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, 1999
or
? Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to _______________
Commission file number: 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 Identification (I.R.S. Employer
Identification
Number) Number)
407 North Big Spring, Suite 300
Midland, Texas 79701
(Address of Principal Executive (Zip Code)
Offices)
Registrants' Telephone Number, Including Area Code: (915) 686-9927
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 X No
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 December 31, 1999, Southwest Royalties, Inc. had outstanding 100
shares of common stock, $.10 par value, which is its only class of stock.
As of December 31, 1999, 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 19
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 7A. Quantitative and Qualitative Disclosures About Market Risk39
Item 8. Financial Statements and Supplementary Data 41
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 73
PART III
Item 10. Directors and Executive Officers of the Registrant 74
Item 11. Executive Compensation 76
Item 12. Security Ownership of Certain Beneficial Owners and Management
77
Item 13. Certain Relationships and Related Transactions 77
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
78
<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 "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 reserves, 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 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.
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.
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 these
partnerships. As of December 31, 1999, Southwest had total estimated net
proved reserves of 24.8 MMBbls of oil and 65.1 Bcf of natural gas,
aggregating 35.7 MMBoe, with a PV-10 Value of $228.7 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, 1999, Red Oak owned and managed 21 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. As of December 31, 1999, the Company
directly owns approximately 28% of the common stock of Sierra and
indirectly owns an additional 11% interest through Southwest, which is the
general partner and 15% interest holder in each of two partnerships that
own approximately 69% of the common stock of Sierra. A Financial
Institution owns preferred stock in Sierra, which can be converted to
common stock at the Financial Institutions option. If the Financial
Institution elects to convert its preferred stock to common stock, the
Companys direct ownership would decrease to 20% and its indirect ownership
would decrease to 7%. The conversion percentage increases over time as
long as the related debt remains outstanding. 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.
("MSS"), Threading Products International, LLC ("TPI"), and Blue Heel
Company ("Blue Heel"). Southwest Software creates and markets computer
software to the oil and gas industry and provides all information system
services as well as hardware maintenance and technical support for
Southwest and Sierra through contractual agreements. TPI produces inserts
used to cut threads by manufacturers of threaded products. Effective
November 1999, TPI was liquidated. Blue Heel holds a nominal interest in
certain oil and gas properties owned by Southwest.
Red Oak has seven wholly-owned subsidiaries, MRO Properties, Inc.
("MROP"), MRO Management, Inc. ("MRO Management"), MRO Commercial, Inc.
("MRO Commercial"), MRO N Cross, Inc. ("Northcross"), MRO La Placita, Inc.
("La Placita"), MRO Madera, Inc. ("Madera") and MRO Southwest, Inc. ("MRO
Southwest"). MROP, MRO Commercial, Northcross, La Placita, Madera and MRO
Southwest each hold titles to certain real estate properties and are the
borrowers under the credit agreements related to such properties. These
credit agreements are non-recourse to Red Oak. MRO Management performs
real estate management services for Red Oak, MROP, MRO Commercial,
Northcross, La Placita, Madera, MRO Southwest and for third party clients.
Both Sierra and Red Oak are operated separately from Southwest;
however, Southwest has historically provided both with significant
administrative and accounting support. Under the terms of separate service
agreements, Southwest provided Sierra and Red Oak with administrative
services including accounting, bookkeeping, tax preparation and banking and
disbursement services. Both agreements had an initial term of five years
and renewed from year to year if not terminated. Under each agreement,
Southwest received 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.
As of December 31, 1999, both Sierra and Red Oak have cancelled these
service 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
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 capital
expenditures or acquisitions will require additional equity or financing
and will be dependent upon financing arrangements available at the time.
The significant decrease in oil and gas prices experienced during the last
quarter of 1997 and extending through the first half of 1999, has severely
limited cash flow from operations, depleted working capital and rendered
most other financing sources unavailable, or if available, on very
unattractive terms to the Company. Based on current commodity prices,
production, rent revenues and its highly leveraged position, the Company
probably will not be able to meet operating and debt obligations in 2000
and beyond.
<PAGE>
Management is constantly monitoring the Company's cash position and
its ability to meet its financial obligations as they become due, and in
this effort, is exploring various strategies for addressing its current and
future liquidity needs. During 1999 and 1998, for instance, Southwest sold
$5.6 million and $5.7 million, respectively, of oil and gas properties in
an ongoing effort to decrease its production costs and improve its cash
position and also negotiated a $50 million revolving line of credit with
BankOne Texas, N.A. the proceeds of which were used to purchase in December
1999 and January 2000, approximately $76.3 million of the 10.5% Senior Note
due 2004. As of December 31, 1999, SRH's consolidated cash balance was
$27.0 million, of which $21.4 million was available to Southwest.
In response to the Company's highly leveraged capital structure and
its limited working capital, the Company is tentatively budgeting $8
million in capital expenditures in its oil and gas business for 2000. The
$8 million capital expenditure budget is for development projects. The
final budget will depend on financial strategies that are currently being
developed including hedging strategies, divestitures and company structure.
The budget will also be affected by the volatility of the oil and gas
commodity prices. Further revisions may be necessary during the year in
response to market conditions and any restructuring which can be negotiated
by the Company.
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,
1999. 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 78% of its PV-10 Value at December 31, 1999, allowing
substantial control over the incurrence and timing of capital and operating
expenditures.
The Company hopes to continue the expansion of its real estate
business, primarily in the southwestern United States. However, the
expansion will depend, to a large extent on Red Oak's ability to
restructure its current debt, or sell equity to reduce its highly leveraged
capital structure. Red Oak is currently experiencing financial
difficulties and is having problems meeting its operating and debt service
obligations as they become due. Red Oak's financial difficulties stem
largely from lagging rents, non-cash producing leveraged assets, and its
highly leveraged capital structure in general. 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,
lessening its financial difficulties.
Southwest
General. Since inception, the Company has focused on increasing its
reserves and average daily production of oil and gas through acquisitions
of producing properties and development drilling and production enhancement
activities. However, due to the severe depression experienced throughout
the oil and gas industry which started in the last quarter of 1997 and
extended through the first half of 1999, the Company is experiencing
financial difficulties in servicing it's highly leveraged capital
structure, and therefore, is limited in its ability to make acquisitions or
participate in developmental drilling and production enhancement
activities.
Private Placement. On October 14, 1997, Southwest completed a $200
million private placement 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. Proceeds from the
Offering were used to among other things, provide approximately $72 million
for an oil and gas acquisition and approximately $22 million for working
capital. 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").
<PAGE>
Exchange Offer. On March 11, 1998, Southwest concluded a registered
offering to exchange the Series A Notes for 10.5% Series B Senior Notes due
2004, which had been registered under the Securities Act ("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.
An integral part of Southwest's 1997 business strategy in conjunction
with the 10.5% Senior note issuance, involved the successful investment of
the approximately $27 million of additional working capital into both the
development and exploitation of its existing oil and gas properties and the
possible acquisition of additional producing oil and gas properties. It was
imperative to increase production volumes to meet the ongoing cash flow
needs and requirements of the Company. Southwest had made substantial
capital expenditures of $16.7 million and $32.1 million for 1996 and 1995
respectively and had budgeted additional capital spending of approximately
$45 million for the remainder of 1997 and 1998. Management believed that
the successful investment of the additional working capital would have
increased production levels thereby supplying additional cash flow to the
Company to meet requirements and continue to fund additional capital
expenditure projects.
In the last quarter of 1997, oil and gas prices began a dramatic
decrease that continued throughout the first half of 1999. In response,
early in 1998, Southwest implemented an alternate budget that limited
capital investment into the planned developmental and acquisition projects
and eventually suspended almost all investment as prices continued to
decrease and remained depressed.
Throughout 1998 and 1999, Southwest continually reduced expenditures
including corporate general and administrative and lease operating
expenses. General and administrative expenses decreased 40% from 1998 to
1999 and 26% from 1997 to 1998. The average oil and gas operating expense
was $5.22/Boe in 1999, a decrease from $7.03/Boe in 1998. Southwest also
initiated and completed $5.6 and $5.7 million in sales of non-strategic and
relatively high cost oil and gas properties in 1999 and 1998, respectively,
to effectively expand margins and increase efficiencies.
The harsh decline in commodity pricing experienced by the Company
throughout 1998 and the first half of 1999, has had a double impact on
Southwest's cash flow by severely reducing proceeds associated with current
production levels and reducing Southwest's investment into undeveloped
reserves. The inability to replace the existing, depleting reserve base
ultimately and systematically creates lower revenues and margins.
As net revenues fell due to declining price and production, an
increasingly larger portion of the Company's cash flow was necessary to
meet debt interest expense. As prices remained depressed, the existing
cash balance was depleted in an effort to meet current debt interest
requirements.
As opposed to the originally budgeted $45 million of capital
investment, only approximately $10 million was invested for development,
exploration, and acquisitions in 1998 with only $3.7 million being invested
in 1999. Without the ability to follow the original investment strategy
and thereby increase production, Southwest's cash flow will probably be
inadequate to meet its needs and requirements in 2000 and beyond.
Drilling Activities. The Company has historically complemented it's
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 1999, the Company invested
approximately $3.2 million on developmental activity as compared to $7.9
million in 1998.
Exploratory Activities. The Company decreased its spending for
exploratory activities from $834,000 in 1998 to $76,000 in 1999.
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."
<PAGE>
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, 1999, Red Oak owned and
managed fifteen shopping centers, six office buildings and raw land held
for future development.
Red Oak's primary objective has historically been 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 focused its
activities primarily in secondary markets in the southwestern United
States, including San Antonio, Austin, Abilene, Midland and San Angelo,
Texas; Tucson, Arizona; and Tulsa and Oklahoma City, Oklahoma.
From December 1993 through December 31, 1999, Red Oak completed the
acquisition of fifteen regional shopping centers and eight office buildings
for a total acquisition cost of $129.4 million.
Red Oak is currently experiencing financial difficulties. Red Oak has
generated losses for the years ended December 31, 1999, 1998 and 1997 and
is experiencing difficulties in meeting its obligations when they become
due. The capital structure of Red Oak is highly leveraged with $5.2
million and $14.8 million of principal and cash interest payments,
respectively, due in 2000. Management is currently in the process of
renegotiating the terms of Red Oak's various obligations with its lenders
and/or seeking new lenders or equity investors. Additionally, management
would consider disposing of certain assets in order to meet its
obligations.
Employees
As of December 31, 1999, the Company employed 229 people. Of this
total, 97 people were employed by Southwest and 132 by Red Oak. The
Company's future success will depend partially on its ability to attract,
retain and motivate qualified personnel in spite of its current financial
difficulties. 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 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.
The Company's ability to acquire additional oil and gas properties and
to discover reserves in the future will depend upon its ability to
restructure debt facilities and/or procure non-recourse funding as well as
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.
<PAGE>
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.
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.
<PAGE>
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 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.
<PAGE>
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.
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."
<PAGE>
Risks Associated with Business Activities
Adverse Financial Condition. The Company is currently experiencing a
period of adverse financial conditions and due to cash flow shortfalls, the
Company's auditors have added an explanatory paragraph to their report
which states their concerns about the Company's ability to continue as a
going concern. The Company incurred a net loss for the twelve months ended
December 31, 1999 of $5.4 million compared with a net loss of $96.1 million
during the twelve months ended December 31, 1998.
The Company had a stockholders' deficit of $113.2 million as of
December 31, 1999. Such deficit will likely seriously impair the Company's
ability to raise additional equity capital in the future. For further
information about financial condition, please read "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The expected shortfalls in cash flow from operating activities limit
the Company's financial flexibility, including its ability to pay interest,
to access capital markets and to acquire and develop oil and gas
properties. The expected cash flow shortfalls may also impede the
Company's ability to refinance its debt obligations in the event industry
conditions improve. For additional information on our financial condition
please read "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Item 8. Financial Statements and
Supplementary Data."
Substantial Leverage. Because of the Company's substantial level of
indebtedness, a significant portion of the Company's cash flow is dedicated
to the payment of interest. The Company cannot ensure that it will be able
to make the future payments required by it's indebtedness. As of December
31, 1999, the Company's total indebtedness was $347.1 million.
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.
During 1994 and 1995, Red Oak sold 102,000 shares of common stock
through a private placement offering for approximately $2,550,000 and
subsequently repurchased 4,000 shares at $32 per share. This stock is
redeemable at the stockholder's option at a price equal to the purchase
price of $25 per share, plus a 6% annual return computed on a cumulative,
but not compounded, basis. Redemptions are to be paid out of future
earnings of Red Oak. If there are no future earnings, redemptions will be
paid out of Red Oak's additional paid-in-capital. The redemption rights
expired on 58,384 of the shares at December 1, 1999. The remaining shares'
redemption rights will expire in March through June 2000. As of December
31, 1999, Red Oak's potential redemption liability for the remaining 39,616
shares is $1,228,096. In the event of dissolution, liquidation or winding
up Red Oak, the holders of common stock are to share ratably in all assets
remaining after payment of liabilities.
Payment Upon a Change of Control. Upon the occurrence of a "change of
control", as defined in the Indenture, 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 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.
<PAGE>
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 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 or 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.
Voting Control. As of December 31, 1999, H. H. Wommack, III, Chairman
of the Board, President and Chief Executive Officer of SRH and Southwest,
owned 73.2% 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 $15 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 Gas Prices. Revenues from the Company's
operations are highly dependent on the price of oil and gas. The markets
for oil and gas are volatile and prices for oil and gas are subject to wide
fluctuations in response to relatively minor changes in the supply of and
demand for oil and gas and a variety of additional factors that are beyond
the Company's control. These factors include the level of consumer demand,
weather conditions, domestic and foreign governmental regulations, market
uncertainty, the price and availability of alternative fuels, political
conditions in the Middle East, foreign supply of oil and gas, price of
foreign imports and overall economic conditions. It is impossible for the
Company to predict future oil and gas prices with any certainty.
In order to reduce the Company's exposure to price risks in the sale
of its oil and gas, the Company enters into hedging arrangements from time
to time. The hedging arrangements, however, only generally apply to a
portion of the Company's production and provide only limited price
protection against fluctuations in the oil and gas markets. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" and "Hedging Activities" and
"Business."
Southwest uses the full cost method of accounting for its investment
in oil and gas properties. Under the full cost method of accounting, all
costs of acquisition, exploration and development of oil and gas reserves
are capitalized into a "full cost pool" as incurred, and properties in the
pool are depleted and charged to operations using the gross revenues method
based on the ratio of current gross revenues to total proved future gross
revenues, computed based on current prices. Significant downward revisions
of quantity estimates or declines in oil and gas prices that are not offset
by other factors could result in a writedown for impairment of oil and gas
properties. Once incurred, a writedown of oil and gas properties is not
reversible at a later date, even if oil or natural gas prices increase.
During 1998, oil prices were drastically lower than prior years causing the
Company to incur a $64.0 million noncash charge. As of December 31, 1999
oil price had increased significantly over prices received during 1998,
thus no write down of capitalized costs of oil and gas properties was
deemed necessary for the year ended December 31, 1999.
<PAGE>
Replacement of Reserves. The Company may not be able to replace its
existing reserves as they are depleted. In general, the volume of
production from oil and gas properties declines as reserves are depleted.
Unless the Company acquires additional properties containing proved
reserves or conducts successful development and exploration activities on
existing properties, or both, proved reserves will decline as reserves are
depleted and, as a result, cash flow will correspondingly decline. The
Company's future oil and gas production is, therefore, highly dependent
upon its success in finding or acquiring additional reserves. Exploring
for, developing or acquiring new reserves requires substantial amounts of
capital. Because cash flow from operations has been reduced and external
sources of capital have become limited or unavailable, the Company's
ability to make the capital investments necessary to maintain or expand its
reserves has been impaired. In addition, the Company cannot ensure that
future development, acquisition and exploration activities will result in
additional proved reserves or that the Company 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 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.
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.
<PAGE>
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 operations,
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, many of these competitors have greater
financial and other resources than the Company. See "Item 1.
Business-Competition."
<PAGE>
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. 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 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.
Removal as General Partner. The limited partners have the ability to
remove the Company as the general partner of approximately 32 limited
partnerships and such removal would decrease the Company's cash flow and
proved reserves. The Company is the general partner of 32 limited
partnerships. Most of the limited partnership agreements provide that a
majority in interest of the limited partners may remove the Company as the
general partner and elect a replacement general partner. However, under
three of the limited partnership agreements the Company may only be removed
with the Company's consent. As the general partner, the Company receives
management and administrative fees from the partnerships, totaling an
aggregate of approximately $3.5 million and has an ownership interest in
each partnership. The Company's portion of partnership properties
contribute 5.1% of its proved non-producing reserves and 3.9% of PV-10
value. Therefore, the Companys removal as the general partner of some or
all of the limited partnerships would decrease its cash flow and proved
reserves. However, any losses in cash flow would be offset to some degree
by decreasing administrative and operating expense.
<PAGE>
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.
Boepd. 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.
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.
<PAGE>
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.
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.
<PAGE>
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 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 a majority of 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, 1999, the
Company operated properties comprising approximately 78% of its PV-10
Value. The following table provides information for the Company's ten
largest fields which contribute 66% of its reserves and 70% of its PV-10
Value as of December 31, 1999.
As of December 31, 1999
--------------------------------------
Net Proved PV-10 % of Total
Reserves Value PV-10
Field (Mboe) (in thousands) Value
----- ---------------------- --------
Foster 4,700 $41,698 18.23%
Huntley 3,102 $26,199 11.45%
Huntley East 2,205 $17,345 7.58%
Flying M 3,269 $16,541 7.23%
Jo-Mill 2,074 $12,810 5.60%
Halley 3,167 $12,489 5.46%
Magnolia Sealy 1,960 $12,312 5.38%
Ackerly 1,220 $9,114 3.98%
Rhoda Walker 1,026 $6,723 2.94%
Ward-Estes North 777 $5,744 2.51%
------ ------ ----
Total Top Ten Fields 23,500 $160,975 70.36%
<PAGE>
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
59.5% to 100% and operates 60 producing and 31 injection wells. Numerous
workover and development drilling opportunities exist.
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 an 87% working interest and operates
34 producing and 21 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 38 producing and 21 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 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.
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.
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 110 active
producing wells and 32 water injection wells. The field was discovered in
1937 and produces from multiple zones ranging from 2,400 to 3,000 feet in
depth. Development plans, which have commenced, include the drilling of
several proved undeveloped locations and numerous workovers.
Magnolia Sealy Field. The Magnolia Sealy Field is located in Ward
County, Texas and produces primarily form the Yates formation. Pay depths
range from 2,400' to 3,100'. The field was discovered in 1940 and sparsely
developed throughout the late 1940's. Southwest, which has an average
working interest of 90%, purchased the properties in 1988 and has drilled 9
wells to date. Results of the drilling indicate primary reserve additions
of 45 to 55 MBO per well. Additional potential exists both through
development drilling prospects and initiation of a waterflood.
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.
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
locations and infill drilling.
<PAGE>
Ward-Estes North Field. The Ward-Estes North Field is located in Ward
County, Texas and produces from the Yates, Seven Rivers, Queen and Dense
zones, which range in depth from 2,400' to 3,100'. Southwest has working
interests ranging from 52% to 98% in the field. The field was discovered
in 1933 and developed in the late 1950's. Southwest purchased the
properties in 1988 and has drilled several infill wells as well as
performing recompletions on existing wells. Several infill drill locations
remain to be exploited.
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, 1999, 1998 and 1997
have been prepared by Ryder Scott Petroleum Engineers.
As of December 31,
-----------------------------
1999 1998 1997
---- ---- ----
Proved Reserves:
Oil and Condensate (MBbls) 24,828 20,944 29,666
Natural Gas (MMcf) 65,079 58,273 64,725
Total (MBoe) 35,675 30,656 40,453
Proved Developed Reserves:
Oil and Condensate (MBbls) 16,618 12,006 18,472
Natural Gas (MMcf) 43,023 37,481 46,585
Total (MBoe) 23,789 18,253 26,236
PV-10 Value (in thousands)(1) $228,748 $ 71,900 $172,304
Discounted Future Cash Flows (2)
Future cash inflows $727,615 $315,709 $620,418
Future production and development costs (284,354) (181,627)
(303,406)
------- ------- -------
Future net cash flows before income taxes 443,261 134,082
317,012
Future income tax expense (103,067) - (59,764)
------- ------- -------
Future net cash flows, net of tax 340,194 134,082 257,248
10% annual discount for estimated
timing of cash flows (164,634) (62,182) (117,427)
------- ------- -------
Standardized measure of discounted future
net cash flows, net of tax $175,560 $ 71,900 $139,821
======= ======= ======
(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 $23.90/Bbl of oil and
$2.06/Mcf of natural gas, $10.25/Bbl of oil and $1.73/Mcf of natural gas
and $16.30/Bbl of oil and $2.11/Mcf of natural gas as of December 31, 1999,
1998 and 1997, 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.
Exploring for, developing or acquiring new reserves requires substantial
amounts of capital. Because cash flow from operations has been reduced and
external sources of capital have become limited or unavailable, the
Company's ability to make the capital investments necessary to maintain or
expand its reserves has been impaired.
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, 1999, 1998 and 1997:
As of December 31,
-----------------------------
1999 1998 1997
---- ---- ----
Production Volumes:
Oil and condensate (MBbls) 1,306 1,689 1,308
Natural gas (MMcf) 4,627 5,556 5,639
Total (MBoe) 2,077 2,615 2,248
Average Daily Production:
Oil and condensate (Bbls) 3,578 4,628 3,584
Natural Gas (Mcf) 12,677 15,222 15,449
Total (Boe) 5,691 7,165 6,159
Average Realized Prices:
Oil and condensate (per Bbl) $ 16.23 $ 12.73 $ 19.12
Natural gas (per Mcf) 2.19 1.85 2.24
Per Boe 15.09 12.16 16.75
Expenses (per Boe):
Lease operating (including production taxes)$ 5.22 $ 7.03 $
8.23
Oil and gas depletion 2.36 5.97 5.52
General and administrative, net .78 1.04 1.63
<PAGE>
Producing Wells. The following table sets forth the number of
productive wells in which Southwest owned an interest as of December 31,
1999:
Gross Net
Wells Wells
------ ------
Oil 6,650 513
Natural Gas 681 66
----- ---
Total 7,331 579
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, 1999:
Gross Net
------ ------
Developed 1,703,000 200,000
Undeveloped 546,000 59,000
--------- -------
Total 2,249,000 259,000
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.
Drilling Activities. The table below sets forth the drilling activity
of Southwest on its properties for the periods ending December 31, 1999,
1998 and 1997.
Year Ended December 31,
-----------------------------------
1999 1998 1997
-------------------- ----------
Gross Net Gross Net GrossNet
-------------------- ----------
Development wells:
Productive 12 5.1 15 5.7 53 27.3
Non-productive 1 .9 1 .5 3 2.4
-- ---- -- --- -- ---
Total 13 6.0 16 6.2 56 29.7
Exploratory wells:
Productive - - 7 2.5 10 3.3
Non-productive - - 1 1.0 4 1.4
-- ---- -- --- -- ---
Total - - 8 3.5 14 4.7
<PAGE>
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 1999, 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.
Southwest, from time to time, uses option contracts to mitigate the
volatility of price changes on commodities Southwest produces and sells as
well as to lock in prices to protect the economics related to certain
capital projects.
On July 9, 1999, Southwest entered into a commodity swap agreement to
hedge a portion of its crude oil sales. The agreement is for a notional
amount of 1,000 BBls of oil a day with a strike price of $20.22, based on
West Texas Intermediate - NYMEX. The contract is for the period August 1,
1999 through October 31, 1999. At the option of the counter-party the
contract has been extended to January 31, 2000.
On December 30, 1999, Southwest entered into a basket revenue
protection agreement, which provides the Company with an oil and gas
revenue floor. The contract is for the period January 1, 2000 through
December 31, 2000. The agreement is to be calculated on a calendar year
quarter as disclosed in the following table based on NYMEX Natural Gas and
NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas Boe Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.80 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues.
<PAGE>
Red Oak Properties
As of December 31, 1999, Red Oak owned and managed fifteen shopping
centers, six 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 35,748
The Plaza Tulsa, OK 116,889
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 105,749
Crossroads San Antonio, TX 710,724
Northcross Mall Austin, TX 298,762
Victoria Mall Victoria, TX 632,466
Office Building
----------------
Independence Plaza Midland, TX 148,417
50 Penn Place Oklahoma City, OK 311,363
La Placita Village Tucson, AZ 216,446
Reunion Center Tulsa, OK 89,265
Century Plaza Midland, TX 95,443
405 N. Marienfeld Midland, TX 20,750
Land Acres
------ --------
Red Oak (residential) Midland, TX 398.3
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 materially 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 December 31, 1999, 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 December 31, 1999, 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 Revolving Loan Facility Agreement
dated December 29, 1999 with Bank One, Texas, N.A. (the "Revolving Loan
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
Revolving Loan 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%
Series B, Senior Notes due 2004, 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 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,
1999 1998 1997 (a) 1996 1995
------- --------- ------- ------- -------
(in thousands, except per share data)
Consolidated Income Statement Data:
Operating revenues:
Oil and gas $ 31,425 $ 32,467 $ 38,500 $ 33,787 $ 21,211
Well service - - 7,789 8,013 4,218
Real estate 31,301 25,650 9,338 4,487 3,213
Other 1,206 1,392 1,227 614 344
------ ------ ------ ------ ------
Total operating revenue 63,932 59,509 56,854 46,901 28,986
------ ------ ------ ------ ------
Operating expenses:
Oil and gas 10,833 18,395 18,500 14,846 11,511
Well service - - 5,600 6,145 3,315
Real estate 18,374 13,242 4,138 1,887 1,414
General and administrative 3,109 4,450 5,745 5,436 3,504
Depreciation, depletion and
amortization 9,987 19,240 15,034 8,430 6,719
Impairment of oil and gas
properties - 64,000 - - -
Other 798 1,235 1,342 554 228
------- ------ ------ ------ ------
Total operating expenses 43,101 120,562 50,359 37,298 26,691
------- ------ ------ ------ ------
Operating income (loss) 20,831 (61,053) 6,495 9,603 2,295
------- ------ ------ ------ ------
Other income (expense):
Interest expense (41,910) (36,490) (18,894) (10,016) (5,635)
Interest income 954 1,478 1,002 441 269
Other 952 370 145 561 (78)
------- ------ ------ ------ ------
(40,004) (34,642) (17,747) (9,014) (5,444)
------- ------ ------ ------ ------
Income (loss) before income
taxes, minority interest,
equity loss and
extraordinary item (19,173) (95,695) (11,252) 589 (3,149)
Income tax benefit (provision) - 2,348 2,641 (365) 1,044
Minority interest in
subsidiaries, net of tax 1,820 913 430 181 (15)
Equity in loss of subsidiary and
partnerships, net of tax (931) (3,620) (203) - -
Extraordinary item, net of tax 12,875 - (3,109) - -
------- ------ ------ ------ ------
Net income (loss) $ (5,409) $(96,054) $(11,493) $ 405 $ (2,120)
======= ====== ====== ====== ======
Income (loss) per common share
before extraordinary item $ (17.00) $ (89.28) $ (7.78) $ 0.42 $ (2.19)
<PAGE>
Year Ended December 31,
1999 1998 1997 (a) 1996 1995
------- --------- ------- ------- -------
(in thousands, except per share data)
Consolidated Balance Sheet Data:
Cash and cash equivalents $ 16,983 $ 13,801 $ 27,365 $ 8,284 $ 3,364
Net property and equipment 206,146 213,493 237,675 100,176 78,231
Total assets 262,167 257,550 305,443 130,284 95,434
Long-term debt, including
current portion 347,083 335,084 283,642 93,805 73,486
Consolidated Cash Flow Statement
Data:
Net cash provided by (used in)
operating activities (10,772) (5,976) 6,034 10,280 5,634
Net cash used in investing
activities (1,124) (56,283) (173,902) (33,225) (44,532)
Net cash provided by
financing activities 15,078 48,695 186,949 27,865 39,166
(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,
1999 1998 1997 1996 1995
------- -------- ------- ------- -------
Production volumes:
Oil and condensate (Mbbls) 1,306 1,689 1,308 1,001 814
Natural gas (MMcf) 4,627 5,556 5,639 5,403 4,639
Total (MBoe) 2,077 2,615 2,248 1,901 1,587
Average daily production:
Oil and condensate (Bbls) 3,578 4,628 3,584 2,735 2,230
Natural gas (Mcf) 12,677 15,222 15,449 14,762 12,709
Total (Boe) 5,691 7,165 6,159 5,194 4,348
Average realized prices (a):
Oil and gas condensate
(per Bbl) $ 16.23 $ 12.73 $ 19.12 $ 20.44 $ 16.40
Natural gas (per Mcf) 2.19 1.85 2.24 2.22 1.51
Per Boe 15.09 12.16 16.75 17.07 12.83
Expenses (per Boe):
Lease operating(including
production taxes) $ 5.22 $ 7.03 $ 8.23 $ 7.81 $ 7.25
Oil and gas depletion 2.36 5.97 5.52 3.38 3.19
Oil and gas general and
administrative, net (b) .78 1.04 1.63 1.28 1.20
(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.
<PAGE>
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. SRH has grown over the last
several years primarily through acquisitions in each of its businesses.
On October 14, 1997, Southwest completed a $200 million private
placement of 10.5% Senior Notes due 2004, to among other things, provide
approximately $72 million for acquisitions and approximately $22 million of
working capital. An integral part of the Southwest business strategy in
conjunction with the 10.5% Senior Note issuance, involved the successful
investment of the additional working capital into both the development and
exploitation of its existing oil and gas properties and the acquisition of
additional producing oil and gas properties. It was imperative to increase
production volumes to meet the necessary ongoing cash flow needs and
requirements of Southwest. The successful investment of the additional
working capital would dramatically increase production levels thereby
supplying additional cash flow to Southwest to meet requirements and
continue to fund additional capital expenditure projects.
In the last quarter of 1997, oil and gas commodity prices began a
dramatic decrease that continued throughout 1998 and into the first half of
1999. In response, early in 1998, Southwest implemented its alternate
budget that limited capital investment into the planned developmental and
acquisition projects and eventually suspended almost all investment as
prices continued to decrease and remained depressed. As opposed to the
originally budgeted $45 million of capital investment, only approximately
$10 million was invested for development, exploration and acquisitions in
1998, with only $3.7 million being invested in 1999.
Throughout 1998, as oil and gas prices remained depressed, Southwest
continually reduced expenditures including corporate general and
administrative and lease operating expenses. On a per unit of production
basis, Southwest has reduced lease operating expenses to $5.22/Boe in 1999
from $7.03/Boe in 1998, due primarily to management efforts to cut expenses
through more efficient operations and by selectively eliminating high
operating expense properties from its oil and gas portfolio. Southwest
also reduced general and administrative expenses to $.78/Boe in 1999 from
$1.04/Boe in 1998, primarily due to staff reductions initiated by Southwest
early in the oil price downturn. Southwest also initiated and completed
$5.6 million and $5.7 million in sales of non-strategic and relatively high
cost oil and gas properties in 1999 and 1998, respectively, to effectively
expand margins, increase efficiencies, and supply additional working
capital.
The harsh decline in commodity pricing experienced by the Company
throughout 1998 and the first half of 1999, has had a double impact on
Southwest's cash flow by severely reducing proceeds associated with current
production levels and reducing Southwest's investment into undeveloped
reserves. The inability to replace the existing, depleting reserve base
ultimately and systematically creates lower revenues and margins.
<PAGE>
As net revenues fell due to these circumstances of declining price and
production, an increasingly larger portion of cash flow was necessary to
meet debt interest expense.
Southwest uses the full cost method of accounting for its investment
in oil and gas properties. Under the full cost method of accounting, all
costs of acquisition, exploration and development of oil and gas reserves
are capitalized into a "full cost pool" as incurred, and properties in the
pool are depleted and charged to operations using the gross revenues method
based on the ratio of current gross revenues to total proved future gross
revenues, computed based on current prices. Significant downward revisions
of quantity estimates or declines in oil and gas prices that are not offset
by other factors could result in a writedown for impairment of oil and gas
properties. Once incurred, a writedown of oil and gas properties is not
reversible at a later date, even if oil or natural gas prices increase.
During 1998, oil prices were drastically lower than prior years causing the
Company to incur a $64.0 million noncash charge. As of December 31, 1999
oil price had increased significantly over prices received during 1998,
thus no write down of capitalized costs of oil and gas properties was
deemed necessary for the year ended December 31, 1999.
The severe decrease in the commodity prices has drastically affected
revenue and cash flows from operations received by Southwest. The
resulting inability to successfully employ the initial business and
investment plan of Southwest, which was to be initiated immediately after
the $200 million 10.5% Senior Note issuance, and the necessary use of cash
balances and operating cash flows to meet debt interest obligations
therefrom, makes it probable Southwest will not be able to meet its
operating and debt obligations in 2000 and beyond, unless Southwest can
successfully restructure its debt obligations.
Southwest has a highly leveraged capital structure with,
approximately, $16.2 million of cash interest and $35.1 million of
principal due at December 31, 1999. Subsequent to year end, Southwest drew
down the remaining $15.0 million on the Revolving Loan Facility, as a
result, $17.5 million of cash interest payments and $50.1 million of
principal will be due in 2000 (See Note 18). The majority of the cash
interest relates to the 10.5% Senior Notes and the Revolving Loan Facility.
Due to severely depressed commodity prices experienced throughout 1998 and
the first half of 1999, Southwest is experiencing difficulty in generating
sufficient cash flow to meet its obligations and sustain its operations.
Management is attempting to renegotiate the terms of Southwest's
obligations with its note holders and/or attempting to seek new lenders or
equity investors. Additionally, management would consider disposing of
certain assets in order to meet its obligations.
Red Oak. Red Oak acquires and manages 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. As of December 31,
1999, Red Oak owned and managed fifteen shopping centers, six office
buildings and raw land held for future development. Red Oak's revenue,
profitability and cash flows are substantially dependent upon the ability
of Red Oak to lease its properties on economically favorable lease terms.
Red Oak is currently experiencing financial difficulties. Red Oak has
generated losses for the years ended December 31, 1999, 1998 and 1997 and
is experiencing difficulties in meeting its obligations when they become
due. The capital structure of Red Oak is highly leveraged with $5.2
million and $14.8 million of principal and cash interest payments,
respectively, due in 2000. Management is currently in the process of
renegotiating the terms of Red Oak's various obligations with its lenders
and /or seeking new lenders or equity investors. Additionally, management
would consider disposing of certain assets in order to meet its
obligations.
Sierra. Effective July 1, 1997 Sierra was deconsolidated from SRH's
financial statements and SRH has subsequently accounted for its ownership
in Sierra as an investment in an unconsolidated subsidiary, consistent with
the equity method of accounting under GAAP. As such, comparisons of
Sierra's revenue and expenses for the years ended December 31, 1999, 1998
and 1997 are not relevant, and therefore, no discussion of such results of
operations are provided herein.
<PAGE>
Results of Operations
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
The following table summarizes production volumes and average sales
prices for SRH's oil and gas operations, including the effect on revenues,
for the periods indicated:
Year Ended 1999 Compared
December 31, to 1998
----------------- ---------------------
% Revenue
Increase Increase
1999 1998 (Decrease)(Decrease)
------ ------ --------- ---------
(in thousands)
Production volumes:
Oil and condensate (MBbls) 1,306 1,689 (23%) $(6,220)
Natural gas (MMcf) 4,627 5,556 (17%) (2,034)
Average sales prices:
Oil and condensate (per Bbl) $ 16.23 $ 12.73 27% $
5,912
Natural gas (per Mcf) 2.19 1.85 18% 1,889
Revenues. Revenues for SRH increased 7% to $63.9 million in 1999 from
$ 59.5 million in 1998.
Oil and gas revenue decreased 3% to $31.4 million in 1999 from $32.5
million in 1998. The decrease in oil and gas revenue is due primarily to
decreases in oil and gas production which were offset by increases in oil
and gas sales prices during 1999. Increases in oil and gas prices resulted
in increased oil and gas revenues of approximately $7.8 million which were
offset by decreased oil and gas production of $8.3 million and a decline of
other oil and gas partnership distributions of approximately $584,000.
Oil and gas production decreased 21% or approximately 1,500 BOEPD, to
5,700 BOEPD in 1999 from approximately 7,200 BOEPD in 1998. In an ongoing
effort to increase the Company's cash position and reduce the number of
high operating expense properties in its oil and gas portfolio, management
has sold oil and gas properties for approximately $5.6 and $5.7 million in
1999 and 1998, respectively. The production decline resulting from oil and
gas property sales was approximately 1,000 BOEPD, or approximately 14% of
the total decline. The remainder of the production decline of
approximately 7% is mostly results of natural decline. The average sales
price per barrel of oil was $16.23 and the average sales price of natural
gas was $2.19/Mcf in 1999, representing a 27% and 18% increase,
respectively, compared to 1998 sales price levels.
Real estate revenues increased 22% to $31.3 million in 1999 from $25.6
million in 1998. The increase in real estate revenues is due primarily to
several acquisitions made late in the second quarter of 1998 and
subsequent. Other operating revenues decreased 13% to $1.2 million in 1999
from $1.4 million in 1998.
Operating Expenses. Operating expenses, before general and
administrative expense, impairment of oil and gas properties, depreciation,
depletion and amortization, decreased 9% to $30.0 million in 1999 from
$32.9 million in 1998.
<PAGE>
Oil and gas operating expense decreased approximately 41% to $10.8
million in 1999 from $18.4 million in 1998. The decrease is due primarily
to management's efforts to cut expenses through more efficient operations,
and by selectively eliminating high operating expense properties from its
oil and gas portfolio. Property sales accounted for approximately $4.0
million of the decline. The average operating expense decreased 26% to
$5.22/Boe in 1999, from $7.03/Boe 1998.
Real estate operating expense increased approximately 39% to $18.4
million in 1999 from $13.2 million in 1998. The increase in real estate
operating expenses is due primarily to several acquisitions made late in
the second quarter of 1998 and subsequent. Other operating expenses
decreased 35% to $798,000 in 1999 from $1.2 million in 1998.
General and Administrative ("G&A") Expense. G&A expense for the
Company decreased 30% to $3.1 million in 1999 from $4.4 million in 1998.
Oil and gas G&A expense decreased 40% to $1.6 million in 1999 from $2.7
million in 1998, and averaged $.76/Boe in 1999, a 27% decrease compared to
$1.04/Boe in 1998. The oil and gas G&A decline is predominately due to the
reduction in salary expense because of property sales and restructuring of
duties. Real estate G&A expense decreased 12% to $1.6 million in 1999 from
$1.8 million in 1998. The decrease in real estate G&A relates primarily to
charges incurred during the later part of 1998 for travel and other
professional services associated with a non consummated refinance.
Depreciation, Depletion and Amortization ("DD&A") Expense. DD&A
expense for SRH decreased 48% to $10.0 million in 1999 from $19.2 million
in 1998. Oil and gas DD&A expense decreased 67% to $5.4 million in 1999
from 16.1 million in 1998 and on a Boe basis, decreased 58% to $2.60/Boe in
1999 from $6.16/Boe in 1998. The decrease in DD&A expense on an overall
basis and/Boe is due primarily to the reduction in the carrying value of
SRH's oil and gas properties because of the impairment of approximately
$64.0 million, which was recorded during 1998. Real estate DD&A expense
increased 53% to $4.5 million in 1999 from $2.9 million in 1998 due to the
impact of acquisitions.
Interest Expense. Interest expense for SRH increased 15% to $41.9
million in 1999 from $36.5 in 1998. Oil and gas interest expense remained
relatively constant at $22.4 million in 1999 as compared to $22.5 million
in 1998. Real estate interest expense increased 41% to $19.7 million for
1999 from $14.0 million in 1998. The Real estate interest expense
increases were due to additional debt used to finance acquisitions and
operations.
Equity in Loss of Subsidiary. Equity in Loss of Subsidiary resulted
in a charge of $931,000 of which, $744,000 was a non-cash charge for the
impairment of the equity investment in Sierra recognized in 1999. This
amount relates to SRH's 39% direct and indirect investment in Sierra.
Net Income (Loss). Due to the factors described above, net loss for
SRH decreased 94% to $5.4 million in 1999 from $96.1 in 1998. Oil and gas
net income was approximately $7.3 million in 1999 as compared to a net loss
of $88.4 million in 1998. Included in the oil and gas net income for 1999
is an extraordinary gain associated with the repurchase of approximately
19% of the original issue, $200 million face 10.5% senior notes issued in
October of 1997, of approximately $14.5 million. Real estate net losses
increased 122% to $13.0 million in 1999 from $5.9 million in 1998.
Included in the Real estate net loss for 1999 is an extraordinary loss of
$1.6 million associated with the write off of deferred debt costs related
to a portion of MROR's debt which was refinanced in 1999.
<PAGE>
Results of Operations
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
The following table summarizes production volumes and average sales
prices for SRH's oil and gas operations, including the effect on revenues,
for the periods indicated:
Year Ended 1998 Compared
December 31, to 1997
----------------- ---------------------
% Revenue
Increase Increase
1998 1997 (Decrease)(Decrease)
------ ------ --------- ---------
(in thousands)
Production volumes:
Oil and condensate (MBbls) 1,689 1,308 29% $ 7,285
Natural gas (MMcf) 5,556 5,639 (1%) (186)
Average sales prices:
Oil and condensate (per Bbl) $ 12.73 $ 19.12 (33%) $
(10,793)
Natural gas (per Mcf) 1.85 2.24 (17%) (2,167)
Revenues. Consolidated revenues for SRH increased $2.7 million, or
5%, for the year ended December 31, 1998. An increase in revenues at Red
Oak was partially offset by a decrease in revenues at Southwest and Sierra,
which was deconsolidated July 1, 1997.
Oil and gas revenues decreased $6.0 million, or 16%, from 1997 to
1998, due primarily to decreases in oil and gas sales prices during 1998.
Oil production increased 29% for the year while gas production decreased
1%. The increase in oil production is due principally to the full-year
effect in 1998 of a large oil and gas acquisition in October 1997. Changes
in production added $7.1 million to Southwest's revenues. The average
sales price per barrel of oil was $12.73 and the average sales price of
natural gas was $1.85/Mcf in 1998, representing a 33% and 17% decrease,
respectively, compared to prior year sales price levels. These lower oil
and gas prices resulted in a $13.0 million decrease in Southwest's
revenues, offsetting the revenue increase due to increased production.
Real estate revenues increased $16.3 million, or 175%, in 1998
compared to the prior year, due primarily to acquisitions completed in the
last half of 1997 and in 1998. Other operating revenues increased
$165,000.
Operating Expenses. Operating expenses, before general and
administrative expense, impairment of oil and gas properties, depreciation,
depletion and amortization increased $3.3 million, or 11%, in 1998. The
increase is due primarily to acquisition-related growth in SRH's real
estate business, and is partially offset by lower expenses due to the
deconsolidation of Sierra from SRH on July 1, 1997.
Oil and gas operating expense decreased $105,000, or 1%, in 1998, due
primarily to management efforts to cut expenses through more efficient
operations, and by selectively eliminating high operating expense
properties from its oil and gas portfolio. The average operating expense
was $7.03/Boe in 1998, a decrease of 15% from $8.23/Boe for the same period
in 1997.
Real estate operating expense increased $9.1 million, or 220%, for
1998, due primarily to acquisitions. Other operating expenses decreased
$107,000.
<PAGE>
General and Administrative ("G&A") Expense. Consolidated G&A expense
for SRH decreased $1.3 million, or 23%, for 1998. The decrease is due
primarily to the deconsolidation of Sierra from SRH, which contributed $1.3
million of G&A expense in the first half of 1997. Oil and gas G&A expense
decreased approximately $942,000, or 26%, in 1998 compared to 1997, and
averaged $1.04/Boe in 1998, a 36% decrease compared to 1997, due primarily
to reductions in oil and gas technical and administrative staff in response
to significant decreases in oil and gas prices experienced in the last
quarter of 1997 and in 1998. Real estate G&A expense increased $533,000,
or 41%, in 1998 due primarily to administrative staff increases
necessitated by Red Oak's growth during the year.
Depreciation, Depletion and Amortization ("DD&A") Expense.
Consolidated DD&A expense for SRH increased $4.2 million, or 28%, for the
year ended December 31, 1998 due to growth in each of SRH's businesses.
Oil and gas DD&A expense increased approximately $3.3 million, or 26%, in
1998, compared to the prior year. Oil and gas depletion was $5.97/Boe in
1998, an increase of 8% compared to 1997. The increase in oil and gas DD&A
expense on an overall basis and per Boe is due primarily to a decrease in
oil and gas price used in the year-end reserve reports for 1998 compared to
1997, which resulted in a higher depletion rate under the units of revenue
method. Real estate DD&A expense increased approximately $2.1 million, or
261%, in 1998 compared to 1997, attributable primarily to the impact of
acquisitions.
Impairment of Oil and Gas Properties. As of December 31, 1998, the
net capitalized cost exceeded the estimated present value of Southwest's
oil and gas reserves, thus SRH incurred a non-cash charge of $64.0 million
in 1998.
Interest Expense. Consolidated interest expense for SRH increased
$17.6 million, or 93%, in 1998, primarily as a result of increased
borrowings incurred to fund a portion of SRH's acquisitions and oil and gas
development. Oil and gas interest expense increased approximately $10.2
million, or 83%, as a result of increased borrowings for development
drilling and acquisitions made in the fourth quarter of 1997 and in 1998.
Real estate interest expense increased $7.6 million, or 121%, due to
increased borrowing with proceeds used to finance acquisitions as compared
to the prior years. As evidenced by the 93% increase in interest expense,
SRH is extremely leveraged with approximately 61% of its total operating
revenues being used to service interest expense. Based on current
commodity prices, production, rent revenues and current structure, SRH
probably will not be able to make interest payments and meet its operating
and capital needs as they become due beyond 1999.
Other Income (Expense). Other income (expense) increased $225,000, or
155%, due primarily to the sale of land held for investment by Red Oak.
Equity in Loss of Subsidiary and Partnerships. Equity in Loss of
Subsidiary and Partnerships resulted in a net charge $3.6 million for 1998.
Net Income. Due to the factors described above, consolidated net
income for SRH decreased $84.6 million to a loss of $96.1 million for the
year ended December 31, 1998. Included in the $96.1 million loss for the
year ended December 31, 1998 was a non-cash charge of $64.0 million for the
writedown of oil and gas properties.
<PAGE>
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 capital
expenditures or acquisitions will require additional equity or financing
and will be dependent upon financing arrangements available at the time.
The significant decrease in oil and gas prices experienced during the last
quarter of 1997 and extending through the first half of 1999, has severely
limited cash flow from operations, depleted working capital and rendered
most other financing sources unavailable, or if available, on very
unattractive terms to the Company. Based on current commodity prices,
production, rent revenues and its highly leveraged position, the Company
probably will not be able to meet operating and debt obligations in 2000
and beyond.
Management is constantly monitoring the Company's cash position and
its ability to meet its financial obligations as they become due, and in
this effort, is exploring various strategies for addressing its current and
future liquidity needs. During 1999 and 1998, for instance, Southwest sold
$5.6 million and $5.7 million, respectively, of oil and gas properties in
an ongoing effort to decrease its production costs and improve its cash
position and also negotiated a $50 million revolving line of credit with
BankOne Texas, N.A. the proceeds of which were used to purchase in December
1999 and January 2000, approximately $76.3 million of the 10.5% Senior
Notes due 2004. As of December 31, 1999, SRH's consolidated cash balance
was $27.0 million, of which $21.4 million was available to Southwest.
SRH financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The consolidated financial
statements do not include any adjustments relating to the recoverability
and classification of liabilities that might be necessary should SRH be
unable to continue as a going concern.
SRH has a highly leveraged capital structure with, approximately,
$30.8 million of cash interest and $40.3 million of principal due at
December 31, 1999. Subsequent to year end, SRH drew down the remaining
$15.0 million on the Revolving Loan Facility. As a result, $32.1 million
of cash interest payments and $55.3 million of principal will be due in
2000 (See Note 18). Due to severely depressed commodity prices experienced
throughout 1998 and into the first half of 1999, and lagging rental
property utilization, SRH is experiencing difficulty in generating
sufficient cash flow to meet its obligations and sustain its operations.
Management is currently in the process of renegotiating the terms of SRH's
various obligations with its note holders and/or attempting to seek new
lenders or equity investors. Additionally, management would consider
disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's debt restructuring efforts will
be successful or that the note holders will agree to a course of action
consistent with SRH's requirements in restructuring the obligations. Even
if such agreement is reached, it may require approval of additional note
holders, or possibly, agreements of other creditors of SRH, none of which
is assured. Furthermore, there can be no assurance that the sales of
assets can be successfully accomplished on terms acceptable to SRH. Under
current circumstances, SRH's ability to continue as a going concern depends
upon its ability to (1) successfully restructure its Revolving Loan
Facility, the 10.5% Senior Notes and other obligations or obtain additional
financing as may be required, (2) maintain compliance with all debt
covenants, (3) generate sufficient cash flow to meet its obligations on a
timely basis, and (4) achieve satisfactory levels of future earnings. If
SRH is unsuccessful in its efforts, it may be unable to meet its
obligations on the Revolving Loan Facility, the 10.5% Senior Notes, as well
as other obligations, making it necessary to undertake such other actions
as may be appropriate to preserve asset values.
Cash flow information for Sierra is reported through June 30, 1997,
the date prior to its deconsolidation from SRH, but for periods thereafter,
cash flow information has been reported using the equity method of
accounting under GAAP.
<PAGE>
Net Cash Provided By (Used By) Operating Activities. SRH's operating
activities used cash flow of $10.4 million, $6.0 million and provided cash
flow of $6.0 million in 1999, 1998 and 1997, respectively. SRH's ability
to generate cash flow from operating activities is severely restricted due
to its highly leveraged capital structure.
Net Cash Used in Investing Activities. Cash flows used in SRH's
investing activities were $1.1 million, $56.3 million and $173.9 million
for 1999, 1998 and 1997, respectively. Oil and gas and commercial real
estate acquisitions and development activities were the primary uses of
funds in each year.
The following table sets forth capital expenditures, including
acquisitions, made by SRH during the periods indicated.
Year Ended December 31,
-----------------------------------
1999 1998 1997
----- ----- -----
(in thousands)
Oil and gas properties
Development $ 3,195 $ 7,897 $ 19,639
Exploration 76 834 2,769
Acquisitions 417 1,315 80,797
Oil and gas other 233 618 1,135
Real estate 6,723 53,411 53,626
Other 306 433
236
------ ------- -------
Total $ 10,950 $ 64,508 $158,202
====== ======= =======
In response to SRH's highly leveraged capital structure and its
limited working capital, SRH has initiated a short-term alternate business
plan that delays certain development and exploratory projects until oil and
gas industry conditions improve. Based on this plan, SRH has tentatively
budgeted $8 million in capital expenditures at Southwest for oil and gas
development projects. This budget is subject to change based on financial
strategies currently being developed, including hedging strategies,
divestitures and debt restructuring, as well as the level of oil and gas
prices in the future.
Net Cash Provided by Financing Activities. Cash provided by SRH's
financing activities, on a consolidated basis, was $14.8 million (including
additional net borrowings of $14.9 million), $48.7 million (including
additional net borrowings of $49.1 million) and $186.9 million (including
additional net borrowings of $185.0 million and $1.0 million from issuance
of additional equity securities) for 1999, 1998 and 1997, respectively.
Net cash provided by financing activities was primarily used to fund the
purchase of a portion of the 10.5% Senior Notes due 2004 and to refinance
and fund real estate activities. Net cash provided by financing activities
was primarily used to fund real estate activities in 1998.
Senior Notes due 2004. In October 1997, Southwest completed a $200
million private placement of 10.5% Senior Notes due 2004. Proceeds from
the Offering were used primarily for acquisitions, repayment of debt, an
equity investment by SRH in Red Oak and for working capital. The Senior
Notes bear interest at 10.5% per annum and mature on October 15, 2004.
Revolving Loan Facility. In December 1999, Southwest entered into a
Revolving Loan Facility with Bank One Texas, N.A., which provided a
borrowing base of $50 million with a maturity date of December 29, 2000.
Funds from the Revolving Loan Facility may be used for working capital and
other general corporate purposes, including the repurchase of a portion of
Southwest's outstanding 10.5% Senior Notes due 2004. Advances on the
Revolving Loan Facility bear interest at the option of Southwest, based on
the prime rate of Bank One Texas, N.A. (8.5% at December 31, 1999) plus one
fourth of one percent (.25%), when the borrowing base usage is equal to or
greater than 80% or zero percent (0%) when the borrowing base usage is less
than 80% or, a Eurodollar rate (substantially equal to the London InterBank
Offered Rate ("LIBOR")) plus 1.25% up to 2.0% based on the borrowing base
usage percentage. The Revolving Loan Facility is secured by no less than
85% of Southwest's oil and gas properties. As of December 31, 1999, the
company has drawn $35.0 million. The remaining $15.0 million was drawn in
January 2000(See Note 18).
<PAGE>
The Revolving Loan Facility imposes certain limitations on the ability
of Southwest 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 Revolving Loan Facility required Southwest to
establish a sinking fund account with an initial deposit of $3.5 million.
Southwest is to transfer monthly one-twelfth of the annual interest
payments on the 10.5% Senior Notes beginning December 31, 1999 into this
sinking fund account for the purpose of making interest payments on the
10.5% Senior Notes.
In June 1999, MRO Southwest, Inc., a wholly owned subsidiary of Red
Oak negotiated two notes payable in the amount of $97.5 million and $8.0
million, net of discounts of $5.3 million. Borrowings for both notes accrue
interest in arrears at a rate per annum equal to the greater of 8.6% or
LIBOR plus 360 basis points. The interest rate includes a servicing fee of
.10%. Approximately $91.4 million of the $97.5 million note was used to
retire existing debt on properties contributed to MRO Southwest by Red Oak,
$1.5 million was deposited into various restricted cash accounts and the
remaining proceeds were used for general corporate purposes. The $8.0
million note is for capital improvements to rental property and $3.4
million has not been utilized as of December 31, 1999. The notes are
collateralized by the properties owned by MRO Southwest. The notes impose
certain restrictive covenants including restrictions on the incurrence of
additional indebtedness, dissolution, termination or liquidation of all or
substantially all of the assets, changes in the legal structure of the
assets, making any loans or advances to any third party and commingling its
assets with the assets of any of its affiliates or of any other person or
entity.
Hedging Activities. Southwest, from time to time, uses option
contracts to mitigate the volatility of price changes on commodities
Southwest produces and sells as well as to lock in prices to protect the
economics related to certain capital projects.
On July 9, 1999, Southwest entered into a commodity swap agreement to
hedge a portion of its crude oil sales. The agreement is for a notional
amount of 1,000 BBls of oil a day with a strike price of $20.22, based on
West Texas Intermediate - NYMEX. The contract is for the period August 1,
1999 through October 31, 1999. At the option of the counter-party the
contract has been extended to January 31, 2000.
On December 30, 1999, Southwest entered into a basket revenue
protection agreement, which provides the Company with an oil and gas
revenue floor. The contract is for the period January 1, 2000 through
December 31, 2000. The agreement is to be calculated on a calendar year
quarter as disclosed in the following table based on NYMEX Natural Gas and
NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas BOE Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.80 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues.
Other Issues
Year 2000 Issues
SRH has initially incurred no significant problems related to the Year
2000 issue. However, SRH has not yet fully utilized all functions and
processes of its systems and accordingly cannot be sure that all its
systems will be free of Year 2000 issues. Also, SRH has no assurance that
its "critical business partners", or governmental agencies or other key
third parties, have not incurred Year 2000 issues that may affect SRH.
<PAGE>
Derivative Instruments and Hedging Activities.
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133") which established standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement
of financial position and measure those instruments at fair value. It
establishes conditions under which a derivative may be designated as a
hedge, and establishes standards for reporting changes in the fair value of
a derivative. SFAS 133, as amended by SFAS 137, is required to be
implemented for all fiscal quarters of all fiscal years beginning after
June 15, 2000. Early adoption is permitted.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The following quantitative and qualitative information is provided
about financial instruments to which the Company is a party as of December
31, 1999, and from which the Company may incur future earnings gains or
losses from changes in market interest rates or commodity prices.
Quantitative Disclosures
Interest rate sensitivity. The following table provides information
about the Company's debt obligations which are sensitive to changes in
interest rates. The table presents cash maturities by expected maturity
dates together with the weighted average interest rates expected to be paid
on the debt, given current contractual terms and market conditions. For
fixed rate debt, the weighted average interest rate represents the
contractual fixed rates that the Company is obligated to periodically pay
on the debt; for variable rate debt, the average interest rate represents
the average rates being paid on the debt at December 31, 1999.
As of December 31, 1999
2000 2001 2002 2003 2004Thereafter Total
Fair Value
---- ---- ---- ---- -------------- -----
- ----------
Total Debt
maturities $40,277 $ 41,412$ 101,926 $ 391 $ 160,680 $
2,397 $ 347,083 $ 276,420
Fixed rate debt $3,741 $ 42 $ 28 $ 19 $ 160,615 $ 873 $
165,318 $ 94,655
Weighted average
interest rate 10.49% 10.49% 10.49% 10.49% 10.49%
8.04%
Variable rate debt $36,536 $ 41,370$ 101,898 $ 372 $ 65 $ 1,524
$ 181,765 $181,765
Average interest rate 8.96% 10.06% 9.39% 9.37% 9.37%
9.37%
Commodity price sensitivity. See Notes 1 and 13 of Notes to
Consolidated Financial Statements included in "Item 8. Financial
Statements and Supplementary Data" for a description of the accounting
procedures followed by SRH relative to hedge derivative financial
instruments and for specific information regarding the terms of the
Company's derivative financial instrument which is sensitive to changes in
natural gas and crude oil commodity prices.
<PAGE>
On July 9, 1999, Southwest entered into a commodity swap agreement to
hedge a portion of its crude oil sales. The agreement is for a notional
amount of 1,000 BBls of oil a day with a strike price of $20.22, based on
West Texas Intermediate - NYMEX. The contract is for the period August 1,
1999 through October 31, 1999. At the option of the counter-party the
contract has been extended to January 31, 2000.
On December 30, 1999, Southwest entered into a basket revenue
protection agreement, which provides the Company with an oil and gas
revenue floor. The contract is for the period January 1, 2000 through
December 31, 2000. The agreement is to be calculated on a calendar year
quarter as disclosed in the following table based on NYMEX Natural Gas and
NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas BOE Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.80 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues.
Qualitative Disclosures
Non-derivative financial instruments. The Company is a borrower under
fixed rate and variable rate debt instruments that give rise to interest
rate risk. The Company's objective in borrowing under fixed or variable
rate debt is to satisfy capital requirements while minimizing the Company's
costs of capital. To realize its objectives, the Company borrows under
fixed and variable rate debt instruments, based on the availability of
capital and market conditions. See Note 7 of Notes to Consolidated
Financial Statement included in "Item 8. Financial Statements and
Supplementary Date" for a discussion relative to the Company's debt
instruments.
Derivative financial instruments. Revenues from the Company's
operations are highly dependent on the price of oil and gas. The markets
for oil and natural gas are volatile and prices for oil and gas are subject
to wide fluctuations in response to relatively minor changes in the supply
of and demand for oil and gas and a variety of additional factors that are
beyond SRH's control. These factors include the level of consumer demand,
weather conditions, domestic and foreign governmental regulations, market
uncertainty, the price and availability of alternative fuels, political
conditions in the Middle East, foreign imports and overall economic
conditions. It is impossible for SRH to predict future oil and gas prices
with any certainty. In order to reduce the Company's exposure to oil and
gas price risks, from time to time the Company enters into commodity price
derivative contracts to hedge commodity price risks.
As of December 31, 1999, the Company's primary risk exposures
associated with financial instruments to which it is a party include
natural gas and crude oil price volatility and interest rate volatility.
The Company's primary risk exposures associated with financial instruments
have not changed significantly since December 31, 1999.
<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' Report 42
Consolidated Balance Sheets as of December 31, 1999 and 1998 43
Consolidated Statements of Operations for the Years Ended
December 31, 1999, 1998 and 1997 45
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1999, 1998 and 1997 47
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997 48
Notes to Consolidated Financial Statements 50
<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, 1999
and 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1999. 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, 1999
and 1998, and the results of their operations and their cash flows for each
of the years in the three-year period ended December 31, 1999, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed
in Note 2 to the consolidated financial statements, the Company is
experiencing difficulty in generating sufficient cash flow to meet its
obligations and sustain its operations which raises substantial doubt about
its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 2. The consolidated financial
statements do not include any adjustments that might result from the
outcome of this uncertainty.
KPMG LLP
Midland, Texas
March 15, 1999
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
December 31,
------------------------
ASSETS 1999 1998
- ---------------------------------------------------------- ----- -----
Current assets
Cash and cash equivalents $ 16,983 $ 13,801
Restricted cash 10,003 5,050
Accounts receivable, net of allowance of
$440 and $342, respectively 7,134 5,248
Receivables from related parties 836 1,594
Other current assets 1,179 1,624
------- -------
Total current assets 36,135 27,317
------- -------
Oil and gas properties, using the full cost
method of accounting
Proved 193,319 194,096
Unproved 2,059 3,230
------- -------
195,378 197,326
Less accumulated depletion, depreciation
and amortization 126,742 121,841
------- -------
Oil and gas properties, net 68,636 75,485
------- -------
Rental property, net 128,685 132,120
------- -------
Rental property - construction in progress 3,984 -
------- -------
Other property and equipment, net 4,841 5,888
------- -------
Other assets
Equity investment in subsidiary and partnerships -
931
Real estate investments 3,644 4,019
Deferred debt costs, net of accumulated
amortization of $5,681 and $3,136, respectively 13,816
8,725
Noncompete covenants, net of accumulated
amortization of $563 and $269, respectively 1,041 1,335
Other, net 1,385 1,730
------- -------
Total other assets 19,886 16,740
------- -------
Total assets $262,167 $257,550
======= =======
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - (continued)
(in thousands, except per share data)
December 31,
LIABILITIES, MINORITY INTEREST, REDEEMABLE ------------------------
COMMON STOCK AND STOCKHOLDERS' EQUITY 1999 1998
- ---------------------------------------------------------- ----- -----
Current liabilities
Current maturities of long-term debt $ 40,277 $ 12,716
Accounts payable 6,011 7,116
Accounts payable to related parties 867 173
Accrued expenses 10,670 9,737
------- -------
Total current liabilities 57,825 29,742
------- -------
Long-term debt 306,806 322,368
------- -------
Other long-term liabilities 1,220 1,797
------- -------
Minority interest 8 206
------- -------
Redeemable common stock of subsidiary 1,228 2,979
------- -------
Redeemable common stock 8,290 8,290
------- -------
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, 1999
and 1998 116 116
Additional paid-in capital 2,196 2,196
Accumulated deficit (110,784) (105,375)
Note receivable from an officer and stockholder (1,648)
(1,679)
Less: treasury stock - at cost; 214,215 shares at
December 31, 1999 and 1998 (3,090) (3,090)
------- -------
Total stockholders' deficit (113,210) (107,832)
------- -------
Total liabilities, minority interest, redeemable
common stock and stockholders' equity $262,167 $257,550
======= =======
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 December 31,
----------------------------------
1999 1998 1997
----- ----- -----
Operating revenues
Oil and gas $ 31,425 $ 32,467 $ 38,500
Well servicing, including related party
revenues of $0, $0 and $8,
respectively - - 7,789
Real estate 31,301 25,650 9,338
Other 1,206 1,392 1,227
--------- --------- ---------
Total operating revenues 63,932 59,509 56,854
--------- --------- ---------
Operating expenses
Oil and gas production 10,833 18,395 18,500
Well servicing - - 5,600
Real estate 18,374 13,242 4,138
General and administrative, net of
related party management and
administrative fees of $3,515, $3,789
and $3,538, respectively 3,109 4,450 5,745
Depreciation, depletion and amortization 9,987 19,240
15,034
Impairment of oil and gas properties - 64,000
- -
Other 798 1,235 1,342
--------- --------- ---------
Total operating expenses 43,101 120,562 50,359
--------- --------- ---------
Operating income (loss) 20,831 (61,053) 6,495
--------- --------- ---------
Other income (expense)
Interest and dividend income 954 1,478 1,002
Interest expense (41,910) (36,490) (18,894)
Other 952 370 145
--------- --------- ---------
(40,004) (34,642) (17,747)
--------- --------- ---------
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS - (continued)
(in thousands, except per share data)
For the years ended December 31,
----------------------------------
1999 1998 1997
----- ----- -----
Loss before income taxes, minority
interest, equity loss and extraordinary
item (19,173) (95,695) (11,252)
Income tax benefit - 2,348 2,641
--------- --------- ---------
Loss before minority interest,
equity loss and extraordinary item (19,173) (93,347) (8,611)
Minority interest in subsidiaries,
net of tax 1,820 913 430
Equity loss in subsidiary and
partnerships, net of tax (931) (3,620) (203)
--------- --------- ---------
Loss before extraordinary item (18,284) (96,054) (8,384)
Extraordinary gain (loss) from early
extinguishment of debt, net of tax 12,875 -
(3,109)
--------- --------- ---------
Net Loss $(5,409) $(96,054) $(11,493)
========= ========= =========
Loss per common share
Loss per common share before
extraordinary item $ (17.00) $ (89.28) $ (7.78)
Extraordinary gain (loss) from early
extinguishment of debt, net of tax 11.97 -
(2.88)
--------- --------- ---------
Loss per common share $ (5.03) $ (89.28) $ (10.66)
========= ========= =========
Weighted average shares outstanding 1,075,868 1,075,868 1,077,808
========= ========= =========
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, 1999, 1998 and 1997
(in thousands, except share data)
Note
Common StockAdditional ReceivableTreasury Stock
--------------Paid-InAccumulated from ---------------
Shares AmountCapital DeficitStockholderShares Amount
------- ------------- ---------------------------------
- -
Balance -
January 1, 19971,160,537 $116 $2,196 $ 2,172 $(1,735)204,575 $(2,508)
Stock option exercised 500 - - - - - -
Payments received on
note 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)
Payments received on
note receivable - - - - 28 - -
Net loss - - - (96,054) - - -
--------- ---- ----- ------- ------ ------- ------
Balance -
December 31, 19981,161,037 116 2,196 (105,375) (1,679)
214,215 (3,090)
Payments received on
note receivable - - - - 31 - -
Net loss - - - (5,409) - - -
--------- ---- ----- ------- ------ ------- ------
Balance -
December 31, 19991,161,037 $ 116 $ 2,196 $ (110,784) $ (1,648)
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 December 31,
----------------------------------
1999 1998 1997
----- ----- -----
Cash flows from operating activities
Net loss $ (5,409) $(96,054) $(11,493)
Adjustments to reconcile net
loss to net cash provided by (used in)
operating activities:
Depreciation, depletion and amortization 9,987 19,240
15,034
Impairment of oil and gas properties - 64,000
- -
Noncash interest expense 6,344 2,963 1,311
Extraordinary (gain) loss from early
extinguishment of debt (12,875) - 1,411
Gain (Loss) on sale of assets (167) (275) 84
Equity in loss of subsidiary and
partnerships 187 3,620 203
Impairment of equity investment 744 - -
Other noncash items 329 3 (176)
Amortization of lease commissions 525 184 -
Bad debt expense 438 501 241
Deferred income taxes - (2,348) (2,606)
Minority interest in loss of subsidiary (1,820) (913)
(430)
Changes in operating assets and liabilities-
Accounts receivable (1,704) 3,709 (6,029)
Other current assets 60 (226) (594)
Deferred lease costs (398) (773) (402)
Accounts payable and accrued expenses (512) 166
6,612
Accrued interest payable (853) 227 2,898
Income taxes payable - - (30)
Change in restricted cash (5,284) - -
------- ------- -------
Net cash provided by (used in) operating
activities (10,408) (5,976) 6,034
------- ------- -------
Cash flows from investing activities
Proceeds from sale of oil and gas properties 5,575 5,706
1,538
Purchase of oil and gas properties (3,688) (10,046) (103,205)
Purchase of other property and equipment
and rental property (3,277) (54,462) (61,645)
Purchase of other assets (733) (712) (3,121)
Purchase of noncompete covenants - (1,604) -
Increase in construction in progress (3,984) -
- -
Proceeds from sale of other assets 515 1,317 219
Proceeds from sale of other property,
equipment and rental property 3,446 50 209
Purchase of real estate investments - (333) (91)
Proceeds from sale of real estate investment 660 765
- -
Change in restricted cash 331 3,014 (8,064)
Other 31 22 258
------- ------- -------
Net cash used in investing activities (1,124) (56,283) (173,902)
------- ------- -------
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued)
(in thousands)
For the years ended December 31,
----------------------------------
1999 1998 1997
----- ----- -----
Cash flows from financing activities
Proceeds from borrowings 144,740 54,589 309,870
Payments on debt (120,388) (3,877) (113,381)
Decrease in other long-term liabilities (52) (12)
(1,325)
Cash received on subscriptions receivable - -
2,807
Purchase of treasury stock - - (582)
Deferred debt costs (8,546) (1,576) (9,842)
Issuance of redeemable common stock, net
of issue costs - - 32
Net proceeds from sale of subsidiaries
common stock - - 1,007
Prepayment penalty on early
extinguishment of debt (887) - (341)
Dividends paid to minority interest owners (121) (120)
(122)
Purchase of minority interest in subsidiary - (309)
- -
Purchase of treasury stock by subsidiary (32) -
(1,174)
------- ------- -------
Net cash provided by financing activities 14,714 48,695
186,949
------- ------- -------
Net increase (decrease) in unrestricted
cash and cash equivalents 3,182 (13,564) 19,081
Unrestricted cash and cash equivalents -
beginning of period 13,801 27,365 8,284
------- ------- -------
Unrestricted cash and cash equivalents -
end of period $ 16,983 $ 13,801 $27,365
======= ======= =======
Supplemental disclosures of cash flow
information
Interest paid $ 36,419 $ 31,695 $14,802
The accompanying notes are and integral part of these
consolidated financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Business
Southwest Royalties Holdings, Inc. ("SRH"), a Delaware corporation was
formed in June 1997 to serve as a holding company for Southwest Royalties
Inc. ("Southwest"), Sierra Well Service Inc. ("Sierra") and Midland Red Oak
Realty, Inc. ("Red Oak") (collectively, the "Company"). Each shareholder
of Southwest was issued one share in SRH for each share of Southwest stock
held. Prior to the formation of SRH, Red Oak and Sierra were subsidiaries
of Southwest. Southwest paid a dividend of the shares it owned in Red Oak
and Sierra to SRH. After the formation of SRH, Southwest and Red Oak became
subsidiaries of SRH and, as of July 1, 1997, Sierra was deconsolidated.
Southwest is principally involved in the business of oil and gas
development and production, 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. As of December 31, 1999 and 1998, the Company owned
approximately 81% of Red Oak, 39% of Sierra, 100% of Blue Heel, 99% of MSS
and 100% and 98%, respectively, of TPI. Blue Heel, MSS and TPI are
subsidiaries of Southwest. Effective July 1, 1997, Sierra was
deconsolidated and is accounted for using the equity method (see Note 4).
Effective November 1999, TPI was liquidated. 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 over 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>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Restricted Cash
Restricted cash represents amounts required to be reserved in separate
accounts by financial lenders. The interest sinking fund is cash set aside
to pay interest on the 10.5% Senior Notes.
Restricted cash accounts have been established for the following
purposes (in thousands):
1999 1998
---- ----
Cash bonds $ 35 -
Certificate of Deposits 112 105
Tenant security deposits 512 412
Interest reserves - 707
Capital expenditures account 552 1,229
Tax and insurance reserve 2,465 1,009
Tenant bankruptcy reserve - 767
Lockbox 439 217
Customer service reserve 10 10
Escrow fund 627 594
Interest sinking fund 5,251 -
------ -----
$10,003 5,050
====== =====
Real Estate Revenue Recognition
The Company leases offices and retail shopping centers under
noncancelable operating leases. The Company reports base rental revenue
for financial statement purposes straight-line over the terms of the
respective leases. Accrued straight-line rents represent the amount that
straight-line rental revenue exceeds rents collected in accordance with the
lease agreements. Management, considering current information and events
regarding the tenants' ability to fulfill their lease obligations,
considers accrued straight-line rents to be impaired if it is probable that
the Company will be unable to collect all rents due according to the
contractual lease terms. If accrued straight-line rents associated with a
tenant are considered to be impaired, the amount of the impairment is
measured based on the present value of expected future cash flows.
Impairment losses, if any, are recorded through a loss on the write-off of
assets. Cash receipts on impaired accrued straight-line rents are applied
to reduce the remaining outstanding balance and as rental revenue,
thereafter.
Some leases provide for percentage rents based on the tenant's
revenue. Percentage rents are accrued monthly based on prior experience or
current tenant financial information. Some leases require tenants to
reimburse the Company for certain expenses of operating the property.
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 Company has only limited involvement with derivative financial
instruments and generally does not use them for trading purposes. They are
used to manage commodity price risks. The Company is exposed to credit
losses in the event of nonperformance by the counter-parties to its
commodity hedges. The Company anticipates, however, that such counter-
parties will be able to fully satisfy their obligations under the
contracts. The Company does not obtain collateral or other security to
support financial instruments subject to credit risk but monitors the
credit standing of the counter-parties.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The derivative 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 or payable under the commodity option
contracts are accrued as an increase or decrease 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.
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.
As of December 31, 1999, no write down of the capitalized costs of oil and
gas properties was deemed necessary. As of December 31, 1998, the net
capitalized cost exceeded the estimated present value of oil and gas
reserves resulting in a noncash charge of $64.0 million. Once incurred, a
writedown of oil and gas properties is not reversible at a later date, even
if oil or natural gas prices increase.
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 fluctuation of
oil and gas prices or production. Depletion estimates would also be
affected by such changes.
Property and 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 years
Leasehold improvements 2 to 10 years
Machinery and equipment 3 to 5 years
Furniture and fixtures 3 to 5 years
Equipment under capital lease 3 to 5 years
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Rental Property - Construction in Progress
All costs associated with construction in progress are capitalized and
subject to depreciation when each project is completed. Interest is
capitalized for construction in progress. The capitalized interest is
recorded as part of the asset to which it relates and is amortized over the
assets useful life. In 1999 and 1998, no interest costs were capitalized.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
In accordance with the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, the Company reviews its long-lived assets, excluding oil and gas
properties accounted for using the full cost method of accounting, and
certain identifiable intangibles for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. In this circumstance, the Company recognizes an impairment
loss for the amount by which the carrying amount of the asset exceeds the
estimated fair value of the asset.
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.
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, 1999, 1998 and 1997,
the Company was underproduced by approximately 587 MMcf, 620 MMcf and 697
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 1998 and 1997 amounts
to conform to the 1999 presentation.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133") which established standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement
of financial position and measure those instruments at fair value. It
establishes conditions under which a derivative may be designated as a
hedge, and establishes standards for reporting changes in the fair value of
a derivative. SFAS 133, as amended by SFAS 137, is required to be
implemented for all fiscal quarters of all fiscal years beginning after
June 15, 2000. Early adoption is permitted.
Income (loss) per share
Basic net income (loss) per share is computed by dividing income
available to common stockholders by the weighted average number of common
shares outstanding for the period. The computation of diluted net income
(loss) per share 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 would then share in the earnings of the entity. For 1999, 1998 and
1997, the computation of diluted net loss per share was antidilutive;
therefore, the amounts reported for basic and diluted net income (loss) per
share were the same.
Noncompete covenants
Noncompete covenants are carried at cost less accumulated
amortization. The covenants are being amortized over their contractual
lives, generally three to five years.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
2. Liquidity
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and
the satisfaction of liabilities in the normal course of business. The
consolidated financial statements do not include any adjustments relating
to the recoverability and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
SRH has a highly leveraged capital structure with, approximately,
$30.8 million of cash interest and $40.3 million of principal due at
December 31, 1999. Subsequent to year end, SRH drew down the remaining
$15.0 million on the Revolving Loan Facility. As a result, $32.1 million
of cash interest payments and $55.3 million of principal will be due in
2000 (See Note 18). Due to severely depressed commodity prices experienced
throughout 1998 and into the first half of 1999, and lagging rental
property utilization, SRH is experiencing difficulty in generating
sufficient cash flow to meet its obligations and sustain its operations.
Management is currently in the process of renegotiating the terms of SRH's
various obligations with its note holders and/or attempting to seek new
lenders or equity investors. Additionally, management would consider
disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's debt restructuring efforts will
be successful or that the note holders will agree to a course of action
consistent with SRH's requirements in restructuring the obligations. Even
if such agreement is reached, it may require approval of additional note
holders, or possibly, agreements of other creditors of SRH, none of which
is assured. Furthermore, there can be no assurance that the sales of
assets can be successfully accomplished on terms acceptable to SRH. Under
current circumstances, SRH's ability to continue as a going concern depends
upon its ability to (1) successfully restructure its Revolving Loan
Facility, the 10.5% Senior Notes and other obligations or obtain additional
financing as may be required, (2) maintain compliance with all debt
covenants, (3) generate sufficient cash flow to meet its obligations on a
timely basis, and (4) achieve satisfactory levels of future earnings. If
SRH is unsuccessful in its efforts, it may be unable to meet its
obligations on the Revolving Loan Facility, the 10.5% Senior Notes, as well
as other obligations, making it necessary to undertake such other actions
as may be appropriate to preserve asset values.
3. 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. 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. The redemption rights
expired on 58,384 of the redeemable common shares on December 1, 1999. The
remaining shares' redemption rights will expire in March through June of
2000.
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. In April 1997 Red Oak
purchased the interest of the unrelated third party and merged the
subsidiary into Red Oak.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
On October 14, 1997, Southwest 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 for $72.3 million.
Southwest operates 133 of these wells. Southwest funded this acquisition
through the issuance of 10.5% Senior Notes (see Note 7). 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.
In June 1998, Red Oak acquired a retail shopping center in Texas for
$13.5 million. The acquisition was financed by the variable note payable
due July 2001 described in Note 7. The operations of the retail shopping
center from the date of acquisition through December 31, 1998 have been
included in the Consolidated Statement of Operations for the year ended
December 31, 1998.
In December 1998, Red Oak acquired a retail shopping center in Texas
for $21.0 million. The acquisition was financed by the variable note
payable due December 2001 described in Note 7. The operations of the
retail shopping center from the date of acquisition through December 31,
1998 have been included in the Consolidated Statement of Operations for the
year ended December 31, 1998.
4. Equity Investment in Subsidiary and Partnerships
As of December 31, 1999, the investment in subsidiary held by the
Company consists of a 28% direct ownership interest in Sierra as well as an
additional 11% indirect interest the Company obtained through limited
partnerships, Southwest Partners II and Southwest Partners III, for which
Southwest serves as the managing general partner. The investment is
accounted for using the equity method. A Financial Institution owns
preferred stock in Sierra, which can be converted to common stock at the
Financial Institutions option. If the Financial Institution elects to
convert its preferred stock to common stock, the Companys direct ownership
would decrease to 20% and its indirect ownership would decrease to 7%.
Effective July 1, 1997, Southwest Partner III purchased additional shares
of Sierra stock, decreasing Southwest's total direct and indirect ownership
percentage below 50%. 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>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Pertinent financial information for Sierra Well Service, Inc. as of
December 31, 1999 and 1998 and for the years ended December 31, 1999 and
1998 and for the six months ended December 31, 1997 is as follows (in
thousands):
December 31, December 31,
1999 1998
---- ----
Balance Sheets
Assets $ 53,327 $ 46,861
====== ======
Liabilities $ 58,263 $ 59,891
Stockholders' deficit (4,936) (13,030)
------ ------
Total liabilities and stockholders' deficit $ 53,327
$ 46,861
====== ======
For the year For the year Six months
ended ended ended
December 31, December 31, December 31,
1999 1998 1997
---- ---- ----
Statements of Operations
Revenues $ 37,331 $ 45,319 $ 18,370
Expenses 50,732 50,944 19,163
Impairment of long lived assets - 22,671
- -
------ ------ ------
Net Income/(Loss) (13,401) (28,296) (793)
====== ====== ======
Company's share of net loss $ (931) $ (3,620) $ (203)
====== ====== ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
5. Property and Equipment
Property and equipment, including rental property and other, consists of
the following (in thousands):
Years Ended December 31,
------------------------
1999 1998
----- -----
Land $ 2,352 $ 2,287
Building and improvements 1,051 1,419
Machinery and equipment 2,896 3,048
Furniture and fixtures 1,536 2,367
Equipment under capital lease 56 93
Rental property 137,535 137,059
------- ------
145,426 146,273
Less accumulated depreciation 11,900 8,265
------- ------
$133,526 $138,008
======= ======
6. 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, 1999 (in thousands):
2000 $ 19,407
2001 15,279
2002 12,145
2003 9,207
2004 6,886
Thereafter 24,262
------
$ 87,186
======
The preceding future minimum rentals do not include percentage rents
or reimbursements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
7. Long-term Debt
Long-term debt consists of the following (in thousands):
December 31,
-------------------
1999 1998
----- -----
10.5% Senior Notes, interest payable semi-annually due
October 15, 2004, net of discount of $1,487 and $2,116,
respectively $160,598 $197,884
13.5% Notes payable, due April 2000. Cash interest of
10.5% payable monthly with additional interest payable
based on excess cash flow or through the issuance of
additional notes. Collateralized by real estate. -
72,273
Revolving Loan Facility with variable rate interest,
due December 2000. Collateralized by oil and
gas properties. 35,000 -
Variable Rate Notes Payables:
Notes payable due July 2001, accrued interest due and
payable monthly at 7.1%, per annum with additional
1% payable in cash or additional notes.
Net of discount of $944 and $1,611, respectively 15,883
13,891
Notes payable due December 2001, accrued interest due and
payable monthly at 7.1%, per annum with additional
1.5% payable in cash or additional notes.
Net of discount of $2,556 and $3,889, respectively 25,298
21,806
Notes payable due July 2002, interest at 8.5% minimum
per annum, accrued interest due and payable monthly.
Net of discount of $4,229, respectively 101,835 -
Other 8,469 29,230
------- -------
347,083 335,084
Less current maturities 40,277 12,716
------- -------
$306,806 $322,368
======= =======
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 used for working capital.
The Indenture imposes certain limitations on the ability of the
Company and its restricted subsidiaries to, among other things, incur
additional indebtedness or issue disqualified capital stock, make payments
in respect to capital stock, enter into transactions with affiliates, incur
liens, sell assets, change the nature of its business, merge or consolidate
with any other person and sell, lease, transfer or otherwise dispose of
substantially all of its properties or assets. The indenture requires the
issuer to repurchase notes under certain circumstances with the excess cash
of certain asset sales. The limitations are subject to a number of
important qualifications and exceptions. The issuer must report to the
Trustee on compliance with such limitations on a quarterly basis.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
13.5% Note Payable
In April 1997 MRO Properties Inc. ("MROP"), a 100% owned subsidiary of
Red Oak entered into a $42 million credit facility maturing in April 2000
with an institutional lender (the "MROP Facility"). The MROP Facility was
executed in order to consolidate nine mortgage loans, originally incurred
to complete the acquisition of certain Red Oak properties and to finance
the acquisition of an additional real estate property. Borrowings under
the facility bear interest at a rate of 13%, with 10% payable in cash and
the remaining 3% payable in cash or additional notes. The facility
contains a number of covenants that, among other things, restrict the
ability of MROP to incur additional indebtedness and dispose of assets.
The facility is secured by a first lien on substantially all of MROP's
properties. In September 1997, the Company negotiated an additional $30.5
million in loan proceeds which was used to acquire a retail shopping center
and office building in Oklahoma City, Oklahoma and a retail shopping center
in San Antonio, Texas. The loan is collateralized by the properties
purchased, and by properties contributed by Red Oak. This note was repaid
with a portion of the proceeds from the June 1999 Variable Rate Note
Payable.
Revolving Loan Facility
In December 1999, Southwest entered into a Revolving Loan Facility
with Bank One Texas, N.A., which provided a borrowing base of $50 million
with a maturity date of December 29, 2000. Funds from the Revolving Loan
Facility may be used for working capital and other general corporate
purposes, including the repurchase of a portion of Southwest's outstanding
10.5% Senior Notes due 2004. Advances on the Revolving Loan Facility bear
interest at the option of Southwest, based on the prime rate of Bank One
Texas, N.A. (8.5% at December 31, 1999) plus one fourth of one percent
(.25%), when the borrowing base usage is equal to or greater than 80% or
zero percent (0%) when the borrowing base usage is less than 80% or, a
Eurodollar rate (substantially equal to the London InterBank Offered Rate
("LIBOR")) plus 1.25% up to 2.0% based on the borrowing base usage
percentage. The Revolving Loan Facility is secured by no less than 85% of
Southwest's oil and gas properties. As of December 31, 1999, the company
has drawn $35.0 million. The remaining $15.0 million was drawn in January
2000(See Note 18).
The Revolving Loan Facility imposes certain limitations on the ability
of Southwest 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 Revolving Loan Facility required Southwest to
establish a sinking fund account with an initial deposit of $3.5 million.
Southwest is to transfer monthly one-twelfth of the annual interest
payments on the 10.5% Senior Notes beginning December 31, 1999 into this
sinking fund account for the purpose of making interest payments on the
10.5% Senior Notes.
Variable Rate Notes Payable
In June 1998, MRO N Cross, Inc., a wholly owned subsidiary of Red Oak
negotiated two notes payable in the amount of $13.5 million, net of a $2
million discount, and $2.5 million. The $13.5 million note was used for the
acquisition of rental property in the amount of $12.9 million with the
remaining $600,000 to be used for capital improvements to the rental
property purchased. The $2.5 million note is reserved for capital
improvements to the rental property purchased of which $1.3 million has
been utilized as of December 31, 1999. The notes are collateralized by the
property purchased.
In December 1998, MRO Commercial, Inc., a wholly owned subsidiary of
Red Oak negotiated two notes payable in the amount of $21.7 million, net of
a $4 million discount, and $9.7 million. The $21.7 million note was used
for the acquisition of a retail shopping center and the funding of various
escrow balances. The $9.7 million note is for capital improvements to the
rental property purchased of which $1.9 million has been utilized as of
December 31, 1999. The notes are collateralized by the property purchased.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
In June 1999, MRO Southwest, Inc., a wholly owned subsidiary of Red
Oak negotiated two notes payable in the amount of $97.5 million and $8.0
million, net of discounts of $5.3 million. Borrowings for both notes accrue
interest in arrears at a rate per annum equal to the greater of 8.6% or
LIBOR plus 360 basis points. The interest rate includes a servicing fee of
.10%. Approximately $91.4 million of the $97.5 million note was used to
retire existing debt on properties contributed to MRO Southwest by Red Oak,
$1.5 million was deposited into various restricted cash accounts and the
remaining proceeds were used for general corporate purposes. The $8.0
million note is for capital improvements to rental property and $3.4
million has been utilized as of December 31, 1999. The notes are
collateralized by the properties owned by MRO Southwest. The notes impose
certain restrictive covenants including restrictions on the incurrence of
additional indebtedness, dissolution, termination or liquidation of all or
substantially all of the assets, changes in the legal structure of the
assets, making any loans or advances to any third party and commingling its
assets with the assets of any of its affiliates or of any other person or
entity.
Extinguishment of Debt
In 1997, the Company repaid certain notes payable with proceeds from
the 10.5% Senior Notes. The remaining unamortized deferred debt costs
associated with these notes resulted in an extraordinary charge of
$3,109,000, net of $1,241,000 of tax benefit, or $2.88 per share.
In June 1999, MRO Southwest repaid certain notes payable with proceeds
from the aforementioned Variable Note Payable issued in June of 1999.
Prepayment penalties and the remaining unamortized deferred debt costs
associated with these notes resulted in an extraordinary charge of,
approximately, $1,598,000 or $(1.49) per share. Since there is no recorded
income tax benefits on continuing operations there is no income tax
benefits recorded on the extraordinary loss.
In December of 1999, Southwest purchased approximately 19%, or
approximately $37.9 million original face amount, of its 10.5% Senior Notes
with the proceeds from the aforementioned Revolving Loan facility.
Southwest paid approximately $22.0 million, including all fees, to purchase
the 10.5% Senior Notes and wrote off approximately $349,000 of deferred
loan issue costs and approximately $980,000 of the original issue discount
to recognize a $14.5 million extraordinary gain on the purchase of the
Notes. Southwest has not recorded any income tax benefits on continuing
operations and therefore there is no income tax expense recognized on the
extraordinary gain. The extraordinary gain per share is approximately
$13.48. Southwest purchased an additional 19% or approximately $38.4
million original face amount of its 10.5% Senior Notes in January of 2000
(See Note 18).
Aggregate maturities of all long-term debt as of December 31, 1999 are
as follows (in thousands):
2000 $ 40,277
2001 41,412
2002 101,926
2003 391
2004 160,680
Thereafter 2,397
-------
$347,083
=======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
8. Income Taxes
Income tax provision (benefit) and amounts separately allocated were
as follows (in thousands):
December 31,
----------------------------
1999 1998 1997
----- ----- -----
Loss before minority interest, equity loss
and extraordinary item $ - $(2,348) $
(2,641)
Equity loss in subsidiary - - (106)
Extraordinary loss from early extinguishment - -
(1,241)
------ ------ -----
$ - $(2,348) $
(3,988)
====== ====== =====
The U.S. Federal tax provision (benefit) attributable to loss before
income taxes, minority interest and extraordinary item consists of the
following (in thousands):
December 31,
----------------------------
1999 1998 1997
----- ----- -----
Current $ - $ - $ (35)
Benefit of net operating loss carryforward (11,307)
(14,165) (7,340)
Deferred 9,266 (20,237)
3,341
Valuation allowance 2,041 32,054 1,393
------ ------ -----
$ - $(2,348) $(2,641)
====== ====== =====
Reconciliation's between the amount determined by applying the U.S.
federal statutory rate to loss before income taxes, minority interest and
extraordinary item with the income tax provision (benefit) is as follows
(in thousands):
December 31,
----------------------------
1999 1998 1997
----- ----- -----
Computed "expected" tax expense using the
U.S. federal statutory rate $(6,488) $(34,510) $
(3,826)
Reduction in available net operating loss
carryforwards 4,944 - -
Meals and entertainment 16 16 16
Change in valuation allowance 2,041 32,054 1,156
Other (513) 92 13
------ ------ -----
Provision (benefit) for income taxes $ - $(2,348) $(2,641)
====== ====== =====
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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,
-------------------
1999 1998
Deferred tax assets: ----- -----
Net operating loss carry forwards $ 28,226 21,862
Alternative minimum tax credit carryforwards 170 170
Receivables 278 152
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 2,356
7,833
Equity investment in subsidiary 1,081 1,103
Other long term assets 2,192 1,817
Other long term liabilities 286 463
Covenant not to complete 64 57
Other 243 29
------ -------
Total gross deferred tax assets 34,896 33,486
------ -------
Less valuation allowance (34,727) (32,686)
------ -------
Total gross deferred tax assets 169 800
------ -------
Deferred tax liabilities:
Other property and equipment (158) (663)
Real estate investments - (21)
Accounts payable and accrued expenses (11) (7)
Other - (109)
------ -------
Total gross deferred tax liabilities (169) (800)
------ -------
Net deferred tax asset (liability) $ - $ -
====== =======
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, management has determined that taxable income
of Southwest will likely not be sufficient to fully utilize available
carryforwards prior to their ultimate expiration. As such, Southwest has
recorded a valuation allowance of $27,598,000 to reflect the realizability
of its net deferred tax assets. The amount of the valuation allowance
could be reduced if estimates of future taxable income during the
carryforward period are increased.
As of December 31, 1999, Southwest had net operating loss
carryforwards for U.S. federal income tax purposes of approximately
$65,180,000, which are available to offset future regular taxable income,
if any. The net operating loss carryforwards expire in various periods
from 2012 through 2017. Southwest has alternative minimum tax credit
carryforwards totaling $170,000 to offset regular income tax, which have no
scheduled expiration date.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Red Oak files an independent return exclusive of Southwest and has net
operating loss carryforwards of $17,836,000 expiring in various periods
through 2017. Based on expectations for the future, management has
determined that taxable income of Southwest will likely not be sufficient
to fully utilize available carryforwards prior to their ultimate
expiration. Approximately $7,129,000 of 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.
9. 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 $10,000 for the years ended December
31, 1999 and 1998 and $9,500 for the year ended December 31, 1997. For the
years ended December 31, 1999, 1998 and 1997, the Company matched 20% of
the employees' contributions. For the year ended December 31, 2000, 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, 1999, 1998 and 1997, the Company
contributed approximately $72,000, $61,000 and $66,000, respectively, to
the plan.
10. Redeemable Common Stock
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.
11. Stockholders' Equity
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>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
12. 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 $2,447,000 at December 31, 1999. The
total amount of limited partner unit repurchases for the years ended
December 31, 1999 and 1998 was approximately $71,000 and $287,000,
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. Other long-term liabilities at December 31, 1999 includes
$663,000 for estimated future remedial actions and cleanup costs. As of
December 31, 1999, 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.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
13. Commodity Hedging and Derivative Financial Instruments
The Company, from time to time, uses option contracts to mitigate the
volatility of price changes on commodities the Company produces and sells
as well as to lock in prices to protect the economics related to certain
capital projects.
On July 9, 1999, Southwest entered into a commodity swap agreement to
hedge a portion of its crude oil sales. The agreement is for a notional
amount of 1,000 BBls of oil a day with a strike price of $20.22, based on
West Texas Intermediate - NYMEX. The contract is for the period August 1,
1999 through October 31, 1999. At the option of the counter-party the
contract has been extended to January 31, 2000.
On December 30, 1999, Southwest entered into a basket revenue
protection agreement, which provides the Company with an oil and gas
revenue floor. The contract is for the period January 1, 2000 through
December 31, 2000. The agreement is to be calculated on a calendar year
quarter as disclosed in the following table based on NYMEX Natural Gas and
NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas Boe Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.80 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues.
14. 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 amounts paid by the
partnerships to Southwest approximated $3,515,000, $3,789,000 and
$3,538,000 for the years ended December 31, 1999, 1998 and 1997,
respectively. Included in these amounts, an affiliate of Southwest paid
management fees of approximately $136,000 and $147,000, for the years ended
December 31, 1999 and 1998, and approximately $54,000, for the six months
ended December 31, 1997. 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
$365,000, $115,000 and $155,000 for the years ended December 31, 1999, 1998
and 1997. The same affiliate performed services for Southwest that
aggregated approximately $313,000 and $131,000, for the years ended
December 31, 1999 and 1998 and approximately $47,000, for the six months
ended December 31, 1997.
15. 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.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The fair value of the Company's 10.5% Senior Notes is estimated based
on the quoted market price for the notes.
1999 1998
----- -----
Carrying Fair Carrying Fair
Amount Value Amount Value
------- ------ ------- ------
10.5% Senior notes, net discount of
$1,487 and 2,116, respectively $160,598 $89,935 $197,884 $79,154
The fair value of all other long-term debt approximates the carrying
amount as of December 31, 1999 and 1998, based on the borrowing rates
currently estimated to be available to the Company for loans with similar
terms.
The Company purchased the Basket Revenue Protection Agreement on
December 31, 1999, and therefore deems the carrying value of $638,000 to
equate to fair market value at December 31, 1999.
The carrying amount of investment in subsidiary at December 31, 1999
is recorded at zero because the investor's proportionate share of the
investee's net loss exceeded the original investment. The fair value of
SRH's investment in Sierra is undeterminable at December 31, 1999, as
Sierra is highly leveraged and is not publicly traded. If Sierra
subsequently begins to report net income, Southwest will resume applying
the equity method only after its share of net income equals the share of
net losses not recognized during the period the equity method is suspended.
16. 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 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, 1998 (see Note 4.)
1999 1998 1997
----- ----- -----
(in thousands)
Operating Revenue
Oil and gas $31,998 $ 32,599 $38,662
Well service - - 7,833
Real estate 31,301 25,650 9,338
Other and eliminations 633 1,260 1,021
------ ------ ------
$63,932 $ 59,509 $56,854
====== ====== ======
Operating profit (loss)
Oil and gas $14,146 $(68,633) $ 3,654
Well service - - 184
Real estate 6,812 7,605 3,074
Other and eliminations (127) (25) (417)
------ ------ ------
$20,831 $(61,053) $ 6,495
====== ====== ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
1999 1998 1997
----- ----- -----
(in thousands)
Interest Expense
Oil and gas $22,381 $ 22,536 $12,329
Well Service - - 184
Real Estate 19,664 13,969 6,320
Other and eliminations (135) (15) 61
------ ------- -------
$41,910 $ 36,490 $18,894
====== ======= =======
Depreciation, depletion and amortization
Oil and gas $ 5,392 $ 16,118 $12,803
Well Service - - 747
Real Estate 4,485 2,935 1,313
Other and eliminations 110 187 171
------- ------- -------
$ 9,987 $ 19,240 $15,034
======= ======= =======
Identifiable assets
Oil and gas $115,520 $ 111,876
$ 205,054
Well service - - -
Real estate 150,269 148,340 98,890
Other and eliminations (3,622) (2,666) 1,499
------- ------- -------
$262,167 $ 257,550
$ 305,443
======= ======= =======
Capital expenditures
Oil and gas properties $ 3,688 $ 10,046 $103,205
Oil and gas, other 233 618 1,135
Real estate 6,723 53,411 53,626
Other 306 433 236
------- ------- -------
$10,950 $ 64,508 $158,202
======= ======= =======
17. Condensed Issuer Financial Data
Summarized consolidated financial information for Southwest is as
follows (in thousands):
December 31,
---------------------------------
1999 1998 1997
----- ----- -----
Consolidated Balance Sheet Data:
Current assets $28,276 $ 20,486 $35,545
Net property and equipment 73,477 81,373 156,302
Other assets, net 10,814 8,417 11,789
------- ------- -------
$112,567 $ 110,276
$ 203,636
======= ======= =======
Current liabilities $46,597 $ 12,299 $14,614
Long-term debt 161,553 199,058 198,938
Other liabilities 841 1,361 1,412
Deferred income taxes - - 2,522
Minority interest 8 7 202
Stockholders deficit (96,432) (102,449)
(14,052)
------- ------- -------
$112,567 $ 110,276
$ 203,636
======= ======= =======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
December 31,
---------------------------------
1999 1998 1997
----- ----- -----
Consolidated Cash Flow Data:
Net cash provided by (used in) operating
activities $ (8,412) $(5,309) $ 4,920
Net cash provided by (used in) investing
activities 3,022 (5,803) (104,912)
Net cash provided by (used in) financing
activities 8,543 (770) 116,680
------- ------- -------
Net increase (decrease) in unrestricted
cash and cash equivalents $ 3,153 $(11,882) $16,688
======= ======= =======
Consolidated Statement of Operations Data (in thousands):
SRH SouthwestSierraRed Oak ElimConsolidated
---- ---------------------------------------
For the year ended December 31, 1999:
Operating revenues $ - $32,637 $ - $31,301 $ (6) $
63,932
Depreciation, depletion
and amortization - 5,502 - 4,485 - 9,987
Operating income (loss) (55) 14,074 - 6,812 - 20,831
Interest expense - 22,382 - 19,664 (136)
41,910
Loss before taxes, minority interest,
equity loss and extraordinary item (39) (7,623) -
(11,419) (92) (19,173)
Net income (loss) (39) 5,986 - (13,017) 1,661
(5,409)
For the year ended December 31, 1998:
Operating revenues $ - $33,879 $ - $25,650 $ 20 $
59,509
Depreciation, depletion
and amortization - 16,305 - 2,935 - 19,240
Impairment of properties - 64,000 - - - 64,000
Operating income (loss) (44) (68,614) - 7,605 -
(61,053)
Interest expense - 22,544 - 13,969 23
36,490
Loss before taxes, minority interest,
equity loss and extraordinary item (28) (89,769) -
(5,806) 92 (95,695)
Net loss (2,645) (88,425) - (5,858)
(874) (96,054)
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, minority
interest, equity loss and
extraordinary item 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)
18. Subsequent Events
In January of 2000, Southwest drew down the remaining $15.0 million on
the Revolving Loan Facility and applied the proceeds towards the purchase
of an additional 19% or approximately $38.4 million original face amount of
its 10.5% Senior Notes. Southwest paid approximately $23.0 million,
including all fees, to purchase the 10.5% Senior Notes and wrote off an
additional $349,000 of deferred loan issue costs and an additional $980,000
of the original issue discount to recognize an additional $14.0 million
extraordinary gain on the purchase of the notes. Southwest has not
recorded any income tax benefits on the continuing operations and therefore
there is no income tax expense recognized on the extraordinary gain.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
19. 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,
--------------------------------
1999 1998 1997
----- ----- -----
Acquisition of properties $ 417 $ 1,315 $ 80,797
Exploration costs 76 834 2,769
Development costs 3,195 7,897 19,639
------ ------ -------
Total costs incurred $ 3,688 $ 10,046 $103,205
====== ====== =======
Results of operations for oil and gas producing activities are as follows
(in thousands):
Years ended December 31,
--------------------------------
1999 1998 1997
----- ----- -----
Revenues $ 31,425 $ 32,467 $ 38,500
------ ------- ------
Production costs 10,833 18,395 18,500
Depletion 4,901 15,601 12,419
Impairment of oil and gas
properties - 64,000 -
------ ------- ------
15,691 (65,529) 7,581
Income tax provision 5,335 - 2,578
------- ------- ------
Results of operations from oil and
gas producing activities
(excluding corporate overhead) $ 10,356 $ (65,529) $
5,003
======= ======= ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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, 1999 assume an average
oil price of $23.90/Bbl (reflecting adjustments for oil quality and
gathering and transportation costs) and an average gas price of $2.06/Mcf
(reflecting adjustments for BTU content, gathering and transportation costs
and gas processing and shrinkage).
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 Natural Barrels of
Condensate Gas Oil Equivalent
(MBbls) (MMcf) (Mboe)
------ ------ -------
Total Proved Reserves:
Balance, January 1, 1997 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
Extensions and discoveries 27 1,526 282
Purchase of minerals-in-place 288 895 437
Sales of minerals-in-place (1,024) (6,132) (2,046)
Revisions of previous estimates (6,324) 2,815
(5,855)
Production (1,689) (5,556) (2,615)
------ ------ ------
Balance, December 31, 1998 20,944 58,273 30,656
Purchase of minerals-in-place 261 1,329 483
Sales of minerals-in-place (1,704) (2,751) (2,163)
Revisions of previous estimates 6,633 12,855 8,776
Production (1,306) (4,627) (2,077)
------ ------ ------
Balance, December 31, 1999 24,828 65,079 35,675
====== ====== ======
Total proved developed reserves
January 1, 1997 10,302 58,961 20,129
December 31, 1997 18,472 46,585 26,236
December 31, 1998 12,006 37,481 18,253
December 31, 1999 16,618 43,023 23,789
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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 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 and the year 1998, oil prices began a downward trend that
has continued throughout 1998 and the first half of 1999. A continuation
of the oil price environment experienced throughout 1998 and the first half
of 1999 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
2000 capital budget.
December 31,
---------------------------------------
1999 1998 1997
----- ----- -----
(in thousands)
Future cash inflows $ 727,615 $315,709 $ 620,418
Future production and development
costs (284,354) (181,627) (303,406)
-------- -------- --------
Future net cash flows before
income taxes 443,261 134,082 317,012
Future income tax expense (103,067) - (59,764)
-------- -------- --------
Future net cash flows 340,194 134,082 257,248
10% annual discount for estimated
timing of cash flows (164,634) (62,182) (117,427)
-------- -------- --------
Standardized measure of discounted
future net cash flows $ 175,560 $ 71,900 $ 139,821
======== ======== ========
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
The principal sources of change in the standardized measure of
discounted future net cash flows are as follows:
December 31,
---------------------------------------
1999 1998 1997
----- ----- -----
(in thousands)
Sales of oil and gas produced,
net of production costs $(20,592) $(14,072) $(20,000)
Net change in sales prices net of production
costs 116,644 (76,234) (119,553)
Extensions and discoveries, net of future
production and development costs - 1,195 3,540
Revisions to estimated future development
costs (4,059) 3,103 (4,833)
Purchases of minerals-in-place 1,866 1,334 80,690
Revisions of previous quantity estimates 60,317 (18,054)
(37,403)
Accretion of discount 7,190 17,230 25,217
Net change in income taxes (53,188) 32,483 46,887
Sales of minerals-in-place (5,685) (5,899) (384)
Changes in production rates, timing
and other 1,167 (9,007) (12,881)
------- ------- -------
103,660 (67,921) (38,720)
Discounted future net cash flows -
Beginning of period 71,900 139,821 178,541
------- ------- -------
End of period $ 175,560 $ 71,900 $ 139,821
======= ======= =======
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
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 44 Chairman, President, Chief Executive
Officer and Director
H. Allen Corey 43 Secretary and Director
Bill E. Coggin 45 Vice President and Chief Financial
Officer
J. Steven Person 41 Vice President, Marketing
Paul L. Morris 58 Director
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.
Paul L. Morris has served as a director of SRH since August 1998 and
Southwest since September 1998. Mr. Morris is President and CEO of Wagner
& Brown, Ltd., one of the largest independently owned oil and gas companies
in the United States. Prior to his position with Wagner & Brown, Mr.
Morris served as President of Banner Energy and in various managerial
positions with Columbia Gas System, Inc.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
Other key employees of Southwest and Red Oak include:
Southwest.
Jon P. Tate, age 42, 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
land manager. Mr. Tate is a member of the Permian Basin Landman's
Association.
R. Douglas Keathley, age 44, 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.
Red Oak.
W. Neil McClung, age 49, 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 40, 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>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
Item 11. Executive Compensation.
The following table sets forth certain information for fiscal years
1998 and 1999 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, 1999 and 1998. 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 Salary Bonus(2)Compensati
on(1)
- -------------------------------------------------------------------- -----
- ---------------
H. H. Wommack, III, President and Treasurer (3) 1999 $ 671,750
$ 182,303 $51,934
1998 667,026 130,006
27,345
---- ------- -------
- -------
Bill E. Coggin, Vice President and Chief 1999 175,000 67,667
4,750
Financial Officer 1998 188,219 30,387
7,180
---- ------- -------
- -------
J. Steven Person, Vice President, Marketing 1999 141,083 58,476
6,550
1998 163,589 14,540
8,036
---- ------- -------
- -------
R. Douglas Keathley, Vice President, 1999 106,800 7,257
5,511
Operations 1998 106,800 2,764
7,316
---- ------- -------
- -------
Jon Tate, Vice President, Land 1999 98,000 14,041
4,369
1998 98,719 3,514
5,343
---- ------- -------
- -------
Carried
Profit Interest in
Insurance Sharing/401(k)Oil and Gas
Name Year Premiums ContributionProperties(3)
- ------ ---- -----------------------------------
H. H. Wommack, III 1999 $ 4,550 $2,000 $ 45,384
1998 6,599 2,000 18,746
---- ----- ----- -------
Bill E. Coggin 1999 2,750 2,000 -
1998 5,180 2,000 -
---- ----- ----- -------
J. Steven Person 1999 4,550 2,000 -
1998 6,244 1,612 -
---- ----- ----- -------
R. Douglas Keathley 1999 4,550 961 -
1998 6,355 961 -
---- ----- ----- -------
Jon Tate 1999 2,690 1,679 -
1998 4,109 1,234 -
---- ----- ----- -------
(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.
In 1999 there were two non-employee directors who received $4,000 each
for their services as directors of Southwest. In 1998 there were two non-
employee directors who received $10,000 each for their services as
directors of Southwest.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
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 787,977 73.2%
c/o Southwest Royalties Holdings, Inc.
Southwest Royalties Building
407 N. Big Spring
Midland, TX 79701-4326
Paul L. Morris - -
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,
1999, the outstanding balance of this loan was $1.6 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>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
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, 1999 and 1998
Consolidated Statements of Operations from the years ended December
31, 1999, 1998 and 1997
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1999, 1998 and 1997
Consolidated Statements of Cash Flows for the years ended December 31,
1999, 1998 and 1997
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 filed an 8-K on December 31, 1999 under Item 5 "Other
Events."
<PAGE>
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.
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 Credit Agreement among Southwest Royalties, Inc., as
borrower and Bank One, Texas, N.A. and the Institutions named
herein as Banks, and Bank One, Texas as Administrative Agent
dated December 29, 1999, incorporated by reference to Exhibit 4.0
to Form 8-K/A filed December 30, 1999.
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: April 14, 2000
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/ April 14, 2000
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
-------------------------Vice President/Chief April 14, 2000
Bill E. Coggin Financial Officer
/s/ H. Allen Corey
-------------------------
H. Allen Corey Director/Secretary April 14, 2000
<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: April 14, 2000
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/ April 14, 2000
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
------------------------ Vice President/Chief April 14, 2000
Bill E. Coggin Financial Officer
/s/ H. Allen Corey
------------------------
H. Allen Corey Director/Secretary April 14, 1999
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Balance Sheet at December 31, 1999 and the Statement of Operations for the
Year Ended December 31, 1999 and is qualified in its entirety by reference
to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 26,986,000
<SECURITIES> 0
<RECEIVABLES> 7,134,000
<ALLOWANCES> (440,000)
<INVENTORY> 236,985
<CURRENT-ASSETS> 36,135,000
<PP&E> 344,788,000
<DEPRECIATION> (138,642,000)
<TOTAL-ASSETS> 262,167,000
<CURRENT-LIABILITIES> 57,825,000
<BONDS> 306,806,000
9,518,000
0
<COMMON> 116,000
<OTHER-SE> (113,326,000)
<TOTAL-LIABILITY-AND-EQUITY> 262,167,000
<SALES> 63,932,000
<TOTAL-REVENUES> 65,838,000
<CGS> 30,005,000
<TOTAL-COSTS> 43,101,000
<OTHER-EXPENSES> 9,987,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 41,910,000
<INCOME-PRETAX> (19,173,000)
<INCOME-TAX> 0
<INCOME-CONTINUING> (18,284,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 12,875,000
<CHANGES> 0
<NET-INCOME> (5,409,000)
<EPS-BASIC> (5.03)
<EPS-DILUTED> (5.03)
</TABLE>
