1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
x Annual report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the Fiscal year ended December 31, 1997
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)
Registrants' Telephone Number, Including Area Code: (915) 686-9
927
Securities to be registered pursuant to Section 12(b) of the Act:
None
Securities to be registered pursuant to Section 12(g) of the Act:
10.5% Senior Notes due 2004
(Title of Class)
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 No X
Indicate by check mark if disclosure of delinquent files
pursuant to Item 405 of Regulation S-K is not contained herein,
and will not be contained, to the best of registrant's knowledge,
in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
<PAGE>
As of March 16, 1998, Southwest Royalties, Inc. had outst
anding 100 shares of common stock, $.10 par value, which is its
only class of stock. As of March 16, 1998, Southwest Royalties
Holdings, Inc. had outstanding 1,075,868 shares of common stock,
$.10 par value, which is its only class of stock. The common
stock of Southwest Royalties Holdings, Inc. is not traded on any
exchange and, therefore, its aggregate market value and the value
of shares held by nonaffiliates cannot be determined. All of the
outstanding shares of Southwest Royalties, Inc. are held by
Southwest Royalties Holdings, Inc.
Documents Incorporated by Reference: None
TABLE OF CONTENTS
Page
Number
PART I
Item 1. Business
3
Item 2. Properties
18
Item 3. Legal Proceedings
25
Item 4. Submission of Matters to a Vote of Security Holders
25
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 26
Item 6. Selected Financial and Operating Data
28
Item 7. Management's Discussion and Analysis of Financial
Condition and
Results of Operations
30
Item 8. Financial Statements and Supplementary Data
39
Item 9. Changes in and Disagreements with Accountants on
Accounting and
Financial Disclosure
70
PART III
Item 10. Directors and Executive Officers of the Registrant
71
Item 11. Executive Compensation
73
Item 12. Security Ownership of Certain Beneficial Owners and
Management 74
Item 13. Certain Relationships and Related Transactions
74
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 75
<PAGE>
Parts I and II of this Report contain ''forward-looking
statements'' within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act") and Section 21E of
the Securities Exchange Act of 1934, as amended (the "Exchange
Act'). All statements other than statements of historical facts
included in this Report, including, without limitation,
statements in this "Item 1. Business" and under "Item 2.
Properties" and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" regarding proved
preserves, estimated future net reserves, present values, planned
capital expenditures (including the amount and nature thereof),
increases in oil and gas production, the number of wells
anticipated to be drilled and the Company's financial position,
business strategy and other plans and objective for future
operations, are forward-looking statements. Although the Company
believes that the expectations reflected in such forward-looking
statements are reasonable, there can be no assurance that the
actual results or developments anticipated by the Company will be
realized or, even if substantially realized, that they will have
the expected consequences to or effects on its business or
operations. There are numerous risks and uncertainties that can
affect the outcome and timing of such events, including many
factors beyond the control of the Company.
PART I
Certain oil and gas terms used in this report are defined
under "Item 1. Business - Glossary of Oil and Gas Terms."
ITEM 1. BUSINESS.
The Company
Southwest Royalties Holdings, Inc. ("SRH") , a Delaware
corporation, was formed in 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").
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 and Red Oak, and Sierra, an unconsolidated
affiliate.
The principal operating subsidiary of SRH is Southwest, a
Delaware corporation that was formed in 1983 to acquire and
develop oil and gas properties. Southwest initially financed the
acquisition of oil and gas reserves and its exploration and
development efforts through public and private limited
partnership offerings. Southwest is a general partner of these
limited partnerships, owns interests in these partnerships and
receives management fees and operating cost reimbursements from
such partnerships. As of December 31, 1997, Southwest had total
estimated net proved reserves of 29.7 MMBbls of oil and 64.8 Bcf
of natural gas, aggregating 40.5 MMBoe, with a PV-10 Value of
$172 million. Southwest's primary operations are in the Permian
Basin of West Texas and southeastern New Mexico.
Red Oak, a Delaware corporation, was formed in 1992 to own and
manage commercial real estate properties, including shopping
centers and office buildings, in secondary real estate markets in
the southwestern United States. As of December 31, 1997, Red Oak
owned and managed 17 commercial real estate properties. SRH
owns approximately 81% of the common stock of Red Oak on a
diluted basis.
<PAGE>
Sierra, a Delaware corporation, was formed in 1992 to provide
certain well services for oil and gas companies. Sierra provides
a broad range of well services to oil and gas companies,
including workover rig services, liquids handling and other
services. SRH directly owns approximately 29% of the common
stock of Sierra and indirectly owns an additional 10% interest
through Southwest, which is the general partner and 15% interest
holder in each of two partnerships that own approximately 70% of
the common stock of Sierra. This direct and indirect ownership by
SRH and the position of Southwest as general partner of the
partnerships provides SRH with effective voting control of
Sierra. As of July 1, 1997, Sierra was deconsolidated from SRH
and is currently being accounted for as an equity investment.
Southwest has three subsidiaries, Midland Southwest Software,
Inc. (''Southwest Software''), Threading Products International,
LLC (''TPI''), and Blue Heel Company (''Blue Heel''). Southwest
Software creates and markets computer software to the oil and gas
industry. TPI produces inserts used to cut threads by
manufacturers of threaded products. Blue Heel holds a nominal
interest in certain oil and gas properties owned by Southwest.
Red Oak has two wholly-owned subsidiaries, MRO Properties, Inc.
(''MROP'') and MRO Management, Inc. (''MRO Management''). MROP
holds titles to certain real estate properties and is the
borrower under a credit agreement related to such properties.
This credit agreement is non-recourse to Red Oak. MRO Management
performs real estate management services for MROP and Red Oak.
Both Sierra and Red Oak are operated separately from
Southwest; however, Southwest provides both with significant
administrative and accounting support. Under the terms of
separate service agreements, Southwest has agreed to provide to
Sierra and Red Oak administrative services including accounting,
bookkeeping, tax preparation and banking and disbursement
services. Both agreements have an initial term of five years and
renew from year to year if not terminated. Under each agreement,
Southwest receives a fixed fee of $12,000 per month. These fees
may be adjusted at any time by agreement of the parties. The
service agreements may be terminated upon 30 days' notice by
either party to the agreements.
The Company's principal executive offices are located at 407
North Big Spring, Suite 300, Midland, Texas 79701. The Company's
telephone number is (915) 686-9927.
Operating Strategy
The Company's long-term objective is to increase its revenues,
cash flow, earnings and assets through a balanced growth strategy
of acquisition, development and exploitation of oil and gas
properties, and through its investments in real estate. The
strategies are designed to achieve the Company's oil and gas
objectives, which consist of developing and increasing production
through development drilling and other activities. Strategies
for both oil and gas and real estate include concentration on
defined geographic areas to achieve operating and technical
efficiencies and pursuing strategic acquisitions that complement
the Company's existing asset base in order to provide additional
growth opportunities.
The Company has acquired a diversified portfolio of oil and
gas properties that contain numerous identified development
opportunities. The Company's long-term plans are to increase its
capital spending to pursue these opportunities, which consist of
step-out drilling, recompletions, enhanced recovery operations
and workover opportunities.
In response to the recent and severe decline in oil price, the
Company has initiated a short-term alternate business plan that
delays certain development and exploratory projects until the
market strengthens. The Company is budgeting $5.8 million in
capital expenditures in its oil and gas business for 1998,
revised from its previous $17.8 million budget. The $5.8 million
capital expenditure budget consists of $5.1 million in
development and $700,000 in exploratory
<PAGE>
projects. Further revisions may be necessary during the year in
response to market conditions. No amount has been budgeted for
acquisitions although the Company will continue to search for
strategic and complementary acquisitions and would make such an
acquisition under the right conditions and circumstances.
The Company concentrates its oil and gas activities in the
Permian Basin of West Texas and southeastern New Mexico, with
properties in this region representing over 90% of the Company's
PV-10 Value at December 31, 1997. The Company believes that its
long-life oil and gas properties and large inventory of
development projects in the Permian Basin, coupled with region-
specific geological, engineering and production experience,
provide it with focused operations. Company-operated properties
comprised approximately 65% of its PV-10 Value at December 31,
1997, allowing substantial control over the incurrence and timing
of capital and operating expenditures.
The Company plans to continue the expansion of its real estate
business, primarily in the southwestern United States. The
Company expects that Red Oak's active management practices will
lead to consolidation benefits, cost savings, more efficient
utilization and improved cash flow, thereby enhancing the return
on capital invested. Red Oak has budgeted $7.2 million in
capital improvements for 1998. Although no amount has been
budgeted for acquisitions, Red Oak will continue to search for
strategic and complementary acquisitions.
Southwest
General. Since inception, the Company has focused its
efforts toward increasing its reserves and average daily
production of oil and gas through acquisitions of producing
properties and development drilling and production enhancement
activities.
Acquisition Activities. In October 1997, the Company acquired
various working interests in 431 producing oil and gas wells,
located in seven oil and gas fields in the Permian Basin of West
Texas and southeastern New Mexico (the "Oil and Gas Properties
Acquisition"). The Company operates 133 of these wells. The
purchase price for the Oil and Gas Properties Acquisition was
$72.3 million. These properties complement the Company's
existing proved reserve base with an average reserve life of
approximately 15 years and over 130 identified development
opportunities. The Company believes that it has significant
opportunities to improve production and cash flow from these
properties through additional development, reconfiguration of
operations and reduction of operating and administrative costs.
Drilling Activities. The Company complements its increase in
oil and gas reserves, production and cash flow by concentrating
on drilling low-risk development wells and by conducting
additional development activities such as recompletions. During
1997, the Company was involved in drilling 70 gross (34.4 net)
wells of which 63 gross (30.6 net) wells were successfully
completed as productive.
Exploratory Activities. The Company increased its spending
for exploratory activities from $184,000 in 1996 to $2.8 million
in 1997. Additionally, the Company anticipates that
approximately $700,000 of its revised 1998 capital budget will be
spent on exploratory projects. Exploratory drilling involves
greater risks of dry holes or failure to find commercial
quantities of hydrocarbons than development drilling or enhanced
recovery activities. See "Item 1. - Operating Hazards and
Risks."
Private Placement. On October 14, 1997, Southwest completed a
$200 million private placement sale of 10.5% Senior Notes due
2004, Series A ("Series A Notes") pursuant to Rule 144A of the
Securities Act (the "Private Placement"). Thereupon, the Series
A Notes were offered and sold by the underwriters only to
qualified institutional buyers. The net proceeds from the
Private Placement were approximately $190 million.
<PAGE>
The Series A Notes were issued pursuant to an indenture,
dated October 14, 1997 (the "Indenture"), by and among Southwest,
as Issuer, SRH as the Parent Guarantor, and State Street Bank and
Trust Company, N.A., as Trustee (the "Trustee"). The Indenture
is governed by certain provisions contained in the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act").
The terms of the Series A Notes include those stated in the
Indenture and those made part of the Indenture by reference to
the Trust Indenture Act.
Exchange Offer. On March 11, 1997, Southwest concluded a
registered offering to exchange the Series A Notes for 10.5%
Senior Notes due 2004, Series B which had been registered under
the Securities Act (the "Notes). The form and terms of the Notes
are identical in all material respects to the form and terms of
the Series A Notes. The Notes evidence the same debt as the
Series A Notes and were issued under and are entitled to the
benefits of the Indenture governing the Series A Notes.
Red Oak
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 December 31, 1997, Red Oak
owned and managed 14 shopping centers, three office buildings and
raw land held for future development.
Red Oak's primary objective is to acquire, own and manage a
portfolio of commercial properties that provides opportunity to
increase net operating income and results in significant capital
appreciation. Consistent with this strategy, Red Oak focuses its
activities primarily in secondary markets in the southwestern
United States, including San Antonio, Midland and San Angelo,
Texas; Tucson, Arizona; and Tulsa and Oklahoma City, Oklahoma.
Red Oak believes that the potential for population growth in
these markets and a lower level of interest from institutional
real estate buyers, as compared to primary markets, result in
attractive acquisition opportunities of multi-tenant, income
producing properties ranging in purchase price from $1 million to
$20 million. Red Oak's capital budget for 1998 includes capital
improvements of $7.2 million. Although no amount has been
budgeted for acquisitions, Red Oak will continue to search for
strategic and complementary acquisitions.
From December 1993 through December 31, 1997, Red Oak
completed the acquisition of 14 regional shopping centers and
three office buildings for a total acquisition cost of $82.8
million. Red Oak has financed and expects to continue to finance
the acquisition of its real estate properties with senior secured
credit arrangements between Red Oak and private lenders, that are
generally non-recourse to the Company.
Employees
As of December 31, 1997, the Company employed 170 people. Of
this total, 133 people were employed by Southwest, and 37 by Red
Oak. Additionally, 659 people were employed by Sierra, an
unconsolidated affiliate. The Company's future success will
depend partially on its ability to attract, retain and motivate
qualified personnel. The Company is not a party to any collective
bargaining agreements and has not experienced any strikes or work
stoppages. The Company considers its relations with its employees
to be satisfactory.
Competition
The oil and natural gas industry is highly competitive. The
Company's oil and gas business competes for the acquisition of
oil and natural gas properties, primarily on the basis of the
price to be paid for such properties, with numerous entities
including major oil companies, other independent oil and natural
gas concerns and individual
<PAGE>
producers and operators. Many of these competitors are large,
well established companies and have financial and other resources
substantially greater than those of the Company's oil and gas
business. The Company's ability to acquire additional oil and gas
properties and to discover reserves in the future will depend
upon its ability to evaluate and select suitable properties and
to consummate transactions in a highly competitive environment.
The Company's real estate business also competes for the
acquisition of desirable commercial real estate properties,
primarily on the basis of price.
Operating Hazards and Risks
The oil and natural gas business involves a variety of
operating risks, including the risk of fire, explosions, blow
outs, pipe failure, abnormally pressured formations and
environmental hazards such as oil spills, gas leaks, ruptures or
discharges of toxic gases. Any of these occurrences could result
in substantial losses to the Company due to injury or loss of
life, severe damage to or destruction of property, natural
resources and equipment, environmental damage, clean-up
responsibilities, regulatory investigation and penalties and
suspension of operations.
Drilling activities are subject to many risks, including the
risk that no commercially productive reservoirs will be
encountered. There can be no assurance that new wells drilled by
the Company will be productive or that the Company will recover
all or any portion of its investment. Drilling for oil and gas
may involve unprofitable efforts, not only from dry wells, but
from wells that are productive but do not produce sufficient net
revenues to return a profit after drilling, operating or other
costs. The cost of drilling, completing and operating wells is
often uncertain. The Company's drilling operations may be
curtailed, delayed or canceled as a result of numerous factors,
many of which are beyond the Company's control, including title
problems, weather conditions, mechanical problems, compliance
with governmental requirements and shortages and delays in the
delivery of equipment and services. The Company's future drilling
activities may not be successful and, if unsuccessful, such
failure may have a material adverse effect on the Company's
future results of operations and financial condition.
Although the Company maintains insurance coverage considered
to be customary in each industry in which it participates, it is
not fully insured against certain risks, either because insurance
is not available or because of the high premium costs. The
Company's real estate business carries business interruption
insurance. The Company does maintain physical damage, employer's
liability, comprehensive commercial general liability and
workers' compensation insurance. There can be no assurance that
any insurance obtained by the Company will be adequate to cover
any losses or liabilities, or that such insurance will continue
to be available or available on terms which are acceptable to the
Company.
Regulation
General. Various aspects of the Company's oil and natural gas
operations are subject to extensive and continually changing
regulation, as legislation affecting the oil and natural gas
industry is under constant review for amendment or expansion.
Numerous departments and agencies, both federal and state, are
authorized by statute to issue, and have issued, rules and
regulations binding upon the oil and natural gas industry and its
individual members. The Federal Energy Regulatory Commission
(''FERC'') regulates the transportation and sale for resale of
natural gas in interstate commerce pursuant to the Natural Gas
Act of 1938 (''NGA'') and the Natural Gas Policy Act of 1978
(''NGPA''). In the past, the Federal government has regulated the
prices at which oil and natural gas could be sold. While sales by
producers of natural gas and all sales of crude oil, condensate
and natural gas liquids can currently be made at uncontrolled
market prices, Congress could reenact price controls in the
future. Deregulation of wellhead sales in the natural gas
industry began with the enactment of the NGPA in 1978. In 1989,
Congress enacted the Natural Gas Wellhead Decontrol Act (the
''Decontrol Act''). The Decontrol Act removed all remaining NGA
and NGPA price and nonprice controls affecting wellhead sales of
natural gas effective January 1, 1993.
<PAGE>
Regulation of Sales and Transportation of Natural Gas. The
Company's sales of natural gas are affected by the availability,
terms and cost of transportation. The price and terms for access
to pipeline transportation are subject to extensive regulation.
In recent years, the FERC has undertaken various initiatives to
increase competition within the natural gas industry. As a result
of initiatives like FERC Order No. 636, issued in April 1992, the
interstate natural gas transportation and marketing system has
been substantially restructured to remove various barriers and
practices that historically limited non-pipeline natural gas
sellers, including producers, from effectively competing with
interstate pipelines for sales to local distribution companies
and large industrial and commercial customers. The most
significant provisions of Order No. 636 require that interstate
pipelines provide firm and interruptible transportation service
on an open access basis that is equal for all natural gas
supplies. In many instances, the results of Order No. 636 and
related initiatives have been to substantially reduce or
eliminate the interstate pipelines' traditional role as
wholesalers of natural gas in favor of providing only storage and
transportation services. While the United States Court of Appeals
upheld most of Order No. 636 last year, certain related FERC
orders, including the individual pipeline restructuring
proceedings, are still subject to judicial review and may be
reversed or remanded in whole or in part. While the outcome of
these proceedings cannot be predicted with certainty, the Company
does not believe that it will be affected materially differently
than its competitors.
The FERC has also announced several important transportation-
related policy statements and proposed rule changes, including a
statement of policy and a request for comments concerning
alternatives to its traditional cost-of-service rate making
methodology to establish the rates interstate pipelines may
charge for their services. A number of pipelines have obtained
FERC authorization to charge negotiated rates as one such
alternative. In February 1997, the FERC announced a broad inquiry
into issues facing the natural gas industry to assist the FERC in
establishing regulatory goals and priorities in the post-Order
No. 636 environment. Similarly, the Texas Railroad Commission has
been reviewing changes to its regulations governing
transportation and gathering services provided by intrastate
pipelines and gatherers. While the changes being considered by
these federal and state regulators would affect the Company only
indirectly, they are intended to further enhance competition in
natural gas markets. The Company cannot predict what further
action the FERC or state regulators will take on these matters,
however, the Company does not believe that it will be affected by
any action taken materially differently than other natural gas
producers with which it competes.
Additional proposals and proceedings that might affect the
natural gas industry are pending before Congress, the FERC, state
commissions and the courts. The natural gas industry historically
has been very heavily regulated; therefore, there is no assurance
that the less stringent regulatory approach recently pursued by
the FERC and Congress will continue.
Oil Price Controls and Transportation Rates. Sales of crude
oil, condensate and gas liquids by the Company are not currently
regulated and are made at market prices. The price the Company
receives from the sale of these products may be affected by the
cost of transporting the products to market.
Environmental. Extensive federal, state and local laws
regulating the discharge of materials into the environment or
otherwise relating to the protection of the environment affect
Southwest's oil and natural gas operations. Numerous
governmental departments issue rules and regulations to implement
and enforce such laws, which are often difficult and costly to
comply with and which carry substantial civil and even criminal
penalties for failure to comply. Some laws, rules and regulations
relating to protection of the environment may, in certain
circumstances, impose strict liability for environmental
contamination, rendering a person liable for environmental
damages and cleanup costs without regard to negligence or fault
on the part of such person. Other laws, rules and regulations may
restrict the rate of oil and natural gas production below the
rate that would otherwise exist or even prohibit exploration and
production activities in sensitive areas. In addition, state laws
often require various forms of remedial action to prevent
pollution, such as closure of inactive pits and plugging of
abandoned wells. The regulatory burden on the oil and natural gas
industry increases the Company's cost of doing business and
consequently affects the Company's profitability. The Company
believes that
<PAGE>
it is in substantial compliance with current applicable
environmental laws and regulations and that continued compliance
with existing requirements will not have a material adverse
impact on the Company's operations. However, environmental laws
and regulations have been subject to frequent changes over the
years, and the imposition of more stringent requirements could
have a material adverse effect upon the capital expenditures,
earnings or competitive position of the Company.
In addition, Red Oak's real estate management activities are
subject to federal, state and local laws, rules and regulations
pertaining to protection of the environment which may, in certain
circumstances, impose strict liability for environmental
contamination, thus rendering Red Oak liable for environmental
damages and clean up costs without regard to negligence or fault
on the part of Red Oak. Asbestos-containing materials may be
present at Red Oak's real estate holdings which may dictate
costly remediation to abate asbestos or which may increase the
cost of renovations to property when they become necessary.
Further, activities on adjacent properties, such as dry cleaning,
gasoline retailing, and automobile maintenance, may result in
subsurface soil and groundwater contamination that could impair
Red Oak's use or sale of real estate holdings or cause Red Oak to
incur costs to remediate any contamination caused by activities
of lessors or adjacent properties.
The Comprehensive Environmental Response, Compensation and
Liability Act (''CERCLA'') imposes liability, without regard to
fault on certain classes of persons that are considered to be
responsible for the release of a ''hazardous substance'' into the
environment. These persons include the current or former owner or
operator of the disposal site or sites where the release occurred
and companies that disposed or arranged for the disposal of
hazardous substances. Under CERCLA such persons may be subject to
joint and several liability for the costs of investigating and
cleaning up hazardous substances that have been released into the
environment, for damages to natural resources and for the costs
of certain health studies. In addition, companies that incur
liability frequently also confront third party claims because it
is not uncommon for neighboring landowners and other third
parties to file claims for personal injury and property damage
allegedly caused by hazardous substances or other pollutants
released into the environment from a polluted site.
The Federal Solid Waste Disposal Act, as amended by the
Resource Conservation and Recovery Act of 1976 (''RCRA''),
regulates the generation, transportation, storage, treatment and
disposal of hazardous wastes and can require cleanup of hazardous
waste disposal sites. RCRA currently excludes drilling fluids,
produced waters and other wastes associated with the exploration,
development or production of oil and natural gas from regulation
as ''hazardous waste.'' Disposal of such non-hazardous oil and
natural gas exploration, development and production wastes
usually are regulated by state law. Other wastes handled at
exploration and production sites or used in the course of
providing well services may not fall within this exclusion.
Moreover, stricter standards for waste handling and disposal may
be imposed on the oil and natural gas industry in the future.
From time to time legislation is proposed in Congress that would
revoke or alter the current exclusion of exploration, development
and production wastes from the RCRA definition of ''hazardous
wastes'' thereby potentially subjecting such wastes to more
stringent handling, disposal and cleanup requirements. If such
legislation were enacted it could have a significant impact on
the operating costs of Southwest and Sierra, as well as the oil
and natural gas industry and well servicing industry in general.
The impact of future revisions to environmental laws and
regulations cannot be predicted.
The Company's operations are also subject to the Clean Air Act
(''CAA'') and comparable state and local requirements. Amendments
to the CAA were adopted in 1990 and contain provisions that may
result in the gradual imposition of certain pollution control
requirements with respect to air emissions from operations of
Southwest. Southwest may be required to incur certain capital
expenditures in the next several years for air pollution control
equipment in connection with obtaining and maintaining operating
permits and approvals for air emissions. However, Southwest
believes its operations will not be materially adversely affected
by any such requirements, and the requirements are not expected
to be any more burdensome to Southwest than to other similarly
situated companies involved in oil and natural gas exploration
and production activities or well servicing activities.
<PAGE>
Southwest maintains insurance against ''sudden and
accidental'' occurrences which may cover some, but not all, of
the risks described above. Most significantly, the insurance
maintained by Southwest will not cover the risks described above
which occur over a sustained period of time. Further, there can
be no assurance that such insurance will continue to be available
to cover all such costs or that such insurance will be available
at premium levels that justify its purchase. The occurrence of a
significant event not fully insured or indemnified against could
have a material adverse effect on Southwest's financial condition
and operations.
Regulation of Oil and Natural Gas Exploration and Production.
Exploration and production operations of the Company are subject
to various types of regulation at the federal, state and local
levels. Such regulations include requiring permits and drilling
bonds for the drilling of wells, regulating the location of
wells, the method of drilling and casing wells, and the surface
use and restoration of properties upon which wells are drilled.
Many states also have statutes or regulations addressing
conservation matters, including provisions for the utilization or
pooling of oil and natural gas properties, the establishment of
maximum rates of production from oil and natural gas wells and
the regulation of spacing, plugging and abandonment of such
wells. Some state statutes limit the rate at which oil and
natural gas can be produced from Southwest's properties. See
''Risk Factors-Compliance with Governmental Regulations.''
Risks Associated with Business Activities
Substantial Leverage. As of December 31, 1997, the total
indebtedness of the Company, including current portion, was $284
million. The Company's level of indebtedness has several
important effects on its operations, including: (i) the covenants
may limit its ability to borrow additional funds or to dispose of
assets and may affect the Company's flexibility in planning for,
and reacting to, changes in business conditions, (ii) the
Company's ability to obtain additional financing in the future
for working capital, capital expenditures, acquisitions, general
corporate purposes or other purposes may be impaired, and (iii) a
substantial portion of the Company's cash flow may be dedicated
to the payment of interest. Moreover, future acquisition or
development activities may require the Company to alter its
capitalization significantly. These changes in capitalization may
significantly alter the leverage of the Company. The Company's
ability to meet its debt service obligations and to reduce its
total indebtedness will be dependent upon the Company's future
performance, which will be subject to general economic conditions
and to financial, business and other factors affecting the
operations of the Company, many of which are beyond its control.
There can be no assurance that the Company's future performance
will not be adversely affected by such economic conditions and
financial, business and other factors. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources.''
Certain holders, who collectively own approximately 12% of
SRH's common stock, have an option to cause SRH to redeem such
holders' common stock at any time beginning December 31, 2001,
five years from the date of issuance of such common stock,
subject to the terms of a subscription agreement under which SRH
sold the common stock (the ''Subscription Agreement'') and
subject to any restrictions imposed by law. The Subscription
Agreement provides that this redemption right terminates on the
effective date of any registration statement under the Securities
Act filed with the Commission relative to the offer and sale of
any amount of SRH's common stock to the public. SRH is unable to
predict the amount of money it would be required to pay if the
redemption right is exercised. In addition, the Company is
subject to an Indenture pursuant to its 10.5% Senior Notes due
2004 (the "Indenture") which may also restrict SRH's ability to
make such payments. In addition, SRH can give no assurance that
it will be able to cause a registration statement to become
effective under the Securities Act in order to terminate the
redemption option.
Payment Upon a Change of Control. Upon the occurrence of a
change of control of the Company, each holder of the Notes may
require Southwest to purchase all or a portion of such holder's
Notes at 101% of the principal amount of the Notes, together with
accrued and unpaid interest, if any, to the date of purchase. If
a change of control were to
<PAGE>
occur, Southwest may not have the financial resources to repay
all of the Notes and the other indebtedness that might become
payable upon the occurrence of such change of control.
Adequacy of Collateral; Risks of Foreclosure. SRH has pledged
to the Trustee (under the Indenture), for the ratable benefit of
the holders of the Notes, all of the Sierra common stock and Red
Oak common stock directly owned by SRH as security for the Parent
Guarantee (collectively, the "Collateral").
In the event of a default under the Indenture, there can be no
assurance that the Trustee would be able to foreclose on or
dispose of any of the Collateral without substantial delays and
other risks or that the proceeds obtained therefrom would be
sufficient to pay all amounts owing to holders of the Notes. SRH
would be required to file a shelf registration statement and any
of SRH's other subsidiaries whose stock is pledged to the Trustee
would be required to grant registration rights with respect to
such stock, in each case to allow the Trustee to be able to sell
the pledged shares of their common stock publicly. Circumstances
beyond the control of the Company, however, may delay the
availability of a current prospectus. There is currently no
public market for the shares of SRH common stock and there can be
no assurance that there will be any public market for the common
stock of any subsidiary of SRH.
In addition, if Southwest becomes a debtor in a case under the
United States Bankruptcy Code ("The Bankruptcy Code"), the
automatic stay imposed by the Bankruptcy Code would prevent the
Trustee from selling or otherwise disposing of the Collateral
without bankruptcy court authorization. In that case, the
foreclosure might be delayed indefinitely. Moreover, the
bankruptcy of any entity related to the Southwest might result in
a similar delay if Southwest were "substantively consolidated"
with the related entity.
Possible Limitations on Enforceability of Subsidiary
Guarantees. Southwest's obligations under the Notes may under
certain circumstances be guaranteed on a senior basis by certain
subsidiaries of Southwest as set forth in the Indenture. Various
fraudulent conveyance laws have been enacted for the protection
of creditors and may be utilized by a reviewing court to
subordinate or void a subsidiary guaranty. It is also possible
that under certain circumstances a court could hold that the
direct obligations of a subsidiary guarantor could be superior to
the obligations under a subsidiary guaranty.
To the extent that a court were to find that at the time a
subsidiary guaranty was entered into either (1) the subsidiary
guaranty was incurred with the intent to hinder, delay or defraud
any present of future creditor or that the subsidiary guarantor
contemplated insolvency with a design to favor one or more
creditors to the exclusion in whole or in part of others or (2)
the subsidiary guarantor did not receive fair consideration or
reasonably equivalent value for issuing the subsidiary guaranty
and, at the time it issued the guaranty, the subsidiary guarantor
(i) was insolvent or rendered insolvent by reason of the issuance
of the subsidiary guaranty, (ii) was engaged or about to engage
in a business or transaction for which the remaining assets of
the subsidiary guarantor constituted unreasonably small capital,
or (iii) intended to incur, or believed that it would incur,
debts beyond its ability to pay such debts as they matured, the
court could void or subordinate the subsidiary in favor of the
subsidiary guarantor's other creditors. Among other things, a
legal challenge of a subsidiary guaranty issued on fraudulent
conveyance grounds may focus on the benefits, if any, realized by
the subsidiary guarantor as a result of the issuance by Southwest
of the Notes. To the extent that proceeds from the Private
Placement were used to refinance the indebtedness of the Company,
a court might find that a subsidiary guarantor did not benefit
from incurrence of the indebtedness represented by the Notes.
The measure of insolvency for purposes of determining whether
a transfer is voidable as a fraudulent transfer varies depending
upon the law of the jurisdiction that is being applied.
Generally, however, a debtor would be considered insolvent if the
sum of all its debts, including contingent liabilities, was
greater than the value of all its assets at a fair valuation or
if the present fair saleable value of the debtor's assets was
less than the amount required to repay its probable liability on
its debts, including contingent liabilities, as they become
absolute and mature.
<PAGE>
To the extent that a subsidiary guaranty is voided as a
fraudulent conveyance or found unenforceable for any other
reason, holders of the Notes would cease to have any claim in
respect to the applicable subsidiary. In such event, the claims
of the holders of the Notes against such subsidiary would be
subject to the prior payment of all liabilities and preferred
stock claims of such subsidiary guarantor. There can be no
assurance that, after providing for all prior claims and referred
stock interests, if any, there would be sufficient assets to
satisfy the claims of the holders of the Notes relating to any
voided portion of such subsidiary guaranty.
Lack of Public Market; Restriction of Transferability. The
Notes were a new securities issue for which there was no active
trading market. The Notes are generally permitted to be resold or
otherwise transferred (subject to the certain restrictions) by
each holder of the Notes without the requirement of further
registration. Accordingly, there can be no assurance as to the
development or liquidity of any market for the Notes.
Voting Control. As of December 31, 1997, H. H. Wommack, III,
Chairman of the Board, President and Chief Executive Officer of
SRH and Southwest, owned 72.9% of the outstanding voting shares
of common stock of SRH, which owns 100% of the common stock of
Southwest. Therefore, Mr. Wommack has the ability to elect all
of the directors of SRH and Southwest and, directly and
indirectly, influence all decisions made by SRH and Southwest.
Dependence on Key Personnel. The Company depends to a large
extent on the services of H. H. Wommack, III and certain other
senior management personnel. The loss of the services of Mr.
Wommack and other senior management personnel could have a
material adverse effect on the Company's operations. The Company
does not currently have an employment contract with any senior
management or key personnel. The Company believes that its
success is also dependent upon its ability to continue to employ
and retain skilled technical personnel. The inability of the
Company to employ or retain skilled technical personnel could
have a material adverse effect on the Company's operations.
Although the Company maintains key man life insurance on the life
of Mr. Wommack in the amount of $8 million, the existence of such
insurance does not mean that the death or disability of Mr.
Wommack would not have a materially adverse effect upon the
Company.
Volatility of Oil and Natural Gas Prices. Revenues generated
from Southwest's operations are highly dependent upon the price
of, and demand for, oil and natural gas. Historically, the
markets for oil and natural gas have been volatile and are likely
to continue to be volatile in the future. Prices for oil and
natural gas are subject to wide fluctuations in response to
relatively minor changes in the supply of and demand for oil and
natural gas, market uncertainty and a variety of additional
factors that are beyond the control of Southwest. These factors
include the level of consumer product demand, weather conditions,
domestic and foreign governmental regulations, the price and
availability of alternative fuels, political conditions in the
Middle East, the foreign supply of oil and natural gas, the price
of foreign imports and overall economic conditions. It is
impossible to predict future oil and natural gas price movements
with any certainty. Declines in oil and natural gas prices may
materially adversely affect Southwest's financial condition,
liquidity and results of operations. Lower oil and natural gas
prices also may reduce the amount of Southwest's oil and natural
gas that can be produced economically. In order to reduce its
exposure to price risks in the sale of its oil and natural gas,
Southwest may enter into hedging arrangements from time to time;
however, Southwest's hedging arrangements are likely to apply to
only a portion of its production and provide only limited price
protection against fluctuations in the oil and natural gas
markets. See ''Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations-General'' and
''Item 1. Business.''
Southwest uses the full cost method of accounting for its
investment in oil and natural gas properties. Under the full cost
method of accounting, all costs of acquisition, exploration and
development of oil and natural gas reserves are capitalized into
a ''full cost pool'' as incurred, and properties in the pool are
depleted and charged to operations using the future gross
revenues method based on the ratio of current gross revenue to
total proved future gross revenues, computed based on current
prices. Significant downward revisions of quantity estimates or
declines in oil and natural
<PAGE>
gas prices that are not offset by other factors could result in a
write down for impairment of oil and natural gas properties. Once
incurred, a write down of oil and natural gas properties is not
reversible at a later date even if oil or natural gas prices
increase.
Risks of Acquisition Strategy. The Company's growth strategy
includes the acquisition of oil and gas properties and commercial
real estate properties. There can be no assurance, however, that
the Company will be able to continue to identify attractive
acquisition opportunities, obtain financing for acquisitions on
satisfactory terms or successfully acquire identified targets. In
addition, no assurance can be given that the Company will be
successful in integrating acquired businesses into its existing
operations, and such integration may result in unforeseen
operational difficulties or require a disproportionate amount of
management's attention. Future acquisitions may be financed
through the incurrence of additional indebtedness to the extent
permitted under the Indenture or through the issuance of capital
stock. Furthermore, there can be no assurance that competition
for acquisition opportunities in these industries will not
escalate, thereby increasing the cost to the Company of making
further acquisitions or causing the Company to refrain from
making additional acquisitions.
Replacement of Reserves. In general, the volume of production
from oil and natural gas properties declines as reserves are
depleted. Except to the extent Southwest acquires properties
containing proved reserves or conducts successful development and
exploration activities, or both, the proved reserves of Southwest
will decline as reserves are produced. Southwest's future oil and
natural gas production is, therefore, highly dependent upon its
level of success in finding or acquiring additional reserves. The
business of exploring for, developing or acquiring reserves is
capital intensive. To the extent cash flow from operations is
reduced and external sources of capital become limited or
unavailable, Southwest's ability to make the necessary capital
investment to maintain or expand its asset base of oil and
natural gas reserves would be impaired. In addition, there can be
no assurance that Southwest's future development, acquisition and
exploration activities will result in additional proved reserves
or that Southwest will be able to drill productive wells at
acceptable costs.
Uncertainty of Reserve Information and Future Net Revenue
Estimates. There are numerous uncertainties inherent in
estimating oil and natural gas reserves and their estimated
values, including many factors beyond the control of Southwest.
The reserve data set forth herein represent only estimates.
Reservoir engineering is a subjective process of estimating
underground accumulations of oil and natural gas that cannot be
measured in an exact manner. Estimates of economically
recoverable oil and natural gas reserves and of future net cash
flows necessarily depend upon a number of variable factors and
assumptions, such as historical production from the area compared
with production from other producing areas, the assumed effects
of regulations by governmental agencies and assumptions
concerning future oil and natural gas prices, future operating
costs, severance and excise taxes, development costs and workover
and remedial costs, all of which may in fact vary considerably
from actual results. For these reasons, estimates of the
economically recoverable quantities of oil and natural gas
attributable to any particular group of properties,
classifications of such reserves based on risk recovery and
estimates of the future net cash flows expected therefrom
prepared by different engineers or by the same engineers at
different times may vary substantially and such reserve estimates
may be subject to downward or upward adjustment based upon such
factors. Actual production, revenues and expenditures with
respect to Southwest's reserves will likely vary from estimates,
and such variances may be material. See ''Item 2. Properties-Oil
and Gas Reserves.''
The present values of estimated future net cash flows referred
to herein should not be construed as the current market value of
the estimated oil and natural gas reserves attributable to
Southwest's properties. In accordance with applicable
requirements of the Commission, the estimated discounted future
net cash flows from proved reserves are generally based on prices
and costs as of the date of the estimate, whereas actual future
prices and costs may be materially higher or lower. Actual future
net cash flows also will be affected by factors such as the
amount and timing
<PAGE>
of actual production, supply and demand for oil and natural gas,
curtailments or increases in consumption by gas purchasers and
changes in governmental regulations or taxation. The timing of
actual future net cash flows from proved reserves, and their
actual present value, will be affected by the timing of both the
production and the incurrence of expenses in connection with
development and production of oil and natural gas properties. In
addition, the calculation of the present value of the future net
revenues using a 10% discount, as required by the Commission, is
not necessarily the most appropriate discount factor based on
interest rates in effect from time to time and risks associated
with Southwest's reserves or the oil and natural gas industry in
general.
Substantial Capital Requirements. Southwest makes, and will
continue to make, substantial capital expenditures for the
exploration, development and acquisition of oil and natural gas
reserves. Southwest made capital expenditures of $32 million
during 1995 and $17 million during 1996. For 1997, Southwest
spent $103 million in the aggregate for oil and gas acquisition,
development and exploration activities and has budgeted
additional capital spending, of approximately $5.8 million for
1998, principally to complete planned development drilling and
recompletion projects. Although management believes that
Southwest will have sufficient cash provided by operating
activities, bank lines and the proceeds from the Offering to fund
planned capital expenditures in 1998, if revenues decrease as a
result of lower oil and natural gas prices or operating
difficulties, Southwest may be limited in its ability to expend
the capital necessary to undertake or complete its drilling
program in future years. There can be no assurance that
additional debt or equity financing or cash generated by
operations will be available to meet these requirements. See
''Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations-Liquidity and Capital
Resources.''
Drilling Risks. Drilling involves numerous risks, including
the risk that no commercially productive oil or natural gas
reservoirs will be encountered. The cost of drilling, completing
and operating wells is often uncertain, and drilling operations
may be curtailed, delayed or canceled as a result of a variety of
factors, including unexpected drilling conditions, pressure or
irregularities in formations, equipment failures or accidents,
adverse weather conditions, title problems and shortages or
delays in the delivery of equipment. Southwest's future drilling
activities may not be successful and, if unsuccessful, such
failure will have an adverse effect on Southwest's future results
of operations and financial condition.
Marketability of Production. The marketability of Southwest's
oil and natural gas production depends upon the availability and
capacity of oil and gas gathering systems, pipelines and
processing facilities, and the unavailability or lack of capacity
thereof could result in the shut-in of producing wells or the
delay or discontinuance of development plans for properties. In
addition, federal and state regulation of oil and natural gas
production and transportation, general economic conditions and
changes in supply and demand could adversely affect Southwest's
ability to produce and market its oil and natural gas on a
profitable basis.
Operating Risks of Oil and Natural Gas Operations. The oil
and natural gas business involves a variety of operating risks,
including the risk of fire, explosions, blowouts, pipe failure,
casing collapse, abnormally pressured formations and hazards such
as oil spills, natural gas leaks, ruptures or discharges of toxic
gases. The occurrence of any of these operating risks could
result in substantial losses to Southwest due to injury or loss
of life, severe damage to or destruction of property and
equipment, pollution or other environmental damage, including
damage to natural resources, clean-up responsibilities, penalties
and suspension of operations. In accordance with customary
industry practice, Southwest maintains insurance against some,
but not all, of the risks described above. There can be no
assurance that any insurance obtained by Southwest will be
adequate to cover any losses or liabilities. Southwest cannot
predict the continued availability of insurance or the
availability of insurance at premium levels that justify its
purchase.
Compliance with Governmental Regulations. The Company's oil
and natural gas and well service operations are subject to
various federal, state and local governmental laws and
regulations that may be changed from time to time in response to
economic or political conditions. Matters subject to regulation
include discharge permits for drilling oper-
<PAGE>
- -ations, drilling and abandonment bonds or other financial
responsibility requirements, reports concerning operations, the
spacing of wells, utilization and pooling of properties and
taxation. From time to time, regulatory agencies have imposed
price controls and limitations on production by restricting the
rate of flow of oil and natural gas wells below actual production
capacity to conserve supplies of oil and natural gas. In
addition, the production, handling, storage, transportation and
disposal of oil and natural gas, by-products thereof and other
substances and materials produced or used in connection with oil
and natural gas operations are subject to regulation under
federal, state and local laws and regulations primarily relating
to protection of human health and the environment. These laws and
regulations may impose increasingly strict requirements for water
and air pollution control and solid waste management and can
result in the imposition of civil and even criminal penalties.
The Company's commercial real estate properties are subject to
various federal, state and local regulatory requirements, such as
laws with respect to access by disabled persons and state and
local fire and life safety requirements. Failure to comply with
these requirements could result in the imposition of fines by
governmental authorities or awards of damages to private
litigants. The Company believes that the properties are currently
in compliance in all material respects with all such regulatory
requirements. However, there can be no assurance that these
requirements will not be changed or that new requirements will
not be imposed which would require significant unanticipated
expenditures by the Company's real estate business and could have
an adverse effect on expected distributions by the Company's real
estate business.
Substantial Competition. The Company experiences intense
competition in its markets. Such markets are highly competitive
and no one competitor is dominant. Southwest competes with major
and independent oil and natural gas companies for the acquisition
of desirable oil and natural gas properties, as well as for the
equipment and labor required to develop and operate such
properties. Southwest also competes with major and independent
oil and natural gas companies in the marketing and sale of oil
and natural gas to marketers and end-users. Red Oak competes
with other companies for the acquisition of desirable real estate
properties principally on the basis of price. Although the
Company believes that it has certain advantages over these
competitors, some of these competitors have greater financial and
other resources than the Company. See ''Item 1.
Business-Competition.''
Environmental Risks. The Company is subject to a variety of
federal, state and local governmental regulations related to the
storage, use, discharge and disposal of toxic, volatile or
otherwise hazardous materials. The Company does not currently
anticipate any material adverse effect on its business, financial
condition or results of operations as a result of the Company's
required compliance with U.S. federal, state, provincial, local
or foreign environmental laws or regulations or remediation
costs. However, some risk of environmental liability and other
costs is inherent in the nature of the Company's business.
Moreover, the Company anticipates that such laws and regulations
will become increasingly stringent in the future, which could
lead to material costs for environmental compliance and
remediation by the Company. See ''Item 1. Business-Regulation.''
Any failure by the Company to obtain required permits for,
control the use of, or adequately restrict the discharge of,
hazardous substances under present or future regulations could
subject the Company to substantial liability or could cause its
operations to be suspended. Such liability or suspension of
operations could have a material adverse effect on the Company's
business, financial condition and results of operations.
Red Oak Operations-Economic Performance and Value of Real
Estate Dependent on Many Factors. Real estate property
investments are subject to varying degrees of risk. The economic
performance and values of real estate can be affected by many
factors, including changes in the national, regional and local
economic climates, local conditions such as an oversupply of
space or a reduction in demand for real estate in the area, the
attractiveness of the properties to tenants, competition from
other available space, the ability of the owner to provide
adequate maintenance and insurance and increased operating costs.
In recent years, there has been a proliferation of new retailers
and a growing
<PAGE>
consumer preference for value-oriented shopping alternatives that
have, among other factors, heightened competitive pressures. In
certain areas of the country, there may also be an oversupply of
retail space. As a consequence, many companies in all sectors of
the retailing industry have encountered significant financial
difficulties. A substantial portion of Red Oak's income is
derived from rental revenues from retailers in neighborhood and
community shopping centers. Red Oak's income would be adversely
affected if a significant number of Red Oak's tenants were unable
to meet their obligations to Red Oak or if Red Oak were unable to
lease a significant amount of space in its properties on
economically favorable lease terms. Accordingly, no assurance can
be given that Red Oak's financial results will not be adversely
affected by these developments in the retail industry.
All subsequent written and oral forward looking statements
attributable to the Company or persons acting on its behalf are
expressly qualified in their entirety by such factors. The
Company assumes no obligation to update any such forward-looking
statements.
Glossary of Oil and Gas Terms
The following are abbreviates and definitions of terms
commonly used in the oil and gas industry that are used in this
Report. All volumes of natural gas referred to herein are stated
at the legal pressure base to the state or area where the
reserves exit and at 60 degrees Fahrenheit and in most instances
are rounded to the nearest major multiple.
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume.
Bcf. Billion cubic feet.
Boe. Barrel of oil equivalent, determined using the ratio of
one Bbl of crude oil, condensate or natural gas liquids to six
Mcf of natural gas.
Bopd. Barrels of oil per day.
Completion. The installation of permanent equipment for the
production of oil and natural gas, or in the case of a dry hole,
the reporting of abandonment to the appropriate agency.
Development well. A well drilled within the proved area of an
oil or natural gas reservoir to the depth of a stratigraphic
horizon known to be productive.
Dry hole or well. A well found to be incapable of producing
hydrocarbons in sufficient quantities such that proceeds from the
sale of such production exceed production expenses and taxes.
Exploratory well. A well drilled to find and produce oil or
natural gas reserves not classified as proved, to find a new
reservoir in a field previously found to be productive of oil or
natural gas in another reservoir or to extend a known reservoir.
Field. An area consisting of a single reservoir or multiple
reservoirs all grouped on or related to the same individual
geological structural feature and/or stratigraphic condition.
<PAGE>
Gross acres or gross wells. The total acres or wells, as the
case may be, in which a working interest is owned.
Horizontal drilling. A drilling technique that permits the
operator to contact and intersect a larger portion of the
producing horizon than conventional vertical drilling techniques
and can result in both increased production rates and greater
ultimate recoveries of hydrocarbons.
MBbls. One thousand barrels.
MBoe. One thousand barrels of oil equivalent, determined using
the ratio of one Bbl of crude oil, condensate or natural gas
liquids to six Mcf of natural gas.
Mcf. One thousand cubic feet.
Mcfd. One thousand cubic feet per day.
Mcfe. One thousand cubic feet equivalent, determined using the
ratio of six Mcf of natural gas to one Bbl of crude oil,
condensate or natural gas liquids.
MMBbls. One million barrels of crude oil or other liquid
hydrocarbons.
MMBoe. One million barrels of oil equivalent, determined using
the ratio of one Bbl of crude oil, condensate or natural gas
liquids to six Mcf of natural gas.
MMcf. One million cubic feet.
Net acres or net wells. The sum of the fractional working
interests owned in gross acres or gross wells, as the case may
be.
Oil. Crude oil, condensate and natural gas liquids.
Present value and PV-10 Value. When used with respect to oil
and natural gas reserves, the estimated future net revenue to be
generated from the production of proved reserves, determined in
all material respects in accordance with the rules and
regulations of the Securities and Exchange Commission (generally
using prices and costs in effect as of the date indicated)
without giving effect to non-property related expenses such as
general and administrative expenses, debt service and future
income tax expenses or to depreciation, depletion and
amortization, discounted using an annual discount rate of 10%.
Productive well. A well that is found to be capable of
producing hydrocarbons in sufficient quantities such that
proceeds from the sale of such production exceed production
expenses and taxes.
Proved developed producing reserves. Proved developed reserves
that are expected to be recovered from completion intervals
currently open in existing wells and capable of production.
Proved developed reserves. Proved reserves that are expected
to be recovered from existing wellbores, whether or not currently
producing, without drilling additional wells. Production of such
reserves may require a recompletion.
Proved reserves. The estimated quantities of crude oil,
natural gas, and natural gas liquids that geological and
engineering data demonstrate with reasonable certainty to be
recoverable in future years from known reservoirs under existing
economic and operating conditions.
<PAGE>
Proved undeveloped location. A site on which a development
well can be drilled consistent with spacing rules for purposes of
recovering proved undeveloped reserves.
Proved undeveloped reserves. Proved reserves that are expected
to be recovered from new wells on undrilled acreage.
Recompletion. The completion for production of an existing
wellbore in another formation from that in which the well has
been previously completed.
Reserve life. A ratio determined by dividing the existing
reserves by production from such reserves for the prior twelve
month period.
Reservoir. A porous and permeable underground formation
containing a natural accumulation of producible oil and/or
natural gas that is confined by impermeable rock or water
barriers and is individual and separate from other reserves.
Royalty interest. An interest in an oil and natural gas
property entitling the owner to a share of oil or natural gas
production free of costs of production.
Undeveloped acreage. Lease acreage on which wells have not
been drilled or completed to a point that would permit the
production of commercial quantities of oil and natural gas
regardless of whether such acreage contains proved reserves.
Wellbore. The hole drilled by the bit.
Working interest. The operating interest that gives the owner
the right to drill, produce and conduct operating activities on
the property and a share of production.
Workover. Operations on a producing well to restore or
increase production.
ITEM 2. PROPERTIES.
Facilities
The principal offices of SRH, Southwest and Red Oak are
located in Midland, Texas. SRH, Southwest, and Red Oak believe
that their leased and owned properties, none of which
individually is material to any of the companies, are adequate
for current needs.
Title to Properties
The Company believes it has satisfactory title to all of its
properties in accordance with standards generally accepted in the
oil and gas, well servicing and real estate industries. As is
customary in the oil and natural gas industry, Southwest makes
only a cursory review of title to farmout acreage and to
undeveloped oil and natural gas leases upon execution of any
contracts. Prior to the commencement of drilling operations, a
thorough title examination is conducted and curative work is
performed with respect to significant defects. To the extent
title opinions or other investigations reflect title defects,
Southwest, rather than the seller of the undeveloped property, is
typically responsible to cure any such title defects at its
expense. If Southwest were unable to remedy or cure any title
defect of a nature such that it would not be prudent to commence
drilling operations on the property, Southwest could suffer a
loss of its entire investment
<PAGE>
in the property. Southwest has obtained title opinions on
substantially all of its producing properties and believes that
it has satisfactory title to such properties in accordance with
standards generally accepted in the oil and natural gas industry.
Prior to completing an acquisition of producing oil and natural
gas leases, Southwest obtains title opinions on all leases.
Southwest's oil and natural gas properties are subject to
customary royalty interests, liens for current taxes and other
burdens that Southwest believes do not materially interfere with
the use of or affect the value of such properties.
Oil and Gas Properties
Southwest's Principal Oil and Gas Properties
The Company's oil and gas properties are primarily located in
the Permian Basin of West Texas and southeastern New Mexico. Over
90% of the Company's PV-10 Value is concentrated in this region.
The region is characterized by numerous known producing horizons,
providing significant opportunities to increase reserves,
production and ultimate recoveries through additional
development, horizontal drilling, recompletions, enhanced
recovery methods, and the use of 3-D seismic, reprocessed 2-D
seismic data and other advanced technologies. As of December 31,
1997, the Company operated properties comprising approximately
65% of its PV-10 Value. The following table provides information
for the Company's ten largest fields which contribute 61% of its
reserves and PV-10 Value as of December 31, 1997.
As of December 31, 1997
--------------------------------------------------------
Net Proved PV-10 % of Total
Reserves Value PV-10
Field (Mboe)(in thousands)Value
------- ----------------------------------
- ------
Huntley 3,567 $21,843 12.7%
Ackerly 3,178 15,551 9.0
Foster 2,260 13,472 7.8
Huntley East 2,157 11,231 6.5
Halley 1,916 8,934 5.2
Jo-Mill 2,337 8,846 5.1
Flying M 3,666 8,013 4.7
Magnolia Sealy 2,413 7,991 4.6
Rhoda Walker 1,767 5,666 3.3
Vealmoor 916 3,786 2.2
Huntley Field. The Huntley Field is located in Garza County,
Texas. The field was discovered in 1953 and produces from the San
Andres and Glorieta reservoirs. Southwest owns a 74% working
interest and operates 33 producing and 12 injection wells.
Ackerly (Dean) Field. The Ackerly (Dean) Field is located in
Dawson County, Texas and produces from the Dean Sand oil
reservoir. The field was discovered in 1954 with the drilling and
completion of the Pan American Graves ''A'' No. 1 well. Southwest
owns a 60% working interest in the East Ackerly Dean Unit-Phase
II, along with interests in two additional leases. Henry
Petroleum operates 70 producing and 30 injection wells.
Foster Field. The Foster Field is located in Ector County,
Texas. The field was discovered in 1936 and produces from the
Grayburg and Queen formations in the Gist Unit. Southwest owns
working interests ranging from 46% to
<PAGE>
100% and operates 63 producing and 57 injection wells.
Huntley East Field. The Huntley East Field is located in Garza
County, Texas. The field was discovered in 1956 and produces from
a low-relief anticline which covers approximately 1,400 surface
acres. Southwest has a 100% working interest in the Huntley East
San Andres Unit, which comprises substantially all of the field,
and a 100% working interest in the Harold L. Davies lease, and
operates 37 producing and 7 injection wells.
Halley Field. The Halley Field is located in Winkler County,
Texas and consists of two leases totaling 7,608 gross acres, of
which 3,190 gross acres have been developed. Southwest acquired
working interests ranging from 43% to 70% in this field in 1995
and currently operates 123 active producing wells and 33 water
injection wells. The field was discovered in 1937 and produces
from multiple zones ranging from 2,400 to 3,000 feet in depth. To
date, Southwest has performed 30 workovers, increasing average
daily production from approximately 200 Bopd and 280 Mcfd of
natural gas in 1995 to 321 Bopd and 1,500 Mcfd of natural gas in
1996. Development plans, which have commenced, include the
drilling of 20 proved undeveloped locations.
Jo-Mill Field. The Jo-Mill Field is located in Borden County,
Texas. The field was discovered in 1954, unitized in 1969, and
produces from the Upper Spraberry, Lower Spraberry and Dean Sand
reservoirs. Southwest owns a 6% working interest in the Jo-Mill
Unit. Texaco, Inc. operates 172 producing and 73 injection wells.
Flying M Field. The Flying M Field is located in northern Lea
County, New Mexico and produces from the San Andres oil
reservoir. The field was discovered in 1964 and was unitized in
1967 when water injection commenced. In 1997, Southwest acquired
working interests ranging from 83% to 100% in 6,160 gross acres
of the field area, of which 2,240 gross acres are undeveloped.
Southwest operates all 46 producing wells and nine active water
injection wells, including wells that are not contained within
the unitized portion of the field. Development plans for this
field include the drilling of ten undrilled 40-acre proved
undeveloped locations and the conversion of ten wells to water
injection. Further development of the field, including the
reduction to 20-acre spacing from the current 40-acre spacing, is
presently under evaluation.
Magnolia Sealy Field. The Magnolia Sealy Field is located in
Ward County, Texas and produces from the Upper Yates oil
reservoir. Southwest acquired its interest in this field in 1988
and operates 21 producing wells and three water disposal wells
with a working interest of 90%. There are currently 33 proved
undeveloped locations to be drilled on the 1,800 gross acres
operated by Southwest. Development plans also include the
initiation of a water flood on a portion of the field by early
1998.
Rhoda Walker Field. The Rhoda Walker Field is located in Ward
County, Texas and produces from 18 different reservoirs ranging
in depth from 4,700 to 7,000 feet. Southwest acquired its working
interests in this field, ranging from 1% to 34%, in 1990.
Southwest operates 37 producing wells and five water disposal
wells and also owns non-operated interests in 46 wells. The field
was discovered in 1971 and contains significant proved developed
non-producing reserves. Development plans include 24
recompletions, the drilling of 47 proved undeveloped locations
and infill drilling.
Vealmoor Field. The Vealmoor Field is located in northwest
Howard County, Texas. Southwest acquired its 35% non-operated
working interest in this field in 1995. The field was discovered
in 1948 and is currently producing from 20 wells in the Horseshoe
Atoll-Canyon Reef trend. Development plans include the drilling
of nine infill wells resulting in 20-acre spacing in a portion of
the field. Additionally, seven development locations have been
identified to test proved undeveloped locations and Southwest is
currently evaluating 3-D seismic data over the field.
<PAGE>
Oil and Gas Reserves. The following table summarizes the
estimates of Southwest's historical net proved reserves and the
related present values of such reserves at the dates shown. The
reserve and present value data for the Company's existing
properties as of December 31, 1997 were prepared by Ryder Scott
Company Petroleum Engineers. The reserve and present value data
as of December 31, 1996 and 1995 were prepared by independent
petroleum engineer, Donald R. Creamer.
As of December 31,
---------------------------
- --- ---------------------------
1997 1996 1995
-------- -------- -------
Proved Reserves:
Oil and Condensate (MBbls) 29,666 18,806 16,580
Natural Gas (MMcf) 64,725 76,776 70,590
Total (MBoe) 40,453 31,602 28,345
Proved Developed Reserves:
Oil and Condensate (MBbls) 18,472 10,302 7,349
Natural Gas (MMcf) 46,585 58,961 51,926
Total (MBoe) 26,236 20,129 16,003
PV-10 Value (in thousands)(1) $172,304 $252,170 $117,902
Discounted Future Cash Flows (2)
Future cash inflows $620,418 $735,100 $433,514
Future production and development costs (303,406)
(283,894) (213,698)
---------- ---------- ----------
Future net cash flows before income taxes 317,012 451,206
219,816
Future income tax expense (59,764)(142,017) (64,064)
-------------------------------
Future net cash flows, net of tax 257,248 309,189 155,752
10% annual discount for estimated timing
of cash flows (117,427)(130,648) (71,646)
-------------------------------
Standardized measure of discounted future
net cash flows, net of tax $139,821 $178,541 $84,106
====== ====== =======
(1) The present value of future net revenues attributable
to Southwest's reserves was prepared using prices in effect at
the end of the respective periods presented, discounted at 10%
per annum on a pre-tax basis.
(2) Discounted future cash flows, including taxes, are not
intended to represent estimates of the fair value of oil and gas
properties. Estimates of fair value should also consider
probable reserves, anticipated future oil and gas prices,
interest rate, changes in development and production costs and
production costs and risks associated with future production.
Because of these considerations, any estimate of fair value is
necessarily subjective and imprecise.
In accordance with applicable requirements, estimates of
Southwest's proved reserves and future net revenues are made
using oil and natural gas sales prices estimated to be in effect
as of the date of such reserve estimates and are held constant
throughout the life of the properties (except to the extent a
contract specifically provides for escalation.) The average
prices used in the reserve report were $16.30 per Bbl of oil and
$2.11 per Mcf of natural gas, $23.89 per Bbl of oil and $3.67 per
Mcf of natural gas and $17.23 per Bbl of oil and $2.07 per Mcf of
natural gas as of December 31, 1997, 1996 and 1995, respectively.
<PAGE>
Estimated quantities of proved reserves and future net
revenues therefrom are affected by oil and natural gas prices,
which have fluctuated widely in recent years. There are numerous
uncertainties inherent in estimating oil and natural
gas reserves and their values, including many factors beyond the
control of the producer. Reservoir engineering is a subjective
process of estimating underground accumulations of oil and
natural gas that cannot be measured in an exact manner. The
accuracy of any reserve estimate is a function of the quality of
available data and of engineering and geological interpretation
and judgment. As a result, estimates of different engineers,
including those used by Southwest, may vary. In addition,
estimates of reserves are subject to revision based upon actual
production, results of future development and exploration
activities, prevailing oil and natural gas prices, operating
costs and other factors, which revisions may be material.
Accordingly, reserve estimates are often different from the
quantities of oil and natural gas that are ultimately recovered
and are highly dependent upon the accuracy of the assumptions
upon which they are based.
In general, the volume of production from oil and natural gas
properties declines as reserves are depleted. Except to the
extent Southwest acquires properties containing proved reserves
or conducts successful exploration and development activities, or
both, the proved reserves of Southwest will decline as reserves
are produced. Southwest's future oil and natural gas production
is, therefore, highly dependent upon its level of success in
finding or acquiring additional reserves.
Net Production, Unit Prices and Costs. The following table
presents certain information with respect to oil and gas
production, prices and costs attributable to all oil and gas
property interests owned by Southwest for the years ended
December 31, 1997, 1996 and 1995:
Year Ended December 31,
---------------------------
- - --------------------------
1997 1996 1995
-------- -------- ---------
Production Volumes:
Oil and condensate (MBbls) 1,308 1,001 814
Natural gas (MMcf) 5,639 5,403 4,639
Total (MBoe) 2,248 1,901 1,587
Average Daily Production:
Oil and condensate (Bbls) 3,584 2,735 2,230
Natural Gas (Mcf) 15,449 14,762 12,709
Total (Boe) 6,159 5,194 4,348
Average Realized Prices:
Oil and condensate (per Bbl) $19.12 $20.44 $16.40
Natural gas (per Mcf) 2.24 2.22 1.51
Per Boe 16.75 17.07 12.83
Expenses (per Boe):
Lease operating (including production taxes) $8.23
$7.81 $7.25
Oil and gas depletion 5.52 3.38 3.19
General and administrative, net (a) 1.63 1.28
1.20
(a) Certain related party
management fees received from oil and gas partnerships have
been reclassified as a reduction of general and
administrative expenses for all periods presented.
<PAGE>
Producing Wells. The following table sets forth the number of
productive wells in which Southwest owned an interest as of
December 31, 1997:
Gross Net
Wells Wells
-------- --------
Oil 10,898 662.3
Natural Gas 876 85.9
-------- -------
Total 11,774 748.2
Productive wells consist of producing wells and wells capable
of production, including gas wells awaiting pipeline connections
and oil wells awaiting connection to production facilities. Wells
that are completed in more than one producing horizon are counted
as one well. A gross well is a well in which an interest is
owned. A net well is the fractional working interest in a gross
well. The number of net wells is the sum of the fractional
interest owned in gross wells.
Acreage. The following table sets forth Southwest's developed
and undeveloped gross and net leasehold acreage as of December
31, 1997:
Gross Net
------------ ----------
Developed 1,934,272 239,846
Undeveloped 618,338 74,931
------------ ----------
Total 2,552,610 314,777
Undeveloped acreage includes leased acres on which wells have
not been drilled or completed to a point that would permit the
production of commercial quantities of oil and gas, regardless of
whether or not such acreage contains proved reserves. A gross
acre is an acre in which an interest is owned. A net acre is the
fractional working interest in a gross acre. The number of net
acres is the sum of the fractional interests owned in gross
acres.
<PAGE>
Drilling Activities. The table below sets forth the drilling
activity of Southwest on its properties for the periods ending
December 31, 1997, 1996 and 1995.
Year Ended December 31,
--------------------------------------------------------------
- -----
1997 1996 1995
-----------------------------------------
- ----------
GrossNet GrossNet GrossNet
-----------------------------------------
- ----------
Development wells:
Productive 53 27.3 14 5.7 28 5.6
Non-productive 3 2.4 - - 2 0.4
--- ----- ---
- ---- -------
Total 56 29.7 14 5.7 30 6.0
Exploratory wells:
Productive 10 3.3 1 0.1 - -
Non-productive 4 1.4 6 - 5 1.0
------- -- ---- -------
Total 14 4.7 7 0.1 5 1.0
Oil and Natural Gas Marketing and Hedging. The revenues
generated by Southwest's operations are highly dependent upon the
prices of and demand for oil and natural gas. The price received
by Southwest for its oil and natural gas production depends on
numerous factors beyond Southwest's control. Historically the
markets for oil and natural gas have been volatile and are likely
to continue to be volatile in the future. Prices for oil and
natural gas are subject to wide fluctuation in response to
relatively minor changes in the supply and demand for oil and
natural gas, market uncertainty and a variety of additional
factors. These factors include the level of consumer product
demand, weather conditions, domestic and foreign governmental
regulations, the price and availability of alternative fuels,
political conditions in the Middle East, the actions of OPEC, the
foreign supply of oil and natural gas and overall economic
conditions. It is impossible to predict future oil and natural
gas price movements with any certainty.
During 1997, the Company did not have any significant
customers. The Company does not believe the loss of any
purchaser would have a material adverse effect on its operations,
revenues or cash flow.
All of Southwest's oil and natural gas production is currently
sold at spot market prices, under various short-term and
intermediate term contracts. Southwest currently does not utilize
commodity swap agreements or fixed price arrangements to reduce
its exposure to oil or natural gas price movements.
<PAGE>
Red Oak Properties
As of December 31, 1997, Red Oak owned and managed 14 shopping
centers, three office buildings and raw land held for future
development. Red Oak's holdings are located primarily in
secondary markets in the southwestern United States. Red Oak's
existing property portfolio is shown in the table below.
Gross Leasable
Area
Shopping Centers Location (Square
Feet)
- -------------------------------------- ---------------
Plaza Oaks Midland, TX 94,779
Southwest Plaza San Angelo, TX 198,983
Town & Country Odessa, TX 120,855
State Bank Plaza Tulsa, OK 34,867
The Plaza Tulsa, OK 116,605
Madera Village Tucson, AZ 96,702
Bear Canyon Tucson, AZ 70,941
Bears Path Tucson, AZ 40,728
Plaza Palomino Tucson, AZ 98,634
River Oaks Abilene, TX 140,899
San Miguel Square Midland, TX 77,582
Colonnade at Polo Park Midland, TX 105,018
Crossroads San Antonio, TX 676,705
50 Penn Place Oklahoma City, OK 129,183
Office Building
-----------------------
Woodhill Midland, TX 45,920
Independence Plaza Midland, TX 148,397
50 Penn Place Oklahoma City, OK 182,146
Land Acres
-------- --------
Red Oak (residential) Midland, TX 398.3
Southwest Corner (commercial) Midland, TX 3.9
Lewisville (residential) Lewisville, TX 95.3
ITEM 3. LEGAL PROCEEDINGS.
From time to time, the Company is party to litigation or other
legal proceedings that each company considers to be a part of the
ordinary course of its business. The Company is not involved in
any legal proceedings nor is it party to any pending or
threatened claims that could reasonably be expected to have a
material adverse effect on its financial condition, cash flow or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.
Holders
Southwest has one class of common equity securities
outstanding, its Common Stock, par value $.10 per share.
On March 16, 1998, all 100 outstanding shares of Southwest's
Common Stock were held by SRH. SRH has one class of common
equity securities, its Common Stock, par value $.10 per share.
On March 16, 1998, 1,075,868 shares of SRH's Common Stock were
held by 382 holders of record. SRH's and Southwest's Common
Stock are collectively referred to hereafter as the "Common
Stock."
Market
There is currently no public market for the Common Stock and
the Company does not anticipate that any such market will
develop. The Common Stock has not been registered under the
Securities Act. The stockholders have no rights to require
registration of the Common Stock under the Securities Act or
other applicable securities laws. The Common Stock may not be
sold, transferred or otherwise disposed of except in a
transaction that is either registered or exempt from registration
under the Securities Act and all applicable state securities
laws. In addition, the Common Stock is subject to transfer
restrictions contained in SRH's and Southwest's By-Laws. Both
SRH's and Southwest's By-Laws prohibit the transfer of its Common
Stock except to a spouse, family member or affiliate of a
stockholder. Any other transfer by a stockholder requires the
prior written consent of the Company. In addition, SRH and H.H.
Wommack, III have the option to purchase the shares in the event
of a third party offer to purchase any of the Common Stock.
Dividends
Southwest and SRH have never paid cash dividends on the Common
Stock and do not anticipate paying cash dividends in the
foreseeable future. The Company intends to retain any future
earnings to finance the expansion and continuing development of
the Company's business. The future payment of dividends, if any,
on the common Stock is within the discretion of the Company's
Board of Directors and will depend upon the Company's earnings,
capital requirements, and financial position, future loan
covenants, general economic conditions and other relevant
factors. There is no assurance that the Company will pay any
dividends.
There are several restrictions on the Company's ability to pay
dividends, including (i) the provisions of the Delaware
Corporation Laws, (ii) certain restrictive provisions in the
Indenture executed in connection with Southwest's 10.5% Senior
Notes due 2004 (the "Indenture"), and (iii) a restrictive
covenant in the Company's Restated Senior Secured Loan Agreement
dated October 9, 1997 with Bank One, Texas, N.A. and Banque
Paribas (the "Southwest Credit Facility"). Under the Indenture,
the Company must meet several financial tests before it can pay
cash dividends. These requirements work together to effectively
prohibit the payment of cash dividends. In addition, the
Southwest Credit Facility expressly prohibits the payment of cash
dividends on Southwest's common stock.
<PAGE>
Recent Sales of Unregistered Securities
On October 14, 1997, Southwest completed a $200 million
private placement sale of 10.5% Senior Notes due 2004, Series A
(the "Series A Notes") to Jefferies & Company, Inc., Banc One
Capital Corporation, and Paribas Corporation (the
"Underwriters"). The Underwriters then offered and sold the
Series A Notes to qualified institutional buyers. The offer and
sale of the Series A Notes was exempt from registration under the
Securities Act pursuant to Section 4(2) and Rule 144A.
Southwest concluded an offer to exchange the Series A Notes
for 10.5% Senior Notes due 2004, Series B Notes which had been
registered under the Securities Act on March 11, 1998. The
Exchange Offer was conducted pursuant to Securities Act
Registration Statement No. 333-41915, which became effective
February 9, 1998. All of the Series A Notes were exchanged for
Notes prior to the termination of the Exchange Offer. The
Company did not receive any cash proceeds from the issuance of
the Notes.
In 1996, Southwest issued 45,628 warrants, to purchase common
stock of Southwest, to Joint Energy Development Investments
Limited Partnership pursuant to an $8 million loan to Southwest
which was repaid with the issuance of the Series A Notes. The
issue of the warrants was exempt from registration pursuant to
Section 4(2) of the Securities Act. The warrants are presently
exercisable upon payment of a prescribed purchase price. In
connection with the reorganization in 1997, these warrants were
exchanged for warrants in SRH.
In 1996, Southwest issued 129,046 shares of its Common Stock,
par value $.10, solely to accredited investors for $68 a share.
The aggregate offering price of the shares was $8,624,000 and the
aggregate commissions for the offering were $333,000. The offer
and sale of the stock was exempt from registration under the
Securities Act pursuant to Regulation D thereunder. Such stock
was exchanged for SRH stock in conjunction with the
reorganization in July 1997.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following tables set forth selected historical and pro
forma financial information of the Company for the periods shown.
The following information should be read in conjunction with
"Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations,'' and the Company's
Financial Statements and Notes thereto included in "Item 8.
Financial Statements and Supplementary Data."
Year Ended December 31,
1997 (a) 1996 1995 1994
1993
--------- -------------- --------------
(in thousands, except per share data)
Consolidated Income Statement Data:
Operating Revenues:
Oil and gas $38,500 $33,787 $21,211 $ 15,083
$ 18,314
Well service 7,789 8,013 4,218 2,377 1,363
Real estate 9,338 4,487 3,213 605 -
Other 1,227 614 344 318 271
--------- -------- -------
- - -------- --------
Total operating revenue 56,854 46,901 28,986 18,383
19,948
--------- -------- -------
- - -------- --------
Operating expenses:
Oil and gas 18,500 14,846 11,511 7,879 7,472
Well service 5,600 6,145 3,315 2,136 1,349
Real estate 4,138 1,887 1,414 195 -
General and administrative 5,745 5,436 3,504 3,047
2,885
Depreciation, depletion and
amortization 15,034 8,430 6,719 4,437 6,072
Other 1,342 554 228 105 4
--------- -------- -------
- - -------- --------
Total operating expenses 50,359 37,298 26,691 17,799
17,782
--------- -------- -------
- - -------- --------
Operating income 6,495 9,603 2,295 584 2,166
Other income (expense):
Interest expense (18,894)(10,016)(5,635) (1,975)(2,260)
Interest income 1,002 441 269 229 287
Other 145 561 (78) 1,687 26
--------- -------- -------
- -------- -------
Income (loss) before income taxes,
minority interest, equity earnings
and extraordinary item (11,252) 589 (3,149) 525
219
Income tax benefit (provision) 2,641 (365) 1,044
(171) (72)
Minority interest in subsidiaries 430 181 (15)
(1) -
Equity in loss of subsidiary (203) - - -
- -
Extraordinary item, net of tax (3,109) -
- - - -
--------- ----- --------
- -------- --------
Net income (loss) $(11,493) $ 405 $ (2,120) $
353 $ 147
====== ===== ===== =====
=====
Earnings (loss) per common share
before extraordinary item $ (7.78) $ 0.42 $
(2.19) $ 0.37 $ 0.15
<PAGE>
Year Ended December 31,
-------------------------------------------------------------
- -----------
1997(a) 1996 1995 1994
1993
---------------------------------------
- ---------
(in thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents $27,365 $8,284 $3,364 $3,095 $
2,461
Net property and equipment 237,675 100,176 78,231
36,886 28,257
Total assets 305,443 130,284 95,434
49,709 42,128
Long-term debt, including current portion 283,642
93,805 73,486 33,723 29,875
Consolidated Cash Flow Statement Data:
Net cash provided by operating activities 8,134 10,280
5,634 5,222 6,992
Net cash used by investing
activities (174,304) (33,225) (44,532)
(9,641) (4,882)
Net cash provided (used) by financing
activities 185,251 27,865 39,166
5,054 (4,945)
(a) Sierra was deconsolidated on July 1, 1997. Earnings for the
six months ended June 30, 1997 are included in the Company's
consolidated statement of operations. Subsequent to June 30,
1997, any earnings (loss) associated with Sierra are reflected in
equity in loss of subsidiary.
Selected Operating Data
The following table sets forth selected information with
respect to the Company's operating data for the periods shown.
Year Ended December 31,
--------------------------------------------------------------
- -------
1997 1996 1995 1994
1993
-------- ----------------------------
- ---
Production volumes:
Oil and condensate (Mbbls) 1,308 1,001 814 629
647
Natural gas (MMcf) 5,639 5,403 4,639 3,178 4,737
Total (Mboe) 2,248 1,901 1,587 1,159 1,437
Average daily production:
Oil and condensate (Bbls) 3,584 2,735 2,230 1,723
1,772
Natural gas (Mcf) 15,449 14,762 12,709 8,707
12,978
Total (Boe) 6,159 5,194 4,348 3,174 3,935
Average realized prices (a):
Oil and gas condensate (per Bbl) $ 19.12 $20.44 $16.
40 $ 14.30 $ 16.23
Natural gas (per Mcf) 2.24 2.22 1.51 1.72 1.61
Per Boe 16.75 17.07 12.83 12.47 12.60
Expenses (per Boe):
Lease operating(including production
taxes) $8.23 $7.81 $7.25 $6.80 $5.20
Oil and gas depletion 5.52 3.38 3.19 3.03 3.61
Oil and gas general and
administrative, net (b) 1.63 1.28 1.20 1.73 1.58
<PAGE>
(a) Reflects the actual realized prices received by the Company,
including the results of the Company's hedging activities. See
''Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.''
(b) Certain related party management fees received from oil and
gas partnerships have been reclassified as a reduction of general
and administrative expenses for all periods presented.
ITEM 7. 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 and 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
October 1997, the Company acquired various working interests in
431 producing oil and gas wells, located in seven oil and gas
fields in the Permian Basin of West Texas and southeastern New
Mexico (the "Oil and Gas Properties Acquisition"). The Company
operates 133 of these wells. The purchase price for the Oil and
Gas Properties Acquisition was $72.3 million. These properties
complement the Company's existing proved reserve base with an
average reserve life of approximately 15 years and over 130
identified development opportunities. The Company believes that
it has significant opportunities to improve production and cash
flow from these properties through additional development,
reconfiguration of operations and reduction of operating and
administrative costs. The Company complements its increase to
oil and gas reserves, production and cash flow by concentrating
on drilling low-risk development wells and by conducting
additional development activities such as recompletions. During
1997, the Company was involved in drilling 70 gross (34.4 net)
wells of which 63 gross (30.6 net) wells were successfully
completed as productive.
The Company will continue to place 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 is also actively
seeking to develop its inventory of existing proved developed non-
producing and proved undeveloped reserves. The Company's staff
and operations are structured to be able to 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.
<PAGE>
In March 1998, the Company purchased put options on a total of
13,000 MMBTU of natural gas per day, establishing a floor price
of $1.90 for 6,500 MMBTU per day and a floor price of $1.70 for
the remaining 6,500 MMBTU per day, for the period April 1, 1998
through October 31, 1998.
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 future 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 write down for impairment of oil and gas properties.
Once incurred, a write-down 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 fourth quarter of 1997, oil prices began a downward
trend that has continued into March 1998. A continuation of the
oil price environment experienced during the first quarter of
1998 will have an adverse affect on the Company's revenues and
operating cash flow, and may result in a downward adjustment to
the Company's current 1998 capital budget. Also, a continuing
decline in oil prices could result in a decrease 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 December 31, 1997, Red Oak
owned and managed 14 shopping centers, three office buildings and
raw land held for future development.
From December 1993 through December 31, 1997, Red Oak
completed the acquisition of 14 regional shopping centers and
three office buildings for a total acquisition cost of $82.8
million. Red Oak has financed and expects to continue to finance
the acquisition of its real estate properties with senior secured
credit arrangements between Red Oak and private lenders, that are
generally non-recourse to the Company. Red Oak believes that as a
result of minor capital investment and limited releasing
activities, the performance of these properties will improve in a
manner consistent with Red Oak's historical experience.
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 year ended 1997 to 1996 are not relevant and
therefore no discussion of such results of operations are
provided.
<PAGE>
Results of Operations
Year Ended December 31, 1997 Compared to Year Ended December 31,
1996
Revenues. Revenues for the Company increased $10.0 million, or
21%, for the year ended December 31, 1997, reflecting increased
revenues in each of the Company's businesses.
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:
Year Ended 1997 Compared
December 31, to 1996
------------------------- --------------------
- ---------------- %
Revenue
Increase Increase
1997 1996 (Decrease)
(Decrease)
------- ------- ----------- -----------
(in thousands)
Production volumes:
Oil and condensate (MBbls) 1,308 1,001 31 % $ 6,275
Natural gas (MMcf) 5,639 5,403 4 % 524
Average sales prices:
Oil and condensate (per Bbl) $ 19.12 $20.44 (6) % $
(1,727)
Natural gas (per Mcf) 2.24 2.22 1 % 113
Oil and gas revenues increased $4.7 million, or 14%, from 1996
to 1997, due primarily to increases in oil production. Oil and
gas production increased 31% and 4%, respectively, due
principally to several acquisitions in the last quarter of 1996
and throughout 1997. Changes in production contributed $6.8
million to increased oil and gas revenues. The average price per
barrel of oil was $19.12, a decrease of 6%, and the average price
of natural gas was $2.24 per Mcf, an increase of 1%, for 1997 as
compared to 1996. These lower oil prices, offset by the
increased gas prices, offset the increase in oil and gas revenue
due to production by approximately $1.6 million.
Real estate revenues increased $4.9 million, or 108%, for
1997, due primarily to acquisitions completed in the last half of
1996 and in 1997. Other operating revenues increased $613,000.
Operating Expenses. Operating expenses, before general and
administrative expense and depreciation, depletion and
amortization, increased $6.1 million, or 26%, during 1997, due
primarily to growth in the Company's businesses through
acquisitions.
Oil and gas operating expense increased $3.7 million, or 25%,
in 1997, due primarily to an increase in the number of oil and
gas properties owned by the Company during the period. The
average operating expense was $8.23 per Boe in 1997, an increase
of 5% from $7.81 per Boe for the same period in 1996. The
increase on a Boe basis is due primarily to non-operated
properties, which comprise approximately 35% of the Company's oil
and gas properties, for which the Company has minimal control.
Real estate operating expense increased $2.3 million, or 119%,
for 1997, due primarily to acquisitions. Other operating expenses
increased $788,000.
<PAGE>
General and Administrative (''G&A'') Expense. G&A expense for
the Company increased $309,000, or 5%, for 1997, due primarily to
an increase in the Company's activities resulting from recent
acquisitions. Oil and gas G&A expense increased approximately
$1.2 million, or 50%, for 1997, and was $1.63 per Boe, an
increase of 27% from 1996, due primarily to additions to oil and
gas technical and administrative staff in conjunction with
planned increases in oil and gas acquisition and development
activities. Real estate G&A expense increased $161,000, or 25%,
for 1997.
Depreciation, Depletion and Amortization (''DD&A'') Expense.
DD&A expense for the Company increased $6.6 million, or 78%, for
the year ended December 31, 1997 due to growth in each of the
Company's businesses. Oil and gas DD&A expense increased
approximately $6.0 million, or 90%. Oil and gas depletion was
$5.52 per Boe, an increase of 63% from 1996. The increase in DD&A
expense on an overall basis and per Boe is due primarily to the
decrease in oil and gas price used in the year end reserve
reports for 1997 compared to 1996 which led to a higher depletion
rate under the units of revenue method. Real estate DD&A expense
increased approximately $653,000, or 99%, in 1997 compared to
1996, attributable primarily to the impact of acquisitions.
Interest Expense. Interest expense for the Company increased
$8.9 million, or 89%, for 1997, primarily as a result of
increased borrowings incurred to fund a portion of the Company's
acquisitions and oil and gas development. Oil and gas interest
expense increased approximately $4.4 million, or 55%, as a result
of increased borrowings for development drilling and acquisitions
made in the last quarter of 1996 and in 1997. The average
interest rate paid on these borrowings also increased by
approximately 1.0%. Real estate interest expense increased $4.4
million, or 232%, due to increased debt used to finance
acquisitions as compared to the prior year.
Other Income/Expense. Other income/expense decreased
$416,000, or 74%, due primarily to the receipt of an insurance
settlement in 1996.
Net Income. Due to the factors described above, net income for
the Company decreased $11.9 million to a loss of $11.5 million
for the year ended December 31, 1997. Included in the $11.5
million loss for the year ended December 31, 1997 was an
extraordinary loss of $3.1 million, net of tax, for the early
extinguishment of debt. See note 6 of Notes to Consolidated
Financial Statements included in "Item 8. Financial Statements
and Supplementary Data."
Year Ended December 31, 1996 Compared to Year Ended December
31, 1995
Revenues. Revenues for the Company increased $17.9 million, or
62%, for the year ended December 31, 1996, reflecting increased
revenues in each of the Company's businesses.
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:
Year Ended
December 31, 1996 Compared to
1995
---------------------------- -------------------
- ----------------- %
Revenue
Increase Increase
1996 1995 (Decrease)
(Decrease)
--------------------------- ---------
- --
(in thousands)
Production volumes:
Oil and condensate (MBbls) 1,001 81423%
$ 3,067
Natural gas (MMcf) 5,403 4,639 16% 1,156
Average sales prices:
Oil and condensate (per Bbl) $ 20.44 $16.40
25% $ 4,043
Natural gas (per Mcf) 2.22 1.51 47%
3,834
<PAGE>
Oil and gas revenues increased $12.6 million, or 59%, from
1995 to 1996, due primarily to increases in oil and gas
production and prices. Production of oil and gas increased 23%
and 16%, respectively, due to the inclusion of production
attributable to several acquisitions completed in late 1995, as
well as to acquisitions in 1996, resulting in an increase in
revenues of $4.2 million. The average realized oil price was
$20.44 per Bbl, an increase of 25%, and the average realized gas
price was $2.22 per Mcf, an increase of 47%, for 1996 as compared
to 1995. These price increases resulted in increased revenues of
$7.9 million.
Well servicing revenues increased $3.8 million, or 90%,
attributable primarily to acquisitions completed in 1996, which
increased the number of well servicing rigs owned at year end
1996 to 22 from 10 at year end 1995, as well as to an increase in
rates for well servicing rigs resulting from increased demand for
these services. Real estate revenues increased $1.3 million, or
40%, for 1996, primarily due to the acquisition of three
properties in 1996. Other operating revenues increased $270,000.
Operating Expenses. Operating expenses, before general and
administrative expense and depreciation, depletion and
amortization, for the Company increased $7.0 million, or 42%, for
1996, due primarily to growth in the Company's businesses through
acquisitions.
Oil and gas operating expense increased $3.3 million, or 29%,
for 1996, due principally to the overall increase in production
generated from properties acquired during 1996 and the prior
year. The average operating expense was $7.81 per Boe in 1996, an
increase of 8% from the prior year, attributable primarily to
acquisitions of properties with generally higher per unit
operating expenses and to increased production taxes resulting
from higher oil and gas prices.
Well servicing operating expense increased $2.8 million, or
85%, for 1996, attributable primarily to increases in expenses
arising from acquisitions, but partially offset by a reduction in
expenses due to a shift from plugging and abandonment to well
servicing activities. Real estate operating expense increased
$473,000, or 33%, for 1996, due principally to acquisitions and
related increases in direct operating costs. Both well servicing
and real estate operating expenses declined as a percentage of
revenues as the Company experienced efficiencies resulting from
acquisitions in each of these businesses. Other operating
expenses increased $326,000.
G&A Expense. G&A expense for the Company increased $1.9
million, or 55%, for 1996, due to an increase in the Company's
activities resulting primarily from acquisitions. Oil and gas G&A
expense increased approximately $530,000, or 28%, for 1996, and
was $1.28 per Boe, an increase of 6% from 1995. G&A expense
increased as the result of the addition of technical and
administrative personnel relating to growth in the Company's oil
and gas business. Well servicing G&A expense increased $905,000,
or 104%, for 1996 compared to the prior year, due primarily to
growth through acquisitions and the related additions of
operating and administrative personnel. Real estate G&A expense
increased $232,000, or 55%, for 1996 compared to the prior year,
primarily as the result of a one time incentive compensation
payment to management. Both well servicing and real estate G&A
expenses increased slightly as a percentage of revenues.
DD&A Expense. DD&A expense for the Company increased $1.7
million, or 25%, for 1996 due primarily to acquisitions. Oil and
gas DD&A expense increased $1.1 million, or 19%, for 1996 due
primarily to increases in oil and gas production. Oil and gas
depletion was $3.38 per Boe, an increase of 6% as compared to
1995 results. Well servicing DD&A expense increased $415,000, or
93%, and real estate DD&A expense increased $214,000, or 48%, in
1996 compared to the prior year, attributable primarily to the
impact of acquisitions.
Interest Expense. Interest expense for the Company increased
$4.4 million, or 78%, for 1996, primarily as a result of
increased borrowings. Oil and gas interest expense increased $3.7
million, or 85% for 1996, as a result of a higher average
outstanding debt balance due primarily to development activities
and acquisitions made in 1995 and 1996. Well
<PAGE>
servicing interest expense increased $12,000 for 1996,
attributable to an increase in average debt balances. Real estate
interest expense increased $632,000, or 50%, for 1996, due
principally to increased debt used to finance acquisitions.
Other Income/Expense. Other income increased $639,000 or
819%, due to the receipt of an insurance settlement in 1996.
Net Income. Due to the factors described above, net income for
the Company increased $2.5 million to $405,000 for 1996.
Liquidity and Capital Resources
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. Any
future acquisitions may require additional financing and will be
dependent upon financing arrangements available at the time.
As discussed previously, as of July 1, 1997, Sierra Well
Service was deconsolidated from SRH and is currently being
accounted for under the equity method. Therefore, cash flow
information for Sierra is reported through June 30, 1997, but for
periods thereafter, no cash flow information for Sierra will be
reported except for the equity earnings in subsidiary.
Net Cash Provided by Operating Activities
Cash flows provided by operating activities from the
Company's operations were $8.1 million, $10.3 million, $5.6
million for 1997, 1996 and 1995, respectively. Increases in oil
and gas production and revenues resulting principally from
acquisitions in all the Company's businesses, and development
activities cash flows in 1996. In 1997 lower oil and gas prices,
higher operating costs and G&A expenses decreased cash flows.
Net Cash Used in Investing Activities
Cash flows used in investing activities by the Company were
$174.3 million, $33.2 million, $44.5 million for 1997, 1996 and
1995, respectively. Acquisitions and oil and gas development
activities were the primary uses of funds.
The following table sets forth capital expenditures, including
acquisitions, made by the Company during the periods indicated.
Year Ended December 31,
------------------------------
- -----------------------------
1997 1996 1995
-------------------------------------
(in thousands)
Oil and gas
Development $19,639 $13,322 $6,683
Exploration 2,769 184 1,278
Acquisitions 80,797 3,234 24,116
Well servicing - 3,826 1,598
Real estate 53,184 13,947 13,239
---------- --------- -------
- -
Total $156,389 $34,513 $ 46,914
====== ===== =====
<PAGE>
In response to the recent and severe decline in oil prices,
the Company has implemented an alternate short-term business plan
for its oil and gas operations that delays discretionary
development and exploratory projects until the oil prices
strengthen. The Company is pursuing a $5.8 million capital
expenditure budget for 1998, revised from its previous $17.8
million budget for oil and gas activities. Further revisions may
be necessary during 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
capital expenditures in 1998 for Red Oak of approximately $7.2
million for capital improvements, with unspecified amounts for
acquisitions.
Net Cash Provided by Financing Activities.
Cash provided by the Company's financing activities was
$185.3 million (including additional net borrowings of $183.3
million and $1 million from issuance of additional equity
securities), $27.9 million (including additional borrowings of
$17.9 million and $9.9 million net proceeds from issuance of
additional equity securities) and $39.2 million (including
additional net borrowings of $37.1 million) for 1997, 1996 and
1995, respectively.
Private Placement. On October 14, 1997, Southwest completed a
$200 million private placement sale of 10.5% Senior Notes due
2004, Series A ("Series A Notes") pursuant to Rule 144A of the
Securities Act (the "Private Placement"). Thereupon, the Series
A Notes were offered and sold by the underwriters only to
qualified institutional buyers. The net proceeds from the
Private Placement were approximately $190 million. Southwest
uses the net proceeds primarily to (i) fund the oil and gas
properties acquisitions, (ii) repay substantially all
indebtedness outstanding under Southwest's bank credit facility
and its reserve-based loan facilities, (iii) fund a $10 million
equity investment by SRH in Red Oak through a dividend in that
amount from the Southwest to SRH, (iv) make a general partner
capital contribution to a limited partnership of approximately
$1.7 million, which funds were immediately invested in Sierra
common stock, and (v) provided additional working capital for
general corporate purposes, including future acquisitions and
development of producing oil and gas properties.
The Series A Notes were issued pursuant to an indenture,
dated October 14, 1997 (the "Indenture"), by and among Southwest,
as Issuer, SRH as the Parent Guarantor, and State Street Bank and
Trust Company, N.A., as Trustee (the "Trustee"). The Indenture
is governed by certain provisions contained in the Trust
Indenture Act of 1939, as amended (the "Trust Indenture Act").
The terms of the Series A Notes include those stated in the
Indenture and those made part of the Indenture by reference to
the Trust Indenture Act.
Exchange Offer. On March 11, 1997, Southwest concluded a
registered offering to exchange the Series A Notes for 10.5%
Senior Notes due 2004, Series B which had been registered under
the Securities Act (the "Notes). The form
and terms of the Notes are identical in all material respects to
the form and terms of the Series A Notes. The Notes evidence the
same debt as the Series A Notes and were issued under and are
entitled to the benefits of the Indenture governing the Series A
Notes.
MROP Facility. In 1997, MROP, a wholly-owned subsidiary of
Red Oak, entered into a $72 million credit facility maturing in
April 2000 with an institutional lender (the ''MROP Facility'').
The MROP Facility was arranged 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. MROP's obligations under
the facility are nonrecourse to SRH, Southwest, Red Oak and
Sierra. In order to partially fund Red Oak's recent acquisitions,
the MROP Facility was increased by an additional $30 million,
which aggregated $72 million, and Red Oak entered into two
additional mortgage facilities with separate lenders (the ''Red
Oak Acquisition Facilities''). The Red Oak Acquisition Facilities
are secured by a first lien on the properties acquired. The two
additional mortgage
<PAGE>
facilities contain a number of covenants that, among other
things, restrict the ability of Red Oak to incur additional
indebtedness and dispose of assets, and borrowings thereunder
bear interest at 9.25%. Red Oak's obligations under the Red Oak
Acquisition Facilities are nonrecourse to SRH and Southwest.
Southwest Credit Facility. The Southwest Credit Facility was
amended to provide for a $75 million revolving line of credit
maturing in February 1999, resulting in availability of $40
million, subject to semi-annual borrowing base redetermination.
The initial borrowing base of $40 million is subject to a $15
million sub-limit on availability 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 incur 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. The Company and the lenders are
currently reviewing the Southwest Credit Facility. The review
should be completed in April 1998. Based on current discussions
with the lenders, the Company believes its borrowing base will
not change significantly as part of the borrowing base
redetermination. 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 reverse
the minimum interest coverage ratio to .7 to 1.0. It is
possible, in response to the downward trend in oil and gas prices
experienced in the last quarter of 1997 and continuing through
the first quarter of 1998, that the borrowing base may decrease
significantly and therefore limit the Company's ability to fund
future capital expenditures, acquisitions or general working
capital.
To partially fund its 1997 acquisitions, Red Oak sold
additional common stock to SRH for $10 million. SRH funded its
purchase of additional common stock from the proceeds of a
dividend of $10 million from Southwest, paid out of a portion of
the net proceeds from the Private Placement.
In 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.
The Company believes that availability under the Southwest
Credit Facility, the Red Oak Acquisition Facilities, cash flow
from operations and current cash balances, will be sufficient for
planned operating and capital expenditure requirements in 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
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 to-date.
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.
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 is effective for
fiscal years beginning after December 15, 1997.
<PAGE>
Comprehensive income consists of the change in equity of a
business enterprise during a period from transactions and other
events and circumstances from nonowner sources. Specifically,
this includes net income and other comprehensive income, which is
made up of certain changes in assets and liabilities that are not
reported in a statement of operations but are included in the
balances within a separate component of equity in a statement of
financial position. Such changes include, but are not limited to,
unrealized gains for marketable securities and future contracts,
foreign currency translation adjustments and minimum pension
liability adjustments.
Segment Reporting. In June 1997, the FASB issued Statement
of Financial Accounting Standards No. 131 "Disclosures about
Segments of and 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. SFAS 131 is
effective for financial statements for periods beginning after
December 15, 1997.
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Index to Consolidated Financial Statements
Page
- ------------
Consolidated Financial Statements of Southwest Royalties
Holdings, Inc. and Subsidiaries
Independent Auditors' Reports 40
Consolidated Balance Sheets as of December 31, 1997 and 1996
42
Consolidated Statements of Operations for the Years Ended
December 31, 1997, 1996 and 1995 44
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1997, 1996 and 1995 46
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995 47
Notes to Consolidated Financial Statements 49
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Southwest Royalties Holdings, Inc.:
We have audited the accompanying consolidated balance sheets
of Southwest Royalties Holdings, Inc. and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated
statements of operations, stockholders' equity and cash flows for
the years then ended. These consolidated financial statements
are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the
financial position of Southwest Royalties Holdings, Inc. and
subsidiaries as of December 31, 1997 and 1996, and the results of
their operations and their cash flows for the years then ended,
in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
February 25, 1998, (except as to the sixth paragraph of Note 6,
which is as of March 27, 1998)
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
SOUTHWEST ROYALTIES, INC.
Midland, Texas
We have audited the accompanying consolidated statements of
operations, stockholders' equity and cash flows of SOUTHWEST
ROYALTIES, INC. and subsidiaries for the year ended December 31,
1995. These consolidated financial statements are the
responsibility of the company's management. Our responsibility
is to express an opinion on these consolidated financial
statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the consolidated financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial presentation.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the results of
operations and cash flows of SOUTHWEST ROYALTIES, INC. and
subsidiaries for the year ended December 31, 1995, in conformity
with generally accepted accounting principles.
Joseph Decosimo and Company,
LLP
Chattanooga, Tennessee
March 27, 1996, except for
note 14, as to which the date
is August 11, 1997
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
-----------------------------------
ASSETS 1997 1996
- -----------------------------------------------------------------
- ------------- ---------------- ---------------
Current assets
Cash and cash equivalents $27,365 $8,284
Accounts receivable, net of allowance of $254 and $173,
respectively 8,376 7,728
Receivables from related parties 2,556 792
Subscription receivable - 2,807
Other current assets 1,209 1,074
----------
- ----------
Total current assets 39,506
20,685
----------
- ----------
Oil and gas properties, using the full cost method of accounting
Proved 188,432
89,453
Unproved 4,554 1,866
----------
- ----------
192,986
91,319
Less accumulated depletion, depreciation and amortization
42,240 29,821
----------
- ----------
Oil and gas properties, net 150,746
61,498
----------
- ----------
Well servicing property and equipment, net -
4,628
----------
- ----------
Rental property, net 81,373
29,177
----------
- ----------
Other property and equipment, net 5,556 4,873
----------
- ----------
Other assets
Restricted cash 8,064 -
Equity investment in subsidiary 2,443 -
Real estate investments 4,203 4,510
Deferred debt costs, net of accumulated amortization of
$903 and $1,041, respectively 9,382 2,892
Other, net 4,170 2,021
----------
- ----------
Total other assets 28,262
9,423
----------
- ----------
Total assets $ 305,443 $
130,284
======= ======
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
LIABILITIES, MINORITY INTEREST, REDEEMABLE
COMMON STOCK AND STOCKHOLDERS' EQUITY
December 31,
- -----------------------------------------------------------------
- -------------------------------------------------------
1997 1996
-------------
------------
Current liabilities
Current maturities of long-term debt $ 1,878 $ 10,216
Accounts payable 7,119
6,893
Accounts payable to related parties 64
1,179
Accrued expenses 9,450
3,038
Federal income taxes payable - 30
Deferred income taxes 254 425
----------
- ----------
Total current liabilities 18,765 21,781
----------
- ----------
Long-term debt 281,764 8
3,589
----------
- ----------
Other long-term liabilities 1,809 3,134
-----------
- ----------
Deferred income taxes 2,094 5,830
-----------
- ----------
Minority interest 1,861 4,931
-----------
- ----------
Redeemable common stock of subsidiary 2,666 2,520
-----------
- ----------
Redeemable common stock 8,290 8,258
----------
- ----------
Stockholders' equity
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 at December 31, 1997 and
1,160,537 issued at December 31, 1996 116
116
Additional paid-in capital 2,196 2,196
Retained earnings (accumulated deficit) (9,321)
2,172
Note receivable from an officer and stockholder
(1,707) (1,735)
Less: treasury stock - at cost; 214,215
shares at December 31, 1997
and 204,575 at December 31, 1996 (3,090) (2,5
08)
-----------
- -----------
Total stockholders' equity (deficit) (11,806) 2
41
-----------
- -----------
Total liabilities, minority interest, redeemable common stock
and stockholders' equity $ 305,443 $
130,284
======= =======
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)
For the years ended Dece
mber 31,
----------------------------------------------------
1997 1996 1995
--------------------------------
- ----
Operating revenues
Oil and gas $38,500 $33,787 $21,211
Well servicing, including related party revenues
of $8, $112 and $166, respectively 7,789 8,013
4,218
Real estate 9,338 4,487 3,213
Other 1,227 614 344
---------- -----
- ----- --------- Total
operating revenues 56,854 46,901 28,9
86
---------- -----
- ----- ---------
Operating expenses
Oil and gas production 18,500 14,846 11,5
11
Well servicing 5,600 6,145 3,315
Real estate 4,138 1,887 1,414
General and administrative, net of related party management
and administrative fees of $3,538, $3,648 and
$3,545, respectively 5,745 5,436 3,504
Depreciation, depletion and amortization 15,034 8,430
6,719
Other 1,342 554 228
---------- -----
- ------ ---------
Total operating expenses 50,359 37,298 26,6
91
---------- -----
- ----- ---------
Operating income 6,495 9,603 2,295
---------- -----
- ----- ---------
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - (continued)
(in thousands, except per share data)
For the years ended Dece
mber 31,
----------------------------------------------------
1997 1996 1995
--------------------------------
- ----
Other income (expense)
Interest and dividend income 1,002 441 269
Interest expense (18,894) (10,016) (5,6
35)
Other 145 561 (78)
----------- -----
- ------ ----------
(17,747) (9,014) (5,4
44)
---------- -----
- ------ ---------
Income (loss) before income taxes, minority interest,
equity earnings and extraordinary item (11,252) 589
(3,149)
Income tax benefit (provision) 2,641 (365) 1,044
---------- -----
- ----- ---------
Income (loss) before minority interest, equity earnings
and extraordinary item (8,611) 224 (2,1
05)
Minority interest in subsidiaries, net of tax 430
181 (15)
Equity loss in subsidiary, net of tax (203) -
- -
--------- ----------
- ---------
Income (loss) before extraordinary item (8,384) 405
(2,120)
Extraordinary loss from early extinguishment of debt,
net of tax (3,109) - -
---------- -----
- ----- ----------
Net income (loss) $ (11,493) $ 405
$ (2,120)
====== ======= ====
==
Income (loss) per common share
Income (loss) per common share before extraordinary item $
(7.78) $ .42 $ (2.19)
Extraordinary loss from early extinguishment of debt,
net of tax (2.88) -
- -
----------- -----
- ------ ---------
Income (loss) per common share $ (10.66) $ .42
$ (2.19)
======== =======
=====
Weighted average shares outstanding 1,077,808 964,009
965,962
======= ======= ====
==
The accompanying notes are an integral part of these consolidated
financial statements
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
For the years ended December 31, 1997, 1996 and 1995
(in thousands, except share data)
Common Stock Additional
Treasury Stock
- ------------------------------ Paid-InNote Receivable
- -------------------------------
Shares Amount Capital Earnings
from Stockholder Shares Amount
-----------------------------------------------------------
- ----------------------------------------------
Balance -
January 1, 19951,156,537 $115 $1,306 $3,887 $ (1,736)
194,575 $ (1,869)
Stock option exercised4,000 1 (1) - -
- - -
Accrued interest on
note receivable - - - - (24) - -
Net loss - - - (2,120) - -
- -
------------- ----- ------- ----------- --------
- -- ---------- ---------
Balance -
December 31, 19951,160,537 116 1,305 1,767
(1,760) 194,575 (1,869)
Payments received on note
receivable - - - - 25 - -
Issuance of common stock
warrants - - 857 - - - -
Issuance of stock options
as additional
compensation - - 34 - - - -
Purchase of treasury stock - - - - -
10,000 (639)
Net income - - - 405 - - -
------------- ---- ------- ----------- --------
- -- ----------- ----------
Balance -
December 31, 19961,160,537 116 2,196 2,172
(1,735) 204,575 (2,508)
Stock option exercised500 - - - - -
- -
Payments received on
notes receivable - - - - 28 - -
Purchase of treasury stock - - - - -
9,640 (582)
Net loss - - - (11,493) - -
- -
------------ ---- ----------------- ---------- --------
- --- ----------
Balance -
December 31, 19971,161,037 $ 116$ 2,196 $ (9,321)
$ (1,707) 214,215 $ (3,090)
======= === ==== ===== ===== ====== =====
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)
For the years ended Dece
mber 31,
------------------------------------------------------
1997 1996 1995
-------------------------------
- -------
Cash flows from operating activities
Net income (loss) $(11,493) $ 405$
(2,120)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation, depletion and amortization 15,034 8,430
6,719
Noncash interest expense 1,311 1,902 47
Extraordinary loss from early extinguishment of debt 3,109
- - -
Loss on sale of assets 84 226 78
Equity loss of subsidiary 203 - -
Other noncash items (176) 257 -
Bad debt expense 241 168 315
Deferred income taxes (2,606) 747 (869)
Minority interest in (income) loss of subsidiary (430)
(181) 15
Changes in operating assets and liabilities-
Accounts receivable (6,029) (1,128) (2,0
78)
Income tax receivable - 270 (270)
Other current assets (594) (379) (297)
Accounts payable and accrued expenses 9,510 (467)
4,161
Income taxes payable (30) 30 (67)
------------ ------
- --- -----------
Net cash provided by operating activities 8,134 10,280 5,634
------------- ------
- --- -----------
Cash flows from investing activities
Proceeds from sale of oil and gas properties 1,538 1,081
2,082
Purchase of oil and gas properties (103,205)
(16,740) (17,897)
Purchase of Espero Energy Corporation - - (13,
000)
Purchase of other property and equipment and rental property
(61,645) (14,443) (14,737)
Purchase of other assets (3,523) (1,095) (979)
Proceeds from sale of other assets 219 196 320
Proceeds from sale of other property and equipment 209
274 287
Purchase of real estate investments (91) (2,569) (608)
Increase in restricted cash (8,064) - -
Other 258 71 -
------------ ------
- --- -----------
Net cash used by investing activities (174,304)
(33,225) (44,532)
------------ ------
- --- -----------
Cash flows from financing activities
Proceeds from borrowings 309,870 29,094 46,514
Payments on debt (113,381)
(9,379) (7,486)
Payments on other long-term liabilities (2,166) (512)
(105)
Increase in other long-term liabilities 841 46
80
Cash received on subscriptions receivable 2,807 -
- -
Purchase of treasury stock (582) (250) -
Deferred debt costs (9,842) (1,333) (1,931)
Issuance of stock warrants - 857 -
Issuance of redeemable common stock, net of issue costs
32 5,451-
Net proceeds from sale of subsidiaries common stock 1,007
4,158 2,094
Prepayment penalty on early extinguishment of debt (2,039)
- - -
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued)
For the years ended December 3
1,
-------------------------------------------------------------
1997 1996 1995
------------------------------------
- ----
(in thousands)
Dividends paid to minority interest owners (122)
(139) -
Purchase of treasury stock by subsidiary (1,174)
(128) -
------------ ------
- --- ----------
Net cash provided by financing activities 185,251 27,865 39,166
------------ ------
- --- ----------Net increase in
unrestricted cash and cash equivalents 19,081 4,920
268
Unrestricted cash and cash equivalents -
beginning of period 8,284 3,364 3,096
------------------------------
Unrestricted cash and cash equivalents - end of period $
27,365 $ 8,284 $ 3,364
======= ===== ======
Supplemental disclosures of cash flow information
Interest paid $14,802 $ 7,780 $ 4,964
Income taxes paid (received) $ (74) $ (559) $ 141
Supplemental schedule of noncash investing and
financing activities-
Long-term debt and liabilities assumed in acquisition
of real estate $ - $ 150 $ -
Increase in other long-term liabilities from general
partner contribution to partnership $ - $ 198
$ 188
Debt issued for other property and equipment $ -
$ 604 $ 662
Deferred taxes relating to acquisition of oil and gas
properties $ - $ - $ 3,315
Increase in other long-term liabilities from purchase
of treasury stock $ - $ 389 $ -
Transfer oil and gas properties as debt issue costs $
- - $ 204 $ -
Increase in subscription receivable from sale of
redeemable common stock $ - $ 2,087 $ -
The accompanying notes are and integral part of these
consolidated financial statements.
<PAGE>
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, as well as organizing and serving
as managing general partner for various public and private
limited partnerships engaged in oil and gas acquisitions,
exploration, development and production. Southwest is also 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 the 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 and Threading Products International, LLC
("TPI"), a subsidiary of Southwest. As of December 31, 1997 and
1996, the Company owned approximately 81% and 76% of Red Oak, 39%
and 54% of Sierra and 98% and 95% of TPI, respectively.
Effective July 1, 1997, Sierra was deconsolidated and is
accounted for using the equity method (see Note 3). 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 Southwest Partners II and III using the equity
method, as the Company exercises significant influence of the
operations of these partnerships. All significant intercompany
transactions have been eliminated.
Estimates and Uncertainties
Preparation of the accompanying consolidated financial
statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could
differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments
purchased with a maturity of three months or less to be cash
equivalents. In addition, the Company maintains its excess cash
in several interest bearing accounts in various financial
institutions.
<PAGE>
Restricted Cash
Restricted cash represents amounts required to be reserved in
separate accounts by financial lenders. These reserves are
principally held in the name of MRO Properties, Inc. ("MROP"), a
wholly owned subsidiary of Red Oak, but withdrawals from such
accounts require the signature or authorization of the lender.
Restricted cash accounts, principally for MROP, have been
established for the following purposes (in thousands):
Property liens $ 54
Tenant security deposits 365
Interest reserves 694
Capital expenditures account 5,112
Tax and insurance reserve 518
Tenant bankruptcy reserve 753
Escrow fund 568
-------
$8,064
====
Concentrations of Credit Risk
The Company is subject to credit risk through oil and gas
trade receivables and real estate lease receivables. Although a
substantial portion of its customers' ability to pay is dependent
upon conditions in the oil and gas industry as well as general
economic conditions, credit risk is reduced due to a large
customer base.
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 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.
Premiums paid for commodity option contracts which qualify as
hedges 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.
Oil and Gas Properties
All of the Company's oil and gas properties are located in
the United States and are accounted for at cost under the full
cost method. Under this method, all productive and nonproductive
costs incurred in connection with the acquisition, exploration
and development of oil and gas reserves are capitalized. No gain
or loss is recognized on the sale of oil and gas properties
unless nonrecognition would significantly alter the relationship
between capitalized costs and remaining proved reserves for the
affected amortization base. When gain or loss is not recognized,
the amortization base is reduced by the amount of sales proceeds.
<PAGE>
Net capitalized costs of oil and gas properties, including the
estimated future costs to develop proved reserves, are amortized
using the units of revenue method, whereby the provision is
computed on the basis of current gross revenues from production
in relation to future gross revenues, based on current prices,
from estimated production of proved oil and gas reserves. Should
the net capitalized costs net of related deferred income taxes
exceed the estimated present value of oil and gas reserves
discounted at 10% and adjusted for related income taxes, such
excess costs would be charged to expense in the Consolidated
Statements of Operations.
It is reasonably possible that the estimates of anticipated
future gross revenues, the remaining estimated economic life of
the product, or both could change significantly in the near term
due to the potential fluctuation of oil and gas prices or
production. Depletion estimates would also be affected by such
changes.
Property and Equipment
Oil and gas well servicing equipment, rental property and
other property and equipment is stated at cost. Repairs and
maintenance are charged to expense as incurred, with additions
and improvements being capitalized. Upon sale or other
retirement of depreciable property, the cost and accumulated
depreciation are removed from the related accounts and any gain
or loss is reflected in the Consolidated Statements of
Operations.
Depreciation is provided on the straight-line method based on
the estimated useful lives of the depreciable assets as follows:
Building and improvements 20 to 30
years
Rental property and improvements 5 to 30 y
ears
Leasehold improvements 2 to 10 y
ears
Machinery and equipment 3 to 5 ye
ars
Furniture and fixtures 3 to 5 ye
ars
Equipment under capital lease 3 to 5 ye
ars
Impairment of Long-Lived Assets and Long-Lived Assets to Be
Disposed Of
The Company adopted the provisions of SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to Be Disposed Of, on January 1, 1996. This
Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Adoption of this
Statement did not have an impact on the Company's financial
position, results of operations, or liquidity.
Deferred Debt Costs
The Company capitalizes certain costs incurred in connection
with issuing debt. These costs are being amortized to interest
expense on the straight-line method over the term of the related
debt.
<PAGE>
Gas Balancing
The Company utilizes the sales method of accounting for over
or under deliveries of natural gas. Under this method, the
Company recognizes sales revenue on all natural gas sold. As of
December 31, 1997, 1996 and 1995, the Company was underproduced
by approximately 697, 693 and 990 MMcf, respectively.
Income Taxes
Deferred tax assets and liabilities are recognized for the
estimated future tax effects attributable to differences between
the financial statement carrying amount of existing assets and
liabilities and their respective tax bases. Deferred tax assets
and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rate is
recognized in income in the period that includes the enactment
date. Deferred tax assets are reduced, if necessary, by a
valuation allowance for the amount of tax benefits that may not
be realized.
SRH and its eligible subsidiaries file a consolidated U.S.
federal income tax return. Sierra (through June 30, 1997)
and Red Oak are consolidated for financial reporting purposes,
but beginning January 1, 1996, were not eligible to be included
in the consolidated U.S. federal income tax return. Separate
provisions for income taxes have been determined for these
entities.
Reclassifications
Certain reclassifications have been made to the 1996 and 1995
amounts to conform to the 1997 presentation.
Income (loss) per share
In February, 1997 the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("SFAS 128") which simplifies the existing
standards for computing earnings per share ("EPS") and makes them
comparable to international standards. In accordance with the
provisions of SFAS 128, the Company adopted SFAS 128 in its year
ended December 31, 1997 consolidated financial statements and all
prior period EPS information (including interim EPS) have been
restated. Under SFAS 128, primary EPS is replaced by "basic" EPS
excludes dilution and is computed by dividing income available to
common stockholders by the weighted average number of common
shares outstanding for the period. "Diluted" EPS, which is
computed similarly to fully-diluted EPS, reflects the potential
dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock
or resulted in the issuance of common stock that then shared in
the earnings of the entity. The computation of diluted net
income (loss) per share was antidilutive for all periods
presented; therefore, the amounts reported for basic and diluted
net income (loss) per share were the same.
2. Subsidiaries, Acquisitions and Dispositions
During 1994, Red Oak sold 62,384 shares of redeemable common
stock for approximately $1,560,000 million through a private
placement offering. During 1995, Red Oak sold an additional
39,616 shares of redeemable common stock for approximately
$990,000 and 34,611 shares of its Series A cumulative convertible
preferred stock, for approximately $1,731,000. The redeemable
common stock is redeemable at the stockholder's option at a price
equal to the purchase price plus a 6% annual return computed on a
cumulative, but not compounded, basis between December 1, 1996
and December 1, 1999. Redemptions are to be paid out of future
earnings of Red Oak. If there are no future earnings,
redemptions will be paid out of additional paid-in capital.
<PAGE>
On August 2, 1995, SW Espero, Inc., a wholly owned subsidiary
of Southwest, acquired all of the stock of Espero Energy
Corporation for approximately $13,000,000, which was funded
through a credit agreement with an asset management company. SW
Espero, Inc. and Espero Energy Corporation were immediately
merged, with Espero Energy Corporation being the surviving
corporation. The acquisition was accounted for as a purchase and
the total purchase price was allocated to the assets and
liabilities acquired based upon their estimated respective fair
market values. The results of operations of Espero Energy
Corporation are included in the Consolidated Statements of
Operations beginning August 2, 1995.
On September 26, 1996, Red Oak formed a subsidiary with an
unrelated third party. On October 15, 1996, the subsidiary
acquired three shopping centers for a total purchase price of
$12.5 million. The transaction was funded through a $2.3 million
contribution from Red Oak and a $1.2 million contribution from
the unrelated third party. The subsidiary funded the remaining
$9 million of the purchase price through a note payable due June
1, 1998 (see Note 6.) The transaction was accounted for using
the purchase method. The results of operations of the properties
acquired are included in the Consolidated Statements of
Operations beginning September 26, 1996.
On October 14, 1997, the Company acquired various working
interests in 431 producing oil and gas wells, located in seven
oil and gas fields in the Permian Basin of West Texas and
southeastern New Mexico. The Company operates 133
of these wells. The purchase price for the Oil and Gas
Properties Acquisition was $72.3 million. The Company funded
this acquisition through the issuance of 10.5% Senior Notes (see
Note 6). The results of operations of the properties acquired
are included in the Consolidated Statement of Operations
beginning October 14, 1997.
In 1997, Red Oak acquired five shopping centers and two office
buildings in Texas, Oklahoma and Arizona for a total cost of
$50.9 million. The transactions were accounted for using the
purchase method. The results of operations of the properties
acquired are included in the Consolidated Statements of
Operations as of the close of each acquisition.
Pro Forma Results of Operations - (unaudited)
The following table reflects the pro forma results of
operations as though the acquisitions had occurred on January 1,
1996. The pro forma amounts are not necessarily indicative of
the results that may be reported in the future.
Years Ended Decemb
er 31
----------------------------------------
1997 1996
------------------------
- --
Revenues $71,066 $49,626
Net loss (11,706) (29)
Net loss per share (10.86) (0.03)
3. Equity Investment in Subsidiary
The investment in subsidiary held by the Company consists of a
29% direct ownership interest in Sierra as well as an additional
10% indirect interest the Company obtained through limited
partnerships. The investment is accounted for using the equity
method. Effective July 1, 1997 an affiliate of the Company
purchased additional shares of Sierra stock, thus decreasing
Southwest's total direct and indirect ownership percentage.
Therefore, with the change of Southwest's ownership percentage
from a majority to a minority interest, Sierra was
deconsolidated. The deconsolidation of Sierra required an
adjustment to the investment account to reflect the change in
accounting from the consolidation method to the equity method.
<PAGE>
Pertinent financial information for Sierra Well Service, Inc.
as of December 31, 1997 and for the six months ended December 31,
1997 is as follows (in thousands):
Balance sheet as of December 31, 1997
Assets $87,119
======
Liabilities $63,759
Equity 23,360
----------
$ 87,119
======
Income statement for the six months ended December 31, 1997
Revenues $18,370
Expenses 19,163
---------
(793)
x 39%
-------
Company's share of net loss for the six months ended December 31,
1997 $ (309)
====
4. Property and Equipment
Property and equipment, including oil and gas well servicing,
rental property and other, consists of the following (in
thousands):
December 31,
-------------------------
- -----------------
1997 1996
----------- ----------
Land $ 2,157 $ 2,157
Building and improvements 1,413 1,326
Machinery and equipment 2,277 7,365
Furniture and fixtures 1,743 1,714
Equipment under capital lease 614 1,000
Rental property 83,696 30,287
-------- -------
- -
91,900 43,849
Less accumulated depreciation 4,971 5,171
-------- -------
- -
$ 86,929 $38,678
-------- --------
<PAGE>
5. Future Lease Receivables
Red Oak leases office and retail shopping centers under
noncancelable operating leases that expire at various dates
through 2035. The following is a summary of minimum future
rentals expected to be received under noncancelable operating
leases as of December 31, 1997 (in thousands):
1998 $12,339
1999 10,131
2000 7,448
2001 5,428
2002 4,014
Thereafter 12,342
---------
$ 51,702
======
The preceding future minimum rentals do not include percentage
rents or reimbursements.
<PAGE>
6. Long-term Debt
Long-term debt consists of the following (in thousands):
December 31,
-------------------------------
1997 19
96
----------------------
10.5% Senior Notes, interest payable semi-annually due
October 15, 2004, net of discount of $2,346 $ 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. 70,628 -
Revolving line of credit with variable-rate interest, due
February 1999.
Collateralized by
oil and gas properties 100 28,125
9% Notes payable, with variable quarterly payments including
interest, due
December 2003.
- - 27,649
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 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
Other 14,787 5,048
---------- --------
283,642 93,805
Less current maturities 1,878 10,216
---------- --------
$ 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>
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 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. 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>
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 the 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.
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 December 31,
1997, including capital leases, are as follows (in thousands):
1998 $1,878
1999 407
2000 71,202
2001 247
2002 1,969
Thereafter 207,939
7. Income Taxes
Income tax provision (benefit) and amounts separately
allocated were as follows (in thousands):
1997 1996 1995
--------------------------
Income (loss) before minority interest, equity loss
and extraordinary item $(2,641) $ 365 $
(1,044)
Equity loss in subsidiary (106) - -
Extraordinary loss from early extinguishment (1,241)
- - -
-------- ----- --------
$(3,988) $ 365 $
(1,044)
===== ===
=====
<PAGE>
The U.S. Federal tax provision (benefit) attributable to
income (loss) before income taxes, minority interest and
extraordinary item consists of the following (in thousands):
December 31,
---------------------------------------------------
1997 1996 1995
------- ------ -----
- --
Current $ (35) $ (382) $ (175)
Benefit of net operating loss carryforward (7,340) (913)
(1,765)
Deferred 3,341 1,660 896
Valuation allowance 1,393 - -
-------- -------
- --------
$ (2,641) $ 365 $
(1,044)
===== ==== =====
Reconciliation's between the amount determined by applying the
U.S. federal statutory rate to income (loss) before income taxes,
minority interest and extraordinary item with the income tax
provision (benefit) is as follows (in thousands):
December 31,
---------------------------------------------
1997 1996
1995
---------------------------
- -----
Computed "expected" tax expense using the
U.S. federal statutory rate $(3,826) $ 206 $
(1,071)
Reduction in available net operating loss
carryforwards resulting from certain
subsidiaries which became ineligible for
inclusion in the consolidated return - 143 -
Meals and entertainment 16 32 16
Valuation allowance 1,156 - -
Other 13 (16)
11
-------- -----
- -------
Provision (benefit) for income taxes $ (2,641) $ 365 $
(1,044)
===== === ====
<PAGE>
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax
liabilities were as follows (in thousands):
December 31,
-------------------
- -------
1997 1996
----------
- ---------
Deferred tax assets:
Net operating loss carry forwards $ 9,662 $2,485
Alternative minimum tax credit carryforwards
170 170
Receivables - 469
Equity investment in subsidiary 250 -
Other long term assets 1,561 247
Other long term liabilities 480 397
Other 38 55
-------- -------
- -
Total gross deferred tax assets 12,161 3,823
-------- -------
- -
Deferred tax liabilities:
Oil and gas properties, principally due to differences in
the tax and book basis and depletion methods and the
deduction of intangible drilling costs for tax purposes
(11,918) (8,406)
Other property and equipment (763) (600)
Real estate investments (88) -
Accounts payable and accrued expenses (250)
(1,026)
Other (97) (46)
---------
- ---------
Total gross deferred tax liabilities (13,116) (10,078)
---------
- ---------
Net deferred tax liability before valuation allowance
(955) (6,255)
Valuation Allowance (1,393) -
---------
- ----------
Net deferred tax liability $(2,348) $(6,255)
` ====== ======
A valuation allowance is provided when it is more likely than
not that some portion of the deferred tax assets will not be
realized. Based on expectations for the future and the
availability of certain tax planning strategies that would
generate taxable income to realize the net tax benefits, if
implemented, management has determined that taxable income
of Southwest will more likely than not be sufficient to fully
utilize available carryforwards prior to their ultimate
expiration. Red Oak files an independent return exclusive of
Southwest and has net operating loss carryforwards of $3,627,000
expiring in various periods from 2010 through 2012. The
valuation allowance relates primarily to the uncertainty of the
realizability of Red Oak's carryforwards, the amount of the
valuation allowance could be reduced if estimates of future
taxable income during the carryforward period are increased.
<PAGE>
As of December 31, 1997, Southwest had net operating loss
carryforwards for U.S. federal income tax purposes of
approximately $24,795,000, which are available to offset future
regular taxable income, if any. The net operating loss
carryforwards expire in various periods from 2010 through 2012.
Southwest has alternative minimum tax credit carryforwards
totaling $170,000 to offset regular income tax, which have no
scheduled expiration date.
8. Profit Sharing Plan
On January 1, 1991, the Company adopted an employee profit
sharing plan that is intended to provide participating employees
with additional income upon retirement. Employees may contribute
between 1% and 15% of their base salary up to a maximum of $9,500
for the years ended December 31, 1997 and 1996 and $9,240 for the
year ended December 31, 1995. For the years ended December 31,
1997, 1996 and 1995, the Company matched 20% of the employees'
contributions. For the year ended December 31, 1998, the Company
will match 20% of the employees' contributions. For subsequent
years, the Company will make contributions to the plan on a
discretionary basis.
Employee contributions are fully vested at all times.
Employer contributions are fully vested upon retirement or after
five years of service. For the years ended December 31, 1997,
1996 and 1995, the Company contributed approximately $66,000,
$60,000 and $54,000, respectively, to the plan.
9. Stockholders' Equity
In August 1996, the Company issued 129,046 shares of
redeemable common stock through a private placement offering for
$68 per share. The stock is redeemable at the stockholder's
option at any time beginning five years from the issuance of the
stock (December 31, 2001) at a purchase price determined as
follows:
(i) The Company shall review no less than five and
no more than ten publicly traded oil and gas
companies each with a market capitalization between
$50 million and $150 million ("Public Company"). The
Company shall determine the ratio of each Public
Company's market capitalization to EBITDA for the
most recent fiscal year. The Company shall then
average such multiples and take this averaged
multiple and apply it to the Company's EBITDA for the
most recent fiscal year, to estimate a value for the
Company's common stock.
(ii) The Company will determine the multiple of the
market capitalization of each Public Company relating
to the present value of such Public Company's oil and
gas reserves. Present value will be determined by
discounting the expected net cash flow from the oil
and gas reserves by 10%. The Company will then take
the average multiple based on this methodology and
apply it to the present value of the Company's oil
and gas reserves discounted by 10% to determine a
value for the expected net cash flow from the
Company's common stock.
The Company will then take the average of (i) and
(ii) to determine the value of the Company's common
stock. The redemption right terminates on the
effective date of any registration statement filed
with the Securities and Exchange Commission relative
to the offer and sale of the Company's common stock
to the public.
During 1994, the Company issued a 6% note to a stockholder.
The note requires semi-monthly payments of $5,500 and is
collateralized by the Company's common stock held by the
stockholder.
<PAGE>
10. Commitments and Contingencies
The partnership agreements relating to certain limited
partnerships for which Southwest serves as managing general
partner provide for Southwest to offer to repurchase such limited
partner units. Under the terms of three of the partnership
agreements, Southwest is obligated to repurchase a maximum of
$100,000 annually of the units of limited partnerships' interests
originally outstanding. Under the terms of nine other
partnership agreements, Southwest's obligation to repurchase
units in any one year is limited to 10% of the capital
contributed by all of the respective limited partners. The
repurchase price is based on the discounted future revenues from
oil and gas reserves of the respective partnership and the value
of other partnership assets. Such amounts required for
repurchase in connection with the acceptance by a portion of the
limited partners is approximately $4,792,000 at December 31,
1997. The total amount of limited partner unit repurchases for
the years ended December 31, 1997 and 1996 was approximately
$1,041,000 and $378,000, respectively.
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. Current accrued expenses and other long-
term liabilities at December 31, 1997 include $159,000 and
$504,000 for estimated future remedial actions and cleanup costs.
As of December 31, 1997, 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.
11. Related Party Transactions
Southwest is the managing general partner for several public
and private oil and gas limited partnerships, with an officer of
Southwest also serving as a general partner for certain of the
limited partnerships. As is usual in the oil and gas industry,
the operator is paid an amount for administrative overhead
attributable to operating such properties and management fees
attributable to serving as managing general partner. As provided
for in the partnership agreements, such
<PAGE>
amounts paid by the partnerships to Southwest approximated
$3,538,000, $3,648,000, and $3,545,000 for the years ended
December 31, 1997, 1996 and 1995, respectively. In addition,
Southwest and certain officers and employees may have an interest
in some of the partnership properties.
An affiliate of the company performs various oilfield services
for limited partnerships managed by Southwest. Such services
aggregated $155,000, $112,000 and $166,000 for the years ended
December 31, 1997, 1996 and 1995.
12. Disclosures About Fair Value of Financial Instruments
The carrying amount of cash and cash equivalents, accounts
receivable, accounts payable and accrued expenses, other current
assets and other current liabilities approximates fair value
because of the short maturity of these instruments.
Based on the borrowing rates currently estimated to be
available to the Company for loans with similar terms, the fair
value of long-term debt approximates the carrying amount as of
December 31, 1997 and 1996.
The carrying amount of investment in subsidiary at December
31, 1997 is approximately $2.4 million. Based on Sierra's
issuance of common stock at December 31, 1997 the estimated fair
value of SRH's investment in Sierra is approximately $14.6
million.
13. 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 only six months of income
statement information is displayed in the tables and no balance
sheet information is displayed as of December 31, 1997 (see Note
3.)
1997 1996 1995
-----------------------------
- --
Operating profit (loss) (in thousands)
Oil and gas $3,654 $ 9,676 $2,151
Well service 184 (506) (177)
Real estate 3,074 1,288 933
Other and eliminations (417) (855) (612)
---------- -----
- ---- --------
$ 6,495 $ 9,603
$ 2,295
====== ====== =====
Interest Expense
Oil and gas $ 12,329$ 7,966
$ 4,296
Well Service 184 82 70
Real Estate 6,320 1,904 1,272
Other and eliminations 61 64
(3)
---------- ------
- ---- --------
$ 18,894$ 10,016
$ 5,635
<PAGE> ====== ======
=====
1997 1996 1995
-----------------------------
- --
Depreciation, depletion and amortization
Oil and gas $ 12,803$ 6,734
$ 5,643
Well Service 747 863 448
Real Estate 1,313 660 446
Other and eliminations 171 173
182
---------- ------
- ---- ---------
$ 15,034$ 8,430
$ 6,719
====== ====== ======
Identifiable assets
Oil and gas $ 205,054 $95,042
$ 76,170
Well service - 6,585 2,993
Real estate 98,890 35,365 21,666
Other and eliminations 1,499 (6,708) (5,3
95)
---------- ------
- ---- ---------
$ 305,443 $130,
284 $ 95,434
====== ====== =====
Capital expenditures
Oil and gas $ 103,205 $16,740
$ 32,077
Well service - 3,826 1,598
Real estate 53,184 13,947 13,239
---------- -------
- --- --------
$ 156,389 $34,513
$ 46,914
====== ====== =====
<PAGE>
14. Restatement
The Company has restated its previously issued financial
statements for the year ended December 31, 1995, to adjust for
the understatement of previously reported assets, liabilities and
net income, resulting in the following changes (in thousands):
Oil and Gas
ReceivablesLiabilitiesNet Inco
me (Loss)
------------------- -------------- --------------------
-
As previously reported $2,295 $ 95,602 $ (2,374)
Understatement of oil and gas accrual
net of lease operating expense and production 527 179 348
Understatement of redeemable common stock due
to redemption feature - 94 (94)
------- -------- -----
- ---
As adjusted $2,822 $95,875 $(2,120)
==== ===== =====
15. Condensed Issuer Financial Data
Summarized consolidated financial information for Southwest
is as follows (in thousands):
December 31,
------------------------
- ------------------
1997 1996 1
995
------------------------
- -
Consolidated Balance Sheet Data:
Current assets $ 36,113 $ 18,439
$ 11,198
Net property and equipment 156,302 66,348
57,422
Other assets, net 11,196 3,991
2,439
---------- -------
- - ---------
$ 203,611 $ 88,778
$ 71,059
====== ===== ======
Current liabilities $ 14,614 $ 19,127
$ 14,548
Long-term debt 198,938 55,234
53,641
Other liabilities 1,412 2,968 1,404
Deferred income taxes 2,522 6,025 5,620
Minority interest 177 158 140
Redeemable common stock 8,290 8,258 -
Stockholders equity (22,342) (2,992)
(4,294)
---------- -------
- - ----------
$ 203,611 $ 88,778
$ 71,059
====== ===== ======
<PAGE>
Consolidated Statement of Operations Data (in thousands):
SRHSouthwest SierraRed Oak Elim
Consolidated
---------------------------------------
- --- ------------------------
For the year ending December 31, 1997:
Operating revenues $ - $ 39,727 $ 7,833 $9,338
$ (44) $56,854
Depreciation, depletion and amortization - 12,974
747 1,313 - 15,034
Operating income - 3,237 184 3,074
- - 6,495
Interest expense - 12,372 184 6,320
18 18,894
Income (loss) before taxes 15,249 (8,097) (5)
(3,125) (15,274) (11,252)
Net income (loss) 15,046 (7,733) (4)
(3,987) (14,815) (11,493)
For the year ended December 31, 1996:
Operating revenues $ - $ 34,488 $ 8,273 $4,487
$ (347) $46,901
Depreciation, depletion and amortization - 6,907 863
660 - 8,430
Operating income (loss) - 8,824 (506) 1,288
(3) 9,603
Interest expense - 8,030 82 1,904
- - 10,016
Income (loss) before taxes - 1,823 (608) (607)
(19) 589
Net income (loss) - 1,152 (448) (441)
142 405
For the year ended December 31, 1995:
Operating revenues $ - $ 21,578 $ 4,437 $3,213
$ (242) $28,986
Depreciation, depletion and amortization - 5,825 448
446 - 6,719
Operating income (loss) - 1,540 (177) 933
(1) 2,295
Interest expense - 4,358 70 1,272
(65) 5,635
Loss before taxes - (2,522) (248) (322)
(57) (3,149)
Net loss - (1,656) (168) (221)
(75) (2,120)
16. Subsequent Events
In January and February of 1998, Red Oak escrowed
approximately $600,000 to be used towards the purchase price of
approximately $24,050,000 for two commercial office centers and a
retail shopping center located in Tucson, AZ, Tulsa, OK, and
Austin, TX. Management anticipates to complete the acquisitions
in April and May of 1998.
On February 3, 1998, Red Oak purchased a real estate
management company and brokerage firm for $1.6 million. The
acquisition was financed by two notes payable totaling the
purchase price.
In March 1998, the Company purchased put options on a total of
13,000 MMBTU of natural gas per day, establishing a floor price
of $1.90 for 6,500 MMBTU per day and a floor price of $1.70 for
the remaining 6,500 MMBTU per day, for the period April 1, 1998
through October 31, 1998.
<PAGE>
17. Supplemental Financial Data - Oil and Gas Producing
Activities (unaudited):
The following information is presented in accordance with
Statement of Financial Accounting Standards No. 69, "Disclosure
about Oil and Gas Producing Activities," (SFAS No. 69), except as
noted.
Costs incurred in connection with oil and gas producing
activities are as follows (in thousands):
Years ended December 31,
-------------------------------------------------------
1997 1996 1995
---------- --------------------
Acquisition of properties $80,797 $3,234 $ 24,116
Exploration costs 2,769 184 1,278
Development costs 19,639
13,322 6,683
---------- ---------
- ---------
Total costs incurred $ 103,205 $ 16,740
$ 32,077
====== ===== =====
Results of operations for oil and gas producing activities are as
follows (in thousands):
Years ended December 31,
-------------------------------------------------------
1997 1996 1995
--------- --------------------
Revenues $38,500 $33,787 $21,211
Production costs 18,500 14,846 11,511
Depreciation, depletion and amortization 12,419
6,434 5,068
--------- ----------
- ---------
7,581 12,507 4,632
Income tax provision 2,578 4,253 1,575
-------- --------- ---------
Results of operations from oil and gas producing
activities (excluding corporate overhead)$ 5,003 $
8,254 $ 3,057
===== ======
======
Reserve Quantity Information
The estimates of the Company's proved oil and gas reserves,
which are located in the United States, are based on evaluations
reviewed by independent petroleum engineers. Reserves were
estimated in accordance with guidelines established by the U. S.
Securities and Exchange Commission and the Financial Accounting
Standards Board, which require
that reserve estimates be prepared under existing economic and
operating conditions with no provision for price and cost
escalations except by contractual arrangements. The reserve
estimates at December 31, 1997 assume an average oil price of
$16.30 per Bbl (reflecting adjustments for oil quality and
gathering and transportation costs) and an average gas price of
$2.11 per Mcf (reflecting adjustments for BTU content, gathering
and transportation costs and gas processing and shrinkage).
<PAGE>
Oil and gas reserve quantity estimates are subject to numerous
uncertainties inherent in the estimation of quantities of proved
reserves and the projection of future rates of production and the
timing of development expenditures. The accuracy of such
estimates is a function of the quality of available data,
engineering and geological interpretation and judgement. Results
of subsequent drilling, testing and production may cause either
upward or downward revision of previous estimates. Further, the
volumes considered to be commercially recoverable fluctuate with
the changes in prices and operating costs. The Company
emphasizes that reserve estimates are inherently imprecise and
that estimates of new discoveries are more imprecise than those
of currently producing oil and gas properties. Accordingly,
these estimates are expected to change, as additional information
becomes available in the future.
Oil and Barrels of
Condensate Natural Oil Equivalent
Total Proved Reserves: (MBbls) Gas (MMcf) (MBOE)
----------------------- ----------
- -
Balance, January 1, 1995 10,008 37,990 16,340
Purchase of minerals-in-place 4,760 25,156 8,953
Sales of minerals-in-place (1,013) (5,978) (2,009)
Revisions of previous estimates 3,639 18,061 6,648
Production (814) (4,639) (1,587)
-------- --------- ---------
Balance, December 31, 1995 16,580 70,590 28,345
Purchase of minerals-in-place 2,843 6,844 3,983
Sales of minerals-in-place (989) (466) (1,067)
Revisions of previous estimates 1,373 5,211 2,242
Production (1,001) (5,403) (1,901)
-------- --------- ---------
Balance, December 31, 1996 18,806 76,776 31,602
Extensions and discoveries 474 1,230 679
Purchase of minerals-in-place 16,419 7,274 17,631
Sales of minerals-in-place (83) (91) (98)
Revisions of previous estimates (4,642) (14,825) (7,113)
Production (1,308) (5,639) (2,248)
--------- ---------- ----------
Balance, December 31, 1997 29,666 64,725 40,453
====== ====== ======
Total proved developed reserves
January 1, 1995 4,760 27,587 9,358
December 31, 1995 7,349 51,296 16,003
December 31, 1996 10,302 58,961 20,129
December 31, 1997 18,472 46,585 26,236
Standardized Measure of Discounted Future Net Cash Flows
The standardized measure of discounted future net cash flows
is computed by applying year-end prices of oil and gas (with
consideration of price changes only to the extent provided by
contractual arrangements) to the estimated future production of
proved oil and gas reserves less estimated future expenditures
(based on year-end costs) to be incurred in developing and
producing the proved reserves, discounted using a rate of 10% per
year to reflect the estimated timing of
<PAGE>
the future cash flows. Future income taxes are calculated by
comparing discounted future cash flows to the tax basis of oil
and gas properties plus available carryforwards and credits and
applying the current tax rates to the difference.
Discounted future cash flow estimates like those shown below
are not intended to represent estimates of the fair value of oil
and gas properties. Estimates of fair value should also consider
probable reserves, anticipated future oil and gas prices,
interest rates, changes in development and production costs and
risks associated with future production. Because of these and
other considerations, any estimate of fair value is necessarily
subjective and imprecise.
During most of 1996 and 1997, the Company benefited from
higher oil and gas prices as compared to previous years.
However, during the fourth quarter of 1997, oil prices began a
downward trend that has continued into March 1998. A continuation
of the oil price environment experienced during the first quarter
of 1998 will have an adverse affect on the Company's revenues and
operating cash flow, and may result in a downward adjustment to
the Company's current 1998 capital budget. Also, a continuing
decline in oil prices could result in a decrease in the carrying
value of the Company's oil and gas properties.
December 31,
------------------------------------------------------------
- ----
1997 1996 1995
----------------------------------------
- ---------
(in thousands)
Future cash inflows $620,418 $735,100 $433,514
Future production and development costs
(303,406) (283,894) (213,698)
-----------------------------
- ---
Future net cash flows before income taxes 317,012 451,206
219,816
Future income tax expense (59,764) (142,017) (64,0
64)
---------- ---------
- - ---------
Future net cash flows 257,248 309,189 155,752
10% annual discount for estimated timing
of cash flows (117,427) (130,648) (71,646)
---------- ---------- -------
- --
Standardized measure of discounted
future net cash flows $139,821 $178,541 $84,106
====== ====== ======
<PAGE>
The principal sources of change in the standardized measure of
discounted future net cash flows are as follows:
December 31,
--------------------------------
- ----------------------------------
1997 1996 1995
-----------------------
- --------- ---------------
(in thousands)
Sales of oil and gas produced,
net of production costs $
(20,000) $(18,941) $(9,700)
Net change in sales prices net of production
costs (119,553) 92,332 13,
106
Extensions and discoveries, net of future
production and development
costs 3,540 - -
Revisions to estimated future development
costs (4,833) 1,854
(78)
Purchases of minerals-in-place 80,690 38,480 42,733
Revisions of previous quantity estimates (37,403) 19,794
17,756
Accretion of discount 25,217 11,790 5,802
Net change in income taxes 46,887 (39,268)
(18,134)
Sales of minerals-in-place (384) (2,439)
(7,979)
Changes in production rates, timing
and other (12,881)
(9,167) (1,506)
--------- --------
--------
(38,720) 94,435
42,000
Discounted future net cash flows -
Beginning of period 178,541
84,106 42,106
---------- -------
- --- ---------
End of period $ 139,821
$ 178,541 $84,106
====== ======
=====
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.
The Company previously disclosed its change of accountants on
S-4 Registration Statement No. 333-41915, which became effective
February 9, 1998.
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The directors and executive officers of SRH and Southwest are
as follows:
Name Age Position
H. H. Wommack, III 42 Chairman, President, Chief
Executive Officer and Director
H. Allen Corey 41 Secretary and Director
Bill E. Coggin 43 Vice President and Chief
Financial Officer
J. Steven Person 39 Vice President, Marketing
Set forth below is a description of the backgrounds of the
directors and executive officers of SRH and Southwest.
H. H. Wommack, III has served as Chairman of the Board,
President, Chief Executive Officer and a director of SRH since it
was formed in July 1997 and of Southwest since its founding in
1983. Mr. Wommack has served as a director of Red Oak since 1992.
Prior to the formation of Southwest, Mr. Wommack was a self-
employed independent oil and gas producer engaged in the purchase
and sale of royalty and working interests in oil and gas leases
and the drilling of wells.
H. Allen Corey has served as Secretary and a director of SRH
since it was formed in July 1997 and of Southwest since its
founding in 1983. Mr. Corey has served as a director and
Assistant Secretary of Red Oak since 1992. Since January 1997,
Mr. Corey has been president of Trolley Barn Brewery, Inc., a
brew pub restaurant chain based in the southeastern United States
and of counsel to the law firm of Baker, Donelson, Bearman &
Caldwell, P.C. From 1986 to 1997, Mr. Corey was a partner at the
law firm of Miller & Martin in Chattanooga, Tennessee.
Bill E. Coggin has served as Vice President and Chief
Financial Officer of SRH since it was formed in July 1997. Mr.
Coggin has served as Vice President and Chief Financial Officer
of Southwest since 1985. Mr. Coggin has served as a director and
Vice President, Finance of Red Oak since 1995. Previously, Mr.
Coggin was controller for an oil and gas drilling company and an
independent oil and gas operator.
J. Steven Person has served as Vice President, Marketing of
SRH since it was formed in July 1997. Mr. Person has served as
Vice President, Marketing for Southwest since 1989 and as Vice
President, Marketing of Red Oak since 1996. Prior to joining
Southwest, Mr. Person was involved in the syndication of mortgage-
based securities.
Other key employees of Southwest and Red Oak include:
Southwest.
Jon P. Tate, age 40, has served as Vice President, Land and
Assistant Secretary of Southwest since 1989. From 1981 to 1989,
Mr. Tate was employed by C.F. Lawrence & Associates, Inc., an
independent oil and gas company, as
<PAGE>
land manager. Mr. Tate is a member of the Permian Basin Landman's
Association.
R. Douglas Keathley, age 42, has served as Vice President,
Operations of Southwest since 1992. Before joining Southwest, Mr.
Keathley worked as a senior drilling engineer for ARCO Oil and
Gas Company and in similar capacities for Reading & Bates
Petroleum Co. and Tenneco Oil Co.
Phillip Hock, age 55, has served as Vice President,
Exploration of Southwest since October, 1997. Mr. Hock has
worked for Southwest as a geologist since November 1993. Prior
to joining Southwest, Mr. Hock was employed by Ramco Oil and Gas
as Exploitation Manager from 1989 to 1993, and was active in the
oil and gas industry from 1971 to 1989.
Rick Morton, age 36, has served as Vice President, Operations
of Southwest since February, 1998. Before joining Southwest in
June 1997, Mr. Morton worked for Merit Energy Company from 1990
to 1997 in various capacities, including District Manager. Mr.
Morton also worked as a reservoir engineer and production
supervisor for Arco Oil and Gas Company from 1983 to 1990.
Red Oak.
W. Neil McClung, age 47, has served as President and a
director of Red Oak since 1994. Prior to his involvement with Red
Oak, Mr. McClung was senior vice president of Heitman Properties,
Ltd. from 1989 through 1993 where he was responsible for
marketing, budget development and leasing for three million
square feet of high-rise office building and industrial center
space in several metropolitan and secondary markets. Mr. McClung
has also served as a property and leasing manager for Heitman in
Midland, Texas.
J. Wesley Tune, age 38, has served as Vice President and
Secretary of Red Oak since 1994. Mr. Tune was employed by Heitman
Properties, Ltd. as property and leasing manager from 1992 until
1994 in Midland, Texas. Prior to his involvement with Heitman,
Mr. Tune was a property manager for Mike Lewis & Associates in
Midland, Texas, from 1990 to 1992, and manager and controller for
Mission Country Club from 1988 to 1990.
<PAGE>
Item 11. Executive Compensation.
The following table sets forth certain information for fiscal
years 1996 and 1997 with respect to the compensation paid to Mr.
Wommack, the Chairman and President, and the four other most
highly compensated executive officers of Southwest. No other
executive officers of Southwest received annual compensation
(including salary and bonuses earned) that exceeded $100,000 for
the years ended December 31, 1996 and 1997. Mr. Wommack
determines the compensation of Southwest's executive officers.
No compensation has been paid to the executive officers of SRH
for their services to SRH.
All Other
Name and Principal Position Year SalaryBonus(2)Compensati
on(1)
H. H. Wommack, III, President and Treasurer (3) 1997
$ 623,884 $113,600116,869
1996586,320 100,677 148,031
Bill E. Coggin, Vice President and Chief 1997183,7531
01,659 7,764
Financial Officer 1996153,000 61,169 7,471
J. Steven Person, Vice President, Marketing 1997112,078
73,153 7,464
1996 96,062 13,821 7,064
R. Douglas Keathley, Vice President, Operations 1997101,567
17,556 6,771
1996 - - -
Richard E. Masterson, Vice President, Exploration 1997112,707
- - 11,306
& Acquisitions 1996 92,000 8,293 15,494
Carried
Profit Interest in
InsuranceSharing/401(k)Oil and
Gas
Name Year PremiumsContribution Properties
H. H. Wommack, III 1997 $5,864 $1,900 $109,105,
1996 5,571 1,900 140,560
Bill E. Coggin 1997 5,864 1,900 -
1996 5,571 1,900 -
J. Steven Person 1997 5,864 1,600 -
1996 5,571 1,493 -
R. Douglas Keathley 1997 5,864 907 -
1996 - - -
Richard E. Masterson 1997 5,864 669
4,773
1996 4,362 690 10,442
(1) Reflects (i) Southwest's contributions to the Southwest
Royalties, Inc. Employee Profit Sharing and 401(k) Plan and
premium payments made by Southwest for health, disability and
life insurance policies for the referenced individuals and (ii)
net cash received from carried interests in Oil and Gas
Properties.
(2) Amount includes club dues and automobiles furnished by
Southwest.
(3) Mr. Wommack has acted as a general partner of the
income funds and certain of the drilling funds sponsored by
Southwest since 1983, holding a 1% interest in these
partnerships.
The non-employee director of Southwest received $ 20,000 in
each of 1997 and 1996 for his services.
<PAGE>
Item 12. Security Ownership of Certain Beneficial Owners and
Management.
The following table sets forth information with respect to the
beneficial ownership of the common stock, excluding treasury
shares, of SRH by each person who is known by the Company to own
beneficially 5% or more of the common stock of SRH, by each
director, and by all officers and directors of SRH as a group.
Southwest is a wholly-owned subsidiary of SRH.
Number of
Name and Address of Shares Percentage
Beneficial Owner Owned of Class
----------------------------------------------------------
H. Allen Corey 48,968 4.6%
c/o Southwest Royalties Holdings, Inc.
Southwest Royalties Building
407 N. Big Spring
Midland, TX 79701-4326
George H. Jewell 61,855 5.7%
Baker & Botts, L.L.P.
One Shell Plaza
910 Louisiana
Houston, Texas 77002
H. H. Wommack, III 783,977 72.9%
c/o Southwest Royalties Holdings, Inc.
Southwest Royalties Building
407 N. Big Spring
Midland, TX 79701-4326
Directors and officers as a group (five persons) 848,925
78.9%
Item 13. Certain Relationships and Related Transactions.
The descriptions set forth below do not purport to be complete
and are qualified in their entirety by reference to the
applicable agreements.
On December 15, 1994, H. H. Wommack, III borrowed
approximately $1.7 million on an unsecured basis from Southwest
for the purpose of purchasing the Southwest common stock held by
a certain stockholder. The note held by Southwest was amended on
March 15, 1995 to include $35,225 of accrued but unpaid interest.
The note carries a 6% interest rate and is being amortized over
30 years with payments of $5,500 semi-monthly. As of December 31,
1997, the outstanding balance of this loan was $1.7 million. Mr.
Wommack serves as a general partner of substantially all of the
oil and gas limited partnerships sponsored by Southwest since
1983, and he holds an interest in these partnerships of
approximately 1%.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on
Form 8-K.
Financial Statements
The following financial statements of the Company are
included in "Item 8. Financial Statements and Supplementary
Data":
Independent Auditors' Report
Consolidated Balance Sheets as of December 31, 1997 and 1996
Consolidated Statements of Operations from the years ended
December 31, 1997, 1996 and 1995
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1996 and 1995
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995
Notes to Consolidated Financial Statements
All other statements and schedules for which provision is
made in the applicable accounting regulations of the Securities
and Exchange Commission have been omitted because they are not
required under related instructions or are inapplicable, or the
information is shown in the financial statements.
Reports on Form 8-K
The Company has not filed any reports on Form 8-K.
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
-------------------- ----------------
3.1 Certificate of Incorporation for
Southwest Royalties, Inc. dated as of August 18,
1983, as amended March 30, 1987 and November 20,
1989, incorporated by reference to Exhibit 3.1 to
S-4 Registration Statement No. 333-41915 filed
December 10, 1997.
3.2 Certificate of Incorporation for
Southwest Royalties Holdings, Inc. dated as of
July 1, 1997, incorporated by reference to Exhibit
3.2 to S-4 Registration Statement No. 333-41915
filed December 10, 1997.
3.3 By-Laws of Southwest Royalties, Inc.
dated as of August 12, 1996 as amended,
incorporated by reference to Exhibit 3.3 to S-4
Registration Statement No. 333-41915 filed
December 10, 1997.
<PAGE>
3.4 By-Laws of Southwest Royalties Holdings,
Inc. adopted as of July 1, 1997, incorporated by
reference to Exhibit 3.4 to S-4 Registration
Statement No. 333-41915 filed December 10, 1997.
4.1 Indenture dated as of October 14, 1997
among Southwest Royalties, Inc., as Issuer,
Southwest Royalties Holdings, Inc., as Guarantor,
and State Street Bank and Trust Co., as Trustee,
incorporated by reference to Exhibit 4.1 to S-4
Registration Statement No. 333-41915 filed
December 10, 1997.
4.2 Registration Rights Agreement dated as
of October 14, 1997 by and between Southwest
Royalties, Inc., Southwest Royalties Holdings,
Inc., Jefferies & Company, Inc., Banc One Capital
Corporation and Paribas Corporation, incorporated
by reference to Exhibit 4.2 to S-4 Registration
Statement No. 333-41915 filed December 10, 1997.
4.3 Warrant issued by Southwest Royalties
Holdings, Inc. to Joint Energy Development
Investments Limited Partnership dated as of
October 14, 1997, incorporated by reference to
Exhibit 4.3 to S-4 Registration Statement No. 333-
41915 filed December 10, 1997.
4.4 Registration Rights Agreement by
Southwest Royalties Holdings, Inc. and Joint
Energy Development Investments Limited Partnership
dated as of October 14, 1997, incorporated by
reference to Exhibit 4.4 to S-4 Registration
Statement No. 333-41915 filed December 10, 1997.
10.1 Purchase and Sale Agreement dated as of
September 10, 1997 between Conoco, Inc. and
Southwest Royalties, Inc., incorporated by
reference to Exhibit 10.1 to S-4 Registration
Statement No. 333-41915 filed December 10, 1997.
10.2 Securities Purchase Agreement dated October
14, 1997 between Southwest Royalties Holdings,
Inc. and Joint Energy Development Investments
Limited Partnership, incorporated by reference to
Exhibit 10.2 to S-4 Registration Statement No. 333-
41915 filed December 10, 1997.
10.3 Restated Senior Loan Agreement among
Southwest Royalties, Inc., as borrower and certain
subsidiaries of borrower, as guarantors and Bank
One, Texas, N.A. and Banque Paribus, as Banks, and
Bank One, Texas as agent dated as of October 9,
1997, incorporated by reference to Exhibit 10.3 to
S-4 Registration Statement No. 333-41915 filed
December 10, 1997.
21 List of Subsidiaries, incorporated by
reference to Exhibit 21 to Amendment No. 1 to S-4
Registration Statement No. 333-41915 filed January
30, 1997.
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: March 31, 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
-----------------------------
Chairman/President/ March 31, 1998
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
----------------------------- Vice
President/Chief March 31, 1998
Bill E. Coggin Financial Officer
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary March 31, 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: March 31, 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
-----------------------------
Chairman/President/ March 31, 1998
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
----------------------------- Vice
President/Chief March 31, 1998
Bill E. Coggin Financial Officer
/s/ H. Allen Corey
-----------------------------
H. Allen Corey Director/Secretary March 31, 1998
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Balance Sheet at December 31, 1997 and the Statement of Operations for
the Year Ended December 31, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 27,365,000
<SECURITIES> 0
<RECEIVABLES> 8,630,000
<ALLOWANCES> (254,000)
<INVENTORY> 0
<CURRENT-ASSETS> 39,506,000
<PP&E> 284,886,000
<DEPRECIATION> (47,211,000)
<TOTAL-ASSETS> 305,443,000
<CURRENT-LIABILITIES> 18,765,000
<BONDS> 281,764,000
10,956,000
0
<COMMON> 116,000
<OTHER-SE> (11,922,000)
<TOTAL-LIABILITY-AND-EQUITY> 305,443,000
<SALES> 38,500,000
<TOTAL-REVENUES> 56,854,000
<CGS> 18,500,000
<TOTAL-COSTS> 29,580,000
<OTHER-EXPENSES> 15,034,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 18,894,000
<INCOME-PRETAX> (11,252,000)
<INCOME-TAX> (2,641,000)
<INCOME-CONTINUING> (8,384,000)
<DISCONTINUED> 0
<EXTRAORDINARY> (3,109,000)
<CHANGES> 0
<NET-INCOME> (11,493,000)
<EPS-PRIMARY> (10.66)
<EPS-DILUTED> (10.66)
</TABLE>
