5
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 June 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 June 30, 1998
for Southwest Royalties, Inc........................100.
Number of shares of common stock outstanding as of June 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 June 30, 1998 (unaudited)
and December 31, 1997 3
Consolidated Statements of Operations for the three and six
months ended
June 30, 1998 and 1997 (unaudited) 5
Consolidated Statements of Cash Flows for the three and six
months ended
June 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)
June 30,December
31,
ASSETS 1998
1997
- -----------------------------------------------------------------
- ---------------------------------------------------------------
(unaudited)
Current assets
Cash and cash equivalents $19,491 $27,365
Accounts receivable, net of allowance of $254 6,136
8,376
Receivables from related parties 2,284 2,556
Other current assets 1,501 1,209
----------
- ----------
Total current assets 29,412 39,506
----------
- ----------
Oil and gas properties, using the full cost method of accounting
Proved 191,790 188,432
Unproved 4,704 4,554
----------
- ----------
196,494 192,986
Less accumulated depletion, depreciation and amortization
79,154 42,240
----------
- ----------
Oil and gas properties, net 117,340 150,746
----------
- ----------
Rental property, net 107,406 81,373
----------
- ----------
Other property and equipment, net 5,790 5,556
----------
- ----------
Other assets
Restricted cash 7,008 8,064
Equity investment in subsidiaries 3,470 2,443
Real estate investments 3,686 4,203
Deferred debt costs, net of accumulated amortization of
$1,971 and $903, respectively 9,094 9,382
Noncompete covenants, net of accumulated amortization
of $122 1,481 -
Other, net 1,747 4,170
----------
- ----------
Total other assets 26,486 28,262
----------
- ----------
Total assets $286,434 $305,443
====== ======
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share data)
LIABILITIES, MINORITY INTEREST, REDEEMABLE June 30,December 3
1,
COMMON STOCK AND STOCKHOLDERS' DEFICIT 1998 1997
- -----------------------------------------------------------------
- ------------------------------- ----------------------
- --------
(unaudited)
Current liabilities
Current maturities of long-term debt $5,331 $1,878
Accounts payable 4,888 7,119
Accounts payable to related parties - 64
Accrued expenses 5,701 4,049
Accrued interest payable 5,379 5,401
Deferred income taxes - 254
----------
- ----------
Total current liabilities 21,299 18,765
----------
- ----------
Long-term debt 304,596 281,764
----------
- ----------
Other long-term liabilities 1,774 1,809
----------
- ----------
Deferred income taxes - 2,094
----------
- ----------
Minority interest 1,219 1,861
----------
- ----------
Redeemable common stock of subsidiary 2,740 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 (51,013) (9,321)
Note receivable from an officer and stockholder (1,693)
(1,707)
Less: treasury stock - at cost; 214,215 shares (3,090)
(3,090)
----------
- ----------
Total stockholders' deficit (53,484) (11,806)
---------
- ---------
Total liabilities, minority interest, redeemable common stock
and stockholders' deficit $286,434 $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 endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Operating revenues
Oil and gas $ 9,120 $8,263 $18,831 $17,846
Well servicing - 4,658 - 7,789
Real estate 5,883 1,765 10,794 3,130
Other 351 297 789 541
------------ ------------
- ------------ ------------
Total operating revenues 15,354 14,983
30,414 29,306
------------ ------------
- ------------ ------------
Operating expenses
Oil and gas production 5,209 4,159 10,662 8,161
Well servicing - 3,168 - 5,600
Real estate 3,114 668 5,252 1,222
General and administrative, net of related
party management and administrative
fees of $1,721, $1,420, $2,618 and
$2,305, respectively 1,250 1,683 2,602 2,938
Depreciation, depletion and amortization 5,223 3,161
9,488 5,878
Impairment of oil and gas properties 29,000 -
29,000 -
Other 352 356 727 651
------------ ------------
- ------------ ------------
Total operating expenses 44,148 13,195 57,731
24,450
------------ ------------
- ------------ ------------
Operating income (28,794) 1,788 (27,317) 4,856
------------ ------------
- ------------ ------------
Other income (expense)
Interest and dividend income 354 203 797
389
Interest expense (8,565) (3,832) (16,918) (6,819)
Other 277 (92) 280 (125)
------------ ------------
- ------------ ------------
(7,934) (3,721) (15,841) (6,555)
------------ ------------
- ------------ ------------
(conti
nued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
(in thousands, except per share data)
(unaudited)
Three months endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Loss before income taxes, minority interest,
equity loss and extraordinary item $ (36,728) $(1,933)
$ (43,158) $ (1,699)
Income tax benefit 404 579 2,348 504
------------ ------------
- ------------ ------------
Loss before minority interest, equity loss and
extraordinary item (36,324) (1,354) (40,810) (1,195)
Minority interest in subsidiaries, net of tax 93
174 199 222
Equity in loss of subsidiary, net of tax (759) -
(1,081) -
------------ ------------
- ------------ ------------
Loss before extraordinary item (36,990) (1,180) (41,692)
(973)
Extraordinary item, net of tax - (490) -
(490)
------------ ------------
- ------------ ------------
Net loss $(36,990) $ (1,670) $(41,692)
$ (1,463)
======= ======= ======= =======
Loss per common share before extraordinary
item $(34.38) $(1.10) $(38.75) $(.90)
Extraordinary loss from early extinguishment
of debt - (.46) - (.45)
------------ ------------
- ------------ ------------
Loss per common share $(34.38) $(1.56) $(38.75) $(1.35)
======= ======= ======= =======
Weighted average shares outstanding 1,075,868
1,076,201 1,075,868 1,079,748
======= ======= ======= =======
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 endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Cash flows from operating activities
Net loss $(36,990) $ (1,670) $(41,692)
$ (1,463)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation, depletion and amortization 5,223 3,161
9,488 5,878
Impairment of oil and gas properties 29,000 -
29,000 -
Noncash interest expense 577 385 1,225
543
Extraordinary loss from early extingushment
of debt - 490 - 490
Loss (gain) on sale of assets (261) 125 (261)
125
Equity loss of subsidiary 759 - 1,081
- -
Other noncash items 142 139 77 172
Bad debt expense 150 - 155 -
Deferred income taxes (404) (407) (2,348) (471)
Minority interest in loss of subsidiary (93) (174)
(199) (222)
Changes in operating assets and liabilities-
Accounts receivable 73 (170) 2,370 (5,488)
Other current assets (263) (26) (253) (586)
Accounts payable and accrued expenses 1,457 2,581
(643) 5,847
Accrued interest payable (5,223) (90) (22)
313
Income taxes payable - - - (30)
------------ ------------
- ------------ ------------
Net cash provided (used) by operating activities (5,853)
4,344 (2,022) 5,108
------------ ------------
- ------------ ------------
Cash flows from investing activities
Proceeds from sale of oil and gas properties 2,838
62 3,058 82
Purchase of oil and gas properties (2,275) (8,423)
(6,566) (19,090)
Purchase of other property and equipment
and rental property (25,415) (11,837) (26,451) (16,409)
Purchase of other assets (790) (2,214) (2,147)
(2,660)
Purchase of noncompete covenants - - (1,602)
-
Proceeds from sale of real estate investments 764
- 764 -
Proceeds from sale of other assets 1,040 302
1,060 478
Proceeds from sale of other property and
equipment and rental property 24 117 24
234
Purchase of real estate investments - (53) -
(53)
Change in restricted cash 384 (1,912) 1,056
(2,459)
Purchase of treasury stock by subsidiary - (1,174)
- (1,174)
Other (14) 130 8 137
------------ ------------
- ------------ ------------
Net cash used by investing activities (23,444) (25,002)
(30,796) (40,914)
------------ ------------ ---
--------- ------------
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(unaudited)
Three months endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Cash flows from financing activities
Proceeds from borrowings $ 24,873 $47,331 $26,965
$ 60,032
Payments on debt (561) (27,899) (837) (29,813)
Payments on other long-term liabilities (14) (21)
(63) (43)
Increase in other long-term liabilities 28 81
28 628
Cash received on subscriptions receivable - 97
- - 2,807
Purchase of treasury stock - - -
(552)
Issuance of redeemable common stock,
net of issue costs - 30 - 32
Deferred debt cost (637) (883) (780) (935)
Dividends paid to minority interest owners (30)
(32) (61) (62)
Purchase of minority interest in subsidiary (108)
- - (305) -
Other (3) 6 (3) 6
------------ ------------
- ------------ ------------
Net cash provided by financing activities 23,548 18,710
24,944 32,100
------------ ------------
- ------------ ------------
Net decrease in unrestricted cash and
cash equivalents (5,749) (1,948) (7,874) (3,706)
Unrestricted cash and cash equivalents -
beginning of period 25,240 6,526 27,365 8,284
------------ ------------
- ------------ ------------
Unrestricted cash and cash equivalents -
end of period $19,491 $4,578 $19,491 $4,578
======= ======= ======= =======
Supplemental disclosures of cash flow information
Interest paid $13,212 $3,471 $15,716 $5,898
Income taxes received $ - $ - $ - $ 88
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"), a subsidiary of
Southwest. As of June 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 June 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 six months ended June 30, 1998, Red Oak acquired
three office buildings one real estate fee management and
brokerage company and one retail shopping mall for approximately
$26 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):
June 30, 1998 December 31,
----------------------------------
(unaudited) 1997 1996
------ ------
Land $ 2,287 $ 2,157 $ 2,157
Building and improvements 1,419 1,413
1,326
Machinery and equipment 2,667 2,277 7,365
Furniture and fixtures 1,761 1,743 1,714
Equipment under capital lease 659 614
1,000
Rental property 110,785 83,696 30,287
---------- --------
- --------
119,578 91,900 43,849
Less accumulated depreciation 6,382 4,971
5,171
---------- --------
- --------
$113,196 $ 86,929 $ 38,678
====== ===== =====
4. Long-term Debt
Long-term debt consists of the following (in thousands):
June 30, 1998 December 31,
----------------------------------
(unaudited) 1997 1996
------ ------
10.5% Senior Notes, interest payable
semi-annually due October 15, 2004,
net of discount of $2,245 and $2,346,
respectively $197,755 $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. 71,502 70,628
- -
Revolving line of credit with variable-
rate interest, due February 1999.
Collateralized by oil and gas properties 100
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
June 30, 1998 December 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 385 473
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 $1,944. 13,557
- - -
Other 26,628 14,787 5,048
----------
- ---------- --------
309,927 283,642
93,805
Less current maturities 5,331 1,878 10,216
----------
- ---------- --------
$304,596 $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.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Long-term Debt - continued
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.
13% Note Payable
In April 1997 MROP 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 six 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 June 30, 1998 the Company was not in compliance with
certain reporting requirements of the term note. The Company
has obtained waivers for those events of non-compliance.
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 June 30, 1998, the borrowing base was
$100,000. 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 June 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 June 30,
1998, including capital leases, are as follows (in thousands):
For the twelve
months ended
June 30, 1998 $5,331
June 30, 1999 1,122
June 30, 2000 72,112
June 30, 2001 13,866
June 30, 2002 2,318
Thereafter 215,178
<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 June 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 June 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 six months ended June 30, 1998 is not
displayed in the tables and no balance sheet information is
displayed as of June 30, 1998.
Three months endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
(in thousands) (in thousands)
(unaudited) (unaudited)
Operating profit (loss)
Oil and gas $(30,428) $ 910 $ (30,974)
$ 3,823
Well service - 229 - 184
Real estate 1,702 621 3,680 1,076
Other and eliminations (68) 28 (23)
(227)
---------- ----------
- ---------- ----------
$(28,794) $ 1,788$ (27,317)
$ 4,856
====== ====== ====== ======
Interest Expense
Oil and gas $ 5,569 $2,297 $11,127 $4,480
Well Service - 129 - 184
Real Estate 2,965 1,392 5,746 2,131
Other and eliminations 31 14 45
24
---------- ----------
- ---------- ----------
$ 8,565 $3,832 $16,918 $6,819
====== ====== ====== ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Lines of Business - continued
Three months endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
(in thousands) (in thousands)
(unaudited) (unaudited)
Depreciation, depletion and amortization
Oil and gas $ 4,478 $2,415 $8,169 $4,512
Well service - 432 - 747
Real estate 698 267 1,226 533
Other and eliminations 47 47 93
86
---------- ----------
- ---------- ----------
$ 5,223 $3,161 $9,488 $5,878
====== ====== ====== ======
Capital expenditures
Oil and gas $ 2,537 $10,820 $6,955 $21,722
Well service - 2,969 - 6,905
Real estate 25,043 6,410 25,868 6,802
Other and eliminations 110 61 194
70
---------- ----------
- ---------- ----------
$27,690 $20,260 $33,017 $35,499
====== ====== ====== ======
June 30,December
31,
1998 1997
--------------------
- -----
Identifiable assets
Oil and gas $161,236 $205,054
Real estate 124,727 98,890
Other and eliminations 471
1,499
----------
- ----------
$286,434 $305,443
====== ======
9. Subsequent Events
In July 1998, Red Oak purchased an additional pad site
adjacent to one of its existing properties and a commercial
office center for a combined purchase price of $2.2 million.
Subsequent to June 30, 1998, Red Oak escrowed approximately $530
thousand to be used towards the purchase price of approximately
$25.5 million for a retail pad site, a retail shopping center and
a retail mall in Tucson, AZ, Midland, TX and Victoria, TX,
respectively.
<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. The
Company intends to increase its oil and gas reserves, production
and cash flow by conducting development activities such as
recompletions for the remainder of 1998. During the first half
of 1998, the Company drilled 17 gross (7.3 net) wells, of which
all were successfully completed as productive.
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. 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.
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 June 30, 1998, Red Oak owns and
operates 15 shopping centers, six office buildings and raw land
held for future development.
<PAGE>
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 six months ended 1998 to the six 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 endedSix months ended
June 30, June 30,
-----------------------------------------
- ------------
1998 1997 1998 1997
------- ------ ------ ------
Production volumes:
Oil and condensate (MBbls) 460 282 929
554
Natural gas (MMcf) 1,488 1,543 3,010 2,865
Average sales prices:
Oil and condensate (per Bbl) $12.99 $18.21 $13.66
$ 20.52
Natural gas (per Mcf) $ 1.95 $ 1.87 $ 1.94 $ 2.03
Revenues. Revenues for the Company increased to $15.4 million
and $30.4 million for the three and six months ended June 30,
1998, respectively, as compared to $15.0 million and $29.3
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 10% to $9.1 million for the
three months ended June 30, 1998 and 5% to $18.9 million for the
six months ended June 30, 1998, as compared to $8.3 million and
$17.9 million for the same periods in 1997. The increase for the
three and six months ended June 30, 1998 is primarily due to
increases in oil and gas production, offset by a decrease in
average oil 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 June 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.
Real estate revenues increased 233% to $5.9 million for the
three months ended June 30, 1998 and 245% to $10.8 million for
the six months ended June 30, 1998, as compared to $1.8 million
and $3.1 million for the same periods in 1997.
<PAGE>
Operating Expenses. Operating expenses, before general and
administrative expense, impairment of oil and gas properties and
depreciation, depletion and amortization, increased to $8.7
million and $16.6 million for the three and six months ended June
30, 1998, respectively, as compared to $8.4 million and $15.6
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 6% to $7.35
for the three months ended June 30, 1998 from $7.80 per Boe for
the same period in 1997. For the six months ended June 30, 1998,
operating expense per Boe decreased 6% to $7.45 from $7.91 per
Boe for the same period in 1997. Lease operating expense, the
primary oil and gas operating expense, decreased 3% to $5.86 per
Boe for the six months ended June 30, 1998 from $6.04 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 366% to $3.1million
for the three months ended June 30, 1998 and 330% to $5.3 million
for the six months ended June 30, 1998, as compared to $668,000
and $1.2 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 decreased 26% to $1.3 million for the three months
ended June 30, 1998 and 11% to $2.6 million for the six months
ended June 30, 1998, as compared to $1.7 million and $2.9 million
for the same periods in 1997. The decrease 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 14% to $1.24 for the three
months ended June 30, 1998 from $1.44 per Boe for the same period
in 1997. For the six months ended June 30, 1998, G&A expense per
Boe increased 6% to $1.42 from $1.34 per Boe for the same period
in 1997, due primarily to an unexpected charge in the first
quarter of 1998. Real estate G&A expense increased to $369,000
and $636,000 for the three and six months ended June 30, 1998,
respectively from $208,000 and $299,000 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 $5.2 million and $9.5
million for the three and six months ended June 30, 1998,
respectively, as compared to $3.2 million and $5.9 million for
the same periods in 1997, due to growth in each of the Company's
businesses. Oil and gas depletion expense increased 40% to $6.13
per Boe for the three months ended June 30, 1998 from $4.37 per
Boe for the same period in 1997. For the six months ended June
30, 1998, depletion expense per Boe increased 31% to $5.53 from
$4.23 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 June 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. Real estate
DD&A expense increased to $698,000 and $1.2 million from $267,000
and $533,00 for the three and six months ended June 30, 1998,
respectively, due to the impact of acquisitions.
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. As of June 30, 1998, the
net capitalized cost exceeded the estimated present value of oil
and gas reserves, discounted at 10%, primarily due to depressed
commodity prices; thus, the Company incurred a noncash charge of
$29.0 million for the three and six months ended June 30, 1998.
<PAGE>
Interest Expense. Interest expense for the Company increased
to $8.6 million and $16.9 million for the three and six months
ended June 30, 1998, respectively, as compared to $3.8 million
and $6.8 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 $5.6 million and $11.1 million
for the three and six months ended June 30, 1998 from $2.3
million and $4.5 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 104% to $3.0 million for the three months ended June
30, 1998 and 170% to $5.7 million for the six months ended June
30, 1998, as compared to $1.4 million and $2.1 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
$404,000 and $2.3 million for the three and six months ended June
30, 1998 as compared to $579,000 and $504,000 for the same
periods in 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 $759,000 and $1.1 million for the three
and six months ended June 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 $40.2 million to a net loss of $41.7
million for the six months ended June 30, 1998, as compared to a
net loss of $1.5 million for the same period in 1997.
Liquidity and Capital Resources
As of June 30, 1998, the Company's consolidated cash balance
was $19.5 million, of which $18.1 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 half 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 $3.1
million of oil and gas properties during the first half of 1998
in an ongoing effort to decrease its production costs and improve
its cash position.
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 six months
ended June 30, 1997. For the comparable period in 1998, no cash
flow information for Sierra is reported.
Net Cash Provided by Operating Activities
Net cash used by operating activities was $5.9 million and
$2.0 million for the three and six months ended June 30, 1998,
respectively, as compared to net cash provided by operating
activities of $4.3 million and $5.1 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.
<PAGE>
Net Cash Used in Investing Activities
Net cash used in investing activities by the Company were
$23.4 million and $30.8 million for the three and six months
ended June 30, 1998, as compared to $25.0 million and $40.9 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.
As a result of its success in development projects, the
Company increased its 1998 oil and gas capital expenditure to
$8.1 million, of which $6.6 was expended for the first half of
1998. 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 $7.2 million, of which $1.6
million was expended for the first half of 1998. Red Oak has not
specified an amount for their remaining 1998 acquisition budget;
however, any additional acquisitions would be funded by non-
recourse debt.
Net Cash Provided by Financing Activities.
Net cash provided by the Company's financing activities was
$25.0 million and $32.1 million for the six months ended June 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.
For the remainder of 1998, Red Oak intends to acquire
additional real estate properties. Funding will likely be
obtained through an additional increase in the MROP Facility or
from other sources that are nonrecourse to SRH and Southwest.
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.
<PAGE>
Other Issues
Information Systems for the Year 2000
The Company has reviewed and evaluated its information systems
to determine if its systems accurately process data referencing
the year 2000. Substantially all necessary programming
modifications to correct year 2000 referencing in internal
accounting and operating systems have been made. However, the
Company has not completed its evaluation of its vendors and
suppliers systems to determine the effect, if any, the non-
compliance of such systems would have on the operations of the
Company. The Company expects to have all evaluations completed
by early 1999.
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,
and Chief Executive Officer
Date: August 15, 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 August 15,
1998
/s/ Bill E. Coggin
-----------------------------
Bill E. Coggin Vice President/Chief
Financial Officer August 15, 1998
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary August 15, 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,
and Chief Executive Officer
Date: August 15, 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 August 15,
1998
/s/ Bill E. Coggin
-----------------------------
Bill E. Coggin Vice President/Chief
Financial Officer August 15, 1998
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary August 15, 1998
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Balance Sheet at June 30, 1998 (Unaudited) and the Statement of Operations
for the Six Months Ended June 30, 1998 (Unaudited) and is qualified in its
entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 19,491,000
<SECURITIES> 0
<RECEIVABLES> 6,390,000
<ALLOWANCES> (254,000)
<INVENTORY> 0
<CURRENT-ASSETS> 29,412,000
<PP&E> 316,072,000
<DEPRECIATION> (85,536,000)
<TOTAL-ASSETS> 286,434,000
<CURRENT-LIABILITIES> 21,299,000
<BONDS> 304,596,000
11,030,000
0
<COMMON> 116,000
<OTHER-SE> (53,600,000)
<TOTAL-LIABILITY-AND-EQUITY> 286,434,000
<SALES> 18,831,000
<TOTAL-REVENUES> 30,414,000
<CGS> 10,662,000
<TOTAL-COSTS> 16,641,000
<OTHER-EXPENSES> 38,488,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 16,918,000
<INCOME-PRETAX> (43,158,000)
<INCOME-TAX> (2,348,000)
<INCOME-CONTINUING> (41,692,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (41,692,000)
<EPS-PRIMARY> (38.75)
<EPS-DILUTED> (38.75)
</TABLE>
