
Notes payable due July 2001. Variable rate
interest due and payable monthly with
additional 1% payable based on the lock
box agreement. Net of discount of $1,778. 13,690
- - -
Other 27,857 14,787 5,048
----------
- ---------- --------
311,618 283,642
93,805
Less current maturities 78,450 1,878 10,216
----------
- ---------- --------
$233,168 $281,764
$ 83,589
====== ======
=====
10.5% Senior Notes
In October 1997, the Company issued $200 million aggregate
principal amount of 10.5% Senior Notes due October 15, 2004 (the
"Notes"). The Notes were sold at a discount and interest is
payable April 15 and October 15 of each year, commencing April
15, 1998. The Notes are general unsecured senior obligations of
the Company and rank equally in right of payment with all other
senior indebtedness of the Company and senior in right of payment
of all existing future subordinated indebtedness of the issuer.
Net proceeds from the issuance of the Notes were used primarily
to repay existing debt of approximately $84 million, purchase oil
and gas properties for approximately $72 million, purchase
additional stock in Red Oak for approximately $10 million, invest
$1.7 million in an affiliate, with the remaining balance to be
used for working capital.
The Indenture imposes certain limitations on the ability of
the Company and its restricted subsidiaries to, among other
things, incur additional indebtedness or issue disqualified
capital stock, make payments in respect to capital stock, enter
into transactions with affiliates, incur liens, sell assets,
change the nature of its business, merge or consolidate with any
other person and sell, lease, transfer or otherwise dispose of
substantially all of its properties or assets. The indenture
requires the issuer to repurchase notes under certain
circumstances with the excess cash of certain asset sales. The
limitations are subject to a number of important qualifications
and exceptions. The issuer must report to the Trustee on
compliance with such limitations on a quarterly basis.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Long-term Debt - continued
13% Note Payable
In April 1997 MRO Properties Inc. ("MROP"), a 100% owned
subsidiary of Red Oak entered into a $42 million credit facility
maturing in April 2000 with an institutional lender (the "MROP
Facility"). The MROP Facility was executed in order to
consolidate nine mortgage loans, originally incurred to complete
the acquisition of certain Red Oak properties and to finance the
acquisition of an additional real estate property. Borrowings
under the facility bear interest at a rate of 13%, with 10%
payable in cash and the remaining 3% payable in cash or
additional notes. The facility contains a number of covenants
that, among other things, restrict the ability of MROP to incur
additional indebtedness and dispose of assets. The facility is
secured by a first lien on substantially all of MROP's
properties. In September 1997, the Company negotiated an
additional $30.5 million in loan proceeds which was used to
acquire a retail shopping center and office building in Oklahoma
City, Oklahoma and a retail shopping center in San Antonio,
Texas. The loan is collateralized by the properties purchased,
and by properties contributed by the Company. At December 31,
1997 and September 30, 1998, the Company was not in compliance
with certain covenants of the term loan. Under the capital
reserve clause of the Agreement, MROP was required to deposit in
escrow with the creditor $1 million by September 30, 1998 and an
additional $1 million by October 23, 1998, to be used for future
capital improvements to the properties. Subsequently, the lender
extended the deposit due dates until December 1, 1998.
Management is currently negotiating with the lender as well as
other lenders to restructure or refinance the loan to free up
working capital and make funds available for capital improvement
expenditures, as they become necessary. However, there can be no
assurance that management will be able to renegotiate or
refinance the current facility and therefore under general
accepted accounting principles (GAAP) the entire principal
balance outstanding has been classified as current debt. The
facility is non-recourse to Red Oak.
Revolving Line of Credit
The revolving credit line allows Southwest to borrow the
lesser of $75 million or the borrowing base which is redetermined
periodically. As of December 31, 1996, the borrowing base was
$28.1 million and as of December 31, 1997, the borrowing base was
$40 million. As of September 30, 1998, the borrowing base was
$40,000. The revolving line of credit agreement provides for the
revolver to become due and payable on February 28, 1999. Fees on
the unused portion of the revolving line of credit are three-
eighths of one percent (3/8%) per annum on the daily average of
the unadvanced amount of the borrowing base.
Southwest has the option to elect an interest rate based on
LIBOR plus the applicable Eurodollar Margin or Prime plus a base
rate margin. Both margins are based on the percentage of the
revolving commitment outstanding. The Eurodollar Margin ranges
from a minimum of 1.75% to a maximum of 2.50% and the Prime base
rate margin ranges from a minimum of .25% to a maximum of 1.00%.
Certain covenants of the revolving line of credit require a
tangible net worth of not less than $2 million, a current ratio
of 1.0 to 1, a minimum fixed coverage ratio of 1.1 to 1,
restrictions on cash dividends, additional indebtedness and
purchases of investments. The covenants that the Company violated
as of December 31, 1997 consisted of minimum tangible net worth,
sale of assets and minimum interest coverage ratio which were all
subsequently waived. On March 27, 1998, the covenants were
amended to remove the tangible net worth requirement, increase
allowable sales of assets from $250,000 to at least $10 million
and revise the minimum interest coverage ratio to .7 to 1.0.
Substantially all of Southwest's assets are collateralized in
connection with this debt.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Long-term Debt - continued
9% Note Payable
In August 1995, a subsidiary of Southwest entered into a note
agreement which provided for $30.3 million to purchase oil and
gas properties. In October 1997, this note was repaid with a
portion of the proceeds from the aforementioned Note.
10% Note Payable
In October 1996, Red Oak, through a subsidiary, issued a term
note of $9 million to finance the purchase of real estate. This
note was repaid with a portion of the proceeds from the
aforementioned 13% note payable.
12% Note Payable
In November 1996, Southwest entered into a senior subordinated
note agreement which provided for $8 million to be used for
developmental drilling. This note was repaid with a portion of
the proceeds from the aforementioned 10.5% Senior Notes.
Variable Rate Notes Payable
In June 1998, MRO N Cross, Inc., a wholly owned subsidiary of
Midland Red Oak Realty, Inc. negotiated two notes payable in the
amount of $13.5 million, net of a $2 million discount, and $2.5
million. The $13.5 million note was used for the acquisition of
rental property in the amount of $12.9 million with the remaining
$600,000 to be used for capital improvements to the rental
property purchased. The $2.5 million note is for capital
improvements to the rental property purchased and has not been
utilized as of September 30, 1998. The notes are collateralized
by the property purchased.
Extinguishment of Debt
In 1997, the Company repaid the aforementioned 9% Note
Payable, 10% Note Payable and 12% Note Payable. The remaining
unamortized deferred debt costs associated with these notes
resulted in an extraordinary charge of $4,350,000, net of
$1,241,000 of tax benefit, or $2.88 per share.
Aggregate maturities of all long-term debt as of September 30,
1998, including capital leases, are as follows (in thousands):
For the twelve
months ended
September 30, 1999 $78,450
September 30, 2000 581
September 30, 2001 14,308
September 30, 2002 333
September 30, 2003 8,305
Thereafter 209,641
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
5. Commitments and Contingencies
The Company is subject to extensive federal, state and local
environmental laws and regulations. These laws, which are
constantly changing, regulate the discharge of materials into the
environment and may require the Company to remove or mitigate the
environmental effects of the disposal or release of petroleum or
chemical substances at various sites. Environmental expenditures
are expensed or capitalized depending on their future economic
benefit. Expenditures that relate to an existing condition
caused by past operations and that have no future economic
benefits are expensed. Liabilities for expenditures of a
noncapital nature are expensed when environmental assessment
and/or remediation is probable and the costs can be reasonably
estimated.
Management recognizes a financial exposure that may require
future expenditures presently existing for oil and gas properties
and other operations. As of September 30, 1998, the Company has
not been fined, cited or notified of any environmental violations
which would have a material adverse effect upon capital
expenditures, earnings or the competitive position in the oil and
gas industry. However, management does recognize that by the
very nature of its business, significant costs could be incurred
to bring the Company into total compliance. The amount of such
future expenditures is not readily determinable due to several
factors, including the unknown magnitude of possible
contaminations, the unknown timing and extent of the corrective
actions which may be required, the determination of the Company's
liability in proportion to other responsible parties and the
extent to which such expenditures are recoverable from insurance
or indemnifications from prior owners of the Company's
properties. It is reasonably possible this estimate could change
materially in the near term.
In the normal course of its business, the Company is subject
to pending or threatened legal actions; in the opinion of
management, any such matters will be resolved without material
effect on the Company's operations, cash flow or financial
position.
6. Commodity Hedging and Derivative Financial Instruments
The Company, from time to time, uses option contracts to
mitigate the volatility of price changes on commodities the
Company produces and sells as well as to lock in prices to
protect the economics related to certain capital projects. Prior
to September 30, 1998, the Company purchased put options on a
total of 13,000 MMBtu of natural gas per day. These options
expire on October 31, 1998 and have a strike price, based on the
El Paso Natural Gas Co. - Permian Basin Index, of $1.90 for 6,500
MMBtu per day and $1.70 for the remaining 6,500 MMBtu per day.
In May 1998, the Company purchased a collar for 1,500 MMBtu of
natural gas per day which expires on October 31, 1998. The
collar has a call strike price of $2.63 per MMBtu and a put
strike price of $1.95 per MMBtu based on the NYMEX Henry Hub
Natural Gas Futures Contract.
In August 1998, the Company purchased an additional put option
on a total of 15,000 MMBtu of natural gas per day with a strike
price of $2.00 per MMBtu. The option is based on the El Paso
Natural Gas Co. - Permian Basin Index and is for the period from
November 1, 1998 through March 31, 1999.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Impairment of Oil and Gas Properties
Southwest uses the full cost method of accounting for its
investment in oil and gas properties. Under the full cost method
of accounting, all costs of acquisition, exploration and
development of oil and gas reserves are capitalized into a ''full
cost pool'' as incurred, and properties in the pool are depleted
and charged to operations using the gross revenues method based
on the ratio of current gross revenues to total proved future
gross revenues, computed based on current prices. Should the net
capitalized costs exceed the estimated present value of oil and
gas reserves, discounted at 10%, such excess costs would be
charged to current expense. As of June 30, 1998, the net
capitalized cost exceeded the estimated present value of oil and
gas reserves, thus a noncash adjustment of $29.0 million was made
to the financial statement. Once incurred, a writedown of oil
and gas properties is not reversible at a later date, even if oil
or natural gas prices increase.
8. Lines of Business
The Company operates in three major segments: Oil and Gas
Activities (oil and gas acquisition, development, exploration and
production, as well as organizing and serving as managing general
partner for various public and private limited partnerships
engaged in oil and gas development and production), Oil and Gas
Well Servicing (provides well completion, recompletion and
production equipment, transportation services, tank supply rental
services and other support and well maintenance services to
operating oil and gas companies) and Real Estate Investment and
Management (owns and manages retail shopping centers and office
buildings). Other items include eliminations, manufacturing,
computer service and broker/dealer and the holding company.
Effective July 1, 1997, Sierra, the oil and gas well servicing
business, was deconsolidated, therefore income statement
information for the nine months ended September 30, 1998 is not
displayed in the tables and no balance sheet information is
displayed as of September 30, 1998.
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
(in thousands) (in thousands)
(unaudited) (unaudited)
Operating profit (loss)
Oil and gas $ 1,685 $ 451 $(29,289) $
4,274
Well service - - - 184
Real estate 2,094 755 5,774 1,831
Other and eliminations 3 (56) (20)
(283)
---------- ----------
- ---------- ----------
$ 3,782 $1,150 $(23,535) $
6,006
====== ====== ====== ======
Interest Expense
Oil and gas $ 5,719 $2,375 $16,846 $6,855
Well Service - - - 184
Real Estate 3,882 1,749 9,628 3,880
Other and eliminations (17) 7 28
31
---------- ----------
- ---------- ----------
$ 9,584 $4,131 $26,502 $10,950
====== ====== ====== ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Lines of Business - continued
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
(in thousands) (in thousands)
(unaudited) (unaudited)
Depreciation, depletion and amortization
Oil and gas $ 852 $1,883 $9,021 $6,395
Well service - - - 747
Real estate 808 293 2,034 826
Other and eliminations 47 39 140
125
---------- ----------
- ---------- ----------
$ 1,707 $2,215 $11,195 $8,093
====== ====== ====== ======
Capital expenditures
Oil and gas $ 2,534 $5,431 $9,489 $27,153
Well service - - - 6,905
Real estate 4,174 20,507 30,042 27,309
Other and eliminations 106 29 300
99
---------- ----------
- ---------- ----------
$ 6,814 $25,967 $39,831 $61,466
====== ====== ====== ======
September 30,December
31,
1998 1997
--------------------
- -----
Identifiable assets
Oil and gas $162,909 $205,054
Real estate 126,837 98,890
Other and eliminations (1,472)
1,499
----------
- ----------
$288,274 $305,443
====== ======
9. Subsequent Events
In October 1998, Red Oak purchased an office building in
Midland, TX for a purchase price of $1.1 million. Subsequent to
September 30, 1998, Red Oak escrowed approximately $1.5 million
to be used towards the purchase price of approximately $21.0
million for a retail mall in Victoria, TX.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
Southwest Royalties Holdings, Inc., a Delaware corporation,
was formed in 1997 to serve as a holding company for Southwest
Royalties, Inc., Sierra Well Service, Inc. and Midland Red Oak
Realty, Inc. SRH is an independent oil and gas company engaged
in the acquisition, development and production of oil and gas
properties, primarily in the Permian Basin of West Texas and
Southeastern New Mexico, through its wholly-owned subsidiary,
Southwest. Since 1983, Southwest has grown primarily through
selective acquisitions of producing oil and gas properties, both
directly and through the oil and gas partnerships it manages. SRH
also participates in the well servicing industry through its
affiliate, Sierra, and owns and manages real estate properties
through its subsidiary, Red Oak. References in this report to
the "Company" are to SRH and its consolidated subsidiaries,
including Southwest, Red Oak and Sierra, an unconsolidated
affiliate.
Southwest has grown principally through the acquisition of
producing properties, establishing a substantial base of
producing and undeveloped properties in the Permian Basin. In
the nine months ended September 30, 1998, Southwest drilled 15
gross (5.72 net) development wells and 8 gross (3.53 net)
exploratory wells. Southwest successfully completed 15 gross
(5.72 net) development wells and 7 gross (2.53 net) exploratory
wells, achieving 100% and 88% drilling success in its development
and exploration activities, respectively. The Company expects to
invest $1.2 million in capital expenditures during the last
quarter of 1998 on continuous development commitments and non-
operated property development.
The Company places emphasis on profitable acquisition
opportunities as long as such opportunities exist. However, the
Company understands the cyclical nature of the oil and gas
industry. Therefore, the Company also actively seeks to develop
its inventory of existing proved developed non-producing and
proved undeveloped reserves. The Company's staff and operations
can easily shift emphasis between acquisitions and reserve
development depending on market conditions. A significant
portion of the Company's reserves are proved undeveloped and are
therefore available for development.
Southwest's revenue, profitability and cash flow are
substantially dependent upon prevailing prices for crude oil and
natural gas and the volumes of crude oil and natural gas it
produces. Throughout 1998 and currently, the company as well as
the oil and gas industry as a whole, is experiencing severe
decreases in oil and gas commodity prices. The severe decrease
in the commodity prices has drastically affected revenues and
cashflows from operations received by the company. Based on
current commodity prices and production, the company is limited
in its ability to meet operating and capital needs beyond 1999.
Management is constantly monitoring its cash position and its
ability to meet its financial obligations as they become due, and
in this effort, is exploring various strategies for addressing
its current and future liquidity needs. In addition, Southwest's
proved reserves and oil and gas production will decline as crude
oil and natural gas are produced, unless Southwest is successful
in acquiring producing properties or conducts successful
exploration and development activities.
Southwest uses the full cost method of accounting for its
investment in oil and gas properties. Under the full cost method
of accounting, all costs of acquisition, exploration and
development of oil and gas reserves are capitalized into a ''full
cost pool'' as incurred, and properties in the pool are depleted
and charged to operations using the gross revenues method based
on the ratio of current gross revenues to total proved future
gross revenues, computed based on current prices. Significant
downward revisions of quantity estimates or declines in oil and
gas prices that are not offset by other factors could result in a
writedown for impairment of oil and gas properties. Once
incurred, a writedown of oil and gas properties is not reversible
at a later date, even if oil or natural gas prices increase.
During most of 1996 and 1997, the Company benefited from higher
oil prices as compared to previous years. However, during the
second quarter of 1998, oil prices were significantly lower
causing the Company to incur a $29.0 million noncash charge.
Also, further declines in oil prices could result in additional
decreases in the carrying value of the Company's oil and gas
properties.
<PAGE>
Red Oak was formed by the Company in 1992 to acquire and
manage neighborhood and community shopping centers, other retail
and commercial properties and office buildings. These properties
are primarily leased, on a long-term basis, to major retail
companies, local specialty retailers and professional and
business tenants throughout secondary urban markets in the
southwestern United States. As of September 30, 1998, Red Oak
owns and operates 16 shopping centers, eight office buildings and
raw land held for future development.
Effective July 1, 1997, Sierra was deconsolidated from the
financial statements of SRH and is subsequently reported using
the equity method of accounting. As such, comparisons of revenue
and expenses for the nine months ended 1998 to the nine months
ended 1997 are not relevant and therefore no discussion of such
results of operations are provided.
Results of Operations
The following table summarizes production volumes, average
sales prices and period to period comparisons for the Company's
oil and gas operations, including the effect on revenues, for the
periods indicated:
Three months endedNine months ended
September 30, September 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Production volumes:
Oil and condensate (MBbls) 412 264 1,341
818
Natural gas (MMcf) 1,325 1,277 4,336 4,142
Average sales prices:
Oil and condensate (per Bbl) $12.04 $17.00 $13.16
$ 19.39
Natural gas (per Mcf) $ 1.66 $ 1.99 $ 1.85 $ 2.01
Revenues. Revenues for the Company increased to $14.7 million
and $45.1 million for the three and nine months ended September
30, 1998, respectively, as compared to $9.3 million and $38.6
million for the same periods in 1997. Revenues increased in each
segment, with the exception of Sierra which was deconsolidated.
Oil and gas revenues increased 4% to $7.4 million for the
three months ended September 30, 1998 and 5% to $26.3 million for
the nine months ended September 30, 1998, as compared to $7.1
million and $25.0 million for the same periods in 1997. The
increase for the three and nine months ended September 30, 1998
is primarily due to increases in oil and gas production, offset
by a decrease in average oil and natural gas prices. The majority
of the increased production is a direct result of a large oil and
gas acquisition in October 1997.
The Company, from time to time, uses option contracts to
mitigate the volatility of price changes on commodities the
Company produces and sells as well as to lock in prices to
protect the economics related to certain capital projects. Prior
to September 30, 1998, the Company purchased put options on a
total of 13,000 MMBtu per day, which represents approximately 80%
of the Company's gas production. These options expire on October
31,1998 and have a strike price, based on the El Paso Natural Gas
Co. - Permian Basin Index, of $1.90 for 6,500 MMBtu per day and
$1.70 for the remaining 6,500 MMBTU per day. In May 1998, the
Company purchased a collar for 1,500 MMBtu of natural gas per day
which expires on October 31, 1998. The collar has a strike price
of $2.63 per MMBtu and a put strike price of $1.95 per MMBtu
based on the NYMEX Henry Hub Natural Gas Futures Contract. In
August 1998, the Company purchased an additional put option on a
total of 15,000 MMBtu of natural gas per day based on the El Paso
Natural Gas Co. - Permian Basin Index. The option is for the
period from November 1, 1998 through March 31, 1999 and has a
strike price $2.00 per MMBtu.
<PAGE>
Real estate revenues increased 267% to $7.0 million for the
three months ended September 30, 1998 and 253% to $17.8 million
for the nine months ended September 30, 1998, as compared to $1.9
million and $5.0 million for the same periods in 1997.
Operating Expenses. Operating expenses, before general and
administrative expense, impairment of oil and gas properties and
depreciation, depletion and amortization, increased to $8.1
million and $24.7 million for the three and nine months ended
September 30, 1998, respectively, as compared to $5.0 million and
$20.7 million for the same periods in 1997. The increase relates
primarily to costs associated with the growth in the Company's
businesses through acquisitions, offset by the deconsolidation of
Sierra on July 1, 1997.
Oil and gas operating expense per Boe decreased 20% to $6.69
for the three months ended September 30, 1998 from $8.40 per Boe
for the same period in 1997. For the nine months ended September
30, 1998, operating expense per Boe decreased 11% to $7.22 from
$8.10 per Boe for the same period in 1997. Lease operating
expense, the primary oil and gas operating expense, decreased 8%
to $5.82 per Boe for the nine months ended September 30, 1998
from $6.34 per Boe for the same period in 1997. The decreases on
a Boe basis is due to the Company's ongoing efforts to decrease
operating costs coupled with divestitures of oil and gas
properties with high operating costs.
Real estate operating expense increased 416% to $3.5 million
for the three months ended September 30, 1998 and 361% to $8.8
million for the nine months ended September 30, 1998, as compared
to $685,000 and $1.9 million for the same periods in 1997. These
increases were due primarily to acquisitions.
General and Administrative (''G&A'') Expense. G&A expense for
the Company increased 21% to $1.1 million for the three months
ended September 30, 1998 and decreased 4% to $3.7 million for the
nine months ended September 30, 1998, as compared to $912,000 and
$3.8 million for the same periods in 1997. The decrease for the
nine months is primarily due to the deconsolidation of Sierra
which accounted for $1.3 million for the first half of 1997,
offset by an increase in the Company's activities resulting from
recent acquisitions. Oil and gas G&A expense per Boe decreased
38% to $.99 for the three months ended September 30, 1998 from
$1.60 per Boe for the same period in 1997. For the nine months
ended September 30, 1998, G&A expense per Boe decreased 9% to
$1.29 from $1.42 per Boe for the same period in 1997. Real
estate G&A expense increased to $529,000 and $1.2 million for the
three and nine months ended September 30, 1998, respectively from
$166,000 and $465,000 for the comparable periods of 1997. The
increases are directly related to administrative staff increases
necessitated by Red Oak's significant growth.
Depreciation, Depletion and Amortization (''DD&A'') Expense.
DD&A expense for the Company increased to $1.7 million and $11.2
million for the three and nine months ended September 30, 1998,
respectively, as compared to $2.2 million and $8.1 million for
the same periods in 1997, due to growth in each of the Company's
businesses. Oil and gas depletion expense decreased 70% to $1.14
per Boe for the three months ended September 30, 1998 from $3.76
per Boe for the same period in 1997. The decrease in oil and gas
depletion expense for the three months ended September 30, 1998
is due to the non-cash charge of $29 million in the second
quarter of 1998 which reduced the property base being depleted.
For the nine months ended September 30, 1998, depletion expense
per Boe increased 3% to $4.19 from $4.08 per Boe for the same
period in 1997. The increase in oil and gas depletion expense on
an overall basis and per Boe is due primarily to the decrease in
the oil price used in the period end reserve reports for
September 30, 1998 compared to the reserve reports used for the
same period in 1997, which led to a higher depletion rate using
the units of revenue depreciation method. The increase, due to
price declines was partially offset by the reduction of the
depletion base of the $29 million impairment recognized in June
of 1998. Real estate DD&A expense increased to $808,000 and $2
million from $293,000 and $826,000 for the three and nine months
ended September 30, 1998, respectively, due to the impact of
acquisitions.
<PAGE>
Impairment of Oil and Gas Properties. Southwest uses the full
cost method of accounting for its investment in oil and gas
properties. Under the full cost method of accounting, all costs
of acquisition, exploration and development of oil and gas
reserves are capitalized into a ''full cost pool'' as incurred,
and properties in the pool are depleted and charged to operations
using the gross revenues method based on the ratio of current
gross revenues to total proved future gross revenues, computed
based on current prices. Significant downward revisions of
quantity estimates or declines in oil and gas prices that are not
offset by other factors could result in a writedown for
impairment of oil and gas properties. Once incurred, a writedown
of oil and gas properties is not reversible at a later date, even
if oil or natural gas prices increase. The net capitalized cost
at June 30, 1998, exceeded the estimated present value of oil and
gas reserves, discounted at 10%, primarily due to depressed
commodity prices. The Company due to writedown for the
impairment incurred a noncash charge of $29 million for the nine
months ended September 30, 1998.
Interest Expense. Interest expense for the Company increased
to $9.6 million and $26.5 million for the three and nine months
ended September 30, 1998, respectively, as compared to $4.1
million and $10.9 million for the same periods in 1997. The
increases result from increased borrowings incurred to fund a
portion of the Company's acquisitions and oil and gas
development. Oil and gas interest expense increased to $5.7
million and $16.8 million for the three and nine months ended
September 30, 1998 from $2.3 million and $6.9 million for the
comparable periods in 1997 as a result of increased borrowings
for development drilling and acquisitions made in 1997. Real
estate interest expense increased 122% to $3.9 million for the
three months ended September 30, 1998 and 148% to $9.6 million
for the nine months ended September 30, 1998, as compared to $1.7
million and $3.9 million for the same periods in 1997. The
increases were due to additional debt used to finance
acquisitions.
Income Taxes. The Company recorded an income tax benefit of
$2.3 million for the nine months ended September 30, 1998 as
compared to $1 million for the three months ended September 30,
1997 and $1.5 million for the nine months ended September 30,
1997. As of June 1998, the Company established a valuation
allowance for its deferred tax asset, consisting mainly of net
operating loss carryforwards and a temporary difference relating
to net oil and gas properties. Future benefits will not be
available henceforth; however, the amount of the valuation
allowance could be reduced if estimates of future taxable income
during the carryforward periods are increased.
Equity in Loss of Subsidiary. Equity in Loss of Subsidiary
resulted in a charge of $1.0 and $2.1 million for the three and
nine months ended September 30, 1998. These amounts relate to
the Company's 39% investment in Sierra, which was deconsolidated
on July 1, 1997.
Net Income. Due to the factors described above, net loss for
the Company increased $44.8 million to a net loss of $47.9
million for the nine months ended September 30, 1998, as compared
to a net loss of $3.1 million for the same period in 1997.
Liquidity and Capital Resources
As of September 30, 1998, the Company's consolidated cash
balance was $20 million, of which $19.6 was available to
Southwest. Funding for the Company's business activities has
historically been provided by operating cash flows, bank
borrowings and debt issuance, reserve-based financing and sales
of equity; however, a continuation of the oil price environment
experienced during the first nine months of 1998 will have an
adverse affect on the Company's revenues and operating cash flow.
Any future acquisitions may require additional financing and will
be dependent upon financing arrangements available at the time.
The Company sold $3.8 million of oil and gas properties during
the first nine months of 1998 in an ongoing effort to decrease
its production costs and improve its cash position. Throughout
1998 and currently, the Company as well as the oil and gas
industry as a whole, is experiencing severe decreases in oil and
gas commodity prices. The severe decrease in the commodity
prices has drastically affected revenues and cashflows from
operations received by the company. Based on current commodity
prices and production, the company is limited in its ability to
meet operating and capital needs beyond 1999. Management is
constantly monitoring its cash position and its ability to meet
its financial obligations as they become due, and in this effort,
is exploring various strategies for addressing its current and
future liquidity needs.
<PAGE>
As discussed previously, as of July 1, 1997, Sierra Well
Service was deconsolidated from SRH and is currently being
accounted for using the equity method of accounting; therefore,
cash flow information for Sierra is reported for the nine months
ended September 30, 1997. For the comparable period in 1998, no
cash flow information for Sierra is reported.
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $4.7 million
and $2.7 million for the three and nine months ended September
30, 1998, respectively, as compared to net cash provided by
operating activities of $4.6 million and $9.7 million for the
same periods in 1997. The changes are primarily attributable to
decreases in average oil prices and an increase in interest
expense resulting principally from acquisitions in all the
Company's businesses, which was offset by increases in oil and
gas production.
Net Cash Used in Investing Activities
Net cash used in investing activities by the Company were
$5.6 million and $36.4 million for the three and nine months
ended September 30, 1998, as compared to $27.8 million and $68.7
for the comparable periods in 1997. Acquisitions and oil and gas
development activities and commercial real estate were the
primary uses of funds for both periods.
The Company has increased its 1998 oil and gas capital
expenditure budget to $10.2 million, of which $8.9 million was
expended during the first nine months of 1998 for oil and gas
acquisitions and developmental activities. The Company expects
to invest approximately $1.2 million during the remainder of 1998
to satisfy continuous development commitments and non-operated
property development. Further revisions may be necessary for the
remainder of the year in response to market conditions. No amount
has been budgeted for oil and gas acquisitions, although the
Company will continue to search for strategic and complementary
oil and gas acquisitions. The Company anticipates Red Oak's
capital improvement budget to approximate $10.4 million, of which
$4.1 million was expended for the first nine months of 1998. For
the remainder of 1998, Red Oak intends to acquire one retail
shopping mall. The acquisition will be funded by sources that
are non-recourse to SRH and Southwest.
Net Cash Provided by Financing Activities.
Net cash provided by the Company's financing activities was
$1.4 million and $26.3 million for the nine months ended
September 30, 1998 and 1997, respectively. Net cash provided by
financing activities was primarily used to fund real estate
acquisitions in 1998.
Southwest Credit Facility. The Southwest Credit Facility was
amended to provide for a $75 million revolving line of credit
maturing in February 1999, subject to semi-annual borrowing base
redetermination. The initial borrowing base of $40 million is
subject to a $15 million available sub-limit for oil and gas
acquisitions, with the balance of the borrowing base available
for general corporate purposes. Borrowings accrue interest at
LIBOR plus a margin ranging from 1.75% to 2.50% and the facility
incurs a quarterly commitment fee of three-eighths of one percent
(3/8%) per annum on the daily average of the unadvanced amount of
the borrowing base. The Southwest Credit Facility is secured by
substantially all of Southwest's proved oil and gas properties.
The facility contains a number of covenants that limit loans and
advances, investments, and dividends, as well as setting a
minimum interest coverage ratio for SRH. In March 1998, the
covenants were amended to remove the tangible net worth
requirement, increase allowable sales of assets from $250,000 to
at least $10 million and revise the minimum interest coverage
ratio from 1.0 to 0.7. During the second quarter, in response to
the sustained low oil price environment, the lender issued lower
pricing parameters for the computation of the borrowing base for
all of its oil and gas customers. Using the new price
parameters, Southwest has no current availability under its line
of credit. Scheduled redetermination will occur again at the end
of the year. The lender schedules quarterly reviews of its
pricing policy and should oil prices strengthen, the Company can
request a redetermination at that time.
<PAGE>
The Company believes the availability of the Red Oak
Acquisition Facilities and current cash balances will be
sufficient for planned operating and capital expenditure
requirements for the remainder of 1998. However, if the Company
identifies acquisitions in any of its businesses, additional
financing will be needed and the Company expects to evaluate all
available funding sources including equity and debt financing
alternatives.
Other Issues
Information Systems for the Year 2000
The Company uses a program designed and implemented by Midland
Southwest Software, ("Software") a subsidiary of SRH. Software
currently has a year 2000 plan in effect. They have surveyed
existing programs and hardware and estimate a compliance date of
early 1999. Determination of the total cost in connection with
the year 2000 compliance issue is difficult to determine due to
the fact that they are in the process of developing their new
1998 version of marketed oil and gas software, which has, from
inception, included year 2000 compliance. Third party software
programs utilized by SRH are either in compliance or are not
affected by the year 2000, with the exception of the payroll
service, which is currently modifying its system to accurately
handle the Year 2000 issue.
Effective July 1998, Red Oak initiated the use of real estate
software that is apart from SRH. Red Oak is currently in the
process of evaluating year 2000 compliance issues.
Neither SRH or Red Oak has completed evaluations of vendors or
suppliers systems to determine the effect, if any, the non-
compliance of such systems would have on operations. Plans are
under way to perform an audit in late 1998 or early 1999 to
determine the effect of non-compliance of vendors and suppliers
on SRH and Red Oak and thus formulate a contingency plan.
A potential source of risk includes, but is not limited to,
the inability of principal purchasers and suppliers to be year
2000 compliant, which could have a material effect on SRH
production, cash flow and overall financial condition,
notwithstanding the SRH actions to prepare its own information
systems. SRH currently does not have a contingency plan in place
to cover any unforeseen problems encountered that relate to the
year 2000, but intends to produce one before the end of the
fiscal year.
<PAGE>
Derivative Instruments and Hedging Activities
In June 1998, The FASB issued Statement of Financial
Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" which establishes accounting
and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives
as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated
as (a) a hedge of the exposure to charges in the fair value of a
recognized asset or liability or an unrecognized firm commitment,
(b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency
exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or
a foreign-currency-denominated forecasted transaction.
Under this Statement, an entity that elects to apply hedge
accounting is required to establish at the inception of the hedge
the method it will use for assessing the effectiveness of the
hedging derivative and the measurement approach for determining
the ineffective aspect of the hedge. Those methods must be
consistent with the entity's approach to managing risk.
This Statement applies to all entities and is effective for
all fiscal quarters of fiscal years beginning after June 15,
1999. Initial application of this Statement should be as of the
beginning of an entity's fiscal quarter; on that date, hedging
relationships must be designated anew and documented pursuant to
the provisions of this Statement. Earlier application of all of
the provisions of this Statement is encouraged, but it is
permitted only as of the beginning of any fiscal quarter that
begins after issuance of this Statement. This Statement should
not be applied retroactively to financial statements of prior
periods.
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. REPORTS ON FORM 8K AND EXHIBITS
Reports on Form 8-K
None.
Exhibits
The following instruments and documents are included as
Exhibits to this Report. Exhibits incorporated by reference are
so indicated by parenthetical information.
Exhibit Number Description
-------------------- ----------------
27* Financial Data Schedule.
* Filed herewith.
<PAGE>
SIGNATURES
SOUTHWEST ROYALTIES, INC.
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,
thereto duly authorized.
SOUTHWEST ROYALTIES, INC.
By: /s/ H. H. Wommack, III
-------------------------------------
- --------------
H.H. Wommack, III, Chairman,
President,
Chief Executive Officer, and Director
Date: November 13, 1998
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
----------------- -------- --------
/s/ H.H. Wommack, III
-----------------------------
H. H. Wommack, III Chairman/President/
Chief Executive Officer/Director
November 13, 1998
/s/ Bill E. Coggin
-----------------------------
Bill E. Coggin Vice President/Chief
Financial Officer November 13,
1998
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary November 13,
1998
<PAGE>
SIGNATURES
SOUTHWEST ROYALTIES HOLDINGS, INC.
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,
thereto duly authorized.
SOUTHWEST ROYALTIES HOLDINGS, INC.
By: /s/ H. H. Wommack, III
-------------------------------------
- --------------
H.H. Wommack, III, Chairman,
President,
Chief Executive Officer, and Director
Date: November 13, 1998
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons
on behalf of the registrant and in the capacities and on the
dates indicated.
SIGNATURE TITLE DATE
----------------- -------- --------
/s/ H.H. Wommack, III
-----------------------------
H. H. Wommack, III Chairman/President/
Chief Executive Officer/Director
November 13, 1998
/s/ Bill E. Coggin
-----------------------------
Bill E. Coggin Vice President/Chief
Financial Officer November 13,
1998
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary November 13,
1998
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Balance Sheet at September 30, 1998 (Unaudited) and the Statement of
Operations for the Nine Months Ended September 30, 1998 (Unaudited) and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 20,027,000
<SECURITIES> 0
<RECEIVABLES> 7,078,000
<ALLOWANCES> (265,000)
<INVENTORY> 0
<CURRENT-ASSETS> 29,291,000
<PP&E> 122,754,000
<DEPRECIATION> 7,261,000
<TOTAL-ASSETS> 288,274,000
<CURRENT-LIABILITIES> 101,025,000
<BONDS> 233,168,000
11,067,000
0
<COMMON> 116,000
<OTHER-SE> 59,761,000
<TOTAL-LIABILITY-AND-EQUITY> 288,274,000
<SALES> 26,188,000
<TOTAL-REVENUES> 45,102,000
<CGS> 14,896,000
<TOTAL-COSTS> 24,734,000
<OTHER-EXPENSES> 3,708,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (26,502,000)
<INCOME-PRETAX> (48,588,000)
<INCOME-TAX> (2,348,000)
<INCOME-CONTINUING> (47,860,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (47,860,000)
<EPS-PRIMARY> (44.49)
<EPS-DILUTED> (44.49)
</TABLE>
