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FILED PURSUANT TO
RULE 424(b)(1)
FILE NO: 33-41915
PROSPECTUS
SOUTHWEST ROYALTIES, INC.
OFFER TO EXCHANGE
10 1/2% SERIES B SENIOR NOTES DUE 2004
THAT HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED
FOR ALL OUTSTANDING 10 1/2% SERIES A SENIOR NOTES DUE 2004
PAYMENT FULLY AND UNCONDITIONALLY GUARANTEED ON A SENIOR BASIS BY
SOUTHWEST ROYALTIES HOLDINGS, INC.
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M. NEW YORK CITY TIME,
30 DAYS AFTER THE EFFECTIVE DATE OF THE REGISTRATION STATEMENT.
Southwest Royalties, Inc., a Delaware corporation ("Southwest" or the
"Issuer"), and Southwest Royalties Holdings, Inc., a Delaware corporation
("SRH"), and the parent of the Issuer, hereby offer, upon the terms and
conditions set forth in this Prospectus and the accompanying letter of
transmittal (the "Letter of Transmittal," and together with this Prospectus,
the "Exchange Offer"), to exchange $1,000 principal amount of its 10 1/2%
Series B Senior Notes due 2004 of the Issuer and which are fully and
unconditionally guaranteed on a senior basis by SRH (the "Exchange Notes"),
which have been registered under the Securities Act of 1933, as amended (the
"Securities Act"), pursuant to a Registration Statement (as defined) of which
this Prospectus constitutes a part, for each $1,000 principal amount of its
outstanding 10 1/2% Series A Senior Notes due 2004 of the Issuer and which are
fully and unconditionally guaranteed on a senior basis by SRH (the "Old
Notes"), of which $200,000,000 principal amount is outstanding. The form and
terms of the Exchange Notes are identical in all material respects to the form
and terms of the Old Notes except for certain transfer restrictions and
registration rights relating to the Old Notes. The Exchange Notes will
evidence the same debt as the Old Notes and will be issued under and be
entitled to the benefits of the Indenture (as defined). The Exchange Notes and
the Old Notes are collectively referred to herein as the "Notes."
The Notes are senior obligations of the Issuer, ranking pari passu in right
of payment with all existing and future senior Indebtedness (as defined) and
senior to all existing or future Subordinated Indebtedness (as defined) of the
Issuer. The Notes are fully and unconditionally guaranteed by SRH (the "Parent
Guarantee") on a senior basis. The Parent Guarantee is secured by a pledge of
the common stock of Midland Red Oak Realty, Inc. and Sierra Well Service, Inc.
owned directly by SRH. Such collateral may be released under certain
circumstances. See "Description of Notes--Collateral."
The Notes, the Guarantee and any Subsidiary Guarantee will be effectively
subordinated to: (i) the Southwest Credit Facility, which is secured by
substantially all of Southwest's oil and gas properties, and (ii) all other
secured indebtedness of SRH and Southwest. At September 30, 1997, on a pro
forma basis after giving effect to the Offering and the application of the
proceeds therefrom, SRH and Southwest would have had $88.2 million in
indebtedness that ranks pari passu and senior to the Exchange Notes. The Notes
are redeemable at the option of the Issuer at any time on or after October 15,
2001. In addition, if SRH or the Issuer consummate a Public Equity Offering on
or before October 15, 2000 the Issuer may use a portion of the proceeds to
redeem up to $70,000,000 aggregate principal amount of the Notes
SEE "RISK FACTORS" BEGINNING ON PAGE 19 FOR A DISCUSSION OF CERTAIN FACTORS
THAT SHOULD BE CONSIDERED IN EVALUATING AN INVESTMENT IN THE NOTES.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus is February 9, 1998
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The Issuer and SRH will accept for exchange any and all Old Notes that are
validly tendered on or prior to 5:00 p.m., New York City time, on the date the
Exchange Offer expires, which will be 30 days after the effective date of the
Registration Statement, unless the Exchange Offer is extended. See "The
Exchange Offer--Expiration Date; Extensions; Amendments." Tenders of Old Notes
may be withdrawn at any time prior to 5:00 p.m., New York City time, on the
business day prior to the Expiration Date (as defined), unless previously
accepted for exchange. The Exchange Offer is not conditioned upon any minimum
principal amount of Old Notes being tendered for exchange. However, the
Exchange Offer is subject to certain conditions which may be waived by the
Issuer and SRH and to the terms and provisions of the Registration Rights
Agreement (as defined). Old Notes may be tendered only in denominations of
$1,000 principal amount and integral multiples thereof. The Issuer and SRH
have agreed to pay the expenses of the Exchange Offer. See "Exchange Offer."
The Exchange Notes will bear interest at the rate of 10 1/2% per annum,
payable semi-annually on April 15 and October 15 of each year, commencing on
April 15, 1998. Interest on the Exchange Notes will accrue from (A) the later
of (i) the last interest payment date on which interest was paid on the Notes
surrendered in exchange therefor; or (ii) if the Notes are surrendered for
exchange on a date in a period which includes the record date for an interest
payment date to occur on or after the date of such exchange and as to which
interest will be paid, the date of such interest payment date or (B) if no
interest has been paid on the Notes, from the date of the original issuance of
the Notes, October 14, 1997. Interest on the Old Notes accepted for exchange
will cease to accrue upon issuance of the Exchange Notes.
The Old Notes were sold by the Issuer and SRH on October 14, 1997 to the
Initial Purchasers (as defined) in a transaction not registered under the
Securities Act in reliance upon Section 4(2) of the Securities Act. The Old
Notes were thereupon offered and sold by the Initial Purchasers only to
"qualified institutional buyers" (as defined in Rule 144A under the Securities
Act). Accordingly, the Old Notes may not be offered, resold or otherwise
transferred unless registered under the Securities Act or unless an applicable
exemption from the registration requirements of the Securities Act is
available. The Exchange Notes are being offered hereunder in order to satisfy
the obligations of the Issuer and SRH under the Registration Rights Agreement
entered into with the Initial Purchasers in connection with the offering of
the Old Notes. See "Exchange Offer" and "Exchange and Registration Rights
Agreement."
Based on no-action letters issued by the staff of the Securities and
Exchange Commission (the "Commission" or "SEC") to third parties, including
EXXON CAPITAL HOLDINGS CORPORATION, SEC No-action Letter (available April 13,
1989), MORGAN STANLEY & CO. INC., SEC No-action Letter (available June 5,
1991) (the "Morgan Stanley Letter") and MARY KAY COSMETICS, INC., SEC No-
action Letter (available June 5, 1991), the Issuer and SRH believe that the
Exchange Notes issued pursuant to the Exchange Offer maybe offered for resale,
resold and otherwise transferred by the respective holders thereof (other than
a "Restricted Holder," being (i) a broker-dealer who purchased Old Notes
exchanged for such Exchange Notes directly from the Issuer and SRH to resell
pursuant to Rule 144A or any other available exemption under the Securities
Act or (ii) a person that is an affiliate of the Issuer and SRH within the
meaning of Rule 405 under the Securities Act), without compliance with the
registration and prospectus delivery provisions of the Securities Act,
provided that such Exchange Notes are acquired in the ordinary course of such
holder's business and such holder is not participating in, and has no
arrangement with any person to participate in, the distribution (within the
meaning of the Securities Act) of such Exchange Notes. Eligible holders
wishing to accept the Exchange Offer must represent to the Issuer and SRH that
such conditions have been met. Holders who tender Old Notes in the Exchange
Offer with the intention to participate in the distribution of the Exchange
Notes may not rely upon the Morgan Stanley Letter or similar no-action
letters. See "Exchange Offer." Each broker-dealer that receives Exchange Notes
for its own account pursuant to the Exchange Offer must acknowledge that it
will deliver a prospectus in connection with any resale of such Exchange
Notes. The Letter of Transmittal states that by so acknowledging and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act. This Prospectus,
as it may be amended or supplemented from time to time, may be used by a
broker-dealer in connection with resales of Exchange Notes received in
exchange for Old Notes where such Exchange Notes were acquired by such broker-
dealer as a result
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of market-making activities or other trading activities. The Issuer and SRH
have agreed that, starting on the Expiration Date and ending on the close of
the business 180 days after the Expiration Date, it will make this Prospectus
available to any broker-dealer for use in connection with any such resale. See
"Plan of Distribution." A broker-dealer which delivers such a prospectus to
purchasers in connection with such resales will be subject to certain of the
civil liability provisions under the Securities Act and will be bound by the
provisions of the Registration Rights Agreement (including certain
indemnification rights and obligations).
Neither the Issuer nor SRH will receive any proceeds from the Exchange
Offer.
The Exchange Notes will constitute a new issue of securities with no
established trading market, and there can be no assurance as to the liquidity
of any markets that may develop for the Exchange Notes or as to the ability of
the holders of Exchange Notes to sell their Exchange Notes or as to or the
price at which the holders of Exchange Notes would be able to sell their
Exchange Notes. Future trading prices of the Exchange Notes will depend on
many factors, including, among others, prevailing interest rates, the
Company's operating results and the market for similar securities. The Issuer
and SRH do not intend to apply for listing of the Exchange Notes on any
securities exchange. Jefferies & Company, Inc., Banc One Capital Corporation,
and Paribas Corporation (the "Initial Purchasers") have informed the Company
that they currently intend to make a market for the Exchange Notes. However,
they are not so obligated, and any such market making may be discontinued at
any time without notice. Accordingly, no assurance can be given that an active
public or other market will develop for the Exchange Notes or as to the
liquidity of or the trading market for the Exchange Notes.
THE EXCHANGE OFFER IS NOT BEING MADE TO, NOR WILL THE ISSUER OR SRH ACCEPT
SURRENDERS FOR EXCHANGE FROM, HOLDERS OF OLD NOTES IN ANY JURISDICTION IN
WHICH THE EXCHANGE OFFER OR THE ACCEPTANCE THEREOF WOULD NOT BE IN COMPLIANCE
WITH THE SECURITIES OR BLUE SKY LAWS OF SUCH JURISDICTION.
AVAILABLE INFORMATION
Neither the Issuer nor SRH is subject to the informational requirements of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Pursuant
to the Indenture, the Issuer and SRH have agreed to provide to the holders
annual reports and the information, documents and other reports otherwise
required pursuant to Section 13 of the Exchange Act. While any Old Notes
remain outstanding, the Issuer and SRH will make available, upon request, to
any holder and any prospective purchaser of Old Notes, the information
required pursuant to Rule 144A(d)(4) under the Securities Act during any
period in which the Issuer and SRH are not subject to Section 13 or 15(d) of
the Exchange Act. Any such request should be directed to the Secretary of the
Issuer at 407 North Big Spring, Suite 300, Midland, Texas, 79701; (915) 686-
9927.
This Prospectus constitutes part of a registration statement on Form S-4
(herein, together with all amendments and exhibits, referred to as the
"Registration Statement") filed by the Issuer and SRH with the Commission
under the Securities Act. This Prospectus omits certain of the information set
forth in the Registration Statement. Reference is hereby made to the
Registration Statement and to the exhibits relating thereto for further
information with respect to the Company and the securities offered hereby.
Statements contained herein concerning the provisions of contracts or other
documents are not necessarily complete, and each such statement is qualified
in its entirety by reference to the copy of the applicable contract or other
document filed with the Commission. Copies of the Registration Statement and
the exhibits thereto are on file at the offices of the Commission and may be
obtained upon payment of the fee prescribed by the Commission, may be examined
without charge at the public reference facilities maintained by the Commission
at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, and at the
following regional offices of the Commission: Seven World Trade Center, Suite
1300, New York, New York 10048 and Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661-2511. Copies of such materials can be
obtained by mail from the Public Reference Section of the Commission, 450
Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549, at prescribed
rates. In addition, the Commission maintains a site on the World Wide Web that
contains reports, proxy and information statements and other information filed
electronically by the Issuer and SRH with the Commission which can be accessed
over the Internet at http://www.sec.gov.
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INCORPORATION BY REFERENCE
The Issuer and SRH hereby undertake to provide without charge to each
person, including any beneficial owner, to whom a copy of this Prospectus has
been delivered, upon the written or oral request of such person, a copy of any
or all of the information that has been incorporated by reference in this
Prospectus (not including exhibits to the information that is incorporated by
reference herein unless such exhibits are specifically incorporated by
reference in such information.) Requests for such copies should be directed to
the Secretary of the Issuer at 407 North Big Spring, Suite 300, Midland,
Texas, 79701; (915) 686-9927.
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH ANY OFFERING MADE HEREBY TO
GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAT THOSE CONTAINED
IN THIS PROSPECTUS AND THE ACCOMPANYING LETTER OF TRANSMITTAL AND, IF GIVEN OR
MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE ISSUER, SRH OR THE INITIAL PURCHASERS. NEITHER
THE DELIVERY OF THIS PROSPECTUS OR THE ACCOMPANYING LETTER OF TRANSMITTAL, OR
BOTH TOGETHER, NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY SINCE THE DATE HEREOF. NEITHER THIS PROSPECTUS NOR THE ACCOMPANYING
LETTER OF TRANSMITTAL, OR BOTH TOGETHER, CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFER HEREBY BY ANYONE
IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR
IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO
SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information and financial statements, including the notes thereto, appearing
elsewhere in this Prospectus and in the documents incorporated herein by
reference. Certain terms relating to the oil and gas and well servicing
businesses are defined in the "Glossary of Terms" section of this Prospectus.
Unless otherwise indicated, references to "Southwest" or the "Issuer" are to
Southwest Royalties, Inc. References in this Prospectus to "SRH" are to
Southwest Royalties Holdings, Inc., exclusive of all subsidiaries and
affiliates. References in this Prospectus to the "Company" are to SRH, the
corporate parent of the Issuer and the guarantor of the Notes, and its
consolidated subsidiaries, including Southwest, Midland Red Oak Realty, Inc.
("Red Oak") and Sierra Well Service, Inc. ("Sierra"), an affiliate of SRH and
Southwest. Unless otherwise indicated, all financial and quantitative
information provided in this Prospectus on a "pro forma" basis gives effect, on
the date and for the periods indicated, to the completion of the Private
Placement (as defined) and the Transactions (as defined).
THE COMPANY
The Company 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, the Company has grown primarily through
selective acquisitions of producing oil and gas properties, completing over
$320 million in acquisitions, both directly and through the oil and gas
partnerships it manages. Consistent with this strategy, the Company recently
purchased additional producing oil and gas properties in the Permian Basin from
a major oil company for approximately $72.3 million, (the "Oil and Gas
Properties Acquisition"). The Company also participates in the well servicing
industry through its affiliate, Sierra, and owns and manages real estate
properties through its subsidiary, Red Oak.
The Company pursues a strategy of acquiring long-life, producing oil and gas
properties, which offer current cash flow, significant development potential
and opportunities to reduce operating and administrative costs. Many of the
Company's previous acquisitions were completed during periods of relatively low
oil and gas prices, and the Company generally deferred development of such
acquired properties to invest available capital in additional acquisitions. Due
to increased oil and gas prices and improved availability of capital, the
Company has increased its oil and gas development activities. The Company plans
to increase capital spending on development and exploitation opportunities.
At June 30, 1997, on a pro forma basis, the Company owned interests in
approximately 2.6 million gross leasehold acres, approximately 75% of which
were classified as developed. At such date, the Company's estimated net proved
reserves, on a pro forma basis, would have been 32.5 MMBbls of oil and 75.3 Bcf
of natural gas, or 45.0 MMBoe. The Company's properties are located primarily
in the Permian Basin and generally have well-established production histories
with a pro forma reserve life of approximately 15 years. At June 30, 1997, PV-
10 Value of the Company's pro forma oil and gas reserves would have been $214.5
million.
The Company's development projects generally involve moderate drilling and
completion costs as they are located primarily in shallow to intermediate
depth, normally pressured reservoirs. Additionally, many of these projects
contain multiple horizons that are potentially productive, thereby further
reducing development drilling risk. The Company has identified over 500
recompletion and development opportunities on its properties, including the
properties acquired in the Oil and Gas Properties Acquisition. For the nine
months ended September 30, 1997, Southwest has spent approximately $27 million
in the aggregate for oil and gas acquisition, development and exploration
activities and has budgeted additional capital spending, of approximately $45
million for the remainder of 1997 and 1998, principally to complete over 190
planned development drilling and recompletion projects. The $45 million
budgeted for capital spending is in addition to the $72.3 million purchase
price for the Oil and Gas Properties Acquisition completed October 14, 1997.
The Company anticipates that its development activities, when combined with new
seismic and other data, will result in the identification of additional
development drilling prospects and proved reserves.
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The Company engages in the well servicing business through Sierra, in which
SRH directly owns approximately 26% of the common stock. Southwest is also the
general partner and indirectly owns approximately 10% of Sierra as a 15%
interest holder in two partnerships which own approximately 64% of Sierra.
Sierra, which was formed in 1992, provides a broad range of well services to
oil and gas companies, including workover rig services, liquids handling, fresh
and/or brine water supply and disposal and other services. Since January 1996,
Sierra has purchased 17 well servicing companies for a cost of $58.9 million.
In total, these acquisitions increased the equipment fleet to 84 workover rigs.
Management believes that Sierra is the fourth largest land-based well servicing
company in the United States.
Red Oak, an 82%-owned subsidiary of SRH, on a pro forma basis, owns and
manages retail shopping centers and office buildings in Texas, Oklahoma and
Arizona. Since December 1993, Red Oak has acquired 17 properties for
approximately $82.8 million.
CERTAIN RISK FACTORS
The following Risk Factors should be considered by prospective purchasers in
evaluating an investment in the Notes. This discussion of Certain Risk Factors
is a partial listing and a summary and is qualified in its entirety by the more
detailed discussion of Risk Factors found elsewhere in this Prospectus.
. The Company's level of indebtedness may limit its ability to borrow
additional funds and react to changing business conditions.
. Upon a Change in Control, each holder of a Note may require the Company to
repurchase all or a portion of the Note and the Company may not have the
financial resources necessary to meet such obligations.
. In the event of a default, the Trustee may not be able to foreclose on or
dispose of the Collateral without substantial delays and the resulting
proceeds may not be sufficient to pay all amounts owned to holders of Notes.
. Under certain circumstances, a court could rule that the direct obligations
of a Subsidiary Guarantor are superior to its obligations under the
Subsidiary Guarantee.
. The Old Notes and the Exchange Notes are both new securities for which there
is no active trading market. No assurance can be given as to the liquidity
of the trading market for the Notes. The Old Notes are subject to certain
transfer restrictions.
. Mr. Wommack, the Chairman of the Board, President and Chief Executive
Officer of SRH and Southwest, 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.
. Southwest's revenues are highly dependent on the volatile oil and natural
gas markets.
. There can be no assurance that the Company will be able to continue its
current acquisition strategy. There can be no assurance that Southwest will
be able to find and acquire additional oil and natural gas reserves or have
the funds to finance planned capital expenditures.
. The oil and natural gas business involves a variety of operating risks which
could result in substantial losses to Southwest and not all such risks are
insurable.
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STRATEGY
The Company's objective is to increase its revenues, cash flow, earnings and
assets through a balanced growth strategy of acquisition, development and
exploitation of oil and gas properties, and through its
investments in the well servicing and real estate businesses.
Complete Selective Oil and Gas Acquisitions. The Company seeks to acquire
producing oil and gas properties that provide opportunities for the addition of
reserves, production and cash flow through operational improvements, production
enhancement and additional development. The Company believes these criteria are
met in the Permian Basin due to the region's long history of production and
multiple producing oil and gas horizons. The Company has acquired over $320
million of oil and gas properties since inception, both directly and through
the oil and gas partnerships it manages. Management believes that acquisition
opportunities will continue to be available in the Permian Basin.
Develop and Exploit Existing Oil and Gas Properties. The Company has acquired
a diversified portfolio of oil and gas properties that contains numerous
identified development opportunities. The Company believes that current oil and
gas prices, combined with technical and operating advances, have improved the
attractiveness of accelerated development of these properties. The Company
plans to significantly increase its capital spending during 1997 and 1998 to
pursue these opportunities, which consist principally of infill drilling,
recompletions, enhanced recovery operations and workover opportunities. The
Company is pursuing these projects to increase cash flow and to identify
additional reserves and development projects.
Maintain Geographic Focus. The Company concentrates its oil and gas
activities in the Permian Basin, with properties in this region representing
over 90% of the Company's pro forma PV-10 Value at June 30, 1997. The Company
believes that its long-life oil and gas properties and large inventory of
development projects in the Permian Basin, coupled with region-specific
geological, engineering and production experience, provide it with focused
operations. Company-operated properties comprised approximately 60% of its pro
forma PV-10 Value at June 30, 1997, allowing substantial control over the
incurrence and timing of capital and operating expenditures.
Selectively Grow Well Servicing and Real Estate Businesses. The Company plans
to continue the expansion of its well servicing and real estate businesses,
primarily in the southwestern United States. The Company expects that Sierra's
and Red Oak's active management practices will lead to consolidation benefits,
cost savings, more efficient utilization and improved cash flow, thereby
enhancing the return on capital invested.
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THE TRANSACTIONS
In conjunction with the Private Placement, the Company completed certain
acquisition and financing transactions (the "Transactions") to provide
additional capital for oil and gas development activities and acquisitions by
Southwest, to finance acquisitions by Sierra and Red Oak and to provide the
Company with additional financing and operating flexibility. The Transactions
are summarized below:
Oil and Gas Properties Acquisition. On October 14, 1997, the Company acquired
various working interests in 431 producing oil and gas wells, located in seven
oil and gas fields in the Permian Basin of West Texas and southeastern New
Mexico. The Company operates 133 of these wells. The purchase price for the Oil
and Gas Properties Acquisition was $72.3 million. The Oil and Gas Properties
Acquisition added approximately 14.0 MMBoe of estimated net proved reserves, as
of June 30, 1997. These properties complement the Company's existing proved
reserve base with an average reserve life of approximately 15 years and over
130 identified development opportunities. The Company believes that it has
significant opportunities to improve production and cash flow from these
properties through additional development, reconfiguration of operations and
reduction of operating and administrative costs. Southwest also amended its $75
million revolving credit facility (the "Southwest Credit Facility") resulting
in unutilized availability of $40 million.
Sierra Acquisitions. Since January 1996, Sierra has acquired 17 Texas and New
Mexico well servicing companies and equipment for a total cost of $58.9
million. In total, these acquisitions added 64 workover rigs, 134 vaccum and
transport trucks, 279 frac and test tanks, 32 brine and/or fresh water stations
and nine injection wells and significantly increased the size and scope of
Sierra's well servicing business. Sierra financed these acquisitions with
proceeds from the sale of Sierra common stock (the "Sierra Equity Sale") and
borrowings from an institutional lender (the "Sierra Acquisition Facility").
The Sierra Equity Sale resulted in a reduction of SRH's direct ownership of
Sierra to approximately 26%.
Red Oak Acquisitions. Red Oak recently acquired four shopping centers and two
office buildings in Texas and Oklahoma for a total cost of $40.7 million. These
acquisitions expanded Red Oak's commercial real estate portfolio to 14 shopping
centers and three office buildings. Red Oak financed the acquisitions with $10
million in equity proceeds received from SRH and with certain mortgage
facilities (the "Red Oak Acquisition Facilities").
PRIVATE PLACEMENT
On October 14, 1997 Southwest completed a $200 million private placement sale
of the Old Notes to the Initial Purchasers (the "Private Placement"). Thereupon
the Old Notes were offered and sold by the Initial Purchasers only to qualified
institutional buyers. The net proceeds from the Private Placement were
approximately $190 million. The Issuer used the net proceeds primarily to (i)
fund the Oil and Gas Properties Acquisition (net of deposits paid), (ii) repay
substantially all indebtedness outstanding under Southwest's bank credit
facility and its reserve-based loan facilities, (iii) fund a $10 million equity
investment by SRH in Red Oak through a dividend in that amount from the Issuer
to SRH, (iv) make a general partner capital contribution to Partners III of
approximately $1.7 million, which funds were immediately invested in Sierra
common stock, and (v) provide additional working capital for general corporate
purposes, including future acquisitions and development of producing oil and
gas properties.
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THE OFFERING
The Exchange Offer relates to the exchange of up to $200,000,000 principal
amount of Exchange Notes for up to $200,000,000 principal amount of the Old
Notes. The form and terms of the Exchange Notes are identical in all material
respects to the form and terms of the Old Notes except that the Exchange Notes
have been registered under the Securities Act and will not contain certain
transfer restrictions and hence are not entitled to the benefits of the
Registration Rights Agreement relating to the contingent increases in the
interest rate provided for pursuant thereto. See "Exchange Offer" and "Exchange
and Registration Rights Agreement." The Exchange Notes will evidence the same
debt as the Old Notes and will be issued under and be entitled to the benefits
of the Indenture governing the Old Notes. See "Description of Notes."
Exchange Offer............ Each $1,000 principal amount of Exchange Note will
be issued in exchange for each $1,000 principal
amount of outstanding Old Notes. As of the date
hereof, $200,000,000 principal amount of Old Notes
are issued and outstanding. The Issuer will issue
the Exchange Notes to tendering holders of Old
Notes on or promptly after the Expiration Date.
Resale.................... The Company believes that the Exchange Notes issued
in the Exchange Offer generally will be freely
transferable by the holders thereof without
registration or any prospectus delivery requirement
under the Securities Act, except for certain
Restricted Holders who may be required to deliver
copies of this Prospectus in connection with any
resale of the Exchange Notes. See "Exchange Offer"
and "Plan of Distribution."
Expiration Date........... 5:00 p.m., New York City time, 30 days after the
effective date of the Registration Statement,
unless the Exchange Offer is extended, in which
case the term "Expiration Date" means the latest
date to which the Exchange Offer is extended. See
"Exchange Offer--Expiration Date; Extensions;
Amendments."
Interest on the Notes..... The Exchange Notes will bear interest at the rate
of 10 1/2% per annum, payable semi-annually on
April 15 and October 15 of each year, commencing on
April 15, 1998. Interest on the Exchange Notes will
accrue from (A) the later of (i) the last interest
payment date on which interest was paid on the
Notes surrendered in exchange therefor; or (ii) if
the Notes are surrendered for exchange on a date in
a period which includes the record date for an
interest payment date to occur on or after the date
of such exchange and as to which interest will be
paid, the date of such interest payment date or (B)
if no interest has been paid on the Notes, from the
date or the original issuance of the Notes, October
14, 1997. Interest on the Old Notes accepted for
exchange will cease to accrue upon issuance of the
Exchange Notes. See "Exchange Offer--Interest on
the Exchange Notes."
Procedures for Tendering
Old Notes................. Each holder of Old Notes wishing to accept the
Exchange Offer must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, in
accordance with the instructions contained herein
and therein, and mail or otherwise deliver such
Letter of Transmittal, or such facsimile, or an
Agent's Message (as defined herein) together with
the Old Notes to be exchanged and any required
documentation to the Exchange Agent at the address
set forth herein and therein or effect a tender of
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Old Notes pursuant to the procedures for book-entry
transfer as provided for herein. See "Exchange
Offer--Procedures for Tendering."
Special Procedures for
Beneficial Holders........ Any beneficial holder whose Old Notes are
registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and
who wishes to tender in the Exchange Offer should
contact such registered holder promptly and
instruct such registered holder to tender on the
beneficial holder's behalf. If such beneficial
holder wishes to tender directly, such beneficial
holder must, prior to completing and executing the
Letter of Transmittal and delivering the Old Notes,
either make appropriate arrangements to register
ownership of the Old Notes in such holder's name or
obtain a properly completed bond power from the
registered holder. The transfer of record ownership
may take considerable time. See "Exchange Offer--
Procedures for Tendering."
Guaranteed Delivery
Procedures................ Holders of Old Notes who wish to tender their Old
Notes and whose Old Notes are not immediately
available or who cannot deliver their Old Notes and
a properly completed Letter of Transmittal or any
other documents required by the Letter of
Transmittal to the Exchange Agent prior to the
Expiration Date, or who cannot complete the
procedure for book-entry transfer on a timely basis
and deliver an Agent's Message, may tender their
Old Notes according to the guaranteed delivery
procedures set forth in the "Exchange Offer--
Guaranteed Delivery Procedures."
Withdrawal Rights......... Tenders of Old Notes may be withdrawn at any time
prior to 5:00 p.m., New York City time, on the
business day prior to the Expiration Date, unless
previously accepted for exchange. See "Exchange
Offer--Withdrawal of Tenders."
Termination of the
Exchange Offer............ The Issuer and SRH may terminate the Exchange Offer
if they determine that the Exchange Offer violates
any applicable law or interpretation of the staff
of the SEC. Holders of Old Notes will have certain
rights against the Issuer and SRH under the
Registration Agreement should the Issuer and SRH
fail to consummate the Exchange Offer. See
"Exchange Offer" and "Exchange and Registration
Rights Agreement."
Acceptance of Old Notes
and Delivery of Exchange
Notes..................... Subject to certain conditions (as summarized above
in "Termination of the Exchange Offer" and
described more fully in the "Exchange Offer--
Termination"), the Issuer and the Company will
accept for exchange any and all Old Notes which are
properly tendered in the Exchange Offer prior to
5:00 p.m., New York City time, on the Expiration
Date. The Exchange Notes issued pursuant to the
Exchange Offer will be delivered promptly following
the Expiration Date. See "Exchange Offer."
Exchange Agent............ State Street Bank and Trust Company is serving as
exchange agent (the "Exchange Agent") in connection
with the Exchange Offer. The
10
<PAGE>
mailing address of the Exchange Agent is Corporate
Trust Dept., P.O. Box 778, Boston, Massachusetts
02102-0078, Attn: Ms. Sandra Szozsponik. Hand
deliveries and deliveries by overnight courier
should be sent to Corporate Trust Department, 4th
Floor, Two International Plaza, Boston,
Massachusetts 02110, Attention: Ms. Sandra
Szozsponik. For information with respect to the
Exchange Offer, the telephone number for the
Exchange Agent is (617) 664-5587 and the facsimile
number for the Exchange Agent is (617) 664-5290.
See "The Exchange Offer--Exchange Agent."
Use of Proceeds........... There will be no cash proceeds payable to Issuer or
SRH from the issuance of the Exchange Notes
pursuant to the Exchange Offer. See "Use of
Proceeds." For a discussion of the use of the net
proceeds received by the Issuer and SRH from the
Private Placement, see "Private Placement."
TERMS OF THE NOTES
Notes Offered............. $200,000,000 aggregate principal amount of 10 1/2%
Series B Senior Notes due 2004.
Issuer.................... Southwest Royalties, Inc., a wholly-owned
subsidiary of Southwest Royalties Holdings, Inc.
Maturity Date............. October 15, 2004.
Interest Rate and Payment The Notes will bear interest at a rate of 10 1/2%
Dates..................... per annum. Interest is payable semi-annually in
cash in arrears on April 15 and October 15 of each
year commencing April 15, 1998.
Ranking................... The Notes will be senior obligations of the Issuer,
ranking pari passu in right of payment with all
existing and future senior Indebtedness of the
Issuer and senior to all existing and future
Subordinated Indebtedness of the Issuer. Subject to
certain limitations, the Issuer may incur
additional indebtedness in the future. The Notes,
the Parent Guarantee and any Subsidiary Guarantee
will be effectively subordinated to the Southwest
Credit Facility and all other secured indebtedness
of SRH and Southwest to the extent of the value of
the assets securing such indebtedness. At September
30, 1997, on a pro forma basis after giving effect
to the Offering and the application of the proceeds
therefrom, SRH and Southwest would have had $88.2
million in indebtedness that ranks pari passu and
senior to the Exchange Notes. See "Management's
Discussion and Analysis of Financial Condition and
Results of Operations."
Parent Guarantee.......... The Notes will be unconditionally guaranteed on a
senior basis by SRH. The Parent Guarantee will rank
pari passu in right of payment to all existing and
future senior Indebtedness of SRH and senior to all
existing and future Subordinated Indebtedness of
SRH. See "Description of Notes--Ranking and
Guarantees."
11
<PAGE>
Security.................. The Parent Guarantee will be secured by a pledge of
the Red Oak common stock and Sierra common stock
directly owned by SRH (collectively, the
"Collateral"). Such collateral may be released
under certain circumstances. See "Description of
Notes--Collateral."
Subsidiary Guarantees..... Under certain circumstances, the Notes may be
guaranteed in the future on a senior unsecured
basis by other subsidiaries of SRH in accordance
with the Indenture (the "Subsidiary Guarantors").
Each Subsidiary Guarantee will rank pari passu in
right of payment with all senior Indebtedness of
the Subsidiary Guarantor and senior to all future
Subordinated Indebtedness of the Subsidiary
Guarantor. See "Description of Notes--Ranking and
Guarantees."
Optional Redemption....... The Notes will be redeemable at the option of the
Issuer, in whole or in part, at any time on or
after October 15, 2001, at the redemption prices
set forth herein, together with accrued and unpaid
interest to the date of redemption. In the event
SRH or the Issuer consummates a Public Equity
Offering (as defined) on or prior to October 15,
2000, the Issuer has the option to use all or a
portion of the proceeds from such offering to
redeem up to $70,000,000 aggregate principal amount
of the Notes at a redemption price equal to 110.50%
of the principal amount thereof, together with
accrued and unpaid interest to the date of
redemption, provided that at least $130,000,000
aggregate principal amount of the Notes remains
outstanding after such redemption. See "Description
of Notes--Optional Redemption."
Change of Control......... Upon the occurrence of a Change of Control (as
defined), each holder of the Notes will have the
right to require the Issuer to purchase all or a
portion of such holder's Notes at a price equal to
101% of the principal amount thereof, together with
accrued and unpaid interest to the date of
purchase. See "Description of Notes--Repurchase of
Notes at the Option of the Holder Upon a Change of
Control."
Certain Covenants......... The indenture under which the Notes will be issued
(the "Indenture") contains certain covenants
including, but not limited to, covenants that
limit: (i) incurrence of additional indebtedness
and issuances of disqualified capital stock; (ii)
dividend and other payment restrictions affecting
subsidiaries; (iii) restricted payments; (iv) asset
sales; (v) transactions with Affiliates; (vi)
liens; (vii) merger, sale or consolidation; (viii)
sale or issuance of capital stock of Restricted
Subsidiaries; and (ix) lines of business. The
Indenture also contains covenants regarding the
designation of Unrestricted Subsidiaries, ownership
of Restricted Subsidiaries and issuance of reports.
See "Description of Notes--Covenants."
Exchange Offer............ Pursuant to a Registration Rights Agreement between
the Issuer, SRH and the Initial Purchasers, the
Issuer and SRH agreed to use their best efforts (i)
to make a registered exchange offer (the "Exchange
Offer") pursuant to which holders of the Old Notes
will have the opportunity to exchange their Old
Notes for a like principal amount of new notes
12
<PAGE>
(the "Exchange Notes") that are identical in all
material respects to the Notes and that may be
offered and sold by the holders without
restrictions or limitations under the Securities
Act or (ii) under certain circumstances, to effect
a shelf registration of the Old Notes (the "Shelf
Registration Statement") that would include a
prospectus under which holders would be free to
offer and sell their Notes from time to time. The
Issuer and SRH have agreed to use their best
efforts to file with the Commission a registration
statement relating to the Exchange Offer (the
"Exchange Offer Registration Statement") or the
Shelf Registration Statement within 60 days after
the date of issuance of the Notes (the "Issue
Date"), and to use their best efforts to cause such
registration statement to be declared effective by
the Commission within 120 days after the Issue Date
and, in the case of the Shelf Registration
Statement, to cause such to remain effective until
the second anniversary after the Issue Date. The
interest rate on the Notes is subject to increase
under certain circumstances if the Issuer and SRH
are not in compliance with their obligations under
the Registration Rights Agreement. See "Exchange
and Registration Rights Agreement."
Transfer Restrictions;
Trading Market............ The Old Notes have not previously been registered
under the Securities Act and are subject to
restrictions on transferability and resale. See
"Notice to Investors." The Notes are newly issued
securities for which there is currently no
established market. The Exchange Notes will
generally be freely transferable (subject to the
restrictions discussed elsewhere herein) but will
be new securities for which there will not
initially be a market. Accordingly, there can be no
assurance as to the development or liquidity of any
market for the Old Notes or the Exchange Notes. The
Initial Purchasers have advised the Issuer that
they currently intend to make a market in the Old
Notes and the Exchange Notes. However, the Initial
Purchasers are not obligated to do so, and any
market making with respect to the Old Notes or the
Exchange Notes may be discontinued at any time
without notice.
PORTAL Listing............ The Old Notes sold to QIBs are eligible for trading
in the PORTAL market.
13
<PAGE>
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL AND OPERATING DATA
The following summary historical and pro forma financial and operating data
were derived from the consolidated financial statements of the Company,
including the notes thereto (the "Company Financial Statements"), as well as
the selected historical and pro forma financial and operating information
included elsewhere in this Prospectus. The pro forma consolidated financial
data are based on the assumptions and adjustments described in the accompanying
notes and do not purport to present the results of operations and financial
position of the Company nor are they necessarily indicative of the results of
operations that may be achieved in the future. The information set forth below
should be read in conjunction with "Selected Historical and Pro Forma Financial
Information," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," the Company Financial Statements and the Unaudited Pro
Forma Combined Financial Statements included elsewhere herein.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------ ---------------------------
PRO PRO
FORMA FORMA
1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- -------- -------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA )
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED INCOME
STATEMENT DATA:
Operating revenues:
Oil and gas.......... $16,321 $22,717 $ 35,296 $ 53,016 $24,638 $ 26,068 $ 37,873
Well servicing....... 2,377 4,218 8,013 -- 6,163 7,789 --
Real estate.......... 605 3,213 4,487 17,710 3,092 5,029 13,877
Other................ 325 352 622 362 424 948 904
------- ------- -------- -------- ------- -------- --------
Total operating
revenues.......... 19,628 30,500 48,418 71,088 34,317 39,834 52,654
Operating expenses:
Oil and gas.......... 7,879 11,511 14,846 20,893 10,833 12,166 16,409
Well servicing....... 2,136 3,315 6,145 -- 4,519 5,600 --
Real estate.......... 195 1,414 1,887 8,458 1,295 1,907 6,166
General and
administrative...... 4,292 5,018 6,953 6,290 4,580 5,059 4,651
Depreciation,
depletion and
amortization........ 4,437 6,719 8,430 13,513 6,249 8,093 11,968
Other................ 105 228 554 554 407 1,003 1,003
------- ------- -------- -------- ------- -------- --------
Total operating
expenses.......... 19,044 28,205 38,815 49,708 27,883 33,828 40,197
Operating income....... 584 2,295 9,603 21,380 6,434 6,006 12,457
Other income
(expense):
Interest expense..... (1,975) (5,635) (10,016) (31,862) (7,180) (10,950) (24,617)
Interest income...... 229 269 441 430 275 545 536
Other................ 1,687 (78) 561 592 438 (66) (52)
------- ------- -------- -------- ------- -------- --------
Income (loss) before
income taxes,
minority interest and
equity in earnings of
subsidiary............ 525 (3,149) 589 (9,460) (33) (4,465) (11,676)
Income tax benefit
(provision)........... (171) 1,044 (365) 3,482 (54) 1,526 4,088
Minority interest in
subsidiaries.......... (1) (15) 181 (3) 71 322 321
Equity in earnings of
subsidiary............ -- -- -- (448) -- -- (4)
------- ------- -------- -------- ------- -------- --------
Income (loss) before
extraordinary item.... 353 (2,120) 405 (6,429) (16) (2,617) (7,271)
Extraordinary item,
net of tax............ -- -- -- -- -- (490) --
------- ------- -------- -------- ------- -------- --------
Net income (loss)...... $ 353 $(2,120) $ 405 $ (6,429) $ (16) $ (3,107) $ (7,271)
======= ======= ======== ======== ======= ======== ========
Earnings (loss) per
common share before
extraordinary item.... $ 0.37 $ (2.19) $ 0.42 $ (6.67) $ (0.02) $ (2.42) $ (6.74)
======= ======= ======== ======== ======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
1997
-----------------
PRO
ACTUAL FORMA(6)
-------- --------
(IN THOUSANDS)
<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $ 11,152 $ 47,026
Net property and equipment.................................. 141,450 234,843
Total assets................................................ 180,825 317,506
Long-term debt, including current portion................... 142,213 285,782
</TABLE>
14
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------- -------------------------
PRO PRO
FORMA FORMA
1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA )
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED CASH FLOW
STATEMENT DATA:
Net cash provided by
operating activities.. 5,222 5,634 10,280 NA 4,835 9,411 NA
Net cash used by
investing activities.. (9,641) (44,532) (33,225) NA (12,479) (62,731) NA
Net cash provided by
financing activities.. 5,054 39,166 27,865 NA 9,107 56,188 NA
OTHER FINANCIAL DATA:
Capital
expenditures(2)....... $15,948 $46,914 $34,513 NA $12,891 $60,973 NA
Capital expenditures--
Oil and gas(2)........ 9,988 32,077 16,740 NA 9,808 26,522 NA
Ratio of earnings to
fixed charges(3)...... 1.3x (3) 1.1x (3) (3) (3) (3)
Adjusted EBITDA(4)..... 6,880 7,605 16,760 27,858 11,337 11,063 18,113
Adjusted EBITDA to
Interest(5)........... 3.8x 1.8x 2.1x 1.3x 1.9x 1.6x 1.1x
ACNTA(7)............... 487,468
Ratio of ACNTA to
Indebtedness(7)....... 2.4x
</TABLE>
- --------
(1) Pro forma to reflect the Offering and the Transactions and certain other
acquisitions as if they had occurred on January 1, 1996, as well as the
deconsolidation of Sierra, which will be accounted for using the equity
method in future periods. NA--not applicable.
(2) Includes acquisitions. NA--not applicable.
(3) Earnings were insufficient to cover fixed charges by $3,149,000, $33,000
and $4,465,000 for the historical periods ended December 31, 1995,
September 30, 1996 and September 30, 1997, respectively, and $9,908,000 and
$11,680,000 for the pro forma periods ended December 31, 1996 and September
30, 1997, respectively. For purposes of computing the ratio of earnings to
fixed charges, earnings are computed as income (loss) before extraordinary
item plus minority interest in subsidiaries and income taxes, plus fixed
charges. Fixed charges consist of interest expense and an estimated portion
of rentals representing interest costs.
(4) Adjusted EBITDA (as used herein) is calculated based on the Indenture,
which requires EBITDA to be calculated by adding the net income (loss) of
SRH (as defined on page 5 of this Prospectus) and its Restricted
Subsidiaries, excluding the net income (loss) of any Unrestricted
Subsidiary, to minority interest in subsidiaries, income tax benefit
(provision) and depreciation, depletion and amortization of SRH and
interest expense of SRH and its Restricted Subsidiaries. Specifically, net
income (loss), income tax benefit (expense), interest expense and
depreciation, depletion and amortization of Red Oak is excluded from the
calculation of Adjusted EBITDA, as Red Oak is an Unrestricted Subsidiary.
EBITDA is used because the Company believes it is commonly used by debt
holders and financial statement users as a measurement to determine the
ability of an entity to meet its interest obligations. EBITDA is not a
measurement presented in accordance with generally accepted accounting
principles ("GAAP") and is not intended to be used in lieu of GAAP
presentation of results of operations and cash provided by operating
activities.
(5) Adjusted EBITDA to Interest (as used herein) is the ratio of Adjusted
EBITDA to interest on the Notes plus interest on any other debt of SRH and
any Restricted Subsidiary.
(6) Pro forma to reflect the Offering and the Transactions as if they had
occurred on September 30, 1997.
(7) ACNTA means Adjusted Consolidated Net Tangible Assets, as defined in the
Indenture (see "Description of Notes--Certain Definitions"). In accordance
with the Indenture, ACNTA is calculated using oil and gas prices utilized
in the Company's year end reserve report. Indebtedness (as used herein)
means Indebtedness of SRH and all Restricted Sibsidiaries, which, on a pro
forma basis as of September 30, 1997, would have been $199.9 million.
15
<PAGE>
SUMMARY HISTORICAL AND PRO FORMA RESERVE AND OPERATING DATA
The following tables set forth summary information with respect to the
Company's estimated proved oil and natural gas reserves and the Company's
operating data as of or for the periods shown. See "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business," "Experts," the Company Financial Statements and the
Unaudited Pro Forma Combined Financial Statements included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30,
---------------------------- ------------------
PRO
FORMA
1994 1995 1996 1997 1997(1)
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
RESERVE DATA:
Proved reserves:
Oil and condensate
(MBbls)................. 10,008 16,580 18,806 19,114 32,456
Natural gas (MMcf)....... 37,990 70,590 76,776 71,128 75,313
Total (MBoe)............. 16,340 28,345 31,602 30,969 45,008
Proved Developed Reserves:
Oil and condensate
(MBbls)................. 4,760 7,349 10,302 9,485 21,125
Natural gas (MMcf)....... 27,587 51,926 58,961 51,649 55,214
Total (MBoe)............. 9,358 16,003 20,129 18,093 30,327
PV-10 Value (in
thousands)(2)........... $ 59,064 $117,902 $252,170 $137,688 $214,539
Discounted Future Cash
Flows(3)
Future cash inflows...... $227,864 $433,514 $735,100 $479,048 $726,257
Future production and
development costs ...... (125,113) (213,698) (283,894) (233,654) (337,386)
-------- -------- -------- -------- --------
Future net cash flows
before income taxes..... 102,751 219,816 451,206 245,394 388,871
Future income tax
expense................. (28,879) (64,064) (142,017) (69,348) (118,130)
-------- -------- -------- -------- --------
Future net cash flows,
net of tax.............. 73,872 155,752 309,189 176,046 270,741
10% annual discount for
estimated timing of cash
flows................... (31,766) (71,646) (130,648) (71,277) (115,215)
-------- -------- -------- -------- --------
Standardized measure of
discounted future net
cash flows, net of tax.. $ 42,106 $ 84,106 $178,541 $104,769 $155,526
======== ======== ======== ======== ========
</TABLE>
- --------
(1) Pro forma to reflect the Oil and Gas Properties Acquisition as if it had
occurred on June 30, 1997.
(2) PV-10 Value represents the present value of estimated future net revenues
before income tax discounted at 10% using prices in effect at the end of
the respective periods presented and including the effects of hedging
activities. In accordance with applicable requirements of the Commission,
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 calculating PV-10 Value as of June
30, 1997 were $17.00 per Bbl of oil and $2.16 per Mcf of natural gas,
compared to average prices used as of December 31, 1996 of $23.89 per Bbl
of oil and $3.67 per Mcf of natural gas. The average prices used in
calculating the pro forma PV-10 Value as of June 30, 1997 were $17.34 per
Bbl of oil and $2.16 per Mcf of natural gas.
(3) 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 rates, 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.
16
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30, 1997
---------------------------- ---------------------
PRO PRO
FORMA FORMA
1994 1995 1996 1996(1) 1996 1997 1997(1)
------ ------ ------ ------- ------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Production Volumes:
Oil and condensate
(MBbls)................ 629 814 1,001 1,812 743 818 1,391
Natural gas (MMcf)...... 3,178 4,639 5,403 5,888 3,986 4,142 4,276
Total (MBoe)............ 1,159 1,587 1,901 2,793 1,407 1,508 2,104
Average Realized
Prices(2):
Oil and condensate (per
Bbl)................... $14.30 $16.40 $20.44 $20.17 $19.72 $19.39 $19.46
Natural gas (per Mcf)... 1.72 1.51 2.22 2.29 2.05 2.01 2.10
Per Boe................. 12.47 12.83 17.07 17.91 16.23 16.05 17.12
Expenses (per Boe):
Lease operating
(including production
taxes)............... $ 6.80 $ 7.25 $ 7.81 $ 7.48 $ 7.83 $ 8.10 $ 7.82
Oil and gas
depreciation,
depletion and
amortization......... 3.03 3.19 3.38 3.94 3.42 4.08 4.73
Oil and gas general
and administrative,
net.................. 2.87 2.17 2.17 1.69 1.93 2.31 1.90
Reserve life index (in
years)(3)............ 14.1 17.9 16.6 16.9 NA 15.5 15.3
</TABLE>
- --------
(1) Pro forma to reflect the Oil and Gas Properties Acquisition and certain
other acquisitions as if they had occurred on January 1, 1996.
(2) Reflects the actual realized prices received by the Company, including the
results of the Company's hedging activities. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
(3) Calculated by dividing period-end proved reserves by production for the
prior twelve-month period. September 30, 1997 ratios calculated using June
30, 1997 proved reserves. NA-not applicable.
17
<PAGE>
FORWARD-LOOKING STATEMENTS
This Prospectus includes "forward-looking statements" within the meaning of
Section 27A of 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 Prospectus, including, without
limitation, statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business" regarding planned capital expenditures, increases
in oil and gas production, the number of anticipated wells to be drilled in
1997 and 1998, the Company's financial position, business strategies and other
plans and objectives for future operations, are forward-looking statements.
Although the Company believes that the expectations reflected in such forward-
looking statements are reasonable, it can give no assurance that such
expectations will prove to have been correct. There are numerous uncertainties
inherent in estimating quantities of proved oil and natural gas reserves and
in projecting future rates of production and timing of development
expenditures, including many factors beyond the control of the Company.
Reserve engineering is a subjective process of estimating underground
accumulations of oil and natural gas that cannot be measured in an exact way,
and 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 made by different engineers often vary from one
another. In addition, results of drilling, testing and production subsequent
to the date of an estimate may justify revisions of such estimate and such
revisions, if significant, would change the schedule of any further production
and development drilling. Accordingly, reserve estimates are generally
different from the quantities of oil and natural gas that are ultimately
recovered. Additional important factors that could cause actual results to
differ materially from the Company's expectations are disclosed under "Risk
Factors" and elsewhere in this Prospectus. 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
forward-looking statements contained in this Prospectus are not within the
Safe Harbor for forward-looking statements contained in Section 27A of the
Securities Act and Section 21E of the Exchange Act since this is an initial
public offering.
18
<PAGE>
RISK FACTORS
The following factors, together with the other information contained in this
Prospectus, should be considered carefully before purchasing the Notes offered
hereby.
SUBSTANTIAL LEVERAGE
As of September 30, 1997, as adjusted for the Offering and the application
of the proceeds therefrom and the Transactions, the total indebtedness of SRH
and Southwest, including current portion, would have been $199.9 million. See
"Capitalization." In addition, the Indenture allows the Issuer, SRH and its
other Restricted Subsidiaries to incur a maximum of $51 million in additional
Indebtedness under certain circumstances. See "Description of Notes--
Covenants."
The Company's level of indebtedness has several important effects on its
operations, including: (i) the covenants may limit its ability to borrow
additional funds or to dispose of assets and may affect the Company's
flexibility in planning for, and reacting to, changes in business conditions,
(ii) the Company's ability to obtain additional financing in the future for
working capital, capital expenditures, acquisitions, general corporate
purposes or other purposes may be impaired, and (iii) a substantial portion of
the Company's cash flow may be dedicated to the payment of interest. Moreover,
future acquisition or development activities may require the Company to alter
its capitalization significantly. These changes in capitalization may
significantly alter the leverage of the Company. The Company's ability to meet
its debt service obligations and to reduce its total indebtedness will be
dependent upon the Company's future performance, which will be subject to
general economic conditions and to financial, business and other factors
affecting the operations of the Company, many of which are beyond its control.
There can be no assurance that the Company's future performance will not be
adversely affected by such economic conditions and financial, business and
other factors. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
Certain holders, who collectively own approximately 12% of SRH's common
stock, have an option to cause SRH to redeem such holders' common stock at any
time beginning December 31, 2001, five years from the date of issuance of such
common stock, subject to the terms of a subscription agreement under which SRH
sold the common stock (the "Subscription Agreement") and subject to any
restrictions imposed by law. The Subscription Agreement provides that this
redemption right terminates on the effective date of any registration
statement under the Securities Act filed with the Commission relative to the
offer and sale of any amount of SRH's common stock to the public. SRH is
unable to predict the amount of money it would be required to pay if the
redemption right is exercised. The Indenture 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. If SRH is unable
to make the payments required upon exercise of the redemption right, it would
be subject to suit for breach of contract.
PAYMENT UPON A CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each holder of the Notes may
require the Issuer 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, the Issuer 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. See "Description of Notes--Repurchase of Notes at
the Option of the Holder Upon a Change of Control."
ADEQUACY OF COLLATERAL; RISKS OF FORECLOSURE
SRH has pledged to the Trustee (under the Indenture), for the ratable
benefit of the holders of the Notes, all of the Sierra common stock and Red
Oak common stock directly owned by SRH as security for the Parent Guarantee
(collectively, the "Collateral").
In the event of a default under the Indenture, there can be no assurance
that the Trustee would be able to foreclose on or dispose of any of the
Collateral without substantial delays and other risks or that the proceeds
obtained therefrom would be sufficient to pay all amounts owing to holders of
the Notes. SRH would be required
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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 the Issuer becomes a debtor in a case under the United
States Bankruptcy Code (the "Bankruptcy Code"), the automatic stay imposed by
the Bankruptcy Code would prevent the Trustee from selling or otherwise
disposing of the Collateral without bankruptcy court authorization. In that
case, the foreclosure might be delayed indefinitely. Moreover, the bankruptcy
of any entity related to the Issuer might result in a similar delay if the
Issuer were "substantively consolidated" with the related entity.
POSSIBLE LIMITATIONS ON ENFORCEABILITY OF SUBSIDIARY GUARANTEES
The Issuer's obligations under the Notes may under certain circumstances be
guaranteed on a senior unsecured basis by the Subsidiary Guarantors. Various
fraudulent conveyance laws have been enacted for the protection of creditors
and may be utilized by a court of competent jurisdiction to subordinate or
void any Subsidiary Guarantee issued by a Subsidiary Guarantor. 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 its Subsidiary Guarantee.
To the extent that a court were to find that at the time a Subsidiary
Guarantor entered into a Subsidiary Guarantee either (1) the Subsidiary
Guarantee was incurred by the Subsidiary Guarantor 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 Guarantee and, at the time it issued the Subsidiary Guarantee,
the Subsidiary Guarantor (i) was insolvent or rendered insolvent by reason of
the issuance of the Subsidiary Guarantee, (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 Guarantee in
favor of the Subsidiary Guarantor's other creditors. Among other things, a
legal challenge of a Subsidiary Guarantee issued by a Subsidiary Guarantor on
fraudulent conveyance grounds may focus on the benefits, if any, realized by
the Subsidiary Guarantor as a result of the issuance by the Issuer of the
Notes. To the extent that proceeds from the Offering are used to refinance the
indebtedness of the Company, a court might find that the Subsidiary Guarantors
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.
To the extent that a Subsidiary Guarantee 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 of the applicable Subsidiary
Guarantor. In such event, the claims of the holders of the Notes against such
Subsidiary Guarantor 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 preferred 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
Guarantee.
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LACK OF PUBLIC MARKET; RESTRICTION ON TRANSFERABILITY
The Notes are a new securities issue for which there is currently no active
trading market. If the Notes are traded after their initial issuance, they may
trade at a discount from their initial offering price, depending upon
prevailing interest rates, the market for similar securities and other
factors, including general economic conditions and the financial condition of
the Company. The Issuer does not currently intend to apply for a listing or
quotation of the Notes or the Exchange Notes, on any securities exchange or
stock market. The Initial Purchasers have informed the Issuer that they
currently intend to make a market in the Notes and the Exchange Notes.
However, the Initial Purchasers are not obligated to do so, and any such
market making may be discontinued at any time without notice. No assurance can
be given as to the liquidity of the trading market for the Notes and, if
issued, the Exchange Notes. Accordingly, there can be no assurance as to the
development or liquidity of any market for the Notes.
The Exchange Notes generally will be permitted to be resold or otherwise
transferred (subject to the restrictions described under "Exchange and
Registration Rights Agreement" and "Notice to Investors") by each holder of
the Exchange Notes without the requirement of further registration. The
Exchange Offer will not be conditioned upon any minimum or maximum aggregate
principal amount of Notes being tendered for exchange. No assurance can be
given as to the liquidity of the trading market for the Exchange Notes, or, in
the case of non-tendering holders of the Old Notes, the trading market for the
Old Notes following the Exchange Offer. Holders of Old Notes who do not accept
the Exchange Offer will continue to hold restricted Notes subject to certain
transfer restrictions. Any benefits they had under the Registration Rights
Agreement herein described will be terminated.
The liquidity of, and trading market for, the Notes or the Exchange Notes
also may be adversely affected by general declines in the market for similar
securities. Such a decline may adversely affect such liquidity and trading
markets independent of the financial performance of the Company.
VOTING CONTROL
As of September 30, 1997, H. H. Wommack, III, Chairman of the Board,
President and Chief Executive Officer of SRH and Southwest, owned 72.9% of the
outstanding voting shares of common stock of SRH, which owns 100% of the
common stock of Southwest. See "Principal Stockholders and Ownership of
Management." 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. See "Management." 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 $7.5 million, the existence of such insurance does not mean that the
death or disability of Mr. Wommack would not have a materially adverse effect
upon the Company.
VOLATILITY OF OIL AND NATURAL GAS PRICES
Revenues generated from Southwest's operations are highly dependent upon the
price of, and demand for, oil and natural gas. Historically, the markets for
oil and natural gas have been volatile and are likely to continue to be
volatile in the future. Prices for oil and natural gas are subject to wide
fluctuations in response to relatively minor changes in the supply of and
demand for oil and natural gas, market uncertainty and a variety of additional
factors that are beyond the control of Southwest. These factors include the
level of consumer product demand, weather conditions, domestic and foreign
governmental regulations, the price and availability of alternative fuels,
political conditions in the Middle East, the foreign supply of oil and natural
gas, the price of foreign imports and
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overall economic conditions. It is impossible to predict future oil and
natural gas price movements with any certainty. Declines in oil and natural
gas prices may materially adversely affect Southwest's financial condition,
liquidity and results of operations. Lower oil and natural gas prices also may
reduce the amount of Southwest's oil and natural gas that can be produced
economically. In order to reduce its exposure to price risks in the sale of
its oil and natural gas, Southwest may enter into hedging arrangements from
time to time; however, Southwest's hedging arrangements are likely to apply to
only a portion of its production and provide only limited price protection
against fluctuations in the oil and natural gas markets. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
General" and "Business."
Southwest uses the full cost method of accounting for its investment in oil
and natural gas properties. Under the full cost method of accounting, all
costs of acquisition, exploration and development of oil and natural gas
reserves are capitalized into a "full cost pool" as incurred, and properties
in the pool are depleted and charged to operations using the future gross
revenues method based on the ratio of current gross revenues to total proved
future gross revenues, computed based on current prices. Significant downward
revisions of quantity estimates or declines in oil and natural gas prices that
are not offset by other factors could result in a write down for impairment of
oil and natural gas properties. Once incurred, a write down of oil and natural
gas properties is not reversible at a later date even if oil or natural gas
prices increase.
RISKS OF ACQUISITION STRATEGY
The Company's growth strategy includes the acquisition of oil and gas
properties, well servicing businesses and commercial real estate properties.
There can be no assurance, however, that the Company will be able to continue
to identify attractive acquisition opportunities, obtain financing for
acquisitions on satisfactory terms or successfully acquire identified targets.
In addition, no assurance can be given that the Company will be successful in
integrating acquired businesses into its existing operations, and such
integration may result in unforeseen operational difficulties or require a
disproportionate amount of management's attention. Future acquisitions may be
financed through the incurrence of additional indebtedness to the extent
permitted under the Indenture or through the issuance of capital stock.
Furthermore, there can be no assurance that competition for acquisition
opportunities in these industries will not escalate, thereby increasing the
cost to the Company of making further acquisitions or causing the Company to
refrain from making additional acquisitions.
REPLACEMENT OF RESERVES
In general, the volume of production from oil and natural gas properties
declines as reserves are depleted. Except to the extent Southwest acquires
properties containing proved reserves or conducts successful development and
exploration activities, or both, the proved reserves of Southwest will decline
as reserves are produced. Southwest's future oil and natural gas production
is, therefore, highly dependent upon its level of success in finding or
acquiring additional reserves. The business of exploring for, developing or
acquiring reserves is capital intensive. To the extent cash flow from
operations is reduced and external sources of capital become limited or
unavailable, Southwest's ability to make the necessary capital investment to
maintain or expand its asset base of oil and natural gas reserves would be
impaired. In addition, there can be no assurance that Southwest's future
development, acquisition and exploration activities will result in additional
proved reserves or that Southwest will be able to drill productive wells at
acceptable costs.
UNCERTAINTY OF RESERVE INFORMATION AND FUTURE NET REVENUE ESTIMATES
There are numerous uncertainties inherent in estimating oil and natural gas
reserves and their estimated values, including many factors beyond the control
of Southwest. The reserve data set forth in this Prospectus 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
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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 "Business--Oil and Gas
Reserves."
The present values of estimated future net cash flows referred to in this
Prospectus 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.
SUBSTANTIAL CAPITAL REQUIREMENTS
Southwest makes, and will continue to make, substantial capital expenditures
for the exploration, development and acquisition of oil and natural gas
reserves. Southwest made capital expenditures of $32.1 million during 1995 and
$16.7 million during 1996. For the nine months ended September 30, 1997,
Southwest has spent approximately $27 million in the aggregate for oil and gas
acquisition, development and exploration activities and has budgeted
additional capital spending of approximately $45 million for the remainder of
1997 and 1998, principally to complete over 190 planned development drilling
and recompletion projects. The $45 million budgeted for capital spending is in
addition to the $72.3 million purchase price of the Oil and Gas Properties
Acquisition completed October 14, 1997. Although management believes that
Southwest will have sufficient cash provided by operating activities, bank
lines and the proceeds from the Offering to fund planned capital expenditures
in 1997 and 1998, if revenues decrease as a result of lower oil and natural
gas prices or operating difficulties, Southwest may be limited in its ability
to expend the capital necessary to undertake or complete its drilling program
in future years. There can be no assurance that additional debt or equity
financing or cash generated by operations will be available to meet these
requirements. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
DRILLING RISKS
Drilling involves numerous risks, including the risk that no commercially
productive oil or natural gas reservoirs will be encountered. The cost of
drilling, completing and operating wells is often uncertain, and drilling
operations may be curtailed, delayed or canceled as a result of a variety of
factors, including unexpected drilling conditions, pressure or irregularities
in formations, equipment failures or accidents, adverse weather conditions,
title problems and shortages or delays in the delivery of equipment.
Southwest's future drilling activities may not be successful and, if
unsuccessful, such failure will have an adverse effect on Southwest's future
results of operations and financial condition.
MARKETABILITY OF PRODUCTION
The marketability of Southwest's oil and natural gas production depends upon
the availability and capacity of 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.
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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. Sierra competes on the
basis of the quality of its equipment and service, its safety record and
pricing. Several competitors have access to greater financial and other
resources than those of Sierra, which could allow those companies to price
their services more aggressively than Sierra. Red Oak competes with other
companies for the acquisition of desirable real estate properties principally
on the basis of price. Although the Company believes that it has certain
advantages over these competitors, some of these competitors have greater
financial and other resources than the Company. See "Business--Competition."
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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 "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.
SIERRA OPERATIONS--DEPENDENCE ON OIL AND GAS INDUSTRY; INDUSTRY CONDITIONS
Sierra's business is substantially dependent upon conditions in the oil and
gas industry and, specifically, the expenditures of oil and gas companies. The
demand for well servicing activities is directly influenced by oil and gas
prices, expectations about future prices, the cost of producing and delivering
oil and gas, government regulation, including environmental regulations, local
and international political and economic conditions, and governmental policies
regarding exploration and development of oil and gas reserves. The demand for
well servicing and related services in the United States was severely
depressed for most of the last decade due in large part to prolonged weakness
and uncertainty in oil and gas prices. As a consequence, diminished demand
during that period led to lower rates and reduced use of available equipment.
Demand for well services has improved over the last two years, and prices for
such services have stabilized or increased during that period. Nonetheless,
there can be no assurance that periods of diminished demand in the oil field
service industry will not occur.
RED OAK OPERATIONS--ECONOMIC PERFORMANCE AND VALUE OF REAL ESTATE DEPENDENT ON
MANY FACTORS
Real estate property investments are subject to varying degrees of risk. The
economic performance and values of real estate can be affected by many
factors, including changes in the national, regional and local economic
climates, local conditions such as an oversupply of space or a reduction in
demand for real estate in the area, the attractiveness of the properties to
tenants, competition from other available space, the ability of the owner to
provide adequate maintenance and insurance and increased operating costs. In
recent years, there has been a proliferation of new retailers and a growing
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.
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THE COMPANY
SRH, a Delaware corporation, was formed in 1997 to serve as a holding
company for Southwest, Sierra and Red Oak. 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
raised approximately $115 million in 31 public and private limited partnership
offerings from 1983 to 1994. Southwest is a general partner of these limited
partnerships, owns interests in these partnerships and receives management
fees and operating cost reimbursements from such partnerships. Since
inception, Southwest, on behalf of itself and the investment partnerships, has
acquired over $320 million of oil and gas properties. As of June 30, 1997,
Southwest had total estimated net proved reserves of 32.5 MMBbls of oil and
75.3 Bcf of natural gas, aggregating 45.0 MMBoe, with a PV-10 Value of
approximately $214.5 million. Southwest's primary operations are in the
Permian Basin of West Texas and southeastern New Mexico. Southwest is the
Issuer of the Notes and a Restricted Subsidiary of SRH, the guarantor of the
Notes.
Sierra, a Delaware corporation, was formed in 1992 to provide certain well
services for Southwest and other oil and gas companies. Sierra expanded its
focus to provide a broader range of services, including workover rig services,
liquids handling and other services. Since January 1996, Sierra has pursued a
consolidation strategy, acquiring 15 well servicing companies in New Mexico
and Texas. SRH directly owns approximately 26% of the common stock of Sierra
and indirectly owns an additional 10% interest through Southwest, which is the
general partner and 15% interest holder in two partnerships that own
approximately 64% of the common stock of Sierra. This direct and indirect
ownership by SRH and the position of Southwest as general partner of the
partnerships, provides SRH with effective voting control of Sierra. Sierra, an
affiliate of SRH, is not classified as a Subsidiary of SRH for purposes of the
Indenture.
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.
Through October 31, 1997, Red Oak has acquired 17 commercial real estate
properties for $82.8 million. SRH owns approximately 82% of the common stock
of Red Oak on a fully-diluted basis. Red Oak is an Unrestricted Subsidiary.
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The following chart depicts the organizational structure of the Company and
includes certain additional information with respect to SRH and its
subsidiaries and affiliate related to the Notes. In addition, the chart
indicates SRH's direct ownership percentage in its subsidiaries and affiliate
and the ownership interest held by Southwest in Sierra, as general partner of
Southwest Partners II, L.P. ("Partners II") and Southwest Partners III, L.P.
("Partners III").
SOUTHWEST ROYALTIES
HOLDINGS, INC. ("SRH")
.Parent Guarantor of the
Notes on a Senior
Secured Basis
.Owns Capital Stock
of Sierra and Red Oak,
Pledged as Collateral
to the Parent Guarantee
100% 26% 82%
SOUTHWEST SIERRA RED OAK
OIL AND GAS WELL SERVICING REAL ESTATE
.Issuer of the Notes .Unconsolidated Entity .Unrestricted
Subsidiary
.Restricted Subsidiary .Approximately 26% of .82% of Common
of SRH Common Stock Directly Stock Directly
Owned by SRH Pledged Owned by SRH
.General Partner and as Collateral to the Pledged as
15% interest Parent Guarantee Collateral to the
holder in Partners II Parent Guarantee
and Partners III .Approximately 64%
which owns 64% of of Common Stock .Remaining 18% of
the Common Stock Owned by Southwest Common Stock
of Sierra Partners II and Owned by
Partners III Unaffiliated Third
Parties
.Approximately 9% of
Common Stock .$85.9 Million of
Owned by Pro Forma Debt
Unaffiliated Third Non-Recourse
Parties to SRH
.Approximately 1% of
Common Stock Owned by
Sierra Management
.$52.3 Million of Pro
Forma Debt Non-Recourse
to SRH
LOGO
Southwest has three subsidiaries, Midland Southwest Software, Inc.
("Southwest Software"), Threading Products International, LLC ("TPI"), and
Blue Heel Company ("Blue Heel"), in which Southwest owns approximately 99%,
97%, and 100%, respectively, of the common stock or membership interests.
Southwest
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Software creates and markets computer software to the oil and gas industry.
TPI produces inserts used to cut threads by manufacturers of threaded
products. Blue Heel holds a nominal interest in certain oil and gas properties
owned by Southwest. Southwest also owns 40% of the membership interests in SWV
Aviation, LLC, which owns an aircraft used by the Company and others.
Software, TPI and Blue Heel will be Restricted Subsidiaries under the terms of
the Indenture, but SWV Aviation, LLC will not be a Subsidiary thereunder.
Sierra currently has no subsidiaries, but expects to form or acquire
subsidiaries as a result of future acquisition activities, none of which would
be Subsidiaries for purposes of the Indenture. Red Oak has two wholly-owned
subsidiaries, MRO Properties, Inc. ("MROP") and MRO Management, Inc. ("MRO
Management"), both of which will be Unrestricted Subsidiaries. MROP holds
titles to certain real estate properties and is the borrower under a credit
agreement related to such properties. This credit agreement is non-recourse to
Red Oak. MRO Management performs real estate management services for MROP and
Red Oak.
Both Sierra and Red Oak are operated separately from Southwest; however,
Southwest provides both with significant administrative and accounting
support. Under the terms of separate service agreements dated September 1,
1997, Southwest has agreed to provide to Sierra and Red Oak administrative
services including accounting, bookkeeping, tax preparation and banking and
disbursement services. Both agreements have an initial term of five years and
renew from year to year if not terminated. Under each agreement, Southwest
receives a fixed fee of $12,000 per month. These fees may be adjusted at any
time by agreement of the parties. The service agreements may be terminated
upon 30 days' notice by either party to the agreements.
SRH has also entered into a tax sharing agreement effective September 1,
1997 with Southwest and Red Oak. This agreement provides, in general, that the
consolidated federal income tax liability of the members of the consolidated
group will be apportioned among the members in accordance with the method set
forth in Section 1.152-1(a)(2) of the Internal Revenue Code of 1986, as
amended and Sections 1.1502-33(d)(2)(i) of the Regulations promulgated
thereunder. In order to compensate members of the consolidated group for the
use of any net operating losses or tax credits and arriving at the
consolidated federal income tax liability for the group, group members have
agreed to determine and allocate the tax liability among themselves as
provided in the tax regulations.
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.
28
<PAGE>
PRIVATE PLACEMENT
On October 14, 1997, Southwest completed a $200 million private placement
sale of the Old Notes to the Initial Purchasers. Thereupon the Old Notes were
offered and sold by the Initial Purchasers only to qualified institutional
buyers. The net proceeds from the Private Placement were approximately $190
million. The Issuer used the net proceeds primarily to (i) fund the Oil and
Gas Properties Acquisition (net of deposits paid), (ii) repay substantially
all indebtedness outstanding under Southwest's bank credit facility and its
reserve-based loan facilities, (iii) fund a $10 million equity investment by
SRH in Red Oak through a dividend in that amount from the Issuer to SRH, (iv)
make a general partner capital contribution to Partners III of approximately
$1.7 million, which funds were immediately invested in Sierra common stock,
and (v) provide additional working capital for general corporate purposes,
including future acquisitions and development of producing oil and gas
properties. The following table illustrates the sources and uses of the gross
proceeds of the Offering:
SOURCES OF FUNDS USES OF FUNDS
---------------- -------------
(IN THOUSANDS)
Gross proceeds from sale of
Notes....................... $197,600
--------
Total sources................ $197,600
========
Oil and Gas Properties Acquisition................................ $ 67,700
Repayment of Southwest debt(1).................................... 83,500
Red Oak equity investment by SRH.................................. 10,000
General partner contribution to
Partners III..................................................... 1,700
Working capital................................................... 27,100
Fees and expenses................................................. 7,600
--------
Total uses........................................................ $197,600
========
- --------
(1) Includes amounts owed by Southwest at September 30, 1997 and prepayment
penalties. Southwest's indebtedness as of the Offering includes
approximately $44.9 million under Southwest's bank credit facility, $29.7
million under a reserve-based facility with Trust Company of the West and
TCW Asset Management Company (the "TCW Facility") and $8.9 million under a
reserve-based facility with Enron Capital and Trade Resources and Joint
Energy Development Investments Limited Partnership (the "ECT Facility").
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources" and Notes to
Consolidated Financial Statements.
USE OF PROCEEDS
Neither the Issuer nor SRH will receive any cash proceeds from the issuance
of the Exchange Notes offered hereby. In consideration for issuing the
Exchange Notes as contemplated in this Prospectus, the Issuer and SRH will
receive in exchange a like principal amount of Old Notes, the terms of which
are identical in all material respects to the Exchange Notes. The Old Notes
surrendered in exchange for the Exchange Notes will not result in any change
in capitalization of the Company.
29
<PAGE>
CAPITALIZATION
The following table sets forth as of September 30, 1997, the actual
capitalization of the Company and pro forma for the Private Placement and the
Transactions as if such transactions had occurred on September 30, 1997. The
information was derived from, and is qualified by reference to, the Company
Financial Statements, included elsewhere in this Prospectus. This information
should be read in conjunction with such financial statements, including the
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30,
1997
------------------
PRO
ACTUAL FORMA
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Long-term debt:
Bank credit facility--Southwest.......................... $ 44,900 $ --
9.0% TCW Facility........................................ 26,338 --
12.0% ECT Facility(1).................................... 7,229 --
13.0% mortgage note--Red Oak............................. 55,357 70,357
Other mortgage notes--Red Oak............................ 6,855 15,536
Capital leases and other debt............................ 1,534 2,307
10.5% Senior Notes due 2004.............................. -- 197,582
-------- --------
Total debt and capital leases, including current
portion............................................... 142,213 285,782
Redeemable Common Stock of Red Oak......................... 2,630 2,630
Redeemable Common Stock of SRH(2).......................... 8,291 8,291
Stockholders' equity:
Preferred stock, no par value, 5,000,000 shares
authorized, no shares issued and outstanding............ -- --
Common Stock, $.01 par value, 5,000,000 shares
authorized, 1,160,537 issued and 946,821 outstanding.... 116 116
Additional paid in capital(1)............................ 2,196 2,196
Retained earnings........................................ (935) (3,384)
Note receivable from officer(3).......................... (1,714) (1,714)
Treasury stock........................................... (3,090) (3,090)
-------- --------
Total stockholders' equity (deficit)................... (3,427) (5,876)
-------- --------
Total capitalization................................... $149,707 $290,827
======== ========
</TABLE>
- --------
(1) Represents an $8.0 million note payable, due November 2001, net of a
$771,000 discount remaining for SRH stock purchase warrants issued in
connection with the note. The discount is being amortized to interest
expense, using the interest method, over the life of the note.
(2) Redeemable only if SRH does not file, and cause to become effective, by
December 31, 2001, a registration statement under the Securities Act
related to the offer and sale of any amount of SRH's common stock. The
Indenture will contain restrictions that will require SRH to meet certain
tests to redeem the stock if the holders elect to require SRH to redeem
those shares of common stock. This obligation does not extend to the
Issuer.
(3) See "Certain Transactions" regarding the terms of this note.
30
<PAGE>
SELECTED HISTORICAL AND PRO FORMA FINANCIAL INFORMATION
The following tables set forth selected historical and pro forma financial
information of the Company for the periods shown. The following information
should be read in conjunction with "Capitalization," "Management's Discussion
and Analysis of Financial Condition and Results of Operations," the Company
Financial Statements and the Unaudited Pro Forma Combined Financial Statements
included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------------------ ---------------------------
PRO PRO
FORMA FORMA
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- ------- ------- -------- -------- ------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
<CAPTION>
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED INCOME
STATEMENT DATA:
Operating revenues:
Oil and gas.......... $17,999 $19,612 $16,321 $22,717 $ 35,296 $ 53,016 $24,638 $ 26,068 $ 37,873
Well service......... 746 1,363 2,377 4,218 8,013 -- 6,163 7,789 --
Real estate.......... -- -- 605 3,213 4,487 17,710 3,092 5,029 13,877
Other................ -- 279 325 352 622 362 424 948 904
------- ------- ------- ------- -------- -------- ------- -------- --------
Total operating
revenue........... 18,745 21,254 19,628 30,500 48,418 71,088 34,317 39,834 52,654
Operating expenses:
Oil and gas.......... 6,921 7,472 7,879 11,511 14,846 20,893 10,833 12,166 16,409
Well service......... 623 1,349 2,136 3,315 6,145 -- 4,519 5,600 --
Real estate.......... -- -- 195 1,414 1,887 8,458 1,295 1,907 6,166
General and
administrative...... 4,026 4,191 4,292 5,018 6,953 6,290 4,580 5,059 4,651
Depreciation,
depletion and
amortization........ 4,682 6,072 4,437 6,719 8,430 13,513 6,249 8,093 11,968
Other................ 10 4 105 228 554 554 407 1,003 1,003
------- ------- ------- ------- -------- -------- ------- -------- --------
Total operating
expenses.......... 16,262 19,088 19,044 28,205 38,815 49,708 27,883 33,828 40,197
Operating income....... 2,483 2,166 584 2,295 9,603 21,380 6,434 6,006 12,457
Other income
(expense):
Interest expense..... (1,999) (2,260) (1,975) (5,635) (10,016) (31,862) (7,180) (10,950) (24,617)
Interest income...... 112 287 229 269 441 430 275 545 536
Other................ 425 26 1,687 (78) 561 592 438 (66) (52)
------- ------- ------- ------- -------- -------- ------- -------- --------
Income (loss) before
income taxes,
minority interest and
equity in earnings of
subsidiary............ 1,021 219 525 (3,149) 589 (9,460) (33) (4,465) (11,676)
Income tax benefit
(provision)........... (327) (72) (171) 1,044 (365) 3,482 (54) 1,526 4,088
Minority interest in
subsidiaries.......... -- -- (1) (15) 181 (3) 71 322 321
Equity in earnings of
subsidiary............ -- -- -- -- -- (448) -- -- (4)
------- ------- ------- ------- -------- -------- ------- -------- --------
Income (loss) before
extraordinary item
and cumulative effect
of accounting change.. 694 147 353 (2,120) 405 (6,429) (16) (2,617) (7,271)
Extraordinary item,
net of tax............ -- -- -- -- -- -- -- (490) --
Cumulative effect of
accounting change..... 446 -- -- -- -- -- -- -- --
------- ------- ------- ------- -------- -------- ------- -------- --------
Net income (loss)...... $ 1,140 $ 147 $ 353 $(2,120) $ 405 $ (6,429) $ (16) $ (3,107) $ (7,271)
======= ======= ======= ======= ======== ======== ======= ======== ========
Earnings (loss) per
common share before
extraordinary item
and cumulative effect
of accounting change.. $ 0.66 $ 0.15 $ 0.37 $ (2.19) $ 0.42 $ (6.67) $ (0.02) $ (2.42) $ (6.74)
======= ======= ======= ======= ======== ======== ======= ======== ========
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER
AS OF DECEMBER 31, 30,
---------------------------------------- -----------------
1992 1993 1994 1995 1996 1996 1997
------- ------- ------- ------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE
SHEET DATA:
Cash and cash
equivalents........... $ 5,296 $ 2,461 $ 3,095 $ 3,364 $ 8,284 $ 4,827 $ 11,152
Net property and
equipment............. 29,888 28,257 36,886 78,231 100,176 83,755 141,450
Total assets........... 46,955 42,128 49,709 95,434 130,284 105,866 180,825
Long-term debt,
including current
portion............... 35,590 29,875 33,723 73,486 93,805 81,875 142,213
</TABLE>
31
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------- -------------------------
PRO PRO
FORMA FORMA
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED CASH FLOW
STATEMENT DATA:
Net cash provided by
operating activities.. 5,826 6,992 5,222 5,634 10,280 NA 4,835 9,411 NA
Net cash provided
(used) by investing
activities............ (23,635) (4,882) (9,641) (44,532) (33,225) NA (12,479) (62,731) NA
Net cash provided
(used) by financing
activities............ 21,783 (4,945) 5,054 39,166 27,865 NA 9,107 56,188 NA
OTHER FINANCIAL DATA:
Capital
expenditures(2)....... $40,018 $13,032 $15,948 $46,914 $34,513 NA $12,891 $60,973 NA
Capital expenditures--
oil and gas........... 33,577 10,588 9,988 32,077 16,740 NA 9,808 26,522 NA
Ratio of earnings to
fixed charges(3)...... 1.5x 1.1x 1.3x (3) 1.1x (3) (3) (3) (3)
Adjusted EBITDA(4)..... 8,204 8,769 6,880 7,605 16,760 27,858 11,337 11,063 18,113
Adjusted EBITDA to
Interest(5)........... 4.1x 3.9x 3.8x 1.8x 2.1x 1.3x 1.9x 1.6x 1.1x
</TABLE>
- --------
(1) Pro forma to reflect the Offering and the Transaction and certain other
acquisitions as if they had occurred on January 1, 1996, as well as the
deconsolidation of Sierra, which will be accounted for using the equity
method in future periods.
(2) Includes acquisitions. NA--not applicable
(3) Earnings were insufficient to cover fixed charges by $3,149,000, $33,000
and $4,465,000 for the historical periods ended December 31, 1995,
September 30, 1996 and September 30, 1997, respectively, and $9,908,000
and $11,680,000 for the pro forma periods ended December 31, 1996 and
September 30, 1997, respectively. For purposes of computing the ratio of
earnings to fixed charges, earnings are computed as income (loss) before
extraordinary item plus minority interest in subsidiaries and income
taxes, plus fixed charges. Fixed charges consist of interest expense and
an estimated portion of rentals representing interest costs.
(4) Adjusted EBITDA (as used herein) is calculated based on the Indenture,
which requires EBITDA to be calculated by adding the net income (loss) of
SRH (as defined on page 5 of this Prospectus) and its Restricted
Subsidiaries, excluding the net income (loss) of any Unrestricted
Subsidiary, to minority interest in subsidiaries, income tax benefit
(provision) and depreciation, depletion and amortization of SRH and
interest expense of SRH and its Restricted Subsidiaries. Specifically, net
income (loss), income tax benefit (expense), interest expense and
depreciation, depletion and amortization of Red Oak is excluded from the
calculation of Adjusted EBITDA, as Red Oak is an Unrestricted Subsidiary.
EBITDA is used because the Company believes it is commonly used by debt
holders and financial statement users as a measurement to determine the
ability of an entity to meet its interest obligations. EBITDA is not a
measurement presented in accordance with generally accepted accounting
principles ("GAAP") and is not intended to be used in lieu of GAAP
presentation of results of operations and cash provided by operating
activities.
(5) Adjusted EBITDA to Interest (as used herein) is the ratio of Adjusted
EBITDA to interest on the Notes plus interest on any other debt of SRH and
any Restricted Subsidiary.
32
<PAGE>
HISTORICAL AND PRO FORMA OPERATING DATA
The following table sets forth selected information with respect to the
Company's operating data for the periods shown and pro forma to give effect to
the Oil and Gas Properties Acquisition.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------------------ ---------------------
PRO PRO
FORMA FORMA
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(1)
------ ------ ------ ------ ------ ------- ------ ------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Production Volumes:
Oil and condensate
(MBbls)........... 751 647 629 814 1,001 1,812 743 818 1,391
Natural gas (MMcf). 3,390 4,737 3,178 4,639 5,403 5,888 3,986 4,142 4,276
Total (MBoe)....... 1,316 1,437 1,159 1,587 1,901 2,793 1,407 1,508 2,104
Average Realized
Prices(2):
Oil and condensate
(per Bbl)......... $17.76 $16.23 $14.30 $16.40 $20.44 $20.17 $19.72 $19.39 $19.46
Natural gas (per
Mcf).............. 1.31 1.61 1.72 1.51 2.22 2.29 2.05 2.01 2.10
Per Boe............ 12.80 12.60 12.47 12.83 17.07 17.91 16.23 16.05 17.12
Expenses (per Boe):
Lease operating
(including
production
taxes).......... $ 5.26 $ 5.20 $ 6.80 $ 7.25 $ 7.81 $ 7.48 $ 7.83 $ 8.10 $ 7.82
Oil and gas
depreciation,
depletion and
amortization.... 3.05 3.61 3.03 3.19 3.38 3.94 3.42 4.08 4.73
Oil and gas
general and
administrative,
net............. 2.69 2.49 2.87 2.17 2.17 1.69 1.93 2.31 1.90
</TABLE>
- --------
(1) Pro forma to reflect the Oil and Gas Properties Acquisition and certain
other acquisitions as if they had occurred on January 1, 1996.
(2) Reflects the actual realized prices received by the Company, including the
results of the Company's hedging activities. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
GENERAL
SRH is a holding company that conducts its operations through three
principal businesses. The Company's oil and gas operations are conducted
through Southwest, primarily in the Permian Basin of West Texas and
southeastern New Mexico. Well servicing operations, consisting of workover rig
services, liquids handling and other services, are conducted through Sierra in
Texas and New Mexico. Real estate operations are conducted through Red Oak and
are focused in Texas, Oklahoma and Arizona.
The Company has grown substantially over the last several years primarily
through acquisitions in each of its businesses. As a result of these
acquisitions, operating results may not be comparable from period to period.
The Company's acquisition expenditures for the period from 1994 to September
30, 1997, by business, are listed below:
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
----------------------- -----------------
1994 1995 1996 1997
------- ------- ------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Oil and gas (Southwest)............... $ 7,795 $24,116 $ 3,234 $11,384
Well servicing (Sierra)............... 790 923 2,941 6,677
Real estate (Red Oak)................. 4,400 12,631 12,528 26,954
------- ------- ------- -------
Total acquisition expenditures...... $12,985 $37,670 $18,703 $45,015
======= ======= ======= =======
</TABLE>
On October 14, 1997, the Company purchased additional oil and gas properties
in the Permian Basin from a major oil company for $72.3 million.
As previously indicated, a substantial portion of the Company's revenue
growth for the past several years has been the result of acquisitions. The
Company will continue to place emphasis on profitable acquisition
opportunities as long as such opportunities exist. However, the Company
understands the cyclical nature of the oil and gas industry. Therefore, the
Company is also actively seeking to develop its inventory of existing proved
developed non-producing and proved undeveloped reserves. The Company's staff
and operations are structured to be able to shift emphasis between
acquisitions and reserve development depending on market conditions. Because
the Company actively pursues both avenues of development, no overly disruptive
operational restructuring is required when the Company decides to shift its
focus.
Historically, the Company has placed more emphasis on acquisitions than
reserve development. Management believes, however, that if operations were to
shift toward reserve development, a stable revenue stream would be generated
which would increase as development projects were completed. A significant
portion of the Company's reserves are proved undeveloped and are therefore
available for development. The Company budgeted approximately $102.7 million
in 1997 and $44.9 million in 1998 for oil and gas acquisitions, development
and exploration. In 1997, $19.9 million of the $102.7 million was budgeted for
development and exploration. Of the $44.9 million budgeted for 1998, $24.3
million is allocated to development and exploration. If management determines
that there are fewer acquisition opportunities than expected, it will seek to
allocate additional funds to development and exploration activities.
Southwest's revenue, profitability and cash flow are substantially dependent
upon prevailing prices for crude oil and natural gas and the volumes of crude
oil and natural gas it produces. In addition, Southwest's proved reserves and
oil and gas production will decline as crude oil and natural gas are produced
unless Southwest is successful in acquiring producing properties or conducts
successful exploration and development activities.
Southwest uses the full cost method of accounting for its investment in oil
and gas properties. Under the full cost method of accounting, all costs of
acquisition, exploration and development of oil and gas reserves are
capitalized into a "full cost pool" as incurred, and properties in the pool
are depleted and charged to operations
34
<PAGE>
using the future gross revenues method based on the ratio of current gross
revenues to total proved future gross revenues, computed based on current
prices. Significant downward revisions of quantity estimates or declines in
oil and gas prices that are not offset by other factors could result in a
write down for impairment of oil and gas properties. Once incurred, a
writedown of oil and gas properties is not reversible at a later date, even if
oil or natural gas prices increase.
The Sierra Equity Sale resulted in a reduction in the direct ownership of
Sierra by SRH to approximately 26%. Beginning July 1, 1997, SRH began
accounting for its ownership of Sierra as an investment in an unconsolidated
subsidiary, consistent with the equity method of accounting under GAAP.
RESULTS OF OPERATIONS
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September
30, 1996
Revenues. Revenues for the Company increased $5.5 million, or 16%, for the
nine months ended September 30, 1997, reflecting increased revenues in each of
the Company's businesses.
The following table summarizes production volumes, average sales prices and
period to period comparisons for the Company's oil and gas operations,
including the effect on revenues, for the periods indicated:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED 1997 PERIOD COMPARED
SEPTEMBER 30, TO 1996 PERIOD
------------- ---------------------
REVENUE
% INCREASE INCREASE
1996 1997 (DECREASE) (DECREASE)
------ ------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Production volumes:
Oil and condensate (MBbls)................ 743 818 10 % $1,479
Natural gas (MMcf)........................ 3,986 4,142 4 % 320
Average sales prices:
Oil and condensate (per Bbl).............. $19.72 $19.39 (2)% $ (270)
Natural gas (per Mcf)..................... 2.05 2.01 (2)% (166)
</TABLE>
Oil and gas revenues increased $1.4 million, or 6%, for the nine months
ended September 30, 1997 compared to the same period in 1996, due primarily to
increases in oil production. Oil and gas production increased 10% and 4%,
respectively, due principally to several acquisitions. Changes in production
contributed $1.8 million to increased oil and gas revenues. The average price
per barrel of oil was $19.39, a decrease of 2%, and the average price of
natural gas was $2.01 per Mcf, a decrease of 2%, for the nine months ended
September 30, 1997 compared to the prior period. These lower oil and gas
prices contributed to a decrease of $436,000 to revenues.
Well servicing revenues increased $1.6 million, or 26%, attributable
primarily to acquisitions completed in the last half of 1996 and first half of
1997, as well as an increase in rates for well servicing rigs resulting from
increased demand for workover and completion services, partially offset by the
effects of deconsolidating Sierra at July 1, 1997. The Sierra Equity Sale
resulted in a reduction in the direct ownership of Sierra by SRH to
approximately 26%. Beginning July 1, 1997, SRH began accounting for its
ownership of Sierra as an investment in an unconsolidated subsidiary,
consistent with the equity method of accounting under GAAP. Real estate
operations revenues increased $1.9 million, or 63%, for the nine months ended
September 30, 1997, due primarily to acquisitions completed in the last half
of 1996 and first three quarters of 1997. Other operating revenues increased
524,000 or 124% due primarily to TPI, a small manufacturing subsidiary of
Southwest, which has increased its market share since commencing operations in
1994.
Operating Expenses. Operating expenses, before general and administrative
expense and depreciation, depletion and amortization, increased $3.6 million,
or 21%, for the nine months ended September 30, 1997, due primarily to growth
in the Company's businesses through acquisitions.
35
<PAGE>
Oil and gas operating expense increased $1.3 million, or 12%, for the nine
months ended September 30, 1997, due primarily to an increase in the number of
oil and gas properties owned by the Company and increased workover activity
during the period. The average operating expense was $8.10 per Boe in the nine
months ended September 30, 1997, an increase of 3% from $7.83 per Boe for the
same period in 1996. This increase in per unit operating costs was
attributable primarily to the acquisition of oil and gas properties which
affected 1997 results.
Well servicing operating expense increased $1.1 million, or 23%, for the
nine months ended September 30, 1997, attributable primarily to increased
activity from recently acquired companies, partially offset by the effects of
deconsolidating Sierra at July 1, 1997. Real estate operating expense
increased $612,000, or 47%, for the nine months ended September 30, 1997, due
primarily to acquisitions. Both well servicing and real estate operating
expenses declined, 2% and 4%, respectively, as a percentage of revenues as the
Company experienced efficiencies resulting from integrating acquisitions in
each of these businesses. Other operating expenses increased $596,000 or 146%,
due primarily to the growth of TPI, a small manufacturing subsidiary of
Southwest, which commenced operations in 1994.
General and Administrative ("G&A") Expense. G&A expense for the Company
increased $479,000, or 10%, for the nine months ended September 30, 1997, due
primarily to an increase in the Company's activities resulting from recent
acquisitions. Oil and gas G&A expense increased approximately $768,000, or
28%, for the nine months ended September 30, 1997, and was $2.31 per Boe, an
increase of 20% from the comparable prior period, due primarily to additions
to oil and gas technical and administrative staff in conjunction with planned
increases in future oil and gas development activity. Well servicing G&A
expense increased $192,000, or 17%, for the nine months ended September 30,
1997, due primarily to growth through acquisitions and increased business
insurance expense associated with those acquisitions, partially offset by the
effects of deconsolidating Sierra at July 1, 1997. Well servicing G&A expense
declined as a percentage of revenues as the Company experienced the benefits
of scale resulting from acquisitions in this business. Real estate G&A expense
decreased $31,000, or 6%, for the nine months ended September 30, 1997.
Depreciation, Depletion and Amortization ("DD&A") Expense. DD&A expense for
the Company increased $1.8 million, or 30%, for the nine months ended
September 30, 1997 due to growth in each of the Company's businesses. Oil and
gas DD&A expense increased approximately $1.4 million, or 28%, and was $4.08
per Boe, an increase of 20% from the comparable prior period. The increase in
oil and gas DD&A expense on an overall basis and per Boe was due to a higher
increase in production compared to the decrease in prices which resulted in
increased revenues and a higher depletion rate. Well servicing DD&A expense
remained constant as a percentage of well servicing revenue at 10% for both
periods. Real estate DD&A expense increased as a percentage of real estate
revenues from 15% in the nine months ended September 30, 1996 to 16% in the
nine months ended September 30, 1997.
Interest Expense. Interest expense for the Company increased $3.8 million,
or 53%, for the nine months ended September 30, 1997, primarily as a result of
increased borrowings incurred to fund a portion of the Company's acquisitions
and oil and gas development. Oil and gas interest expense increased
approximately $919,000, or 15%, as a result of increased borrowings for
development drilling and acquisitions made in the last quarter of 1996 and the
first three quarters of 1997. The average interest rate paid on these
borrowings also increased by approximately 1.0%. Well servicing interest
expense increased $132,000, attributable to increased debt incurred for
acquisitions, partially offset by the effects of deconsolidating Sierra at
July 1, 1997. Real estate interest expense increased $2.7 million, or 240%,
due to increased debt used to finance acquisitions and an increase of
approximately 3.0% in the average interest rate paid on these borrowings, as
compared to the prior year. This increase is primarily attributable to the
borrowing of non-recourse debt at Red Oak during the period.
Other Income. Other income decreased $504,000 or 115%, due to the receipt of
an insurance settlement in 1996.
Net Income. Due to the factors described above, net loss for the Company
increased $3.1 million to a loss of $3.1 million for the nine months ended
September 30, 1997.
36
<PAGE>
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenues. Revenues for the Company increased $17.9 million, or 59%, for the
year ended December 31, 1996, reflecting increased revenues in each of the
Company's businesses.
The following table summarizes production volumes, average sales prices and
period to period comparisons for the Company's oil and gas operations,
including the effect on revenues, for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED 1996 COMPARED
DECEMBER 31, TO 1995
------------- ---------------------
REVENUE
% INCREASE INCREASE
1995 1996 (DECREASE) (DECREASE)
------ ------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Production volumes:
Oil and condensate (MBbls)................ 814 1,001 23% $3,067
Natural gas (MMcf)........................ 4,639 5,403 16% 1,156
Average sales prices:
Oil and condensate (per Bbl).............. $16.40 $20.44 25% $4,043
Natural gas (per Mcf)..................... 1.51 2.22 47% 3,834
</TABLE>
Oil and gas revenues increased $12.6 million, or 55%, from 1995 to 1996, due
primarily to increases in oil and gas production and prices. Production of oil
and gas increased 23% and 16%, respectively, due to the inclusion of
production attributable to several acquisitions completed in late 1995, as
well as to acquisitions in 1996, resulting in an increase in revenues of $4.2
million. The average realized oil price was $20.44 per Bbl, an increase of
25%, and the average realized gas price was $2.22 per Mcf, an increase of 47%,
for 1996 as compared to 1995. These price increases resulted in increased
revenues of $7.9 million. Management fees and other oil and gas income also
increased at Southwest.
Well servicing revenues increased $3.8 million, or 90%, attributable
primarily to acquisitions completed in 1996, which increased the number of
well servicing rigs owned at year end 1996 to 22 from 10 at year end 1995, as
well as to an increase in rates for well servicing rigs resulting from
increased demand for these services. Real estate revenues increased $1.3
million, or 40%, for 1996, primarily due to the acquisition of three
properties in 1996. Other operating revenues increased $270,000 or 77%, due
primarily to TPI, a small manufacturing subsidiary of Southwest, which has
increased its market shares since commencing operations in 1994.
Operating Expenses. Operating expenses, before general and administrative
expense and depreciation, depletion and amortization, for the Company
increased $7.0 million, or 42%, for 1996, due primarily to growth in the
Company's businesses through acquisitions.
Oil and gas operating expense increased $3.3 million, or 29%, for 1996, due
principally to the overall increase in production generated from properties
acquired during 1996 and the prior year. The average operating expense was
$7.81 per Boe in 1996, an increase of 8% from the prior year, attributable
primarily to acquisitions of properties with generally higher per unit
operating expenses and to increased production taxes resulting from higher oil
and gas prices.
Well servicing operating expense increased $2.8 million, or 85%, for 1996,
attributable primarily to increases in expenses arising from acquisitions, but
partially offset by a reduction in expenses due to a shift from plugging and
abandonment to well servicing activities. Real estate operating expense
increased $473,000, or 33%, for 1996, due principally to acquisitions and
related increases in direct operating costs. Both well servicing and real
estate operating expenses declined as a percentage of revenues as the Company
experienced efficiencies resulting from acquisitions in each of these
businesses. Other operating expenses increased $326,000 or 143%, due primarily
to the growth of TPI, a small manufacturing subsidiary of Southwest, which
commenced operations in 1994.
G&A Expense. G&A expense for the Company increased $1.9 million, or 39%, for
1996, due to an increase in the Company's activities resulting primarily from
acquisitions. Oil and gas G&A expense increased approximately $686,000, or
20%, for 1996, and was $2.17 per Boe in each year. This expense increased as
the result of the addition of technical and administrative personnel relating
to growth in the Company's oil and gas
37
<PAGE>
business. Well servicing G&A expense increased $905,000, or 104%, for 1996
compared to the prior year, due primarily to growth through acquisitions and
the related additions of operating and administrative personnel. Real estate
G&A expense increased $232,000, or 55%, for 1996 compared to the prior year,
primarily as the result of a one time incentive compensation payment to
management. Both well servicing and real estate G&A expenses increased
slightly as a percentage of revenues.
DD&A Expense. DD&A expense for the Company increased $1.7 million, or 25%,
for 1996 due primarily to acquisitions. Oil and gas DD&A expense increased
$1.4 million, or 27%, for 1996 due primarily to increases in oil and gas
production. The DD&A rate was $3.38 per Boe, an increase of 6% as compared to
1995 results. Well servicing DD&A expense increased $415,000, or 93%, and real
estate DD&A expense increased $214,000, or 48%, in 1996 compared to the prior
year, attributable primarily to the impact of acquisitions.
Interest Expense. Interest expense for the Company increased $4.4 million,
or 78%, for 1996, primarily as a result of increased borrowings. Oil and gas
interest expense increased $3.7 million, or 85% for 1996, as a result of a
higher average outstanding debt balance due primarily to development
activities and acquisitions made in 1995 and 1996. Well servicing interest
expense increased $12,000 for 1996, attributable to an increase in average
debt balances. Real estate interest expense increased $632,000, or 50%, for
1996, due principally to increased debt used to finance acquisitions.
Other Income/Expense. Other income increased $639,000 or 619%, due to the
receipt of an insurance settlement in 1996.
Net Income. Due to the factors described above, net income for the Company
increased $2.5 million to $405,000 for 1996.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Revenues. Revenues for the Company increased $10.9 million, or 55%, for
1995, reflecting increased revenues in each of the Company's businesses,
primarily from acquisitions.
The following table summarizes production volumes, average sales prices and
period to period comparisons for the Company's oil and gas operations,
including the effect on revenues for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED 1995 COMPARED
DECEMBER 31, TO 1994
------------- ---------------------
REVENUE
% INCREASE INCREASE
1994 1995 (DECREASE) (DECREASE)
------ ------ ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Production volumes:
Oil and condensate (MBbls)................ 629 814 29 % $2,645
Natural gas (MMcf)........................ 3,178 4,639 46 % 2,510
Average sales prices:
Oil and condensate (per Bbl).............. $14.30 $16.40 15 % $1,712
Natural gas (per Mcf)..................... 1.72 1.51 (12)% (952)
</TABLE>
Oil and gas revenues increased $6.4 million, or 39%, from 1994 to 1995, due
principally to increased oil and gas production and oil prices. Production of
oil and gas increased 29% and 46%, respectively, due primarily to production
from acquired properties, resulting in an increase in revenues of $5.2
million. The average realized price per barrel of oil was $16.40, an increase
of 15%, and the average realized gas price was $1.51 per Mcf, a decrease of
12%, for 1995 compared to 1994. These price changes resulted in increased
revenues of $760,000 for 1995 compared to 1994. Management fees and other
income also increased at Southwest.
38
<PAGE>
Well servicing revenues increased $1.8 million, or 77%, attributable
primarily to the addition of four well servicing rigs in 1995, resulting in a
fleet of ten rigs at year end 1995 compared to six rigs at year end 1994. Real
estate revenues increased $2.6 million, for 1995, due primarily to the
acquisition of two properties in 1995. Other operating revenues increased
$27,000 or 8%, due to the addition of TPI, a small manufacturing subsidiary of
Southwest.
Operating Expenses. Operating expenses, before general and administrative
expense and depreciation, depletion and amortization, for the Company
increased $6.2 million, or 60%, for 1995, due primarily to growth in the
Company's businesses through acquisitions.
Oil and gas operating expense increased $3.6 million, or 46%, for 1995, due
principally to increased production from acquired properties. The average
operating expense was $7.25 per Boe in 1995, an increase of 7% from $6.80 per
Boe for the prior year, attributable primarily to acquisitions of properties
with generally higher per unit operating expenses and to increased production
taxes resulting from higher oil and gas prices.
Well servicing operating expense increased $1.2 million, or 55%, for 1995,
attributable primarily to increased expense from businesses acquired. Well
servicing operating expense declined as a percentage of revenues, from 90% in
1994 to 79% in 1995 on a consolidated basis, as Sierra achieved improved
pricing for its services and efficiencies from its acquisitions. Real estate
operating expense increased $1.2 million for 1995, due to increased expense
resulting from acquisitions. Other operating expenses increased $123,000 or
117%, due to the addition of TPI, a small manufacturing subsidiary of
Southwest.
G&A Expense. G&A expense for the Company increased $726,000, or 17%, for
1995, compared with 1994, due principally to an increase in the Company's
activities from acquisitions. Oil and gas G&A expense increased $123,000, or
4%, for 1995, and was $2.17 per Boe, a decrease of 24% from the prior year.
This expense increased as the result of an increase in technical and
administrative personnel attributable to growth in the oil and gas business,
but decreased on a per unit basis due primarily to increases in oil and gas
production. Well servicing G&A expense increased $437,000, or 102%, for 1995
compared to the prior year, due principally to the establishment of the East
Texas field office. Real estate G&A expense increased $6,000, or 1%, for 1995
compared to the prior year. Real estate G&A expenses declined as a percentage
of revenues as the Company experienced the benefits of scale resulting from
acquisitions.
DD&A Expense. DD&A expense for the Company increased $2.3 million, or 51%,
for 1995, compared with 1994. This increase was due primarily to an increase
in oil and gas production. Oil and gas DD&A expense increased $1.6 million, or
44%, for 1995, and was $3.19 per Boe, an increase of 5%, compared to the prior
year. The increase in oil and gas DD&A expense was attributable primarily to a
doubling of the oil and gas property base resulting from acquisitions, and was
partially offset by a decreased DD&A rate. Well servicing DD&A expense
increased $294,000, or 191%, for 1995, due principally to a significant
increase in the well servicing asset base from acquisitions. Real estate DD&A
expense increased $364,000, for 1995, due primarily to the acquisition of new
properties.
Interest Expense. Interest expense for the Company increased $3.7 million,
or 185%, for 1995, compared with the same period in 1994, due primarily to
increased borrowings attributable to acquisitions at Southwest and Red Oak.
Oil and gas interest expense increased $2.5 million, or 135%, for 1995. Well
servicing interest expense increased $47,000 for 1995, and real estate
interest expense increased $1.2 million for 1995.
Other Income/Expense. Other income decreased $1,765,000 or 105%, due to a
gain on sale on assets in 1994.
Net Income. Due to the factors described above, net income for the Company
decreased $2.5 million to a loss of $2.1 million for 1995.
39
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Funding for the Company's business activities has historically been provided
by operating cash flows, bank borrowings, reserve-based financing and sales of
equity. While the Company regularly engages in discussions relating to
potential acquisitions of oil and gas properties, well servicing businesses
and real estate properties, it has no present agreement, commitment or
understanding with respect to any such acquisition. Any future acquisitions
may require additional financing and will be dependent upon financing
arrangements available at the time.
Net Cash Provided by Operating Activities. Cash flows provided by operating
activities from the Company's operations were $5.2 million, $5.6 million and
$10.3 million for 1994, 1995 and 1996, respectively. Increases in oil and gas
production and revenues resulting principally from acquisition and development
activities over this three-year period, as well as generally improved oil and
gas prices, increased cash flows. Additionally, growth from well servicing
acquisitions, increased cash flows, partially offset by cash used in real
estate operating activities. Cash flows from the Company's operations for the
nine-month period ended September 30, 1997 were $9.4 million, as compared to
$4.8 million for the prior year. This increase was primarily attributable to
increases in oil and gas production and prices and increased activity
attributable to well servicing and real estate acquisitions.
Net Cash Used in Investing Activities. Cash flows used in investing
activities by the Company were $9.6 million, $44.5 million and $33.2 million
for 1994, 1995 and 1996, respectively. Acquisitions and oil and gas
development activities were the primary uses of funds. Cash flows used in
investing activities by the Company for the nine months ended September 30,
1996 were $12.5 million and for the nine months ended September 30, 1997 were
$62.7 million.
The following table sets forth capital expenditures, including acquisitions,
made by the Company during the periods indicated.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- -----------------
1994 1995 1996 1997
------- ------- ------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Oil and gas
Development...................... $ 2,134 $ 6,683 $13,322 $13,215
Exploration...................... 59 1,278 184 1,923
Acquisitions..................... 7,795 24,116 3,234 11,384
Well servicing..................... 852 1,598 3,826 6,885
Real estate........................ 5,108 13,239 13,947 27,566
------- ------- ------- -------
Total.......................... $15,948 $46,914 $34,513 $60,973
======= ======= ======= =======
</TABLE>
In 1997, the Company budgeted $102.7 million for oil and gas acquisition,
development and exploration, including $72.3 million for the Oil and Gas
Properties Acquisition. The Company actually spent $103.9 million in 1997 on
acquisition, development and exploration. The Company has budgeted $44.9
million for acquisition, development and exploration in 1998. In addition,
Sierra and Red Oak had budgeted $43.6 and $55.0 million, respectively, for
acquisitions and capital expenditures in 1997. Actual expenditures for 1997
were $61.4 million for Sierra and $53.8 for Red Oak. The Company anticipates
capital expenditures in 1998 of $1.3 million at Sierra and $4.0 million at Red
Oak.
Net Cash Provided by Financing Activities. Cash provided by the Company's
financing activities was $5.1 million, $39.2 million (including additional
borrowings of $37.1 million) and $27.9 million (including additional
borrowings of $18.0 million and $9.9 million net proceeds from issuance of
additional equity securities) for 1994, 1995 and 1996, respectively. Cash
provided by financing activities for the Company's operations for the nine
months ended September 30, 1997 was $56.2 million, consisting of additional
net borrowings of $53.7 million and net proceeds from private equity sales by
a subsidiary.
40
<PAGE>
In April 1997, MROP, a wholly-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 six mortgage loans, originally incurred to complete the
acquisition of certain Red Oak properties, and to finance the acquisition of
an additional real estate property. Borrowings under the facility bear
interest at a rate of 13%, with 10% payable in cash and the remaining 3%
payable in cash or additional notes at MROP's option. The facility contains a
number of covenants that, among other things, restrict the ability of MROP to
incur additional indebtedness and dispose of assets. The facility is secured
by a first lien on substantially all of MROP's properties. MROP's obligations
under the facility are nonrecourse to SRH, Southwest, Red Oak and Sierra.
In conjunction with the Private Placement, the Company arranged new
borrowing facilities for each of its businesses. The following discussion
summarizes the material terms of such facilities.
Southwest Credit Facility. The Southwest Credit Facility has been amended to
provide for a $75 million revolving line of credit maturing in February 1999,
resulting in availability of $40 million, subject to semi-annual borrowing
base redetermination. The initial borrowing base of $40 million is subject to
a $15 million sub-limit on availability for oil and gas acquisitions, with the
balance of the borrowing base available for general corporate purposes.
Borrowings accrue interest at LIBOR plus a margin ranging from 1.75% to 2.50%
and incur a quarterly commitment fee of three-eighths of one percent ( 3/8%)
per annum on the daily average of the unadvanced amount of the borrowing base.
The Southwest Credit Facility is secured by substantially all of Southwest's
proved oil and gas properties. The facility contains a number of covenants
that limit loans and advances, investments, and dividends, as well as setting
a minimum interest coverage ratio for SRH.
Sierra Acquisition Facility. Sierra arranged the Sierra Acquisition
Facility, in the amount of $60 million, secured by all of Sierra's assets,
with an institutional lender. Tranche A of the Sierra Acquisition Facility is
for up to $30 million, with interest payable monthly at the prime rate plus
1.0%. The full amount of Tranche A was used to finance part of Sierra's recent
acquisitions and the related working capital and costs and expenses of such
transactions. Tranche B of the Sierra Acquisition Facility is for $30 million,
with an initial availability of $10 million and subsequent advances subject to
lender approval. Sierra spent $61.4 million for acquisitions and capital
expenditures in 1997. $50.0 million of those expenditures were funded from the
Sierra Acquisition Facility. Interest will be payable monthly on funds
advanced under Tranche B, initially at the prime rate plus 3.0%, subject to
adjustment. The final maturity of the Sierra Acquisition Facility is 18 months
after the date of closing of the facility. Under the terms of the Sierra
Acquisition Facility, the lender received certain fees and warrants to
purchase common stock of Sierra.
Red Oak Acquisition Facilities. In order to partially fund Red Oak's recent
acquisitions, the MROP Facility was increased by an additional $30 million and
Red Oak entered into two additional mortgage facilities with separate lenders
(the "Red Oak Acquisition Facilities"). Red Oak spent $53.8 million for
acquisitions and capital expenditures in 1997. $51.1 million of those
expenditures were funded from the Red Oak Acquisition Facilities. The Red Oak
Acquisition Facilities are secured by a first lien on the properties acquired.
The two additional mortgage facilities contain a number of covenants that,
among other things, restrict the ability of Red Oak to incur additional
indebtedness and dispose of assets, and borrowings thereunder bear interest at
9.25%. Red Oak's obligations under the Red Oak Acquisition Facilities are
nonrecourse to SRH, Southwest and Sierra.
To partially fund its recent acquisitions, Red Oak sold additional common
stock to SRH for $10 million. SRH funded its purchase of additional common
stock from the proceeds of a dividend of $10 million from Southwest, paid out
of a portion of the net proceeds from the Private Placement.
The Company believes that availability under the Southwest Credit Facility,
the Sierra Acquisition Facility, the Red Oak Acquisition Facilities, cash flow
from operations and the proceeds from the private placement Note Offering,
will be sufficient for planned operating and capital expenditure requirements
in 1997 and 1998. If the Company makes capital expenditures in excess of
planned levels, it may be required to seek additional financing.
41
<PAGE>
BUSINESS
GENERAL
The Company 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, the Company has grown
primarily through selective acquisitions of producing oil and gas properties,
completing over $320 million in acquisitions, both directly and through the
oil and gas partnerships it manages. The Company also participates in the well
servicing industry through its affiliate, Sierra, and owns and manages real
estate properties through its subsidiary, Red Oak.
The Company pursues a strategy of acquiring long-life, producing oil and gas
properties, which offer both current cash flow, significant development
potential and opportunities to reduce operating and administrative costs. Many
of the Company's previous acquisitions were completed during periods of
relatively low oil and gas prices, and the Company generally deferred
development of such acquired properties to invest available capital in
additional acquisitions. Due to increased oil and gas prices and improved
availability of capital, the Company has increased its oil and gas development
activities. The Company plans to increase capital spending on development and
exploitation opportunities.
At June 30, 1997, on a pro forma basis, the Company owned interests in
approximately $2.6 million gross leasehold acres, approximately 75% of which
were classified as developed. At such date, the Company's estimated net proved
reserves, on a pro forma basis, would have been 32.5 MMBbls of oil and 75.3
Bcf of natural gas, or 45.0 MMBoe. The Company's properties are located
primarily in the Permian Basin and generally have well-established production
histories with a pro forma reserve life of approximately 15 years. At June 30,
1997, the Company's pro forma PV-10 Value would have been $214.5 million.
The Company's development projects generally involve moderate drilling and
completion costs as they are located primarily in shallow to intermediate
depth, normally pressured reservoirs. Additionally, many of these projects
contain multiple horizons that are potentially productive, thereby further
reducing development drilling risk. The Company has identified over 500
recompletion and development opportunities on its properties. For the nine
months ended September 30, 1997, Southwest has spent approximately $27 million
in the aggregate for oil and gas acquisition, development and exploration
activities and has budgeted additional capital spending of approximately $45
million for the remainder of 1997 and 1998 principally to complete over 190
planned development drilling and recompletion projects. The Company
anticipates that its development activities, when combined with new seismic
and other data, will result in the identification of additional development
drilling prospects and proved reserves.
The Company engages in the well servicing business through Sierra, in which
SRH has a 26% direct ownership interest in Sierra as well as an indirect 10%
ownership interest through Southwest which is the general partner and 15%
interest holder in two partnerships which own approximately 64% of Sierra.
Sierra, which was formed in 1992, provides a broad range of well services to
oil and gas companies, including workover rig services, liquids handling and
other services. Since January 1996, Sierra has purchased 15 well servicing
companies for a total cost of $42.1 million, increasing its equipment fleet to
86 workover rigs. Management believes that Sierra is the fourth largest land-
based well servicing company in the United States.
Red Oak, an 82%-owned subsidiary of SRH, on a pro forma basis, owns and
manages retail shopping centers and office buildings in Texas, Oklahoma and
Arizona. Since December 1993, Red Oak has acquired 17 properties for
approximately $82.8 million.
STRATEGY
The Company's objective is to increase its revenues, cash flow, earnings and
assets through a balanced growth strategy of acquisition, development and
exploitation of oil and gas properties, and through its investments in the
well servicing and real estate businesses.
42
<PAGE>
Complete Selective Oil and Gas Acquisitions. The Company seeks to acquire
producing oil and gas properties that provide opportunities for the addition
of reserves, production and cash flow through operational improvements,
production enhancement and additional development. The Company believes these
criteria are met in the Permian Basin due to the region's long history of
production and multiple producing oil and gas horizons. The Company has
acquired over $320 million of oil and gas properties since inception, both
directly and through the oil and gas partnerships it manages. Management
believes that acquisition opportunities will continue to be available in the
Permian Basin.
Develop and Exploit Existing Oil and Gas Properties. The Company has
acquired a diversified portfolio of oil and gas properties that contains
numerous identified development opportunities. The Company believes that
current oil and gas prices, combined with technical and operating advances,
have improved the attractiveness of accelerated development of these
properties. The Company plans to significantly increase its capital spending
during 1997 and 1998 to pursue these opportunities, which consist principally
of infill drilling, recompletions, enhanced recovery operations and workover
opportunities. The Company is pursuing these projects to increase cash flow
and to identify additional reserves and development projects.
Maintain Geographic Focus. The Company concentrates its oil and gas
activities in the Permian Basin, with properties in this region representing
over 90% of the Company's pro forma PV-10 Value at June 30, 1997. The Company
believes that its long-life oil and gas properties and large inventory of
development projects in the Permian Basin, coupled with region-specific
geological, engineering and production experience, provide it with focused
operations. Company-operated properties comprised approximately 60% of its pro
forma PV-10 Value at June 30, 1997, allowing substantial control over the
incurrence and timing of capital and operating expenditures.
Selectively Grow Well Servicing and Real Estate Businesses. The Company
plans to continue the expansion of its well servicing and real estate
businesses, primarily in the southwestern United States. The Company expects
that Sierra's and Red Oak's active management practices will lead to
consolidation benefits, cost savings, more efficient utilization and improved
cash flow, thereby enhancing the return on capital invested.
SOUTHWEST
Prior to 1996, Southwest grew principally through the acquisition of
producing properties, establishing a substantial base of producing and
undeveloped properties in the Permian Basin. Due to relatively low oil and gas
prices, as well as certain other constraints, Southwest pursued limited
exploration and development of its properties during this period. With the
recovery of oil and gas prices, Southwest increased its development activities
in 1996. Southwest plans to accelerate the internal development and
exploitation projects. Southwest's development program focuses on its operated
properties. For the second half of 1997 and for 1998, Southwest has budgeted
capital spending for over 190 drilling and recompletion opportunities within
its existing property base, approximately 90% of which are identified as
proved in its reserve report. Southwest intends to devote a limited amount of
its capital spending to lower risk exploration drilling opportunities,
consisting principally of step-out drilling prospects adjacent to existing
producing fields.
Southwest's estimated actual and pro forma net proved reserves as of June
30, 1997 were approximately 31.0 MMBoe and 45.0 MMBoe, respectively, and
actual and pro forma production during the first nine months of 1997 was
approximately 1.5 MMBoe and 2.1 MMBoe, respectively. Approximately 67% of the
pro forma reserves would have been classified as proved developed. As of June
30, 1997, Southwest's PV-10 Value, on a pro forma basis, would have been
$214.5 million.
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. Approximately 86% of the
Company's PV-10 Value is concentrated in this region (91% on a pro forma
basis). The region is characterized by numerous known producing horizons,
providing
43
<PAGE>
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 June 30, 1997, the Company
operated properties comprising approximately 60% of its PV-10 Value (60% on a
pro forma basis). The following table provides information for the Company's
ten largest fields which contribute approximately 50% of its reserves and PV-
10 Value as of June 30, 1997.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1997
-------------------------
NET % OF
PROVED PV-10 TOTAL
RESERVES VALUE (IN PV-10
FIELD (MBOE) THOUSANDS) VALUE
----- -------- ---------- -----
<S> <C> <C> <C>
Flying M.......................................... 3,778 $10,786 7.8%
Halley............................................ 2,010 10,376 7.5
Magnolia Sealy.................................... 2,450 9,491 6.9
Rhoda Walker...................................... 1,785 8,444 6.1
T.J. Good......................................... 1,202 7,430 5.4
Vealmoor.......................................... 1,476 6,839 5.0
Ward-Estes North.................................. 787 4,574 3.3
Maljamar.......................................... 688 3,533 2.6
Hendrick.......................................... 864 3,190 2.3
Oceanic........................................... 518 2,204 1.6
------ ------- ----
Total........................................... 15,558 $66,867 48.6%
====== ======= ====
</TABLE>
Flying M Field. The Flying M Field is located in northern Lea County, New
Mexico and produces from the San Andres oil reservoir. The field was
discovered in 1964 and was unitized in 1967 when water injection commenced. In
1997, Southwest acquired working interests ranging from 83% to 100% in 6,160
gross acres of the field area, of which 2,240 gross acres are undeveloped.
Southwest operates all 46 producing wells and nine active water injection
wells, including wells that are not contained within the unitized portion of
the field. Development plans for this field include the drilling of ten
undrilled 40-acre proved undeveloped locations and the conversion of ten wells
to water injection. Further development of the field, including the reduction
to 20-acre spacing from the current 40-acre spacing, is presently under
evaluation.
Halley Field. The Halley Field is located in Winkler County, Texas and
consists of two leases totaling 7,608 gross acres, of which 3,190 gross acres
have been developed. Southwest acquired working interests ranging from 43% to
70% in this field in 1995 and currently operates 123 active producing wells
and 33 water injection wells. The field was discovered in 1937 and produces
from multiple zones ranging from 2,400 to 3,000 feet in depth. To date,
Southwest has performed 30 workovers, increasing average daily production from
approximately 200 Bopd and 280 Mcfd of natural gas in 1995 to 321 Bopd and
1,500 Mcfd of natural gas in 1996. Development plans, which have commenced,
include the drilling of 20 proved undeveloped locations. An additional 15
potential well locations have been identified and five workovers are scheduled
to be completed by the end of 1997.
Magnolia Sealy Field. The Magnolia Sealy Field is located in Ward County,
Texas and produces from the Upper Yates oil reservoir. Southwest acquired its
interest in this field in 1988 and operates 21 producing wells and three water
disposal wells with a working interest of 90%. There are currently 33 proved
undeveloped locations to be drilled on the 1,800 gross acres operated by
Southwest. Development plans also include the initiation of a water flood on a
portion of the field by early 1998.
Rhoda Walker Field. The Rhoda Walker Field is located in Ward County, Texas
and produces from 18 different reservoirs ranging in depth from 4,700 to 7,000
feet. Southwest acquired its working interests in this field, ranging from 1%
to 34%, in 1990. Southwest operates 37 producing wells and five water disposal
wells and also owns non-operated interests in 46 wells. The field was
discovered in 1971 and contains significant proved developed non-producing
reserves. Development plans include 24 recompletions, the drilling of 47
proved undeveloped locations and infill drilling.
44
<PAGE>
T.J. Good Field. The T.J. Good Field is located in Dawson and Borden
Counties, Texas. Southwest and Apache Corporation each own a 50% working
interest and Apache operates the 30 producing wells and five injection wells.
The field was discovered in 1949 and produces from the Spraberry, Dean and
Canyon formations. Southwest acquired its interest in this field in 1995.
Development plans include conversion of two producing wells to water
injection, additional development and recompletion of the Spraberry and Dean
formations and the drilling of two Canyon Reef wells.
Vealmoor Field. The Vealmoor Field is located in northwest Howard County,
Texas. Southwest acquired its 35% non-operated working interest in this field
in 1995. The field was discovered in 1948 and is currently producing from 20
wells in the Horseshoe Atoll-Canyon Reef trend. Development plans include the
drilling of nine infill wells resulting in 20-acre spacing in a portion of the
field. Additionally, seven development locations have been identified to test
proved undeveloped locations and Southwest is currently evaluating 3-D seismic
data over the field.
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
Dolomite formations. Southwest acquired its working interests in this field,
ranging from 52% to 98%, in 1988 and operates 32 producing and eight injection
wells. The field was discovered in 1933. Southwest initiated several infill
drilling and recompletion programs since purchasing its interests, increasing
production and reserves. Development plans include five workovers in the Yates
and Queen formations and a reduction in spacing to ten acres from 20 acres,
with additional water injection wells to be added as needed.
Maljamar Field. The Maljamar Field is located in Lea County, New Mexico and
produces from the Queen, Grayburg, Premier and San Andres reservoirs at depths
ranging from 4,200 to 5,500 feet. Southwest acquired its 100% working
interests in this field in 1989. The field was discovered in 1954. Development
and exploration plans include two workovers and the drilling of five proved
undeveloped locations.
Hendrick Field. The Hendrick Field is located in Winkler County, Texas and
produces from the Seven Rivers, Yates and Dolomite formations. Southwest
acquired its interests in this field, ranging from 21% to 54%, in 1991 and
operates 13 producing wells and five disposal wells. The field was discovered
in 1929. Development plans include the completion of three recently drilled
wells, installation of pumps to accelerate production and the drilling of nine
additional development locations.
Oceanic Field. The Oceanic Field is located in Howard County, Texas and
produces from the Horseshoe Atoll-Canyon Reef trend from multiple pay zones
ranging in thickness from 200 to 300 feet. Southwest acquired its 33% non-
operated working interest in this field in 1995. The field was discovered in
1953. Development and exploration plans include the drilling of five
additional proven undeveloped locations and the interpretation of 3-D seismic
data to determine well placement for additional recovery of oil and gas
reserves.
The Oil and Gas Properties Acquisition
On October 14, 1997, the Company acquired various working interests in 431
producing oil and gas wells, located in seven fields in the Permian Basin of
West Texas and southeastern New Mexico. The Company will operate 133 of these
wells. The Company believes that it has significant opportunities to improve
production and cash flow from these properties through additional development,
reconfiguration of operations and reduction of operating and administrative
costs. These acquisitions added estimated net proved reserves of approximately
13.3 MMBbls of oil and 4.2 Bcf of gas, or 14.0 MMBoe, as of June 30, 1997. The
following table provides information for the seven fields included in the
acquisition, and the largest fields are described thereafter.
45
<PAGE>
<TABLE>
<CAPTION>
AS OF JUNE 30,
1997
------------------
NET
PROVED PV-10
RESERVE VALUE (IN
FIELD (MBOE) THOUSANDS)
----- ------- ----------
<S> <C> <C>
Huntley................................................ 3,513 $22,591
Ackerly................................................ 3,327 17,850
Foster................................................. 2,255 13,317
Huntley East........................................... 2,229 12,209
Jo-Mill................................................ 2,425 9,571
South Maljamar Young................................... 172 915
Buffalo................................................ 117 397
------ -------
Total................................................ 14,038 $76,850
</TABLE>
Huntley Field. The Huntley Field is located in Garza County, Texas. The
field was discovered in 1953 and produces from the San Andres and Glorieta
reservoirs. Southwest owns a 74% working interest and operates 33 producing
and 12 injection wells.
Ackerly (Dean) Field. The Ackerly (Dean) Field is located in Dawson County,
Texas and produces from the Dean Sand oil reservoir. The field was discovered
in 1954 with the drilling and completion of the Pan American Graves "A" No. 1
well. Southwest owns a 60% working interest in the East Ackerly Dean Unit--
Phase II, along with interests in two additional leases. Henry Petroleum
operates 70 producing and 30 injection wells.
Foster Field. The Foster Field is located in Ector County, Texas. The field
was discovered in 1936 and produces from the Grayburg and Queen formations in
the Gist Unit. Southwest owns working interests ranging from 46% to 100% and
operates 63 producing and 57 injection wells.
Huntley East Field. The Huntley East Field is located in Garza County,
Texas. The field was discovered in 1956 and produces from a low-relief
anticline which covers approximately 1,400 surface acres. Southwest has a 100%
working interest in the Huntley East San Andres Unit, which comprises
substantially all of the field, and a 100% working interest in the Harold L.
Davies lease, and operates 37 producing and seven injection wells.
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.
Oil and Gas Reserves
The following table summarizes the estimates of Southwest's historical and
pro forma 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 June 30, 1997 were prepared by Ryder Scott Company
Petroleum Engineers for properties representing 89% of the Company's PV-10
Value and by the Company for the remainder of the properties. The reserve and
present value data as of December 31, 1996 and for prior periods were prepared
by independent petroleum engineer, Donald R. Creamer.
46
<PAGE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31, AS OF JUNE 30,
---------------------------- -------------------
PRO FORMA
1994 1995 1996 1997 1997(1)
-------- -------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
Proved Reserves:
Oil and Condensate (MBbls). 10,008 16,580 18,806 19,114 32,456
Natural Gas (MMcf)......... 37,990 70,590 76,776 71,128 75,313
Total (MBoe)............. 16,340 28,345 31,602 30,969 45,008
Proved Developed Reserves:
Oil and Condensate (MBbls). 4,760 7,349 10,302 9,485 21,125
Natural Gas (MMcf)......... 27,587 51,926 58,961 51,649 55,214
Total (MBoe)............. 9,358 16,003 20,129 18,093 30,327
PV-10 Value (in
thousands)(2)............... $ 59,064 $117,902 $252,170 $137,688 $214,539
Discounted Future Cash
Flows(3)
Future cash inflows........ $227,864 $433,514 $735,100 $479,048 $726,257
Future production and
development costs ........ (125,113) (213,698) (283,894) (233,654) (337,386)
-------- -------- -------- -------- --------
Future net cash flows
before income taxes....... 102,751 219,816 451,206 245,394 388,871
Future income tax expense.. (28,879) (64,064) (142,017) (69,348) (118,130)
-------- -------- -------- -------- --------
Future net cash flows, net
of tax.................... 73,872 155,752 309,189 176,046 270,741
10% annual discount for
estimated timing of cash
flows..................... (31,766) (71,646) (130,648) (71,277) (115,215)
-------- -------- -------- -------- --------
Standardized measure of
discounted future net cash
flows, net of tax......... $ 42,106 $ 84,106 $178,541 $104,769 $155,526
======== ======== ======== ======== ========
</TABLE>
- --------
(1) Pro forma to reflect the Oil and Gas Properties Acquisition as if it had
occurred on June 30, 1997.
(2) 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. Such
amounts reflect the effects, if any, of the Company's hedging activities.
See "--Oil and Natural Gas Marketing and Hedging."
(3) 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 rates, 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 of the Commission, 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 as of June 30, 1997, were $17.34 per
Bbl of oil and $2.16 per Mcf of natural gas, compared to average prices used
as of December 31, 1996 of $23.89 per Bbl of oil and $3.67 per Mcf of natural
gas.
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. The reserve data set forth in this Prospectus
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. 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.
47
<PAGE>
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. See "Risk Factors--Replacement of Reserves" and
"--Uncertainty of Reserve Information and Future Net Revenue Estimates."
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 periods shown:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
------------------------------ ----------------
PRO FORMA PRO FORMA
1994 1995 1996 1996(1) 1997 1997(1)
------ ------ ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C>
PRODUCTION VOLUMES:
Oil and condensate (MBbls)... 629 814 1,001 1,812 818 1,391
Natural gas (MMcf)........... 3,178 4,639 5,403 5,888 4,142 4,276
Total (MBoe)............... 1,159 1,587 1,901 2,793 1,508 2,104
AVERAGE REALIZED PRICES:
Oil and condensate (per Bbl). $14.30 $16.40 $20.44 $20.17 $19.39 $19.46
Natural gas (per Mcf)........ 1.72 1.51 2.22 2.29 2.01 2.10
Per Boe.................... 12.47 12.83 17.07 17.91 16.05 17.12
EXPENSES (PER BOE):
Lease operating (including
production taxes)........... $ 6.80 $ 7.25 $ 7.81 $ 7.48 $ 8.10 $ 7.82
Depreciation, depletion and
amortization................ 3.03 3.19 3.38 3.94 4.08 4.73
General and administrative,
net......................... 2.87 2.17 2.17 1.69 2.31 1.90
</TABLE>
- --------
(1) Pro forma to reflect the Oil and Gas Properties Acquisition and certain
other acquisitions as if they had occurred on January 1, 1996.
Producing Wells
The following table sets forth the number of productive wells in which
Southwest owned an interest as of September 30, 1997:
<TABLE>
<CAPTION>
GROSS NET
WELLS WELLS
------ -----
<S> <C> <C>
Oil.......................................................... 10,445 493.3
Natural Gas.................................................. 874 85.2
------ -----
Total...................................................... 11,319 578.5
====== =====
</TABLE>
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.
Acreage
The following table sets forth Southwest's developed and undeveloped gross
and net leasehold acreage as of September 30, 1997:
<TABLE>
<CAPTION>
GROSS NET
--------- -------
<S> <C> <C>
Developed............................................... 1,904,181 230,751
Undeveloped............................................. 618,338 74,931
--------- -------
Total................................................. 2,522,519 305,682
========= =======
</TABLE>
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
48
<PAGE>
acreage contains proved reserves. A gross acre is an acre in which an interest
is owned. A net acre is deemed to exist when the sum of fractional ownership
interests in gross acres equals one. 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, 1994 through December 31, 1996,
and for the nine months ended September 30, 1997.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED DECEMBER 31, ENDED
----------------------------- SEPTEMBER 30,
1994 1995 1996 1997
--------- --------- --------- ---------------
GROSS NET GROSS NET GROSS NET GROSS NET
----- --- ----- --- ----- --- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Development wells:
Productive................... 16 8.0 28 5.6 14 5.7 47 25.2
Non-productive............... 3 1.5 2 0.4 -- -- 3 2.4
--- --- --- --- --- --- ------ -------
Total...................... 19 9.5 30 6.0 14 5.7 50 27.6
Exploratory wells:
Productive................. 1 0.3 -- -- 1 0.1 8 3.0
Non-productive............. 3 0.7 5 1.0 6 -- 3 0.9
--- --- --- --- --- --- ------ -------
Total...................... 4 1.0 5 1.0 7 0.1 11 3.9
</TABLE>
From October 1, 1997 through October 31, 1997, Southwest participated in
drilling activities on 12 gross wells. Of the 12 gross (3.3 net) wells, 4
gross (1.4 net) well have been completed as commercial producers, no wells
were dry holes and 8 gross (1.9 net) wells are currently being drilled.
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. Declines in oil and natural gas prices may adversely affect
Southwest's financial condition, liquidity, and results of operations. See
"Risk Factors--Volatility of Oil and Natural Gas Prices" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
During 1996, Scurlock Permian Corporation purchased crude oil from Southwest
that contributed 13% of Southwest's oil revenue. Southwest does not believe
the loss of this purchaser would have a material adverse effect on its
operations, revenues or cash flow.
All of Southwest's oil and natural gas production is currently sold at spot
market prices, under various short term and intermediate term contracts.
Southwest currently does not utilize commodity swap agreements or fixed price
arrangements to reduce its exposure to oil or natural gas price movements.
SIERRA
Sierra provides a broad range of services used by oil and gas companies in
Texas and New Mexico, including workover rig services, liquids handling, fresh
and brine water supply and disposal and other services. Sierra's workover rig
services include the completion of newly drilled wells, the recompletion and
maintenance of existing wells and the plugging and abandonment of wells at the
end of their useful life. Complementary services include liquids handling
services and fresh and brine water supply and disposal services. SRH currently
owns, directly and indirectly, approximately a 40% interest in Sierra.
49
<PAGE>
Sierra's strategy emphasizes diversification and expansion through the
acquisition of well servicing companies and internal growth in order to
provide an integrated group of oil field services. Sierra is a participant in
the consolidation of the well servicing industry and believes that the highly
fragmented well servicing market will continue to provide attractive
acquisition opportunities.
From January 1996 through November 30, 1997, Sierra completed 17
acquisitions of well servicing companies for an aggregate cost of $58.9
million. In total, these acquisitions added 64 well servicing rigs, 134
trucks, 279 frac and test tanks, 32 brine and/or fresh water stations, eight
injection wells and various related equipment. However, there can be no
assurance that such acquisitions will occur as expected in December or ever.
Sierra believes it has been generally successful in acquiring well servicing
companies and assets, subsequently reducing overhead expenses and improving
the marketing, utilization and efficiency of its growing asset base.
Well Servicing
Sierra uses its well servicing rigs to provide completion, maintenance,
workover and plugging and abandonment services to major and independent oil
and gas companies. Ancillary equipment such as pumps, tanks, blowout
preventers and power swivels are provided by Sierra as may be required for a
particular job. Sierra also provides trucking services for moving large
equipment to and from the job sites of its customers. Sierra generally charges
its customers an hourly rate for its well services, which varies based on
numerous considerations including market conditions in each region, the type
of rig, the amount of ancillary equipment required and the necessary
personnel.
Well services are classified by type of job performed and are generally
categorized as completion, maintenance, workover, recompletion or plugging and
abandonment. Completion services involve the preparation of a newly drilled
well for production and generally involve the installation of permanent
equipment. Maintenance services are required on producing wells to ensure
efficient and continuous operation and generally involve routine mechanical
repairs. Workover and recompletion services involve major repairs and
modifications to existing wells and include extension of existing wells to new
formations, accessing previously bypassed productive zones and conversion of
producing wells to water injection wells. Workover rigs are also used in the
plugging and abandonment of oil and natural gas wells no longer capable of
producing economic quantities.
As of December 5, 1997, Sierra operated 86 land-based well servicing rigs
and ancillary equipment from 9 yards in Texas and New Mexico.
Liquids Handling Services
Sierra provides liquids handling services, comprised of vacuum truck
services, frac tank rentals and test tank rentals. After the pending
transactions have been completed in December 1997, Sierra will own 134 vacuum
and transport trucks. A vacuum truck is a tractor trailer with a fluid hauling
capacity of up to 130 barrels. A large vacuum pump mounted on each truck
extracts fluids from pits, tanks and other storage facilities. Vacuum trucks
are used to transport water to fill frac tanks, to transport produced salt
water to injection wells and to transport drilling and completion fluids to
and from well locations.
50
<PAGE>
After the pending acquisitions have been completed in December 1997, Sierra
will own 235 frac tanks. Each frac tank can store up to 500 barrels of fluid
and is used by oil field operators to store various fluids at the well site,
including water, drilling mud, acid and brine. Frac tanks are used during all
phases of the life of a producing well and are generally rented on a daily
basis.
Sierra will own 44 test tanks after the pending acquisitions. Each test tank
can store up to 250 barrels of fluid and is used by oil field operators to
store various well bore fluids at the well site during the testing of
production of oil wells. Test tanks are rented on a four-day minimum plus any
additional days needed by the operator. Sierra also charges for delivery, set-
up and removal of the test tanks.
Sierra will also own 90 Enviro-Vat systems, the patent for their production
and the right to royalties created by the sale of these systems to other
operators. The Enviro-Vat is a unitized, trailer mounted system that connects
to the well-head to catch normal oil and other liquid spills that occur during
regular maintenance, workovers and completions. Sierra believes that the
Enviro-Vat system will be a profitable addition to its existing well servicing
business as companies increase efforts to minimize the impact of their
operations on the environment.
Fresh and Brine Water Supply and Disposal Services
Sierra provides fresh and brine water supply and disposal services,
including injection wells and fresh water and brine stations.
After the pending acquisitions have been completed in December 1997, Sierra
will own or lease eight injection wells that are authorized to dispose of salt
water and incidental non-hazardous oil and gas wastes. These wells are
strategically located in close proximity to customers' producing oil and gas
wells. Sierra maintains separation equipment at each of its injection wells,
permitting it to salvage residual crude oil which is later sold for Sierra's
account.
After the pending acquisitions have been completed in December 1997, Sierra
owns 32 brine and/or fresh water stations which are used to supply water
necessary for the drilling and completion of oil and gas wells. This
complementary business gives Sierra an advantage over certain competitors for
water sales and the associated transportation and expands Sierra's customer
base.
Other Services
Sierra provides other well services, including pit lining and hot oil
services. Pit lining services consist of excavating, preparing and eventually
closing a pit used during the drilling or completion of oil and gas wells for
the collection of fluids such as drilling mud, other well bore fluids and
fresh water. Hot oil services consist of pumping hot oil into a gathering line
or well tubing to melt paraffin and asphaltines that solidify and restrict
production. Sierra intends to acquire and subsequently offer additional well
services and products that are complementary to its well servicing strategy.
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 October 31, 1997, Red Oak owned and managed 14 shopping centers,
three office buildings and raw land held for future development.
Red Oak's primary objective is to acquire, own and manage a portfolio of
commercial properties that provides opportunity to increase net operating
income and results in significant capital appreciation. Consistent with this
strategy, Red Oak focuses its activities primarily in secondary markets in the
southwestern United States, including San Antonio, Midland, San Angelo, El
Paso, and Corpus Christi in Texas; Reno, Nevada; Tucson, Arizona; and Tulsa
and Oklahoma City, Oklahoma. Red Oak believes that the potential for
population growth in these markets and a lower level of interest from
institutional real estate buyers, as compared to primary markets, result in
attractive acquisition opportunities of multi-tenant, income producing
properties ranging in purchase price from $1 million to $20 million.
51
<PAGE>
Recent Acquisitions
From December 1993 through October 31, 1997, Red Oak completed the
acquisition of 14 regional shopping centers and three office buildings for a
total acquisition cost of $82.8 million. Red Oak has financed and expects to
continue to finance the acquisition of its real estate properties with senior
secured credit arrangements between Red Oak and private lenders, that are
generally non-recourse to the Company. Red Oak believes that as a result of
minor capital investment and limited releasing activities, the performance of
these properties will improve in a manner consistent with Red Oak's historical
experience. Red Oak's existing property portfolio is shown in the table below.
<TABLE>
<CAPTION>
YEAR SEPTEMBER 30, GROSS LEASABLE
COMPLETED/ 1997 AREA
SHOPPING CENTERS LOCATION RENOVATED OCCUPANCY (SQUARE FEET)
---------------- ----------------- ---------- ------------- --------------
<S> <C> <C> <C> <C>
Plaza Oaks.............. Midland, TX 1974/1979 100.0% 94,779
Southwest Plaza......... San Angelo, TX 1978 88.9% 198,983
Town & Country.......... Odessa, TX 1959 61.2% 120,855
State Bank Plaza........ Tulsa, OK 1985 97.8% 34,867
The Plaza............... Tulsa, OK 1985 84.0% 116,605
Madera Village.......... Tucson, AZ 1988 93.3% 96,702
Bear Canyon............. Tucson, AZ 1982 98.0% 70,941
Bears Path.............. Tucson, AZ 1988 72.3% 40,728
Plaza Palomino.......... Tucson, AZ 1985/1986 95.0% 98,634
River Oaks.............. Abilene, TX 1958/1984 82.6% 140,899
San Miguel Square....... Midland, TX 1977 77.0% 77,582
Colonnade at Polo Park.. Midland, TX 1984 96.2% 105,018
Crossroads.............. San Antonio, TX 1961/1990 92.0% 676,705
50 Penn Place........... Oklahoma City, OK 1973 84.0% 129,183
<CAPTION>
OFFICE BUILDING
---------------
<S> <C> <C> <C> <C>
Woodhill................ Midland, TX 1980/1995 98.0% 45,920
Independence Plaza...... Midland, TX 1984 95.6% 148,397
50 Penn Place........... Oklahoma City, OK 1973 85.5% 182,146
<CAPTION>
LAND ACRES
---- ----------
<S> <C> <C> <C> <C>
Red Oak (residential)... Midland, TX 398.3
Southwest Corner
(commercial)........... Midland, TX 3.9
Lewisville
(residential).......... Lewisville, TX 95.3
</TABLE>
The aforementioned properties were acquired from unrelated third parties.
Prior to each acquisition, the Company performs various due diligence
procedures including, but not limited to, evaluation of competition in the
rental market, comparative rents, occupancy rates, related operating expenses,
cash flow and anticipated capital expenditures. The Company believes the
historical operating results of the properties acquired are indicative of
future operating results for each respective acquisition.
EMPLOYEES
As of September 30, 1997, the Company employed 497 people. Of this total,
123 people were employed by Southwest, 359 by Sierra, and 15 by Red Oak. The
Company's future success will depend partially on its ability to attract,
retain and motivate qualified personnel. The Company is not a party to any
collective bargaining agreements and has not experienced any strikes or work
stoppages. The Company considers its relations with its employees to be
satisfactory.
COMPETITION
The oil and natural gas industry is highly competitive. The Company's oil
and gas business competes for the acquisition of oil and natural gas
properties, primarily on the basis of the price to be paid for such
properties, with numerous entities including major oil companies, other
independent oil and natural gas concerns and individual producers and
operators. Many of these competitors are large, well established companies and
have financial and other resources substantially greater than those of the
Company's oil and gas business. The Company's ability to acquire additional
oil and gas properties and to discover reserves in the future will depend
52
<PAGE>
upon its ability to evaluate and select suitable properties and to consummate
transactions in a highly competitive environment.
Competition is intense in all markets in which the Company's businesses
operate. Surplus capacity in the well servicing industry has resulted in price
being the primary means of competition. Pool Energy Services Co., Key Energy
Group, Inc. and Dawson Production Services, Inc., all of which provide
workover rig and liquids handling services, are the largest companies in the
domestic well servicing market. These companies operate in multiple geographic
regions and are larger than the Company's well servicing business. The
Company's well servicing business competes on the basis of pricing,
performance, safety, availability of equipment to meet customer needs and
availability of experienced, skilled personnel in those areas in which it
operates. Several competitors have access to greater financial and other
resources than those of the Company's well servicing business. The Company's
real estate business also competes for the acquisition of desirable commercial
real estate properties, primarily on the basis of price.
OPERATING HAZARDS AND RISKS
The oil and natural gas business involves a variety of operating risks,
including the risk of fire, explosions, blow outs, pipe failure, abnormally
pressured formations and environmental hazards such as oil spills, gas leaks,
ruptures or discharges of toxic gases. Any of these occurrences could result
in substantial losses to the Company due to injury or loss of life, severe
damage to or destruction of property, natural resources and equipment,
environmental damage, clean-up responsibilities, regulatory investigation and
penalties and suspension of operations.
Drilling activities are subject to many risks, including the risk that no
commercially productive reservoirs will be encountered. There can be no
assurance that new wells drilled by the Company will be productive or that the
Company will recover all or any portion of its investment. Drilling for oil
and gas may involve unprofitable efforts, not only from dry wells, but from
wells that are productive but do not produce sufficient net revenues to return
a profit after drilling, operating or other costs. The cost of drilling,
completing and operating wells is often uncertain. The Company's drilling
operations may be curtailed, delayed or canceled as a result of numerous
factors, many of which are beyond the Company's control, including title
problems, weather conditions, mechanical problems, compliance with
governmental requirements and shortages and delays in the delivery of
equipment and services. The Company's future drilling activities may not be
successful and, if unsuccessful, such failure may have a material adverse
effect on the Company's future results of operations and financial condition.
The Company's well servicing operations are also subject to hazards inherent
in the oil and gas industry, such as blowouts, explosions, craterings, fires
and oil spills, that can cause personal injury or loss of life, damage to or
destruction of property, equipment, the environment, and suspension of
operations. In addition, claims for loss of oil and gas production and damage
to formations can occur in the workover business. If a serious accident were
to occur at a location where Sierra's equipment and services are used, it
could result in the Company or Sierra being named as a defendant in a lawsuit
asserting potentially large claims. Additionally, because Sierra's vacuum
trucks and frac/test tank rentals involve the transport of heavy equipment and
materials, traffic accidents resulting in spills, property damage and personal
injury may occur.
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.
LEGAL PROCEEDINGS
From time to time, the Company is party to litigation or other legal
proceedings that each company considers to be a part of the ordinary course of
its business. The Company is not involved in any legal proceedings nor is it
party to any pending or threatened claims that could reasonably be expected to
have a material adverse effect on its financial condition or results of
operations.
53
<PAGE>
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.
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 ratemaking 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.
54
<PAGE>
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 and Sierra's well servicing activities. 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, including the well servicing
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.
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
55
<PAGE>
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 and/or Sierra. Southwest and/or Sierra 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, neither Southwest
nor Sierra believes its operations will be materially adversely affected by
any such requirements, and the requirements are not expected to be any more
burdensome to Southwest or to Sierra 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. Sierra also maintains insurance against certain risks
associated with underground contamination that may occur as a result of well
service activities. However, such insurance is limited to activities at the
wellsite and 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."
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 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.
56
<PAGE>
FACILITIES
The principal offices of SRH, Southwest, Sierra and Red Oak are located in
Midland, Texas. Sierra also has 12 yards in Texas and one in New Mexico. One
building in the principal office complex and nine of Sierra's yards are owned,
and all other facilities are leased by the Company. SRH, Southwest, Sierra 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.
57
<PAGE>
MANAGEMENT
The directors and executive officers of SRH and Southwest are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- ---------------------------------------------------------
<S> <C> <C>
H. H. Wommack, III...... 42 Chairman, President, Chief Executive Officer and Director
H. Allen Corey.......... 41 Secretary and Director
Bill E. Coggin.......... 43 Vice President and Chief Financial Officer
J. Steven Person........ 39 Vice President, Marketing
</TABLE>
The Company expects that following registration of the Notes it will add at
least one outside 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 Chairman
and a director of Sierra and Red Oak since 1992 and 1992, respectively. 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 of Sierra since 1992 and 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, and Vice President,
Treasurer and a director of Sierra since 1995. Mr. Coggin has served as a
director and Vice President, Finance of Red Oak since 1995. Previously, Mr.
Coggin was controller for an oil and gas drilling company and an independent
oil and gas operator.
J. Steven Person has served as Vice President, Marketing of SRH since it was
formed in July 1997. Mr. Person has served as Vice President, Marketing for
Southwest since 1989 and as Vice President, Marketing of Red Oak since 1996.
Prior to joining Southwest, Mr. Person was involved in the syndication of
mortgage-based securities.
Other key employees of Southwest, Sierra, and Red Oak include:
Southwest.
Jon P. Tate, age 40, has served as Vice President, Land and Assistant
Secretary of Southwest since 1989. From 1981 to 1989, Mr. Tate was employed by
C.F. Lawrence & Associates, Inc., an independent oil and gas company, as land
manager. Mr. Tate is a member of the Permian Basin Landman's Association.
R. Douglas Keathley, age 42, has served as Vice President, Operations of
Southwest since 1992. Before joining Southwest, Mr. Keathley worked as a
senior drilling engineer for ARCO Oil and Gas Company and in similar
capacities for Reading & Bates Petroleum Co. and Tenneco Oil Co.
Joel D. Talley, age 36, has served as Vice President, Operations of
Southwest since 1996. Before joining Southwest, Mr. Talley worked in various
capacities, including regional manager, for Merit Energy Company from 1992 to
1996 and prior to that as a production and drilling engineer and production
foreman for ARCO Oil & Gas Company.
58
<PAGE>
Sierra.
Joey D. Fields, age 40, has been the President of Sierra since 1993. From
1988 to 1992, Mr. Fields was operations manager for Smith Brothers Casing
Pullers and Smith Brothers Pipe, Inc. of Midland, Texas. Mr. Fields has also
served as purchasing agent for Permian West Pipe, Inc. in Odessa, Texas.
Dub W. Harrison, age 39, has served as Executive Vice President of Sierra
since 1995 and manages its East Texas operations. From 1987 to 1995, Mr.
Harrison was an area manager for Pool Energy Services Co., with
responsibilities including all aspects of workover rig services and liquids
handling services. Mr. Harrison also served as equipment superintendent and a
safety representative for Pool Energy Services Co.
Charles W. Swift, age 48, has served as Vice President, Operations for
Sierra since July 1997 and manages operations for the Permian Basin. From 1986
to 1997, Mr. Swift was a partner of S & N Well Servicing Ltd. of Midland,
Texas, which was acquired by Sierra in July 1997. Prior to founding S & N, Mr.
Swift served in various capacities in the well servicing industry for over 15
years.
Red Oak.
W. Neil McClung, age 47, has served as President and a director of Red Oak
since 1994. Prior to his involvement with Red Oak, Mr. McClung was senior vice
president of Heitman Properties, Ltd. from 1989 through 1993 where he was
responsible for marketing, budget development and leasing for three million
square feet of high-rise office building and industrial center space in
several metropolitan and secondary markets. Mr. McClung has also served as a
property and leasing manager for Heitman in Midland, Texas.
J. Wesley Tune, age 38, has served as Vice President and Secretary of Red
Oak since 1994. Mr. Tune was employed by Heitman Properties, Ltd. in Midland,
Texas as property and leasing manager from 1992 until 1994. 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.
COMPENSATION OF EXECUTIVE OFFICERS
The following table sets forth certain information for the year ended
December 31, 1996 with respect to the compensation paid to Mr. Wommack, the
Chairman and President, and the three other most highly compensated executive
officers of Southwest. No other executive officers of Southwest received
annual compensation (including salary and bonuses earned) that exceeded
$100,000 for the year ended December 31, 1996. Mr. Wommack determines the
compensation of Southwest's executive officers. No compensation has been paid
to the executive officers of SRH for their services to SRH.
<TABLE>
<CAPTION>
FISCAL YEAR 1996 COMPENSATION
-----------------------------------------
BONUS ALL OTHER
NAME AND PRINCIPAL POSITION SALARY ($) ($)(2) COMPENSATION ($)(1)
--------------------------- ---------- ---------- -------------------
<S> <C> <C> <C>
H. H. Wommack, III, President and
Treasurer (3)....................... 586,320.00 231,569.95 7,471.60
Bill E. Coggin, Vice President and
Chief Financial Officer............. 153,000.00 71,681.14 7,471.60
Richard E. Masterson, Vice President,
Exploration and Acquisitions (4).... 92,000.00 9,043.18 15,495.45
J. Steven Person, Vice President,
Marketing........................... 96,062.04 4,800.00 7,064.93
</TABLE>
- --------
(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.
59
<PAGE>
Mr. Masterson, in his capacity as Vice President, Exploration and
Acquisitions, received overrided and carried interests in Oil and Gas
Properties acquired by Southwest for its own portfolio as part of his annual
compensation.
<TABLE>
<CAPTION>
CARRIED
INTEREST
PROFIT IN OIL AND
INSURANCE SHARING/401(K) GAS
NAME PREMIUMS CONTRIBUTION PROPERTIES
---- --------- -------------- ----------
<S> <C> <C> <C>
H. H. Wommack, III.......................... $5,571.60 $1,900.00 $ --
Bill E. Coggin.............................. $5,571.60 $1,900.00 $ --
Richard E. Masterson........................ $4,362.60 $ 690.00 $10,442.85
J. Steven Person............................ $5,571.60 $1,493.33 $ --
</TABLE>
(2) Amount includes club dues and automobiles furnished by Southwest.
(3) Mr. Wommack has acted as a general partner of the income funds and certain
of the drilling funds sponsored by Southwest since 1983, holding a 1%
interest in these partnerships. The value of these partnership interests
as of September 30, 1997 was in excess of $1.2 million, but this value is
contingent upon future events such as the price and value of the
partnerships' oil and gas reserves and the economic recovery and the
ultimate depletion of those reserves, and cannot be accurately
ascertained.
Directors of Southwest received $40,000 in 1996 for acting as such.
(4) Mr. Masterson left Southwest in November 1997.
60
<PAGE>
PRINCIPAL STOCKHOLDERS AND
OWNERSHIP OF 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.
<TABLE>
<CAPTION>
NUMBER OF
NAME AND ADDRESS OF SHARES PERCENTAGE
BENEFICIAL OWNER OWNED OF CLASS
------------------- --------- ----------
<S> <C> <C>
H. Allen Corey............................................ 48,968 4.6%
c/o Southwest Royalties Holdings, Inc.
Southwest Royalties Building
407 N. Big Spring
Midland, TX 79701-4326
George H. Jewell.......................................... 61,855 5.7%
Baker & Botts, L.L.P.
One Shell Plaza
910 Louisiana
Houston, Texas 77002
H. H. Wommack, III........................................ 783,977 72.9%
c/o Southwest Royalties Holdings, Inc.
Southwest Royalties Building
407 N. Big Spring
Midland, TX 79701-4326
Directors and officers as a group (five (5) persons)...... 848,925 78.9%
</TABLE>
CERTAIN 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 September 30, 1997,
the outstanding balance of this loan was $1.7 million. Mr. Wommack serves as a
general partner of substantially all of the oil and gas limited partnerships
sponsored by Southwest since 1983, and he holds an interest in these
partnerships of approximately 1%.
61
<PAGE>
EXCHANGE OFFER
In connection with the sale of the Old Notes, the purchasers thereof became
entitled to the benefits of certain registration rights under the Registration
Rights Agreement. The Exchange Notes are being offered hereunder in order to
satisfy the obligations of the Issuer and SRH under the Registration Rights
Agreement. See "Exchange and Registration Rights Agreement."
For each $1,000 principal amount of Old Notes surrendered to the Issuer and
SRH pursuant to the Exchange Offer, the holder of such Old Notes will receive
$1,000 principal amount of Exchange Notes. Upon the terms and subject to the
conditions set forth in this Prospectus and in the accompanying Letter of
Transmittal, SRH and the Issuer will accept all Old Notes properly tendered
prior to 5:00 p.m., New York City time, on the Expiration Date. Holders may
tender some or all of their Old Notes pursuant to the Exchange Offer in
integral multiples of $1,000 principal amount.
Under existing interpretations of the staff of the SEC, including EXXON
CAPITAL HOLDINGS CORPORATION, SEC No-action Letter (available April 13, 1989),
the Morgan Stanley Letter and MARY KAY COSMETICS, INC., SEC No-action Letter
(available June 5, 1991), the Issuer and SRH believe that the Exchange Notes
would in general be freely transferable after the Exchange Offer without
further registration under the Securities Act by the respective holders
thereof (other than a "Restricted Holder," being (i) a broker-dealer who
purchased Old Notes exchanged for such Exchange Notes directly from the Issuer
to resell pursuant to Rule 144A or any other available exemption under the
Securities Act or (ii) a person that is an affiliate of the Issuer or SRH
within the meaning of Rule 405 under the Securities Act), without compliance
with the registration and prospectus delivery provisions of the Securities
Act, provided that such Exchange Notes are acquired in the ordinary course of
such holder's business and such holder is not participating in, and has no
arrangement with any person to participate in, the distribution (within the
meaning of the Securities Act) of such Exchange Notes. Eligible holders
wishing to accept the Exchange Offer must represent to the Issuer and SRH that
such conditions have been met. Any holder of Old Notes who tenders in the
Exchange Offer for the purpose of participating in a distribution of the
Exchange Notes could not rely on the interpretation by the staff of the SEC
enunciated in the Morgan Stanley Letter and similar no-action letters, and
must comply with the registration and prospectus delivery requirements of the
Securities Act in connection with any resale transaction.
Each holder of Old Notes who wishes to exchange Old Notes for Exchange Notes
in the Exchange Offer will be required to make certain representations,
including that (i) it is not an affiliate of the Issuer or SRH nor a broker-
dealer tendering Old Notes acquired directly from the Issuer or SRH for its
own account, (ii) any Exchange Notes to be received by it are being acquired
in the ordinary course of its business and (iii) it is not participating in,
and it has no arrangement with any person to participate in, the distribution
(within the meaning of the Securities Act) of the Exchange Notes. In addition,
in connection with any resales of Exchange Notes, any broker-dealer (a
"Participating Broker-Dealer") who acquired Old Notes for its own account as a
result of market-making activities or other trading activities must
acknowledge that it will deliver a prospectus meeting the requirements of the
Securities Act in connection with any resale of such Exchange Notes. The staff
of the SEC has taken the position in no-action letters issued to third parties
including SHEARMAN & STERLING, SEC No-action Letter (available July 2, 1993),
that Participating Broker-Dealers may fulfill their prospectus delivery
requirements with respect to the Exchange Notes (other than a resale of an
unsold allotment from the original sale of Old Notes) with this Prospectus, as
it may be amended or supplemented from time to time. Under the Registration
Rights Agreement, the Issuer and SRH are required to allow Participating
Broker-Dealers to use this Prospectus, as it may be amended or supplemented
from time to time, in connection with the resale of such Exchange Notes. See
"Plan of Distribution."
The Exchange Offer shall be deemed to have been consummated upon the earlier
to occur of (i) the Issuer and SRH having exchanged Exchange Notes for all
outstanding Old Notes (other than Old Notes held by a Restricted Holder)
pursuant to the Exchange Offer and (ii) the Issuer and SRH having exchanged,
pursuant to the Exchange Offer, Exchange Notes for all Old Notes that have
been tendered and not withdrawn on the
62
<PAGE>
Expiration Date. In such event, holders of Old Notes seeking liquidity in
their investment would have to rely on exemptions to registration requirements
under the securities laws, including the Securities Act.
As of the date of this Prospectus, $200,000,000 aggregate principal amount
of Old Notes are issued and outstanding. In connection with the issuance of
the Old Notes, the Issuer and SRH arranged for the Old Notes to be eligible
for trading in the Private Offering, Resale and Trading through Automated
Linkages (PORTAL) Market, the National Association of Securities Dealers'
screen based, automated market trading of securities eligible for resale under
Rule 144A.
The Issuer and SRH shall be deemed to have accepted for exchange validly
tendered Old Notes when, as and if the Issuer and SRH have given oral or
written notice thereof to the Exchange Agent. See "--Exchange Agent." The
Exchange Agent will act as agent for the tendering holders of Old Notes for
the purpose of receiving Exchange Notes from the Issuer and delivering
Exchange Notes to such holders. If any tendered Old Notes are not accepted for
exchange because of an invalid tender or the occurrence of certain other
events set forth herein, certificates for any such unaccepted Old Notes will
be returned, without expense, to the tendering holder thereof as promptly as
practicable after the Expiration Date. Holders of Old Notes who tender in the
Exchange Offer will not be required to pay brokerage commissions or fees or,
subject to the instructions in the Letter of Transmittal, transfer taxes with
respect to the exchange of Old Notes pursuant to the Exchange Offer. The
Issuer and SRH will pay all charges and expenses, other than certain
applicable taxes, in connection with the Exchange Offer. See "--Fees and
Expenses."
This Prospectus, together with the accompanying Letter of Transmittal, is
being sent to all registered holders as of the date of this Prospectus.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The term "Expiration Date" shall mean 30 days after the effective date of
the Registration Statement. 1998 unless the Issuer and SRH, in their sole
discretion, extend the Exchange Offer, in which case the term "Expiration
Date" shall mean the latest date to which the Exchange Offer is extended. In
order to extend the Expiration Date, the Issuer and SRH will notify the
Exchange Agent of any extension by oral or written notice and will mail to the
record holders of Old Notes an announcement thereof, each prior to 9:00 a.m.,
New York City time, on the next business day after the previously scheduled
Expiration Date. Such announcement may state that SRH and the Issuer are
extending the Exchange Offer for a specified period of time. The Issuer and
SRH reserve the right (i) to delay acceptance of any Old Notes, to extend the
Exchange Offer or to terminate the Exchange Offer and to refuse to accept Old
Notes not previously accepted, if any of the conditions set forth herein under
"--Termination" shall have occurred and shall not have been waived by the
Issuer and SRH (if permitted to be waived by the Issuer and SRH), by giving
oral or written notice of such delay, extension or termination to the Exchange
Agent, and (ii) to amend the terms of the Exchange Offer in any manner deemed
by it to be advantageous to the holders of the Old Notes. Any such delay in
acceptance, extension, termination or amendment will be followed as promptly
as practicable by oral or written notice thereof. If the Exchange Offer is
amended in a manner determined by the Issuer and SRH to constitute a material
change, the Issuer and SRH will promptly disclose such amendment in a manner
reasonably calculated to inform the holders of the Old Notes of such
amendment. Without limiting the manner in which the Issuer and SRH may choose
to make public announcements of any delay in acceptance, extension,
termination or amendment of the Exchange Offer, the Issuer and SRH shall have
no obligation to publish, advertise, or otherwise communicate any such public
announcement, other than by making a timely release to the Dow Jones News
Service.
INTEREST ON THE EXCHANGE NOTES
The Exchange Notes will bear interest at the rate of 10 1/2% per annum,
payable semi-annually on April 15 and October 15 of each year, commencing on
April 15, 1998. Interest on the Exchange Notes will accrue from (A) the later
of (i) the last interest payment date on which interest was paid on the Notes
surrendered in exchange therefor; or (ii) if the Notes are surrendered for
exchange on a date in a period which includes the record date for
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an interest payment date to occur on or after the date of such exchange and as
to which interest will be paid, the date of such interest payment date or (B)
if no interest has been paid on the Notes, from the date of the original
issuance of the Notes, October 14, 1997. Interest on the Old Notes accepted
for exchange will cease to accrue upon issuance of the Exchange Notes.
PROCEDURES FOR TENDERING
To tender in the Exchange Offer, a holder must complete, sign and date the
Letter of Transmittal, or a facsimile thereof, have the signatures thereon
guaranteed if required by the Letter of Transmittal, and mail or otherwise
deliver such Letter of Transmittal or such facsimile, or an Agent's Message,
together with the Old Notes and any other required documents, to the Exchange
Agent prior to 5:00 p.m., New York City time, on the Expiration Date. In
addition, either (i) the certificates for such Old Notes must be received by
the Exchange Agent along with the Letter of Transmittal or (ii) a timely
confirmation of a book-entry transfer (a "Book-Entry Confirmation") of such
Old Notes, if such procedure is available, into the Exchange Agent's account
at The Depository Trust Company (the "DTC") pursuant to the procedure for
book-entry transfer described below, must be received by the Exchange Agent
along with an Agent's Message prior to the Expiration Date or (iii) the Holder
must comply with the guaranteed delivery procedures described below. The
tender by a holder of Old Notes will constitute an agreement between such
holder and the Issuer and SRH in accordance with the terms and subject to the
conditions set forth herein and in the Letter of Transmittal.
Delivery of all documents must be made to the Exchange Agent at its address
set forth herein. Holders may also request that their respective brokers,
dealers, commercial banks, trust companies or nominees effect such tender for
such holders.
The term "Agent's Message" means a message, transmitted by the DTC to, and
received by, the Exchange Agent and forming a part of a Book-Entry
Confirmation, which states that such DTC has received an express
acknowledgment from the participant in such DTC tendering Old Notes which are
the subject of such Book-Entry Confirmation that such participant has received
and agrees to be bound by the terms of the Letter of Transmittal, and that the
Issuer and SRH may enforce such agreement against such participant.
The method of delivery of Old Notes and the Letter of Transmittal and all
other required documents to the Exchange Agent is at the election and risk of
the holders. Instead of delivery by mail, it is recommended that holders use
an overnight or hand delivery service. In all cases, sufficient time should be
allowed to assure timely delivery. No Letter of Transmittal or Old Notes
should be sent to the Issuer or SRH. Only a holder of Old Notes may tender
such Old Notes in the Exchange Offer. The term "holder" with respect to the
Exchange Offer means any person in whose name Old Notes are registered on the
books of the Issuer or any other person who has obtained a properly completed
stock power from the registered holder.
Any beneficial holder whose Old Notes are registered in the name of such
holder's broker, dealer, commercial bank, trust company or other nominee and
who wishes to tender should contact such registered holder promptly and
instruct such registered holder to tender on behalf of the registered holder.
If such beneficial holder wishes to tender directly, such beneficial holder
must, prior to completing and executing the Letter of Transmittal and
delivering his Old Notes, either make appropriate arrangements to register
ownership of the Old Notes in such holder's name or obtain a properly
completed bond power from the registered holder. The transfer of record
ownership may take considerable time. If the Letter of Transmittal is signed
by the record holder(s) of the Old Notes tendered thereby, the signature must
correspond with the name(s) written on the face of the Old Notes without
alteration, enlargement or any change whatsoever. If the Letter of Transmittal
is signed by a participant in DTC, the signature must correspond with the name
as it appears on the security position listing as the holder of the Old Notes.
Signatures on a Letter of Transmittal or a notice of withdrawal, as the case
may be, must be guaranteed by a member firm of a registered national
securities exchange or of the National Association of Securities Dealers,
Inc., a commercial bank or trust company having an office or correspondent in
the United States or an "eligible guarantor institution" within the meaning of
Rule 17Ad-15 under the Exchange Act (an
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"Eligible Institution") unless the Old Notes tendered pursuant thereto are
tendered (i) by a registered holder (or by a participant in DTC whose name
appears on a security position listing as the owner) who has not completed the
box entitled "Special Issuance Instructions" or "Special Delivery
Instructions" on the Letter of Transmittal and the Exchange Notes are being
issued directly to such registered holder (or deposited into the participant's
account at DTC) or (ii) for the account of an Eligible Institution. If the
Letter of Transmittal is signed by a person other than the registered holder
of any Old Notes listed therein, such Old Notes must be endorsed or
accompanied by appropriate bond powers which authorize such person to tender
the Old Notes on behalf of the registered holder, in either case signed as the
name of the registered holder or holders appears on the Old Notes. If the
Letter of Transmittal or any Old Notes or bond powers are signed by trustees,
executors, administrators, guardians, attorneys-in-fact, officers of
corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and unless waived by Issuer and SRH,
evidence satisfactory to the Issuer and SRH of their authority to so act must
be submitted with the Letter of Transmittal.
A tender will be deemed to have been received as of the date when the
tendering holder's duly signed Letter of Transmittal accompanied by Old Notes
(or a timely confirmation received of a book-entry transfer of Old Notes into
the Exchange Agent's account at DTC with an Agent's Message) or a Notice of
Guaranteed Delivery from an Eligible Institution is received by the Exchange
Agent. Issuances of Exchange Notes in exchange for Old Notes tendered pursuant
to a Notice of Guaranteed Delivery by an Eligible Institution will be made
only against delivery of the Letter of Transmittal (and any other required
documents) and the tendered Old Notes (or a timely confirmation received of a
book-entry transfer of Old Notes into the Exchange Agent's account at DTC with
an Agent's Message) with the Exchange Agent.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of the tendered Old Notes will be
determined by the Issuer and SRH in their sole discretion, which determination
will be final and binding. The Issuer and SRH reserve the absolute right to
reject any and all Old Notes not properly tendered or any Old Notes their
acceptance of which would, in the opinion of the Issuer and SRH or its
counsel, be unlawful. The Issuer and SRH also reserve the absolute right to
waive any conditions of the Exchange Offer or defects or irregularities in
tender as to particular Old Notes. The Issuer and SRH's interpretation of the
terms and conditions of the Exchange Offer (including the instructions in the
Letter of Transmittal) shall be final and binding on all parties. Unless
waived, any defects or irregularities in connection with tenders of Old Notes
must be cured within such time as the Issuer and SRH shall determine. Neither
the Issuer, SRH, the Exchange Agent nor any other person shall be under any
duty to give notification of defects or irregularities with respect to tenders
of Old Notes nor shall any of them incur any liability for failure to give
such notification. Tenders of Old Notes will not be deemed to have been made
until such irregularities have been cured or waived. Any Old Notes received by
the Exchange Agent that are not properly tendered and as to which the defects
or irregularities have not been cured or waived will be returned without cost
by the Exchange Agent to the tendering holder of such Old Notes unless
otherwise provided in the Letter of Transmittal, as soon as practicable
following the Expiration Date. In addition, the Issuer and SRH reserves the
right in their sole discretion to (i) purchase or make offers for any Old
Notes that remain outstanding subsequent to the Expiration Date, or, as set
forth under "--Termination," to terminate the Exchange Offer and (ii) to the
extent permitted by applicable law, purchase Old Notes in the open market, in
privately negotiated transactions or otherwise. The terms of any such
purchases or offers may differ from the terms of the Exchange Offer.
BOOK-ENTRY TRANSFER
The Exchange Agent will establish an account with respect to the Exchange
Notes at DTC within two business days after the date of this Prospectus, and
any financial institution which is a participant in DTC may make book-entry
delivery of the Old Notes by causing DTC to transfer such Old Notes into the
Exchange Agent's account in accordance with DTC's procedure for such transfer.
Although delivery of Old Notes may be effected through book-entry transfer
into the Exchange Agent's account at DTC, an Agent's Message must be
transmitted to and received by the Exchange Agent on or prior to the
Expiration Date at one of its addresses set forth below under "--Exchange
Agent," or the guaranteed delivery procedure described below must be
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complied with. DELIVERY OF DOCUMENTS TO DTC DOES NOT CONSTITUTE DELIVERY TO
THE EXCHANGE AGENT. All references in this Prospectus to deposit or delivery
of Old Notes shall be deemed to include DTC's book-entry delivery method.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Notes and whose Old Notes are not
immediately available or who cannot deliver their Old Notes, the Letter of
Transmittal or any other required documents to the Exchange Agent prior to the
Expiration Date, or who cannot complete the procedure for book-entry transfer
on a timely basis and deliver an Agent's Message, may effect a tender if: (i)
the tender is made by or through an Eligible Institution; (ii) prior to the
Expiration Date, the Exchange Agent receives from such Eligible Institution a
properly completed and duly executed Notice of Guaranteed Delivery (by
facsimile transmission, mail or hand delivery) setting forth the name and
address of the holder of the Old Notes, the registration number or numbers of
such Old Notes (if applicable), and the total principal amount of Old Notes
tendered, stating that the tender is being made thereby and guaranteeing that,
within five business days after the Expiration Date, the Letter of
Transmittal, together with the Old Notes in proper form for transfer (or a
confirmation of a book-entry transfer into the Exchange Agent's account at DTC
with an Agent's Message) and any other documents required by the Letter of
Transmittal, will be deposited by the Eligible Institution with the Exchange
Agent; and (iii) such properly completed and executed Letter of Transmittal,
together with the certificate(s) representing all tendered Old Notes in proper
form for transfer (or a confirmation of such a book-entry transfer) and all
other documents required by the Letter of Transmittal are received by the
Exchange Agent within five business days after the Expiration Date.
TERMS AND CONDITIONS OF THE LETTER OF TRANSMITTAL
The Letter of Transmittal contains, among other things, certain terms and
conditions which are summarized below and are part of the Exchange Offer.
Each holder who participates in the Exchange Offer will be required to
represent that any Exchange Notes received by it will be acquired in the
ordinary course of its business, that such holder is not participating in, and
has no arrangement with any person to participate in, the distribution (within
the meaning of the Securities Act) of the Exchange Notes, and that such holder
is not a Restricted Holder.
Old Notes tendered in exchange for Exchange Notes (or a timely confirmation
of a book-entry transfer of such Old Notes into the Exchange Agent's account
at DTC) must be received by the Exchange Agent, with the Letter of Transmittal
or an Agent's Message and any other required documents, by the Expiration Date
or within the time periods set forth above pursuant to a Notice of Guaranteed
Delivery from an Eligible Institution. Each holder tendering the Old Notes for
exchange sells, assigns and transfers the Old Notes to the Exchange Agent, as
agent of the Issuer, and irrevocably constitutes and appoints the Exchange
Agent as the holder's agent and attorney-in-fact to cause the Old Notes to be
transferred and exchanged. The holder warrants that it has full power and
authority to tender, exchange, sell, assign and transfer the Old Notes and to
acquire the Exchange Notes issuable upon the exchange of such tendered Old
Notes, that the Exchange Agent, as agent of the Issuer, will acquire good and
unencumbered title to the tendered Old Notes, free and clear of all liens,
restrictions, charges and encumbrances, and that the Old Notes tendered for
exchange are not subject to any adverse claims when accepted by the Exchange
Agent, as agent of the Issuer.
The holder also warrants and agrees that it will, upon request, execute and
deliver any additional documents deemed by the Issuer, the SRH or the Exchange
Agent to be necessary or desirable to complete the exchange, sale, assignment
and transfer of the Old Notes. All authority conferred or agreed to be
conferred in the Letter of Transmittal by the holder will survive the death,
incapacity or dissolution of the holder and any obligation of the holder shall
be binding upon the heirs, personal representatives, successors and assigns of
such holder.
WITHDRAWAL OF TENDERS
Except as otherwise provided herein, tenders of Old Notes may be withdrawn
at any time prior to 5:00 p.m., New York City time, on the business day prior
to the Expiration Date, unless previously accepted for exchange.
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To withdraw a tender of Old Notes in the Exchange Offer, a written or
facsimile transmission notice of withdrawal must be received by the Exchange
Agent at its address set forth herein prior to 5:00 p.m., New York City time,
on the business day prior to the Expiration Date and prior to acceptance for
exchange thereof by the Issuer and SRH. Any such notice of withdrawal must (i)
specify the name of the person having deposited the Old Notes to be withdrawn
(the "Depositor"), (ii) identify the Old Notes to be withdrawn (including, if
applicable, the registration number or numbers and total principal amount of
such Old Notes), (iii) be signed by the Depositor in the same manner as the
original signature on the Letter of Transmittal by which such Old Notes were
tendered (including any required signature guarantees) or be accompanied by
documents of transfer sufficient to permit the Trustee with respect to the Old
Notes to register the transfer of such Old Notes into the name of the
Depositor withdrawing the tender, (iv)specify the name in which any such Old
Notes are to be registered, if different from that of the Depositor and (v) if
applicable because the Old Notes have been tendered pursuant to the book-entry
procedures, specify the name and number of the participant's account at DTC to
be credited, if different than that of the Depositor. All questions as to the
validity, form and eligibility (including time of receipt) of such withdrawal
notices will be determined by the Issuer and SRH, whose determination shall be
final and binding on all parties. Any Old Notes so withdrawn will be deemed
not to have been validly tendered for purposes of the Exchange Offer and no
Exchange Notes will be issued with respect thereto unless the Old Notes so
withdrawn are validly retendered. Any Old Notes which have been tendered but
which are not accepted for exchange will be returned to the holder thereof
without cost to such holder as soon as practicable after withdrawal, rejection
of tender or termination of the Exchange Offer. Properly withdrawn Old Notes
may be retendered by following one of the procedures described above under "--
Procedures for Tendering" at any time prior to the Expiration Date.
TERMINATION
Notwithstanding any other term of the Exchange Offer, SRH and the Issuer
will not be required to accept for exchange any Old Notes not theretofore
accepted for exchange, and may terminate the Exchange Offer if they determine
that the Exchange Offer violates any applicable law or interpretation of the
staff of the SEC.
If the Issuer and SRH determine that they may terminate the Exchange Offer,
as set forth above, the Issuer and SRH may (i) refuse to accept any Old Notes
and return any Old Notes that have been tendered to the holders thereof, (ii)
extend the Exchange Offer and retain all Old Notes tendered prior to the
Expiration of the Exchange Offer, subject to the rights of such holders of
tendered Old Notes to withdraw their tendered Old Notes or (iii) waive such
termination event with respect to the Exchange Offer and accept all properly
tendered Old Notes that have not been withdrawn. If such waiver constitutes a
material change in the Exchange Offer, the Issuer and SRH will disclose such
change by means of a supplement to this Prospectus that will be distributed to
each registered holder of Old Notes, and the Issuer and SRH will extend the
Exchange Offer for a period of five to ten business days, depending upon the
significance of the waiver and the manner of disclosure to the registered
holders of the Old Notes, if the Exchange Offer would otherwise expire during
such period. Holders of Old Notes will have certain rights against the Issuer
and SRH under the Registration Agreement should the Issuer and SRH fail to
consummate the Exchange Offer.
EXCHANGE AGENT
State Street Bank and Trust Company has been appointed as Exchange Agent for
the Exchange Offer. Questions and requests for assistance and requests for
additional copies of this Prospectus or of the Letter of Transmittal should be
directed to the Exchange Agent.
Delivery of Old Notes, the Letter of Transmittal and all other required
documents to the Exchange Agent may be made by (i) Hand/Overnight Courier to
the Corporate Trust Department, 4th Floor, Two International Plaza, Boston
Massachusetts 02110, Attn: Ms. Sandra Szozsponik or (ii) by mail to the
Corporate Trust Department, P.O. Box 778, Boston, Massachusetts 02102-0078,
Attn: Ms. Sandra Szozsponik; or (iii) by facsimile transmission (for Eligible
Institutions only): 617-664-5290. Confirmation may be made by calling 617-664-
5587.
DELIVERY TO AN ADDRESS OTHER THAN SET FORTH ABOVE WILL NOT CONSTITUTE A VALID
DELIVERY.
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FEES AND EXPENSES
The expenses of soliciting tenders pursuant to the Exchange Offer will be
borne by the Issuer and SRH. The principal solicitation for tenders pursuant
to the Exchange Offer is being made by mail. Additional solicitations may be
made by officers and regular employees of the Issuer and SRH in person, by
telegraph or telephone. The Issuer and SRH will not make any payments to
brokers, dealers or other persons soliciting acceptances of the Exchange
Offer. The Issuer and SRH, however, will pay the Exchange Agent reasonable and
customary fees for its services and will reimburse the Exchange Agent for its
reasonable out-of-pocket expenses in connection therewith. The Issuer and SRH
may also pay brokerage houses and other custodians, nominees and fiduciaries
the reasonable out-of-pocket expenses incurred by them in forwarding copies of
this Prospectus, Letters of Transmittal and related documents to the
beneficial owners of the Old Notes and in handling or forwarding tenders for
exchange.
The other expenses incurred in connection with the Exchange Offer, including
fees and expenses of the Exchange Agent and Trustee and accounting and legal
fees, will be paid by the Issuer and SRH. The Issuer and SRH will pay all
transfer taxes, if any, applicable to the exchange of Old Notes pursuant to
the Exchange Offer. If, however, Exchange Notes or Old Notes not tendered or
accepted for exchange are to be delivered to, or are to be registered or
issued in the name of, any person other than the registered holder of the Old
Notes tendered, or if tendered Old Notes are registered in the name of any
person other than the person signing the Letter of Transmittal, or if a
transfer tax is imposed for any reason other than the exchange of Old Notes
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be
payable by the tendering holder. If satisfactory evidence of payment of such
taxes or exemption therefrom is not submitted with the Letter of Transmittal,
the amount of such transfer taxes will be billed directly to such tendering
holder.
ACCOUNTING TREATMENT
No gain or loss for accounting purposes will be recognized by the Issuer or
SRH upon the consummation of the Exchange Offer. The expenses of the Exchange
Offer will be amortized by the Issuer over the term of the Exchange Notes
under generally accepted accounting principles.
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DESCRIPTION OF NOTES
The Old Notes were issued and the Exchange Notes will be 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"). References to the "Notes"
shall include the "Exchange Notes" except where the context otherwise
requires. The Indenture is governed by certain provisions contained in the
Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). The terms
of the Notes include those stated in the Indenture and those made part of the
Indenture by reference to the Trust Indenture Act. The following summaries of
certain provisions of the Notes, the Indenture and the Security Documents do
not purport to be complete and are subject to, and are qualified in their
entirety by reference to all of the provisions of the Indenture or the
Security Documents, as applicable. A copy of the form of the Indenture, the
Registration Rights Agreement and each of the Security Documents is available
from the Issuer upon request. Capitalized terms used herein, and not otherwise
defined herein, have the meanings defined under the heading "Certain
Definitions." Other capitalized terms not otherwise defined herein have the
meanings assigned to them in the Indenture.
The Notes will be issued in full registered form only, without coupons, in
denominations of $1,000 and integral multiples thereof. Initially, the Trustee
will act as Paying Agent and Registrar for the Notes. The Notes may be
presented for registration of transfer and exchange at the offices of the
Registrar, which currently is the Trustee's corporate trust office in
Hartford, Connecticut. The Issuer may change the Paying Agent and Registrar
without notice to Holders of the Notes. The Issuer will pay principal
(premium, if any) and interest on the Notes at the corporate trust offices of
the Trustee or its agency in New York, New York. In addition, in the event the
Notes do not remain in book-entry form, interest may be paid, at the Issuer's
option, by wire transfer or check mailed to the registered addresses of the
Holders as shown on the Note Register.
As of the Issue Date, the Issuer is a Restricted Subsidiary of SRH, the
Parent Guarantor of the Notes. As of the Issue Date, Red Oak will be an
Unrestricted Subsidiary of SRH. Subject to the requirements of the Indenture,
SRH will be able to designate future Subsidiaries as Unrestricted
Subsidiaries. Unrestricted Subsidiaries will not be subject to the restrictive
covenants set forth in the Indenture.
Any Notes that remain outstanding after the completion of this Offer,
together with the Exchange Notes issued in connection with this Offer, will be
treated as a single class of securities under the Indenture.
Under certain circumstances, the obligations of the Issuer under the Notes
may be guaranteed in the future by other Restricted Subsidiaries of SRH. See
"--Ranking and Guarantees."
PRINCIPAL, MATURITY AND INTEREST
The Notes will be limited in aggregate principal amount to $200 million and
will mature on October 15, 2004. Interest on the Notes will accrue at the rate
of 10 1/2% per annum and will be payable semi-annually on each April 15 and
October 15 commencing on April 15, 1998 to the Persons who are registered
Holders at the close of business on April 1 and October 1 immediately
preceding the applicable interest payment date. Interest on the Notes will
accrue from and including the most recent date to which interest has been paid
or, if no interest has been paid, from and including the Issue Date. Interest
will be computed on the basis of a 360-day year comprised of twelve 30-day
months.
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OPTIONAL REDEMPTION
The Issuer does not have the right to redeem the Notes prior to October 15,
2001. Thereafter, the Issuer may redeem the Notes, at its option, in whole or
in part, at any time, at the following redemption prices (expressed as a
percentage of the outstanding principal amount) if redeemed during the twelve-
month period commencing on October 15 of the year set forth below, plus, in
each case, accrued and unpaid interest thereon to the date of redemption:
<TABLE>
<CAPTION>
REDEMPTION
YEAR PRICE
---- ----------
<S> <C>
2001........................................................... 105.250%
2002........................................................... 102.625%
2003 and thereafter............................................ 100.000%
</TABLE>
Notwithstanding the foregoing, at any time on or prior to October 15, 2000,
the Issuer may redeem up to $70 million of the aggregate principal amount of
the Notes in cash at a redemption price equal to 110.50% of the principal
amount of the Notes so redeemed, together with accrued and unpaid interest
thereon to the redemption date, with the net proceeds of any Public Equity
Offering, provided that at least $130 million in aggregate principal amount of
the Notes remains outstanding immediately after the occurrence of such
redemption and provided further that such redemption occurs within 60 days of
the date of the closing of such Public Equity Offering.
Selection and Notice
In the case of any partial redemption, selection of the Notes for redemption
will be made by the Trustee in compliance with the requirements of the
principal national securities exchange, if any, on which the Notes are listed,
or if the Notes are not listed, on a pro rata basis, by lot or by such other
method as the Trustee shall deem fair and appropriate, provided that no Note
of $1,000 or less shall be redeemed in part. Notice of redemption will be sent
by first class mail, at least 30 days and not more than 60 days prior to the
date fixed for redemption, to the Holder of each Note to be redeemed to such
Holder's last address as then shown upon the Note Register. Any notice which
relates to a Note to be redeemed in part only must state the portion of the
principal amount to be redeemed and must state that on and after the date
fixed for redemption, upon surrender of such Note, a new Note in a principal
amount equal to the unredeemed portion thereof will be issued. On and after
the date fixed for redemption, unless the Issuer defaults on its payment
obligations, interest will cease to accrue on the Notes or portions thereof
called for redemption.
RANKING AND GUARANTEES
The indebtedness of the Issuer evidenced by the Notes ranks senior in right
of payment to all Subordinated Indebtedness of the Issuer and pari passu in
right of payment with all existing and future senior Indebtedness of the
Issuer. Pursuant to the Parent Guarantee, SRH unconditionally guarantees on a
senior basis, to each Holder and the Trustee, the full and prompt performance
of the Issuer's obligations under the Indenture and the Notes, including the
payment of principal of, premium, if any, and interest on the Notes. The
Parent Guarantee ranks pari passu in right of payment to all existing and
future senior Indebtedness of SRH. The Parent Guarantee is secured by pledges
of the Capital Stock of Sierra and Red Oak directly owned by SRH. See "--
Collateral." The Notes, the Parent Guarantee and the Subsidiary Guarantees are
effectively subordinated, however, to any secured Indebtedness of the Issuer,
SRH and the Subsidiary Guarantors to the extent of the collateral therefor,
including any Indebtedness under the Southwest Credit Facility, which is
secured by substantially all of the Issuer's oil and gas properties. As of
September 30, 1997, SRH and the Issuer would have had $1.5 million of senior
Indebtedness outstanding, excluding the Notes and the Parent Guarantee. See
"Capitalization."
The Indenture also provides that each Significant Subsidiary of SRH (other
than the Issuer), whether now existing or hereafter formed or acquired,
becomes a Subsidiary Guarantor either by execution of the Indenture or a
supplemental indenture and thereby guarantee the Notes as described herein. In
addition, the Indenture provides that each Restricted Subsidiary (other than
the Issuer) which Incurs any Indebtedness (other than to SRH or the
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Issuer) shall, within 10 days following the Incurrence of such Indebtedness,
become a Subsidiary Guarantor by execution of a supplemental indenture and
thereby guarantee the Notes as described herein. As of the Issue Date, there
will be no Subsidiary Guarantor.
Each Subsidiary Guarantor will unconditionally guarantee on a senior
unsecured basis, jointly and severally, to each Holder and the Trustee, the
full and prompt performance of the Issuer's obligations under the Indenture
and the Notes, including the payment of principal of, premium, if any, and
interest on the Notes. The Subsidiary Guarantee of each Subsidiary Guarantor
will rank pari passu in right of payment to all existing and future senior
Indebtedness of such Subsidiary Guarantor.
The obligation of each Subsidiary Guarantor is limited to the maximum amount
which, after giving effect to all other contingent and fixed liabilities of
such Subsidiary Guarantor and after giving effect to any collections from or
payments made by or on behalf of any other Subsidiary Guarantor in respect of
the obligations of such other Subsidiary Guarantor under its Subsidiary
Guarantee or pursuant to its contribution obligations under the Indenture,
will result in the obligations of such Subsidiary Guarantor under the
Subsidiary Guarantee not constituting a fraudulent conveyance or fraudulent
transfer under applicable federal or state law. SRH and each Subsidiary
Guarantor that makes a payment or distribution under the Parent Guarantee or a
Subsidiary Guarantee shall be entitled to a contribution from each other
Guarantor in a pro rata amount, based on the net assets of SRH and each
Subsidiary Guarantor, determined in accordance with GAAP. See "Risk Factors--
Possible Limitations on Enforceability of Subsidiary Guarantees."
The Indenture provides that, subject to the following paragraph, each
Subsidiary Guarantor (including any existing or future Restricted Subsidiary
that becomes a Subsidiary Guarantor) may not consolidate or merge with or into
(whether or not such Subsidiary Guarantor is the surviving Person) another
Person or sell or convey all or substantially all of its assets to another
Person or group unless (i) the Person formed by or surviving any such
consolidation or merger (if other than such Subsidiary Guarantor) or the
transferee entity (A) is a corporation organized and existing under the laws
of the United States of America, any state thereof, or the District of
Columbia and (B) expressly assumes all the obligations of such Subsidiary
Guarantor pursuant to a supplemental indenture, in a form satisfactory to the
Trustee, under the Notes and the Indenture, (ii) immediately before and after
giving effect to such transaction, no Default or Event of Default exists and
immediately after giving effect to such transaction, the resulting surviving
or transferee entity could Incur $1.00 of additional Indebtedness (other than
Permitted Indebtedness) pursuant to paragraph (i) of the covenant described
herein under the caption "Limitation on Incurrences of Additional Indebtedness
and Issuances of Disqualified Capital Stock," and (iii) such Subsidiary
Guarantor or the Person formed by or surviving any such consolidation or
merger or the transferee entity on a pro forma basis will have Net Worth
(immediately after the transaction) equal to or greater than the Net Worth of
such Subsidiary Guarantor immediately preceding the transaction. The foregoing
does not apply to a merger, consolidation, sale or other such transaction
between Subsidiary Guarantors, between the Issuer and any Subsidiary Guarantor
or between SRH and any Subsidiary Guarantor.
The Indenture provides that in the event of (i) the designation of any
Subsidiary Guarantor as an Unrestricted Subsidiary or (ii) a sale or other
disposition of all or substantially all of the properties or assets of any
Subsidiary Guarantor to a third party or an Unrestricted Subsidiary, by way of
merger, consolidation or otherwise, or a sale or other disposition of all of
the Capital Stock of any Subsidiary Guarantor, in either case, in a
transaction or manner that does not violate any of the covenants in the
Indenture, then such Subsidiary Guarantor (in the event of such a designation
or a sale or other disposition, by way of such a merger, consolidation or
otherwise, or a disposition of all of the Capital Stock of such Subsidiary
Guarantor) or the Person acquiring such properties or assets (in the event of
a sale or other disposition of all or substantially all of the properties or
assets of such Subsidiary Guarantor) will be released from and relieved of any
obligations under its Subsidiary Guarantee, provided that any Net Cash
Proceeds of such sale or other disposition are applied in accordance with the
covenant described under the caption "--Covenants--Limitation on Asset Sales,"
and provided, further, however, that any such termination shall occur only to
the extent that all obligations of such Subsidiary Guarantor under all of its
guarantees of, and under all of its pledges of assets or other security
interests that secure, any other Indebtedness of SRH or its Restricted
Subsidiaries shall also terminate upon such release, sale or disposition.
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REPURCHASE OF NOTES AT THE OPTION OF THE HOLDER UPON A CHANGE OF CONTROL
Upon the occurrence of a Change of Control, each Holder has the right, at
such Holder's option, subject to the terms and conditions of the Indenture, to
require the Issuer to repurchase all or any part of such Holder's Notes
(provided that the principal amount of such Notes must be $1,000 or an
integral multiple thereof) on a date that is no later than 60 Business Days
after the occurrence of such Change of Control (the date on which the
repurchase is effected being referred to herein as the "Change of Control
Payment Date"), at a cash purchase price equal to 101% of the principal amount
thereof (the "Change of Control Purchase Price"), plus accrued and unpaid
interest thereon to the Change of Control Payment Date.
The Issuer shall notify the Trustee within five Business Days after each
date upon which a Change of Control has occurred. Within 20 Business Days
after the occurrence of each Change of Control, the Issuer will make an
irrevocable, unconditional offer (a "Change of Control Offer") to the Holders
of Notes to purchase all of the Notes at the Change of Control Purchase Price,
plus accrued and unpaid interest thereon to the Change of Control Payment
Date, by sending written notice of a Change of Control Offer, by first class
mail, to each Holder at its registered address, with a copy to the Trustee.
The notice to Holders will contain all instructions and materials required by
applicable law and will contain or make available to Holders other information
material to such Holders' decision to tender Notes pursuant to the Change of
Control Offer.
On or before the Change of Control Payment Date, the Issuer will, to the
extent lawful, (i) accept for payment Notes or portions thereof properly
tendered pursuant to the Change of Control Offer, (ii) deposit with the Paying
Agent an amount sufficient to pay the Change of Control Purchase Price of all
Notes so tendered, and (iii) deliver or cause to be delivered to the Trustee
all Notes so accepted, together with an officers' certificate listing the
Notes or portions thereof being purchased by the Issuer. The Paying Agent will
promptly mail to the Holders of Notes so accepted payment in an amount equal
to the Change of Control Purchase Price for such Notes, plus accrued and
unpaid interest thereon to the Change of Control Payment Date, and the Trustee
will promptly cancel all Notes so accepted by the Issuer pursuant to the
Change of Control Offer and authenticate and mail (or cause to be transferred
by book entry) to such Holders a new Note equal in principal amount, as
applicable, to any unpurchased portion of the Note surrendered. Any Notes not
so accepted will be promptly mailed by the Issuer to the Holder thereof. The
Issuer will publicly announce the results of the Change of Control Offer on or
as soon as practicable after the Change of Control Purchase Date.
The Change of Control provisions described above are applicable whether or
not any other provisions of the Indenture are applicable. Except as described
above with respect to a Change of Control, the Indenture does not contain
provisions that permit the Holders to require that the Issuer repurchase or
redeem the Notes in the event of a takeover, recapitalization or other similar
transaction of SRH or the Issuer. The provisions of the Indenture may not
afford Holders protection in the event of a highly leveraged transaction,
reorganization, restructuring, merger or other similar transaction affecting
SRH or the Issuer that may adversely affect the Holders if such transaction is
not the type of transaction included within the definition of "Change of
Control." A transaction involving the management of SRH, the Issuer or any
Affiliate or a transaction involving a recapitalization of SRH or the Issuer
will result in a Change of Control only if it is the type of transaction
specified in such definition.
The existence of a Holder's right to require the Issuer to repurchase Notes
in connection with a Change of Control may deter a third party from acquiring
SRH or the Issuer in a transaction that would constitute a Change of Control.
The source of funds for any repurchase of Notes upon a Change of Control
will be the Company's cash or cash generated from operation or other sources,
including borrowings or sales of assets; however, there can be no assurance
that sufficient funds will be available at the time of any Change of Control
to repay all Indebtedness owing or to make any required repurchase of the
Notes. Any failure by the Issuer to repurchase Notes tendered pursuant to a
Change of Control Offer will constitute an Event of Default. See "--Events of
Default and Remedies."
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The Issuer will not be required to make a Change of Control Offer upon a
Change of Control if a third party makes the Change of Control Offer in the
manner, at the times and otherwise in compliance with the requirements set
forth in the Indenture applicable to a Change of Control Offer made by the
Issuer and repurchases all Notes validly tendered and not withdrawn under such
Change of Control Offer.
The definition of Change of Control includes a phrase relating to the sale,
lease, transfer, conveyance or other disposition of "all or substantially all"
of the assets of (i) SRH and its Restricted Subsidiaries, taken as a whole, or
(ii) the Issuer. Although there is a developing body of judicial opinions
interpreting the phrase "all or substantially all," no precise standard exists
under New York law, which is the law governing the Indenture and the Notes.
Accordingly, the ability of a Holder of Notes to require the Issuer to
repurchase such Notes as a result of a sale, lease, transfer, conveyance or
other disposition of less than all of the assets of (i) SRH and its Restricted
Subsidiaries, taken as a whole, or (ii) the Issuer, to another Person or group
is uncertain.
To the extent applicable and if required by law, SRH and the Issuer will
comply with Section 14 of the Exchange Act, the provisions of Regulation 14E
and any other tender offer rules under the Exchange Act and other securities
laws, rules, and regulations which may then be applicable to any offer by the
Issuer to repurchase the Notes at the option of Holders upon a Change of
Control; and, if such laws, rules, and regulations require or prohibit any
action inconsistent with the foregoing, compliance by SRH and the Issuer with
such laws, rules, and regulations will not constitute a breach of the Issuer's
obligations with respect to the foregoing.
COVENANTS
The Indenture contains, among others, the following covenants:
Limitation on Incurrences of Additional Indebtedness and Issuances of
Disqualified Capital Stock
The Indenture provides that SRH may not, and may not permit any of its
Restricted Subsidiaries to, directly or indirectly, create, incur, assume,
guarantee, or otherwise become liable for, contingently or otherwise (to
"Incur" or, as appropriate, an "Incurrence"), any Indebtedness or issue any
Disqualified Capital Stock, except that SRH or a Restricted Subsidiary may
Incur Indebtedness and SRH or the Issuer may issue shares of Disqualified
Capital Stock if:
(i) the Consolidated Fixed Charge Coverage Ratio for SRH's Reference
Period for which internal financial statements are available immediately
preceding the date on which such additional Indebtedness is Incurred or
such Disqualified Capital Stock is issued would have been (A) at least 2.0
to 1.0 if such additional Indebtedness is Incurred or such Disqualified
Capital Stock is issued during the period commencing on the Issue Date and
ending on December 31, 1998 or (B) at least 2.5 to 1.0 if such additional
Indebtedness is Incurred or such Disqualified Capital Stock is issued at
any time thereafter;
(ii) no Default or Event of Default shall have occurred and be continuing
at the time such additional Indebtedness is Incurred or such Disqualified
Capital Stock is issued or would occur as the result of such Incurrence of
such additional Indebtedness or the issuance of such Disqualified Capital
Stock; and
(iii) SRH's Adjusted Consolidated Net Tangible Assets are equal to or
greater than 150% of the consolidated Indebtedness of SRH and its
Restricted Subsidiaries.
Notwithstanding the foregoing, if no Default or Event of Default shall have
occurred and be continuing at the time or as a consequence of the Incurrrence
of such Indebtedness, SRH and any Restricted Subsidiary may Incur Permitted
Indebtedness.
Any Indebtedness Incurred or Disqualified Capital Stock issued by any Person
that is not a Subsidiary of SRH or any of its Restricted Subsidiaries, as the
case may be, which Indebtedness or Disqualified Capital Stock is outstanding
at the time such Person becomes a Restricted Subsidiary of, or is merged into,
or consolidated with SRH or such Restricted Subsidiary, as the case may be,
shall be deemed to have been Incurred or issued, as the case may be, at the
time such Person becomes a Restricted Subsidiary of, or is merged into, or
consolidated with SRH or such Restricted Subsidiary.
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Limitation on Restricted Payments
(a) The Indenture provides that SRH will not, and will not permit any
Restricted Subsidiary to, directly or indirectly (i) declare or pay any
dividend on, or make any other distribution to holders of, any shares of
Capital Stock of SRH or any Restricted Subsidiary (other than dividends or
distributions payable solely in shares of Qualified Capital Stock of SRH or
any Restricted Subsidiary or dividends or distributions payable to SRH or the
Issuer or any wholly-owned Restricted Subsidiary of SRH or the Issuer or
warrants, rights or options to acquire Qualified Capital Stock of SRH or any
Restricted Subsidiary), (ii) purchase, redeem or otherwise acquire or retire
for value any such shares of Capital Stock of SRH or any Affiliate (other than
any Capital Stock owned by SRH or any of its wholly-owned Restricted
Subsidiaries), or any options, warrants or other rights to acquire such
Capital Stock, (iii) make any principal payment on or repurchase, redeem,
defease or otherwise acquire or retire for value, prior to any scheduled
principal payment, scheduled sinking fund payment or maturity, any
Subordinated Indebtedness, or (iv) make any Restricted Investment (such
payments or other actions described in clauses (i) through (iv) being
collectively referred to as a "Restricted Payment"), unless at the time of and
after giving effect to the proposed Restricted Payment (the amount of any such
Restricted Payment, if other than cash, shall be the amount determined by the
Board of Directors of SRH, whose determination shall be conclusive and
evidenced by a Board Resolution),
(1) no Default or Event of Default shall have occurred and be continuing,
(2) SRH could incur $1.00 of additional Indebtedness (other than Permitted
Indebtedness) in accordance with clause (i) of the covenant "--Limitation on
Incurrences of Additional Indebtedness and Issuances of Disqualified Capital
Stock," and
(3) the aggregate amount of all Restricted Payments declared or made after
the Issue Date shall not exceed the sum (without duplication) of the
following:
(A) 50% of the Adjusted Consolidated Net Income of SRH accrued on a
cumulative basis during the period commencing with the first full quarter
after the Issue Date and ending on the last day of SRH's last fiscal
quarter ending prior to the date of such proposed Restricted Payment (or if
Adjusted Consolidated Net Income is a loss, minus 100% of such loss), plus
(B) the aggregate Net Proceeds received after the Issue Date by SRH or
the Issuer from the issuance or sale (other than to any of its Restricted
Subsidiaries) of shares of Qualified Capital Stock of SRH or the Issuer or
any options, warrants or rights to purchase such shares of Qualified
Capital Stock of SRH or the Issuer, plus
(C) the aggregate Net Proceeds received after the Issue Date by SRH or
the Issuer (other than from any of its Restricted Subsidiaries) upon the
exercise of any options, warrants or rights to purchase shares of Qualified
Capital Stock of SRH or the Issuer, plus
(D) the aggregate Net Proceeds received after the Issue Date by SRH or
the Issuer from the issuance or sale (other than to any of its Restricted
Subsidiaries) of Indebtedness or shares of Disqualified Capital Stock that
have been converted into or exchanged for Qualified Capital Stock of SRH or
the Issuer, together with the aggregate cash received by SRH or the Issuer
at the time of such conversion or exchange, minus
(E) the amount of any write-downs, writeoffs, other negative
revaluations, and other negative extraordinary charges not otherwise
reflected in Adjusted Consolidated Net Income of SRH during such period.
(b) Notwithstanding paragraph (a) above, SRH and its Restricted Subsidiaries
may take the following actions so long as (in the case of clauses (2), (3),
(4), (5) and (7) below) no Default or Event of Default shall have occurred and
be continuing:
(1) the payment of any dividend on Capital Stock of SRH or any Restricted
Subsidiary within 60 days after the date of declaration thereof, if at such
declaration date such declaration complied with the provisions of paragraph
(a) above;
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(2) the repurchase, redemption or other acquisition or retirement of any
shares of any class of Capital Stock of SRH or any Restricted Subsidiary,
in exchange for, or out of the aggregate Net Proceeds from, a substantially
concurrent issue and sale (other than to a Restricted Subsidiary) of shares
of Qualified Capital Stock of SRH or the Issuer;
(3) the repurchase, redemption, repayment, defeasance or other
acquisition or retirement for value of any Subordinated Indebtedness in
exchange for, or out of the aggregate Net Proceeds from, a substantially
concurrent issue and sale (other than to a Restricted Subsidiary) of (i)
Subordinated Indebtedness (provided such Indebtedness is on terms no less
favorable to the Holders of the Notes than the terms of the Subordinated
Indebtedness being redeemed) or (ii) shares of Qualified Capital Stock of
SRH or the Issuer;
(4) the repurchase, redemption or other acquisition of any Capital Stock
of any Affiliate organized as a limited partnership in which SRH or the
Issuer is a general partner pursuant to a redemption which is mandatory
under the terms of such partnership's limited partnership agreement;
(5) the repurchase or other acquisition of any Capital Stock of any
Restricted Subsidiary, whether in one or a series of substantially
contemporaneous transactions, which causes such Person to become a wholly-
owned Restricted Subsidiary of SRH;
(6) the payment on behalf of any Subsidiary or Affiliate of its allocated
pro rata costs associated with the issuance of the Notes and any Investment
in Capital Stock of such Person taken by SRH in payment thereof;
(7) the distribution or dividend by SRH to its stockholders of the shares
of Capital Stock of Red Oak owned by SRH, provided at the time of such
distribution or dividend (and after giving effect thereto):
(i) the Consolidated Fixed Charge Coverage Ratio for SRH's Reference
Period for which internal financial statements are available
immediately preceding the date of such distribution would have been at
least 3.0 to 1.0; and
(ii) SRH's Adjusted Consolidated Net Tangible Assets are equal to or
greater than 200% of the consolidated Indebtedness of SRH and its
Restricted Subsidiaries.
The actions described in clause (1) of this paragraph (b) shall be
Restricted Payments that shall be permitted to be made in accordance with this
paragraph (b) but shall reduce the amount that would otherwise be available
for Restricted Payments under clause (3) of paragraph (a), provided that any
dividend paid pursuant to clause (1) of this paragraph (b) shall reduce the
amount that would otherwise be available under clause (3) of paragraph (a)
when declared, but not also when subsequently paid pursuant to clause (1) of
this paragraph (b), and provided that any Net Proceeds received under clauses
(2) or (3)(ii) of paragraph (b) shall not be included in subclauses (B) or (C)
of clause (3) of paragraph (a) above.
Limitation on Dividend and Other Payment Restrictions Affecting Restricted
Subsidiaries
The Indenture provides that SRH may not, and may not permit any of its
Restricted Subsidiaries to, directly or indirectly, create, or permit or
suffer to exist or become effective any consensual encumbrance or restriction
on the ability of any Restricted Subsidiary of SRH to (a) pay dividends or
make other distributions on its Capital Stock to SRH or any of its other
Restricted Subsidiaries, (b) make loans or advances or pay any Indebtedness or
other obligations owed to SRH or to any other Restricted Subsidiary, or (c)
transfer any of its properties or assets to SRH or to any other Restricted
Subsidiary, except encumbrances and restrictions existing under (i) this
Indenture, any Permitted Bank Credit Facility as in effect on the Issue Date
and any amendments, modifications, restatements, renewals, increases,
supplements, refundings, replacements or refinancings thereof, provided that
such amendments, modifications, restatements, renewals, increases,
supplements, refundings, replacements or refinancings are no more restrictive
with respect to such dividend and other payment or transfer restrictions than
those contained in the Permitted Bank Credit Facility as in effect on the
Issue Date and (ii) any agreement of a Person acquired by SRH or a Restricted
Subsidiary of SRH, which restrictions existed at the time of acquisition, were
not put in place in anticipation of such acquisition, and are not applicable
to any Person or property, other than the Person or any property of the Person
so acquired.
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Limitation on Transactions with Affiliates
The Indenture provides that SRH may not, and may not permit any of its
Subsidiaries to, enter directly or indirectly into, or permit to exist, any
transaction or series of related transactions with or for the benefit of any
Affiliate except for transactions made in good faith, the terms of which are
fair and reasonable to SRH or such Subsidiary, as the case may be, and are at
least as favorable as the terms which could be obtained by SRH or such
Subsidiary, as the case may be, in a comparable transaction made on an arm's
length basis with Persons who are not Affiliates and SRH delivers: (i) with
respect to any transaction or series of transactions with an Affiliate
involving aggregate consideration in excess of $1 million, an officers'
certificate certifying that such transaction or transactions comply with this
covenant, (ii) with respect to any transaction or series of transactions with
an Affiliate involving aggregate consideration in excess of $2 million, a
resolution of the Board of Directors set forth in an officers' certificate
certifying that such transaction or transactions comply with this covenant and
that such transaction or transactions have been approved in good faith by a
majority of the members of the Board of Directors who are independent (which
resolution shall be conclusive evidence of compliance with this provision),
provided that if there is not a majority of independent directors able to
approve such transaction, SRH shall also deliver an opinion as to the fairness
to SRH or such Subsidiary of such transaction or transactions from a financial
point of view issued by an investment banking firm of recognized national
standing, which opinion shall be conclusive evidence of compliance with this
provision; and (iii) with respect to any transaction or series of transactions
with an Affiliate involving aggregate consideration in excess of $5 million,
an officers' certificate as described in subclause (ii) above and an opinion
as to the fairness to SRH or such Subsidiary of such transaction or
transactions from a financial point of view issued by an investment banking
firm of recognized national standing, which resolution and opinion shall be
conclusive evidence of compliance with this provision; provided, however, that
this covenant will not restrict: (1) transactions between SRH and any of its
Restricted Subsidiaries or transactions between Restricted Subsidiaries of
SRH, (2) transactions pursuant to the Tax Sharing Agreement and the Security
Documents, (3) Restricted Payments permitted by the provisions of the
Indenture described under the covenant captioned "--Limitation on Restricted
Payments," (4) any employee compensation arrangements by SRH or any of its
Subsidiaries which has been approved by a majority of SRH's disinterested
directors and found in good faith by such directors to be in the best
interests of SRH or such Subsidiary, as the case may be; and (5) customary
directors' fees and indemnification and similar arrangements.
Limitation on Asset Sales
The Indenture provides that SRH may not, and may not permit any Restricted
Subsidiary to, consummate an Asset Sale unless: (a) SRH or such Restricted
Subsidiary, as the case may be, receives consideration at the time of such
Asset Sale at least equal to the fair market value (as determined in good
faith by resolution of the Board of Directors set forth in an officers'
certificate delivered to the Trustee, which determination shall be conclusive
evidence of compliance with this provision) of the assets or Capital Stock
being sold or issued or otherwise disposed of; and (b) at least 75% of the
value of the consideration for such Asset Sales consists of cash, Cash
Equivalents or Exchange Assets or any combination thereof; provided that the
amount of any liabilities (as shown on SRH's or such Restricted Subsidiary's
most recent balance sheet) of SRH or any Restricted Subsidiary (other than
contingent liabilities and liabilities that are Subordinated Indebtedness or
otherwise by their terms subordinated to the Notes, the Parent Guarantee or
the Subsidiary Guarantees) that are assumed by the transferee of such assets
pursuant to a customary novation agreement that releases SRH and such
Restricted Subsidiary from further liability shall also be deemed to be cash
for purposes of this provision.
Within 365 days after the receipt of any Net Cash Proceeds from an Asset
Sale, SRH or such Restricted Subsidiary may apply such Net Cash Proceeds, at
its option, in any order or combination: (a) to repay and permanently reduce
Indebtedness outstanding under any Permitted Bank Credit Facility to which it,
the Issuer or any other Restricted Subsidiary of SRH is a party, (b) to make
Capital Expenditures or (c) to make other acquisitions of assets to be used in
SRH's and its Restricted Subsidiaries' oil and gas business. Pending the final
application of any such Net Cash Proceeds, SRH or such Restricted Subsidiary
may temporarily invest such Net Cash Proceeds in any manner that is not
prohibited by the terms of the Indenture. Any Net Cash Proceeds from Asset
Sales that are not applied as provided in clauses (a) through (c) of the first
sentence of this paragraph will (after expiration of the relevant periods) be
deemed to constitute "Excess Cash."
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When the amount of Excess Cash exceeds $10 million, the Issuer or SRH will
make an irrevocable, unconditional offer (an "Excess Cash Offer") to the
Holders to purchase the maximum amount of Notes which could be acquired by
application of such amount of Excess Cash as described herein (the "Excess
Cash Offer Amount"), in cash at the purchase price equal to 100% of the
principal amount thereof (the "Excess Cash Offer Price"), together with
accrued and unpaid interest to the Excess Cash Purchase Date.
Notice of an Excess Cash Offer will be sent at least 30 and not more than 60
days prior to the Excess Cash Purchase Date, by first-class mail, by the
Issuer or SRH to each Holder at the address on the Note Register, with a copy
to the Trustee. Such notice will set forth a date on which the Notes tendered
shall be accepted (the "Excess Cash Purchase Date") and the Excess Cash Offer
shall remain open for at least 20 Business Days and close no later than 30
Business Days after the date such notice is given. The notice to the Holders
will contain all information, instructions and materials required by
applicable law or otherwise material to such Holders' decision to tender Notes
pursuant to the Excess Cash Offer.
To the extent applicable and if required by law, the Issuer and SRH will
comply with Section 14 of the Exchange Act, the provisions of Regulation 14E
and any other tender offer rules under the Exchange Act and other securities
laws, rules, and regulations which may then be applicable to any Excess Cash
Offer by the Issuer or SRH; and, if such laws, rules, and regulations require
or prohibit any action inconsistent with the foregoing, compliance by the
Issuer or SRH with such laws, rules, and regulations will not constitute a
breach of its obligations with respect to the foregoing.
On or before an Excess Cash Purchase Date, the Issuer or SRH shall (i)
accept for payment Notes or portions thereof properly tendered pursuant to the
Excess Cash Offer, (ii) deposit with the Paying Agent money sufficient to pay
the Excess Cash Offer Price, plus accrued and unpaid interest thereon to the
Excess Cash Purchase Date of all Notes or portions thereof so accepted, and
(iii) deliver to the Trustee all Notes so accepted together with an officers'
certificate listing the Notes or portions thereof being purchased by the
Issuer or SRH. The Paying Agent shall promptly mail to Holders of Notes so
accepted payment in an amount equal to the Excess Cash Offer Price, plus
accrued and unpaid interest thereon to the Excess Cash Purchase Date. The
Trustee shall promptly cancel all Notes accepted by the Issuer pursuant to the
Excess Cash Offer and authenticate and mail to the Holders of Notes so
accepted a new Note equal to the principal amount of any unpurchased portion
of the Note surrendered. Any Notes not so accepted shall be promptly mailed by
the Issuer to the Holder thereof. The Issuer or SRH will publicly announce the
results of the Excess Cash Offer on or as soon as practicable after the Excess
Cash Purchase Date.
If the amount required to acquire all Notes tendered by Holders pursuant to
the Excess Cash Offer (the "Excess Cash Acceptance Amount") shall be less than
the aggregate Excess Cash Offer Amount, then the excess of the Excess Cash
Offer Amount over the Excess Cash Acceptance Amount may be used by SRH or any
Restricted Subsidiary in any manner permitted by the Indenture. Upon
consummation of any Excess Cash Offer made in accordance with the terms of the
Indenture, the amount of Excess Cash will be reduced to zero.
Limitation on Liens
The Indenture provides that SRH may not, and may not permit any Restricted
Subsidiary to, directly or indirectly, incur, or suffer to exist any Lien upon
any of their respective properties or assets, whether now owned or hereafter
acquired, other than Permitted Liens.
Limitation on Lines of Business
The Indenture provides that SRH will not engage in any line of business
other than to act as a holding company for the Issuer, Sierra and Red Oak and
such other business activities as are reasonably related or incidental
thereto. The Indenture will provide that the Restricted Subsidiaries will not
engage in any line of business other than the oil and gas exploration and
production business, such other business activities as are reasonably related
or incidental thereto and any other business activities of SRH and its
Restricted Subsidiaries conducted as of the Issue Date.
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Designation of Unrestricted Subsidiaries
The Board of Directors of SRH may designate any Restricted Subsidiary (other
than the Issuer) to be an Unrestricted Subsidiary if such designation would
not cause a Default or an Event of Default and following such designation, SRH
could Incur $1.00 of additional Indebtedness pursuant to paragraph (i) of the
covenant described herein under the caption "Limitation on Incurrences of
Additional Indebtedness and Issuances of Disqualified Capital Stock." For
purposes of making such determination, all outstanding Investments by SRH and
its Restricted Subsidiaries in the Subsidiary so designated which have not
been repaid in cash will be deemed to be Restricted Payments at the time of
such designation and will reduce the amount available for Restricted Payments
under clause (3) of paragraph (a) of the covenant "Limitation on Restricted
Payments." All such outstanding Investments will be deemed to constitute
Restricted Investments in an amount equal to the greater of the fair market
value or book value of such Investments at the time of such designation. Such
designation will only be permitted if such Restricted Payment would be
permitted at such time and if such Restricted Subsidiary otherwise meets the
definition of an Unrestricted Subsidiary. In addition, the definition of
"Unrestricted Subsidiary" set forth under the caption "Certain Definitions"
describes the circumstances under which a future Unrestricted Subsidiary of
SRH may be designated as a Restricted Subsidiary by the Board of Directors of
SRH.
The Board of Directors of SRH or any Restricted Subsidiary may designate any
Unrestricted Subsidiary of such Person (other than Red Oak) as a Restricted
Subsidiary of such Person; provided that, (a) if the Unrestricted Subsidiary
has any Indebtedness outstanding or is otherwise liable for any Indebtedness
or has a negative Net Worth, then immediately after giving pro forma effect to
such designation, such Person could Incur at least $1.00 of additional
Indebtedness (other than Permitted Indebtedness) pursuant to the provisions
described under the heading "--Covenants--Limitation on Incurrences of
Additional Indebtedness and Issuances of Disqualified Capital Stock"
(assuming, for purposes of this calculation, that each dollar of negative Net
Worth is equal to one dollar of Indebtedness), (b) all Indebtedness of such
Unrestricted Subsidiary shall be deemed to be Incurred by a Restricted
Subsidiary of the Person on the date such Unrestricted Subsidiary becomes a
Restricted Subsidiary, and (c) no Default or Event of Default would occur or
be continuing after giving effect to such designation. Any Subsidiary of an
Unrestricted Subsidiary shall be an Unrestricted Subsidiary for purposes of
the Indenture.
Limitation on the Sale or Issuance of Capital Stock of Restricted
Subsidiaries
The Indenture provides that SRH will not sell or otherwise dispose of any
shares of Capital Stock of any Restricted Subsidiary (other than the Issuer),
and shall not permit any Restricted Subsidiary (other than the Issuer),
directly or indirectly, to issue or sell or otherwise dispose of any of its
Capital Stock except (a) to SRH or a wholly-owned Restricted Subsidiary, or
(b) if all shares of Capital Stock of such Restricted Subsidiary are sold or
otherwise disposed of. In connection with any sale or disposition of Capital
Stock of any Restricted Subsidiary, SRH will be required to comply with the
covenant described under the caption "Limitation on Asset Sales," and in the
case of a sale of the Issuer, the covenants described under the captions
"Repurchase of Notes at the Option of the Holder Upon a Change of Control" and
"Limitation on Merger, Sale or Consolidation."
Ownership of Restricted Subsidiaries
The Indenture provides that all of the Capital Stock of each Restricted
Subsidiary (other than the Issuer, TPI and Southwest Software) be owned,
whether directly or indirectly, by SRH. The Indenture will also provide that
SRH will ensure that the Issuer remain a Restricted Subsidiary so long as any
of the Notes remains outstanding.
Limitation on Merger, Sale or Consolidation
The Indenture provides that SRH will not consolidate with or merge with or
into any other Person or, directly or indirectly, sell, lease, assign,
transfer, or convey all or substantially all of its assets (computed on a
consolidated basis), to another Person or group of Persons acting in concert,
whether in a single transaction or
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through a series of related transactions, unless (i) either (a) SRH is the
continuing Person or (b) the resulting, surviving, or transferee entity is a
corporation organized under the laws of the United States, any state thereof,
or the District of Columbia, and shall expressly assume all of the obligations
of SRH under the Indenture, the Parent Guarantee and the Security Documents by
appropriate documents supplemental thereto, executed and delivered to the
Trustee on or prior to the consummation of such transaction, in form
satisfactory to the Trustee; (ii) no Default or Event of Default shall exist
or shall occur immediately after giving effect to such transaction; (iii)
immediately after giving effect to such transaction on a pro forma basis, the
Net Worth of the resulting surviving or transferee entity is at least equal to
the Net Worth of SRH immediately prior to such transaction; and (iv) except
for a merger of SRH with or into any wholly-owned Restricted Subsidiary, the
resulting surviving or transferee entity would immediately thereafter be
permitted to Incur at least $1.00 of additional Indebtedness (other than
Permitted Indebtedness) pursuant to paragraph (i) of the covenant described
herein under the caption "Limitation on Incurrences of Additional Indebtedness
and Issuances of Disqualified Capital Stock." For purposes of this covenant,
the Consolidated Fixed Charge Coverage Ratio shall be determined on a pro
forma consolidated basis (giving effect to the transaction) for the Reference
Period immediately preceding such transaction.
The Indenture provides that the Issuer will not consolidate with or merge
with or into any other Person, or, directly or indirectly, sell, lease,
assign, transfer, or convey all or substantially all of its assets (computed
on a consolidated basis), to another Person or group of Persons acting in
concert, whether in a single transaction or through a series of related
transactions, unless (i) either (a) the Issuer is the continuing Person or (b)
the resulting, surviving, or transferee entity is a corporation organized
under the laws of the United States, any state thereof, or the District of
Columbia, and shall expressly assume all of the obligations of the Issuer
under the Indenture and the Notes by a supplemental indenture, executed and
delivered to the Trustee on or prior to the consummation of such transaction,
in form satisfactory to the Trustee; (ii) no Default or Event of Default shall
exist or shall occur immediately after giving effect to such transaction;
(iii) immediately after giving effect to such transaction on a pro forma
basis, the Net Worth of the surviving or transferee entity is at least equal
to the Net Worth of the Issuer immediately prior to such transaction; (iv)
except for a merger of the Issuer with or into SRH or any wholly-owned
Restricted Subsidiary, the resulting surviving or transferee entity would
immediately thereafter be permitted to Incur at least $1.00 of additional
Indebtedness (other than Permitted Indebtedness) pursuant to paragraph (i) of
the covenant described herein under the caption "Limitation on Incurrences of
Additional Indebtedness and Issuances of Disqualified Capital Stock"; (v) SRH
shall have executed and delivered to the Trustee, in form satisfactory to the
Trustee, a supplemental indenture confirming the obligation of SRH to pay the
principal of and interest on the Notes pursuant to the Parent Guarantee and to
perform all the covenants of SRH under the Indenture and the Parent Guarantee;
(vi) each Subsidiary Guarantor shall have executed and delivered to the
Trustee, in form satisfactory to the Trustee, a supplemental indenture
confirming such Subsidiary Guarantor's obligations to pay the principal of and
interest on the Notes pursuant to its Subsidiary Guarantee; and (vii) the
Trustee shall have received an opinion of counsel to the effect that such
consolidation, merger, conveyance, transfer or lease will not result in the
Issuer being required to make any deduction for or on account of taxes from
payments made under or in respect of the Notes. For purposes of this covenant,
the Consolidated Fixed Charge Coverage Ratio shall be determined on a pro
forma consolidated basis (giving effect to the transaction) for the Reference
Period immediately preceding such transaction.
Upon any consolidation or merger or any transfer of all or substantially all
of the assets of SRH or the Issuer in accordance with the foregoing, the
successor Person formed by such consolidation or merger or the Person to whom
such transfer is made, shall succeed to, and be substituted for, and may
exercise every right and power of, SRH under the Parent Guarantee and the
Security Documents or the Issuer under the Indenture, as the case may be, with
the same effect as if such successor corporation had been named as SRH or the
Issuer therein.
This covenant includes a phrase relating to the sale, lease, transfer,
conveyance or other dispositions of "all or substantially all" of the assets
of a Person. Although there is a developing body of judicial opinions
interpreting the phrase "all or substantially all," no precise standard exists
under applicable law. Accordingly, the ability of the Holders of the Notes to
declare an Event of Default as the result of such a disposition or series of
dispositions is uncertain.
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EVENTS OF DEFAULT AND REMEDIES
The Indenture defines an Event of Default as (i) the failure by the Issuer
to pay installments of interest on the Notes as and when the same become due
and payable and the continuance of any such failure for 30 days, (ii) the
failure by the Issuer to pay all or any part of the principal or premium, if
any, on the Notes when and as the same become due and payable at maturity,
redemption, by acceleration or otherwise, (iii) the failure by the Issuer or
SRH to comply with the provisions under the caption "Repurchase of Notes at
the Option of the Holder Upon a Change of Control," "Limitation on Asset
Sales" or "Limitation on Merger, Sale or Consolidation," (iv) the failure by
SRH, the Issuer or any of its other Restricted Subsidiaries to observe or
perform any other covenant, agreement or warranty contained in the Notes, the
Indenture, the Parent Guarantee, any Subsidiary Guarantee or any Security
Document and, subject to certain exceptions, the continuance of such failure
for a period of 30 days after written notice is given to the Issuer by the
Trustee or to the Issuer and the Trustee by the Holders of at least 25% of the
principal amount of the Notes then outstanding, (v) certain events of
bankruptcy, insolvency, or reorganization in respect of SRH, the Issuer or any
of its other Significant Subsidiaries, (vi) a default which extends beyond any
stated period of grace applicable thereto (including any extension thereof)
under any mortgage, indenture, or instrument under which there is outstanding
any Indebtedness of SRH, the Issuer or any of its other Restricted
Subsidiaries aggregating in excess of $1 million or a failure to pay such
Indebtedness at its stated maturity, provided that a waiver by all of the
lenders of such Indebtedness of such default shall constitute a waiver
hereunder for the same period, (vii) one or more final judgments not covered
by insurance aggregating at least $1 million at any one time rendered against
SRH, the Issuer or any of its other Restricted Subsidiaries and not stayed or
discharged within 60 days, (viii) any Note, the Indenture or any Security
Document not being in full force and effect (except where no material adverse
effect to the Holders of the Notes would result) or ceasing to give the
Trustee a perfected Lien on the Collateral, or (ix) the Parent Guarantee or
any of the Subsidiary Guarantees ceases to be in full force and effect or the
Parent Guarantee or any of the Subsidiary Guarantees is declared to be null
and void or unenforceable or the Parent Guarantee or any of the Subsidiary
Guarantees is found to be invalid or any Guarantor denies its liability under
the Parent Guarantee or its Subsidiary Guarantee (other than by reason of
release of a Subsidiary Guarantor in accordance with the terms of the
Indenture).
The Indenture provides that if an Event of Default occurs and is continuing
and if it is known to the Trustee, the Trustee must, within 90 days after the
occurrence of such Event of Default, give to the Holders notice of such
default; provided, that, except in the case of default in payment of principal
of, premium, if any, or interest on the Notes, the Trustee will be protected
in withholding such notice if it in good faith determines that the withholding
of such notice is in the interest of the Holders of the Notes.
If an Event of Default occurs and is continuing (other than an Event of
Default specified in clause (v) above), then in every such case, unless the
principal of all of the Notes shall have already become due and payable,
either the Trustee or the Holders of 25% of the principal amount of Notes then
outstanding, by notice in writing to the Issuer (and to the Trustee if given
by Holders), may declare all principal of, premium, if any, and accrued
interest on the Notes to be due and payable immediately. If an Event of
Default specified in clause (v) above occurs, all principal, premium, if any,
and accrued interest on the Notes will be immediately due and payable on all
outstanding Notes without any declaration or other act on the part of the
Trustee or the Holders. The Holders of not less than a majority of the
principal amount of Notes are authorized to rescind such acceleration if any
existing Events of Default, other than the non-payment of the principal of,
premium, if any, and interest on the Notes which have become due solely by
such acceleration, have been cured or waived.
Prior to the declaration of acceleration of the Notes, the Holders of a
majority of the Notes at the time outstanding may waive on behalf of all the
Holders any Default or Event of Default, except a Default in the payment of
principal of, premium, if any, or interest on any Note not yet cured, or a
Default, or Event of Default with respect to any covenant or provision which
cannot be modified or amended without the consent of all of the Holders of the
Notes. Subject to the provisions of the Indenture relating to the duties of
the Trustee, the Trustee will be under no obligation to exercise any of its
rights or powers under the Indenture at the request, order or direction of any
of the Holders, unless such Holders have offered to the Trustee reasonable
security or indemnity.
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Subject to all provisions of the Indenture, the Holders of a majority of the
Notes at the time outstanding will have the right to direct the time, method
and place of conducting any proceeding for any remedy available to the Trustee
or exercising any trust or power conferred on the Trustee.
COLLATERAL
The Parent Guarantee is secured by the pledge to the Trustee for the ratable
benefit of the Holders of (x) all of the Capital Stock of Sierra now or
hereafter directly owned by SRH, equals approximately 30% of the outstanding
shares of Capital Stock of Sierra, and (y) all of the Capital Stock of Red Oak
now or hereafter directly owned by SRH, which equals approximately 82% of the
outstanding shares of Capital Stock of Red Oak.
In the event of an Equity Offering in which SRH sells its shares of Sierra
or Red Oak, such shares may be released by the Trustee from the Lien of the
Security Documents for sale in connection with such Equity Offering. The
Trustee would have no Lien on the proceeds from any such sale of released
shares. Notwithstanding the foregoing, no such shares may be released by the
Trustee if at the time of such proposed release, a Default or Event of Default
has occurred and is continuing or would occur as a result of such release. In
addition, the Trustee will release the shares of Red Oak from the Lien of the
Security Documents to the extent such shares are subject to a transaction
permitted by clause (7) of paragraph (b) of the covenant. See "--Limitation on
Restricted Payments."
FORECLOSURE ON COLLATERAL
If the Notes become due and payable prior to the Stated Maturity Date
thereof or are not paid in full at the Stated Maturity Date thereof, the
Trustee may take all actions it deems necessary or appropriate, including, but
not limited to, foreclosing upon the Collateral in accordance with the
Security Documents and applicable law. The proceeds received from the sale of
any Collateral that is the subject of a foreclosure or collection suit shall
be applied first to pay the expenses of such foreclosure or suit and amounts
then payable to the Trustee and thereafter to pay the principal of and
interest on the Notes. The Trustee has the power to institute and maintain
such suits and proceedings as it may deem expedient to prevent impairment of,
or to preserve or protect its and the Holders' interest in, the Collateral.
There can be no assurance that the Trustee will be able to sell the
Collateral without substantial delays or that the proceeds obtained will be
sufficient to pay all amounts owing to Holders of the Notes. See "Risk
Factors--Adequacy of Collateral; Risks of Foreclosure" and "--Possible
Limitations on Enforceability of Subsidiary Guarantees."
LEGAL DEFEASANCE; SATISFACTION AND DISCHARGE OF THE INDENTURE
The Issuer will be deemed to have paid and discharged the entire
indebtedness on all of the outstanding Notes (except as to (i) Issuer's right
of optional redemption, (ii) rights of Holders to receive payments of
principal of, premium, if any, and interest on the Notes (but not the Change
of Control Purchase Price or the Excess Cash Offer Price) and any other rights
of the Holders with respect to such amounts, (iii) the rights, obligations and
immunities of the Trustee under the Indenture, and (iv) certain other
specified provisions in the Indenture (the foregoing exceptions (i) through
(iv) are collectively referred to as the "Reserved Rights")) on the 91st day
(or one day after such other greater period of time in which any such deposit
of trust funds may remain subject to set aside or avoidance under applicable
bankruptcy or insolvency laws, e.g., one year after any such deposit) after
the irrevocable deposit by the Issuer with the Trustee, in trust for the
benefit of the Holders, of (i) money in an amount, (ii) U.S. Government
Obligations which through the payment of interest and principal will provide,
not later than one day before the due date of payment in respect of the Notes,
money in an amount, or (iii) a combination thereof, sufficient to pay and
discharge the principal of, premium, if any, and interest on the Notes then
outstanding on the Stated Maturity Date or on the applicable redemption date,
as the case may be, and the Issuer must specify whether the Notes are being
defeased to the Stated Maturity Date or to a particular redemption date. Such
a trust may be established only if certain conditions are satisfied, including
delivery by the Issuer to the Trustee of an opinion of outside counsel
acceptable to the Trustee (who may be outside counsel to the Issuer) to the
effect that (i) the defeasance and discharge will not be deemed, or result in,
a taxable event
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for Federal income tax purposes, with respect to the Holders, (ii) the
Issuer's deposit will not result in the Issuer or any Guarantor, the trust or
the Trustee being subject to regulation under the Investment Company Act of
1940, and (iii) after the passage of 90 days (or any greater period of time in
which any such deposit of trust funds may remain subject to bankruptcy or
insolvency laws insofar as those laws apply to the Issuer or any Guarantor)
following the deposit of the trust funds, such funds will not be subject to
set aside or avoidance under any bankruptcy, insolvency, or other similar laws
affecting creditors' rights generally. The Indenture will not be discharged
if, among other things, an Event of Default relating to certain events of
bankruptcy, insolvency or reorganization of the Issuer or any Guarantor shall
have occurred and be continuing on the date of such deposit. The Indenture,
the Parent Guarantee, any Subsidiary Guarantee and each of the Security
Documents will cease to be of further effect as to all outstanding Notes when
(i) all outstanding Notes have been delivered to the Trustee for cancellation
or (ii) the Issuer has paid or caused to be paid the principal of, premium, if
any, and interest on the Notes.
RULE 144A INFORMATION REQUIREMENT
The Issuer and SRH have agreed to furnish to the Holders or beneficial
Holders of the Old Notes and prospective purchasers of the Old Notes
designated by the Holders of the Old Notes, upon their request, the
information required to be delivered pursuant to Rule 144A(d)(4) under the
Exchange Act until such time as the Issuer either exchanges all of the Old
Notes for the Exchange Notes or has registered all of the Old Notes for resale
under the Exchange Act.
REPORTS
The Indenture requires SRH to furnish to the Trustee, within 60 days after
the end of each fiscal quarter or 90 days after the end of a fiscal quarter
that is also the end of a fiscal year, an officers' certificate to the effect
that responsible officers of SRH have conducted or supervised a review of the
activities of SRH and its Subsidiaries and of performance under the Indenture
and that, to the best of such officers' knowledge, based on their review, SRH
and the Issuer have fulfilled all of their obligations under the Indenture or,
if there has been a Default, specifying each Default known to them, its nature
and its status. SRH and the Issuer will also be required to notify the Trustee
of any changes in the composition of the Board of Directors of SRH or any of
its Subsidiaries or of any amendment to the charter or bylaws of SRH or any of
its Subsidiaries.
Each of SRH and its Subsidiaries, where applicable, shall deliver to the
Trustee and to each Holder, within 15 days after it files them with the SEC,
copies of all reports and information that it is required to file with the SEC
pursuant to Section 13 or 15(d) of the Exchange Act. In addition, whether or
not required by the rules and regulations of the SEC, SRH will file a copy of
all such information with the SEC for public availability (unless the SEC will
not accept such a filing) and make such information available to investors or
prospective investors who request it in writing.
Concurrently with the reports delivered pursuant to the preceding paragraph,
SRH will be required to deliver to the Trustee and to each Holder annual and
quarterly financial statements with appropriate footnotes of SRH and its
consolidated Subsidiaries, all prepared and presented in a manner
substantially consistent with those of SRH required by the preceding
paragraph.
The Issuer is required upon becoming aware of any Default or Event of
Default to deliver to the Trustee a statement specifying such Default or Event
of Default.
AMENDMENTS AND SUPPLEMENTS
The Indenture contains provisions permitting the Issuer, SRH and the Trustee
to enter into a supplemental indenture or amend the Security Documents for
certain limited purposes without the consent of the Holders, including curing
ambiguities, defects or inconsistencies, releasing Subsidiary Guarantees as
described under "--Ranking and Guarantees" or making any other change with
respect to matters arising under the Indenture, so long as such change does
not adversely affect the rights of any of the Holders. With the consent of the
Holders of not less than a majority of the principal amount of the Notes then
outstanding, the Issuer, SRH and the Trustee
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will be permitted to amend or supplement the Indenture or any Security
Document or enter into any supplemental indenture or modify the rights of the
Holders; provided that no such modification may, without the consent of the
Holders of not less than 66% of the principal amount of the Notes then
outstanding, (i) prior to the date on which a Change of Control Offer is
required to be made, reduce the Change of Control Purchase Price or alter the
provisions of the covenant described herein under the heading "Repurchase of
Notes at the Option of the Holder Upon a Change of Control," or (ii) prior to
the date upon which an Excess Cash Offer is required to be made, reduce the
Excess Cash Offer Price or alter the provisions of the covenant described
herein under the heading "Limitation on Asset Sales," in a manner adverse to
the Holders; provided further, that no such modification may, without the
consent of each Holder: (i) change the stated maturity date or the date any
installment of principal of, or any installment of interest on, any Note is
due, or reduce the principal amount thereof or the rate of interest thereon or
any premium payable upon the redemption thereof, or change the place of
payment where, or the coin or currency in which, any Note or any premium or
the interest thereon is payable or impair the right to institute suit for the
enforcement of any such payment on or after the stated maturity date thereof
(or, in the case of redemption, on or after the redemption date), or, (x)
after the date upon which a Change of Control Offer is required to be made,
reduce the Change of Control Purchase Price or alter the provisions of the
covenant described herein under the heading "Repurchase of Notes at the Option
of the Holder Upon a Change of Control" or (y) after the date upon which an
Excess Cash Offer is required to be made, reduce the Excess Cash Offer Price
or alter the provisions of the covenant described herein under the heading
"Limitation on Asset Sales" in a manner adverse to the Holders, (ii) reduce
the percentage of the outstanding Notes whose consent is required for any such
amendment, supplemental indenture, or waiver provided for in the Indenture,
(iii) modify certain of the waiver provisions, except to increase any required
percentage or to provide that certain other provisions of the Indenture cannot
be modified or waived without the consent of all Holders of the Notes, (iv)
adversely affect the ranking of the Notes, the Parent Guarantee or the
Subsidiaries Guarantees; or (v) release any Collateral from the Liens created
pursuant to the Security Documents or release the Parent Guarantee or any
Subsidiary Guarantee, in any case otherwise than in accordance with the terms
of the Indenture.
CONCERNING THE TRUSTEE
The Indenture contains certain limitations on the rights of the Trustee,
should it become a creditor of the Issuer or any Guarantor, to obtain payment
of claims in certain cases, or to realize on certain property received in
respect of any such claim as security or otherwise. The Trustee will be
permitted to engage in other transactions; however, if it acquires any
conflicting interests, it must eliminate such conflict within 90 days, apply
to the SEC for permission to continue or resign.
The Holders of a majority of the principal amount of the then outstanding
Notes will have the right to direct the time, method and place of conducting
any proceeding for exercising any remedy available to the Trustee, subject to
certain exceptions. The Indenture provides that in case an Event of Default
shall occur (which shall not be cured), the Trustee will be required, in the
exercise of its power, to use the degree of care of a prudent man in the
conduct of his own affairs. Subject to such provisions, the Trustee will be
under no obligation to exercise any of its rights or powers under the
Indenture at the request of any Holder of the Notes.
NO PERSONAL LIABILITY OF STOCKHOLDERS, OFFICERS OR DIRECTORS
No stockholder, officer, or director, as such, past, present, or future of
SRH or any of its Subsidiaries or any successor corporation of any of them
shall have any personal liability in respect of the obligations of SRH or such
Subsidiary under the Notes, the Indenture, the Parent Guarantee, any
Subsidiary Guarantees or any Security Document by reason of his or its status
as such stockholder, officer, or director.
GOVERNING LAW
The Indenture, the Notes, the Parent Guarantee, any Subsidiary Guarantees
and the Security Documents are governed by the laws of the State of New York.
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CERTAIN DEFINITIONS
Set forth below is a summary of certain defined terms contained in the
Indenture. Reference is made to the Indenture for the full definition of all
such terms, as well as any other terms used herein for which no definition is
provided.
"Adjusted Consolidated Net Income" of SRH for any period means the Net
Income (loss) of SRH and its Restricted Subsidiaries for such period,
determined in accordance with GAAP, excluding (without duplication) the Net
Income of Red Oak or any other Unrestricted Subsidiary which is a consolidated
Subsidiary for such period, reduced by the amount of the deduction from Net
Income of SRH attributable to the minority interest in Red Oak or any other
Unrestricted Subsidiary which is a consolidated Subsidiary for such period.
"Adjusted Consolidated Net Tangible Assets" means (without duplication), as
of the date of determination, (a) the sum of (i) discounted future net revenue
from proved oil and gas reserves of SRH and its Restricted Subsidiaries
calculated in accordance with SEC guidelines before any state or federal
income taxes, as estimated or audited by independent petroleum engineers in
one or more Reserve Reports prepared as of the end of SRH's most recently
completed fiscal year as increased by, as of the date of determination, the
discounted future net revenue of (A) estimated proved oil and gas reserves of
SRH and its Restricted Subsidiaries attributable to any acquisition
consummated since the effective date of such year-end Reserve Reports and (B)
estimated oil and gas reserves of SRH and its Restricted Subsidiaries
attributable to extensions, discoveries and other additions and upward
revisions of estimates of proved oil and gas reserves due to exploration,
development or exploitation, production or other activities conducted or
otherwise occurring since the effective date of such year-end Reserve Reports
which, in the case of sub-clauses (A) and (B), would, in accordance with
standard industry practice, result in such increases, in each case calculated
in accordance with SEC guidelines (utilizing the prices and costs utilized in
such year-end Reserve Reports), and decreased by, as of the date of
determination, the discounted future net revenue of (C) estimated proved oil
and gas reserves of SRH and its Restricted Subsidiaries produced or disposed
of since the effective date of such year-end Reserve Reports and (D)
reductions in the estimated oil and gas reserves of SRH and its Restricted
Subsidiaries since the effective date of such year-end Reserve Reports
attributable to downward revisions of estimates of proved oil and gas reserves
due to exploration, development or exploitation, production or other
activities conducted or otherwise occurring since the effective date of such
year-end Reserve Reports which would, in accordance with standard industry
practice, result in such revisions, in each case calculated in accordance with
SEC guidelines (utilizing the prices utilized in such year-end Reserve
Reports); provided that, in the case of each of the determinations made
pursuant to sub-clauses (A) through (D) above, such increases and decreases
shall be as estimated by SRH's engineers, except that if there is a Material
Change and in connection with the Incurrence of Indebtedness for which the
Consolidated Fixed Charge Coverage Ratio must be determined, all or any part
of an increase in discounted future net revenue resulting from the matters
described in sub-clauses (A) and (B) above is needed to permit the Incurrence
of such Indebtedness, then the discounted future net revenue utilized for
purposes of this clause (a) (i) shall be confirmed in writing by independent
petroleum engineers, provided further that, if the events referred to in sub-
clauses (C) and (D) above, when taken alone, would not cause a Material
Change, then such written confirmation need only cover the incremental
additions to discounted future net revenue resulting from the determinations
made pursuant to sub-clauses (A) and (B) above to the extent needed to permit
the Incurrence of such Indebtedness, (ii) the capitalized costs that are
attributable to oil and gas properties of SRH and its Restricted Subsidiaries
to which no proved oil and gas reserves are attributed, based on SRH's books
and records as of a date no earlier than the date of SRH's latest annual or
quarterly financial statements, (iii) the Net Working Capital on a date no
earlier than the date of SRH's latest annual or quarterly financial statements
and (iv) the greater of (A) the net book value on a date no earlier than the
date of SRH's latest annual or quarterly financial statements and (B) the
appraised value, as estimated by independent appraisers, of other tangible
assets (including the amount of Investments in unconsolidated Subsidiaries,
Affiliates, other Persons or Unrestricted Subsidiaries) of SRH and its
Restricted Subsidiaries, as of a date no earlier than the date of SRH's latest
audited financial statements, minus (b) the sum of (i) minority interests,
(ii) any non-current portion of gas balancing liabilities of SRH and its
Restricted Subsidiaries reflected in SRH's latest annual or quarterly
financial statements, (iii) the discounted future net revenue, calculated in
accordance with SEC guidelines (utilizing the prices utilized in SRH's year-
end
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Reserve Reports), attributable to reserves which are required to be delivered
to third parties to fully satisfy the obligations of SRH and its Restricted
Subsidiaries with respect to Production Payments on the schedules specified
with respect thereto, (iv) the discounted future net revenue, calculated in
accordance with SEC guidelines (utilizing the same prices utilized in SRH's
initial or year-end Reserve Reports), attributable to reserves subject to
participation interests, overriding royalty interests or other interests of
third parties, pursuant to participation, partnership, vendor financing or
other agreements then in effect, or which otherwise are required to be
delivered to third parties and (v) the amount of environmental liabilities
payable by SRH or any Restricted Subsidiary. If SRH changes its method of
accounting from the full cost method to the successful efforts method or a
similar method of accounting, Adjusted Consolidated Net Tangible Assets will
continue to be calculated as if SRH was still using the full cost method of
accounting.
"Affiliate" means (i) any Person, directly or indirectly, controlling or
controlled by or under direct or indirect common control with SRH or any
Subsidiary of SRH or any officer, director, or employee of SRH or any
Subsidiary of SRH or of such Person, (ii) the spouse, any immediate family
member, or any other relative who has the same principal residence of any
Person described in clause (i) above, and any Person, directly or indirectly,
controlling or controlled by or under direct or indirect common control with,
such spouse, family member or other relative, and (iii) any trust in which any
Person described in clause (i) or (ii), above, is a fiduciary or has a
beneficial interest. For purposes of this definition the term "control" means
(a) the power to direct the management and policies of a Person, directly or
through one or more intermediaries, whether through the ownership of voting
securities, by contract, or otherwise, or (b) the beneficial ownership of 10%
or more of the voting common equity of such Person (on a fully diluted basis)
or of warrants or other rights to acquire such equity (whether or not
presently exercisable).
"Asset Sale" means (i) any direct or indirect conveyance, sale, transfer or
other disposition (including through damage or destruction for which Insurance
Proceeds are paid or by condemnation), in one transaction or a series of
related transactions, of any of the properties, businesses or assets of SRH or
any Restricted Subsidiary, whether owned on the Issue Date or thereafter
acquired or (ii) any sale or other disposition by SRH of any Capital Stock of
any Affiliate, Unrestricted Subsidiary or any Subsidiary of SRH or its
Restricted Subsidiaries (other than the Issuer). Notwithstanding the
foregoing, the following will not be deemed to be an Asset Sale: (a) the
conveyance, sale, lease, transfer or other disposition by any of SRH's
Restricted Subsidiaries of any or all of its assets (upon voluntary
liquidation or otherwise) to SRH; (b) the conveyance, sale, lease, transfer or
other disposition by any Restricted Subsidiary of any or all of its assets
(upon voluntary liquidation or otherwise) to another Restricted Subsidiary;
(c) non-material dispositions of assets in the ordinary course of business;
(d) Asset Sales not otherwise permitted by clauses (a) through (c) or (f) and
(g) of this sentence provided that the aggregate proceeds from all such Asset
Sales do not exceed $2.5 million in any twelve-month period; (e) the
disposition of all or substantially all of the assets of (i) SRH and its
Restricted Subsidiaries, taken as a whole, or (ii) the Issuer, if such
disposition is governed by the provisions of the covenant captioned
"Repurchase of Notes at the Option of Holder Upon a Change of Control"
and/or--"Covenants--Limitation on Merger, Sale or Consolidation;" (f) a
conveyance, sale, assignment, lease, license, transfer, abandonment or other
disposal by SRH and its Restricted Subsidiaries of (i) damaged, worn out,
unserviceable or other obsolete property in the ordinary course of business or
(ii) other property no longer necessary for the proper conduct of their
business; and (g) the conveyance, sale, transfer or otherwise disposition by
SRH and its Restricted Subsidiaries of crude oil and natural gas production
and refined products in the ordinary course of business.
"Attributable Indebtedness" in respect of a Sale and Leaseback Transaction
means, at the time of determination, the present value (discounted at the rate
of interest implicit in such transaction, determined in accordance with GAAP
or, in the event that such rate of interest is not reasonably determinable,
discounted at the rate of interest borne by the Notes) of the obligation of
the lessee for net rental payments during the remaining term of the lease
included in such Sale and Leaseback Transaction (including any period for
which such lease has been extended or may, at the option of the lessor, be
extended).
"Business Day" means any day other than a Saturday, Sunday or any other day
on which banking institutions in the cities of New York, New York, Hartford,
Connecticut or Boston, Massachusetts are required or authorized by law or
other governmental action to be closed.
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"Capital Expenditures" of a Person means expenditures (whether paid in cash
or accrued as a liability) by such Person or any of its Subsidiaries that, in
conformity with GAAP, are or would be included in "capital expenditures,"
"additions to property, plant, or equipment" or comparable items in the
consolidated financial statements of such Person consistent with prior
accounting practices.
"Capital Stock" means, with respect to any Person, any capital stock of such
Person and shares, interests, participations, or other ownership interests
(however designated) of such Person and any rights (other than debt securities
convertible into corporate stock), warrants or options to purchase any of the
foregoing, including without limitation, each class of common stock and
preferred stock of such Person, if such Person is a corporation, and each
general or limited partnership interest or other equity interest of such
Person, if such Person is a partnership or limited liability company.
"Capitalized Lease Obligation" means obligations under a lease that are
required to be capitalized for financial reporting purposes in accordance with
GAAP, and the amount of Indebtedness represented by such obligations shall be
the capitalized amount of such obligations, as determined in accordance with
GAAP.
"Cash Equivalents" means (a) United States dollars, (b) securities issued or
directly and fully guaranteed or insured by the United States government or
any agency or instrumentality thereof having maturities of not more than one
year from the date of acquisition, (c) certificates of deposit with maturities
of one year or less from the date of acquisition, bankers' acceptances with
maturities not exceeding one year, and overnight bank deposits, in each case,
with any Eligible Institution, (d) repurchase obligations with a term of not
more than seven days for underlying securities of the types described in
clauses (b) and (c) entered into with any Eligible Institution, (e) commercial
paper rated "P-l," "A-l" or the equivalent thereof by Moody's Investors
Service, Inc. or Standard & Poor's Ratings Service, respectively, and in each
case maturing within 180 days after the date of acquisition, (f) shares of
money market funds, including those of the Trustee, that invest solely in
United States dollars and securities of the types described in clauses (a)
through (e), and (g) demand and time deposits and certificates of deposit with
an Eligible Institution or with commercial banks insured by the Federal
Deposit Insurance Corporation.
"Change of Control" means the occurrence of any of the following: (i) the
sale, lease, transfer, conveyance or other disposition (other than by merger
or consolidation), in one or a series of related transactions, of all or
substantially all of the assets of SRH and its Restricted Subsidiaries, taken
as a whole, to any person (as such term is used in Section 13(d)(3) of the
Exchange Act) other than to SRH or a Subsidiary Guarantor; (ii) the sale,
lease, transfer, conveyance or other disposition, in one or a series of
related transactions, of all or substantially all of the assets of the Issuer
to any person (as such term is used in Section 13(d)(3) of the Exchange Act)
other than to SRH or a Subsidiary Guarantor; (iii) SRH or the Issuer
consolidates with or merges into another Person or any Person consolidates
with, or merges into, SRH or the Issuer, in any such event pursuant to a
transaction in which the outstanding Voting Stock of SRH or the Issuer is
changed into or exchanged for cash, securities or other property, other than
any such transaction where (a) the outstanding Voting Stock of SRH or the
Issuer is changed into or exchanged for Voting Stock of the surviving or
resulting Person that is Qualified Capital Stock and (b) the holders of the
Voting Stock of SRH or the Issuer immediately prior to such transaction own,
directly or indirectly, not less than a majority of the Voting Stock of the
surviving or resulting Person immediately after such transaction; (iv) the
adoption of a plan relating to the liquidation or dissolution of SRH or the
Issuer not involving a merger or consolidation or a sale or other disposition
of assets described in clause (i) or (ii) above; (v) the consummation of any
transaction (including, without limitation, any merger or consolidation) the
result of which is that any person (as defined above), excluding the Permitted
Holders, becomes the "beneficial owner" (as that term is used in Rules 13d-3
and 13d-5 under the Exchange Act), directly or indirectly, of more than 50% of
the total voting power of SRH's or the Issuer's then outstanding Voting Stock;
provided that the sale of Voting Stock of SRH or the Issuer to a Person or
Persons acting as underwriters in connection with a firm commitment
underwriting shall not constitute a Change of Control; or (vi) the first day
on which a majority of the members of the Board of Directors of SRH are not
Continuing Directors (other than by action of the Permitted Holders). For
purposes of this definition, any transfer of an equity interest of an entity
that was formed for the purpose of acquiring Voting Stock of SRH or the Issuer
will be deemed to be a transfer of such portion of such Voting Stock as
corresponds to the portion of the equity of such entity that has been so
transferred.
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"Change of Control Offer" shall have the meaning given to it under the
covenant--"Repurchase of Notes at the Option of the Holder Upon a Change of
Control."
"Change of Control Purchaser Price" shall have the meaning given to it under
the covenant--"Repurchase of Notes at the Option of the Holder Upon a Change
of Control."
"Collateral" shall mean the Capital Stock of Sierra and Red Oak directly
owned by SRH and any other property described in the Pledge Agreement or any
other Security Documents as being subject to the Liens created thereby.
"Consolidated Fixed Charge Coverage Ratio" on any date means, with respect
to SRH, the ratio, on a pro forma basis, of (i) the aggregate amount of EBITDA
attributable to continuing operations and businesses and exclusive of the
amounts attributable to operations and businesses discontinued or disposed of,
on a pro forma basis as if such operations and businesses were discontinued or
disposed of on the first day of the Reference Period, for the Reference Period
to (ii) the aggregate Consolidated Interest Expense (exclusive of amounts
attributable to discontinued operations and businesses on a pro forma basis as
if such operations and businesses were discontinued or disposed of on the
first day of the Reference Period, but only to the extent that the obligations
giving rise to such Consolidated Interest Expense would no longer be
obligations contributing to Consolidated Interest Expense subsequent to the
date of discontinuation or disposal) during the Reference Period; provided,
that for purposes of such computation, in calculating EBITDA and Consolidated
Interest Expense, (a) the transaction giving rise to the need to calculate the
Consolidated Fixed Charge Coverage Ratio shall be assumed to have occurred on
the first day of the Reference Period, (b) the Incurrence of any Indebtedness
or issuance of Disqualified Capital Stock or the retirement of any
Indebtedness or Capital Stock during the Reference Period or subsequent
thereto shall be assumed to have occurred on the first day of such Reference
Period, and (c) Consolidated Interest Expense attributable to any Indebtedness
(whether existing or being incurred) bearing a floating interest rate shall be
computed as if the rate in effect on the date of determination had been the
applicable rate for the entire period, unless SRH or any of its Restricted
Subsidiaries is a party to a Swap Obligation (that remains in effect for the
12-month period after the date of determination) that has the effect of fixing
the interest rate on the date of computation, in which case such rate (whether
higher or lower) shall be used.
"Consolidated Interest Expense" of SRH means, for any period, the aggregate
interest expense (without duplication), during such period in respect of all
Indebtedness of SRH and its Restricted Subsidiaries (including all
commissions, discounts, other fees and charges owed with respect to letters of
credit and banker's acceptance financing and costs associated with Swap
Obligations, but excluding any interest accrued on intercompany payables among
SRH and its Restricted Subsidiaries or among Restricted Subsidiaries for taxes
to the extent the liability for such taxes has been assumed pursuant to the
Tax Sharing Agreement) determined on a consolidated basis in accordance with
GAAP. For purposes of this definition, (x) interest on a Capitalized Lease
Obligation shall be deemed to accrue at an interest rate reasonably determined
to be the rate of interest implicit in such Capitalized Lease Obligation in
accordance with GAAP (including Statement of Financial Accounting Standards
No. 13 of the Financial Accounting Standards Board), and (y) Consolidated
Interest Expense attributable to any Indebtedness represented by the guarantee
by SRH or a Restricted Subsidiary of such Person other than with respect to
Indebtedness of SRH or a Restricted Subsidiary of SRH shall be deemed to be
the interest expense attributable to the item guaranteed.
"Continuing Directors" means, as of any date of determination, any member of
the Board of Directors of SRH who (i) was a member of such Board of Directors
on the Issue Date or (ii) was nominated for election or elected to such Board
of Directors with the approval of a majority of the Continuing Directors who
were members of such Board of Directors at the time of such nomination or
election.
"Default" means an event or condition, the occurrence of which is, or with
the lapse of time or giving of notice or both would be, an Event of Default.
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"Disqualified Capital Stock" means with respect to any Person any Capital
Stock of such Person or its Subsidiaries that, by its terms or by the terms of
any security into which it is convertible or exchangeable, is, or upon the
happening of an event or the passage of time would be, required to be redeemed
or repurchased by such Person or its Subsidiaries, including at the option of
the holder, in whole or in part, or has, or upon the happening of an even or
passage of time would have, a redemption or similar payment due, on or prior
to the Stated Maturity Date.
"EBITDA" means for any period the sum of the Adjusted Consolidated Net
Income of SRH for such period, plus the sum, without duplication (and only to
the extent such amounts are deducted from net revenues in determining such
Adjusted Consolidated Net Income), of (i) the provision for income taxes for
such period for SRH, (ii) depreciation, depletion, and amortization of SRH for
such period and (iii) Consolidated Interest Expense for such period,
determined, in each case, on a consolidated basis for SRH and its consolidated
Subsidiaries otherwise in accordance with GAAP.
"Eligible Institution" means a commercial banking institution that has
combined capital and surplus of not less than $500 million and that is rated
"A" (or higher) according to Moody's Investors Service, Inc. or Standard &
Poor's Ratings Service at the time as of which any investment or rollover
therein is made.
"Equity Offering" means any Public Equity Offering or other bona fide sale
of Qualified Capital Stock of Sierra and/or Red Oak to any Person (other than
SRH or any Affiliate) resulting in Net Proceeds to SRH in excess of
$15,000,000.
"Excess Cash Acceptance Amount" shall have the meaning given to it in the
covenant described herein under the heading "--Covenant--Limitation on Asset
Sales."
"Excess Cash Offer" shall have the meaning given to it under the heading "--
Covenant--Limitation on Asset Sales."
"Excess Cash Offer Amount" shall have the meaning given to it in the
covenant described herein under the heading "--Covenant--Limitation on Asset
Sales."
"Excess Cash Offer Price" shall have the meaning given to it in the covenant
described herein under the heading "--Covenant--Limitation on Asset Sales."
"Excess Cash Purchase Date" shall have the meaning given to it in the
covenant described herein under the heading "--Covenant--Limitation on Asset
Sales."
"Exchange Act" means the Securities Exchange Act of 1934, as amended, and
the rules and regulations promulgated by the SEC thereunder.
"Exchange Assets" means assets acquired by SRH or any Restricted Subsidiary
in exchange for assets of SRH or any Restricted Subsidiary in connection with
an Asset Sale, which acquired assets include proved reserves with a value
that, together with the cash or Cash Equivalents received therefor by SRH or
such Restricted Subsidiary, is equal to or greater than the value of the
proved reserves included in the assets disposed of by SRH or such Restricted
Subsidiary in connection with such Asset Sale; provided, that (i) ownership of
such assets does not violate the covenant "Limitation on Lines of Business"
and (ii) during any fiscal year, SRH and its Restricted Subsidiaries can
collectively acquire assets (other than proved reserves, cash or Cash
Equivalents) with a fair market value of up to $500,000 in exchange for assets
of SRH and the Restricted Subsidiaries with proved reserves, and such assets
acquired by such Person shall constitute "Exchange Assets" hereunder.
"GAAP" means generally accepted accounting principles as in effect in the
United States on the Issue Date applied on a basis consistent with that used
in the preparation of the audited financial statements of SRH included in this
Prospectus.
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"Guarantors" means SRH and each Subsidiary Guarantor.
"Holders" means any Person from time to time in whose name any Note is
registered on the Note Register.
"Hydrocarbons" means oil, natural gas, condensate, and natural gas liquids.
"Indebtedness" means, with respect to any Person, without duplication (i)
all liabilities, contingent or otherwise, of such Person (a) for borrowed
money (whether or not the recourse of the lender is to the whole of the assets
of such Person or only to a portion thereof), (b) evidenced by bonds, notes,
debentures, or similar instruments or letters of credit or representing the
balance deferred and unpaid of the purchase price of any property acquired by
such Person or services received by such Person, but excluding trade account
payables and accrued liabilities arising in the ordinary course of business
that are not overdue by 90 days or being contested in good faith by
appropriate proceedings, promptly instituted and diligently pursued, (c)
evidenced by bankers' acceptances or similar instruments issued or accepted by
banks or Swap Obligations, (d) for the payment of money relating to a
Capitalized Lease Obligation, (e) for the Attributable Indebtedness associated
with any Sale and Leaseback Transaction or (f) for Production Payments that
such Person or any of its Restricted Subsidiaries elect to treat as
Indebtedness; (ii) reimbursement obligations of such Person with respect to
letters of credit; (iii) all liabilities of others of the kind described in
the preceding clause (i) or (ii) that such Person has guaranteed or that is
otherwise its legal liability (to the extent of such guaranty or other legal
liability) other than for endorsements, with recourse, of negotiable
instruments in the ordinary course of business; and (iv) all obligations
secured by a Lien (other than Permitted Liens, except to the extent the
obligations secured by such Permitted Liens are otherwise included in clause
(i), (ii) or (iii) of this definition and are obligations of such Person) to
which the property or assets (including, without limitation, leasehold
interests and any other tangible or intangible property rights) of such Person
are subject, regardless of whether the obligations secured thereby shall have
been assumed by or shall otherwise be such Person's legal liability (but, if
such obligations are not assumed by such Person or are not otherwise such
Person's legal liability, the amount of such Indebtedness shall be deemed to
be limited to the fair market value of such property or assets determined as
of the end of the preceding fiscal quarter).
"Insurance Proceeds" means the interest in and to all proceeds (net of costs
of collection, including attorneys' fees) which now or hereafter may be paid
under any insurance policies now or hereafter obtained by or on behalf of SRH
or any Restricted Subsidiary in connection with any assets thereof, together
with interest payable thereon and the right to collect and receive the same,
including, without limitation, proceeds of casualty insurance, title
insurance, business interruption insurance and any other insurance now or
hereafter maintained with respect to such assets.
"Interest Rate or Currency Agreement" of any Person means any forward
contract, futures contract, swap, option or other financial agreement or
arrangement (including, without limitation, caps, floors, collars, puts and
similar agreements) relating to, or the value of which is dependent upon,
interest rates or currency exchange rates.
"Investment" by any Person in any other Person means (a) the acquisition
(whether for cash, property, services, securities or otherwise) of capital
stock, bonds, notes, debentures, partnership, or other ownership interests or
other securities of such other Person or any agreement to make any such
acquisition; (b) the making by such Person of any deposit with, or advance,
loan or other extension of credit to, such other Person (including the
purchase of property from another Person subject to an understanding or
agreement, contingent or otherwise, to resell such property to such other
Person) and (without duplication) any amount committed to be advanced, loaned
or extended to such other Person; (c) the entering into of any guarantee of,
or other contingent obligation with respect to, Indebtedness or other
liability of such other Person; (d) the entering into of any Swap Obligation
with such other Person; or (e) the making of any capital contribution by such
Person to such other Person.
"Investment Grade Rating" means with respect to any Person or issue of debt
securities or preferred stock, a rating in one of the four highest letter
rating categories (without regard to "+" or "-" or other modifiers) by
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any rating agency or if any such rating agency has ceased using letter rating
categories or the four highest of such letter rating categories are not
considered to represent "investment grade" ratings, then the comparable
"investment grade" ratings (as designated by any such rating agency).
"Issue Date" means the date of first issuance of the Notes under the
Indenture.
"Lien" means any mortgage, lien, pledge, charge, security interest, or other
encumbrance of any kind, regardless of whether filed, recorded, or otherwise
perfected under applicable law (including any conditional sale or other title
retention agreement and any lease deemed to constitute a security interest and
any option or other agreement to give any security interest).
"Material Change" means an increase or decrease (excluding changes that
result solely from changes in prices) of more than either (i) 10% from the end
of the immediately preceding fiscal quarter in the estimated discounted future
net revenue from proved oil and gas reserves of SRH and its Restricted
Subsidiaries, or (ii) 20% from the end of the immediately preceding year in
the estimated discounted future net revenue from proved oil and gas reserves
of SRH and its Restricted Subsidiaries, in each case calculated in accordance
with clause (a) (i) of the definition of Adjusted Consolidated Net Tangible
Assets; provided, however, that the following will be excluded from the
calculation of Material Change: (a) any acquisitions of oil and gas reserves
made after the end of the immediately preceding year for which the discounted
future net revenues have been estimated by independent petroleum engineers
since the end of the preceding year and on which a Reserve Report or Reserve
Reports exist and (b) any disposition of properties existing at the beginning
of the current quarter or current year, as the case may be, for purposes of
clause (i) or clause (ii) above, that have been disposed of in accordance with
the covenant "Limitation on Asset Sales."
"Net Cash Proceeds" means an amount equal to the aggregate amount of cash
and Cash Equivalents received by SRH or any Restricted Subsidiary in respect
of an Asset Sale, less the sum of (i) all reasonable out-of-pocket fees,
commissions, and other expenses incurred in connection with such Asset Sale,
including the amount (estimated in good faith by SRH) of income, franchise,
sales and other applicable taxes to be paid, payable or accrued by SRH or such
Restricted Subsidiary (in each case as estimated in good faith by SRH without
giving effect to tax attributes unrelated to such Asset Sale) in connection
with such Asset Sale, and (ii) the aggregate amount of cash and Cash
Equivalents so received which is used to retire any then existing Indebtedness
of SRH or such Restricted Subsidiary (other than the Notes), as the case may
be, which is secured by a Lien on the property subject of the Asset Sale or
which is required by the terms of such Indebtedness to be repaid in connection
with such Asset Sale.
"Net Income" of any Person for any period means the net income (loss) of
such Person for such period, determined on a consolidated basis in accordance
with GAAP, excluding (without duplication) (i) all extraordinary, unusual and
nonrecurring gains, (ii) the net income, if positive, of any other Person, in
which such Person or any of its consolidated Subsidiaries has an interest,
except to the extent of the amount of any dividends or distributions actually
paid in cash to such Person or a consolidated Subsidiary of such Person during
such period, (iii) the net income, if positive, of any Person acquired in a
pooling of interests transaction for any period prior to the date of such
acquisition and (iv) the net income, if positive, of any Subsidiary of such
Person to the extent that the declaration or payment of dividends or similar
distributions is not at the time permitted by operation of the terms of its
charter or any agreement, instrument, judgment, decree, order, statute, rule,
or governmental regulation applicable to such Subsidiary.
"Net Proceeds" means (a) in the case of any sale by a Person of Qualified
Capital Stock or other securities, the aggregate net cash proceeds received by
such Person from the sale of such securities (other than to a Restricted
Subsidiary) after payment of reasonable out-of-pocket expenses, commissions
and discounts incurred in connection therewith, and (b) in the case of any
exchange, exercise, conversion or surrender of any outstanding securities or
Indebtedness of such Person for or into shares of Qualified Capital Stock of
such Person, the net book value of such outstanding securities as adjusted on
the books of such Person or Indebtedness of such Person to the extent recorded
in accordance with GAAP, in each case, on the date of such exchange, exercise,
conversion
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or surrender (plus any additional amount required to be paid by the holder of
such Indebtedness or securities to such Person upon such exchange, exercise,
conversion or surrender and less (i) any and all payments made to the holders
of such Indebtedness or securities and (ii) all other expenses incurred by
such Person in connection therewith, in each case, in so far as such payments
or expenses are incident to such exchange, exercise, conversion, or
surrender).
"Net Working Capital" of any Person means (i) all current assets of such
Person and its Restricted Subsidiaries, minus (ii) all current liabilities of
such Person and its consolidated Subsidiaries other than the current portion
of long term Indebtedness, each item to be determined on a consolidated basis
in conformity with GAAP.
"Net Worth" of any Person means, at any date of determination, stockholders'
equity as set forth on the most recently available quarterly or annual
consolidated balance sheet of such Person and its Restricted Subsidiaries
(which shall be as of a date not more than 90 days prior to the date of such
computation), less any amounts included therein attributable to Disqualified
Capital Stock or any equity security convertible into or exchangeable for
Indebtedness, the cost of treasury stock (not otherwise deducted from
stockholder's equity), and the principal amount of any promissory notes
receivable from the sale of the Capital Stock of such Person or any of its
Restricted Subsidiaries each item to be determined in conformity with GAAP.
"Note Register" means the register maintained by or for the Issuer in which
the Issuer shall provide for the registration of the Notes and the transfer of
the Notes.
"Parent Guarantee" means an unconditional senior guarantee of the Notes
given by SRH pursuant to the terms of the Indenture.
"Parent Guarantor" means SRH, which will execute the Parent Guarantee.
"Permitted Bank Credit Facility" means, with respect to any Person, a
revolving credit and/or letter of credit facility with a commercial banking
institution, the proceeds of which are used for working capital and other
general corporate purposes, as the same may be amended, extended or refinanced
from time to time.
"Permitted Hedging Transactions" means non-speculative transactions in
futures, forwards, swaps or option contracts (including both physical and
financial settlement transactions) engaged in by SRH and its Restricted
Subsidiaries as part of their normal business operations as a risk-management
strategy or hedge against adverse changes in the prices of natural gas,
feedstock or refined products; provided, that such transactions do not in the
case of SRH and its Restricted Subsidiaries, on a monthly basis, relate to
more than 90% of their combined average net natural oil and gas production per
month for the most recent 3-month period measured at the time of such
transaction; provided, further, that, at the time of such transaction (i) the
counter party to any such transaction is an Eligible Institution or a Person
that has an Investment Grade Rating or has an issue of debt securities or
preferred stock outstanding with an Investment Grade Rating or (ii) such
counter party's obligation pursuant to such transaction is unconditionally
guaranteed in full by, or secured by a letter of credit issued by, an Eligible
Institution or a Person that has an Investment Grade Rating or that has an
issue of debt securities or preferred stock outstanding with an Investment
Grade Rating.
"Permitted Holders" means H.H. Wommack III (or his heirs, his estate or any
trust in which he or his immediate family members own, directly or indirectly,
a beneficial interest in excess of 50%).
"Permitted Indebtedness" means, without duplication, each of the following:
(a) the Indebtedness evidenced by the Notes, the Parent Guarantee or the
Subsidiary Guarantees; (b) Indebtedness owed by any Restricted Subsidiary to
SRH or any other Restricted Subsidiary or Indebtedness owed by SRH to any
Restricted Subsidiary; provided that, such Indebtedness is Subordinated
Indebtedness; (c) Indebtedness outstanding under a Permitted Bank Credit
Facility so long as the aggregate principal amount of all Indebtedness
outstanding under all Permitted Bank Credit Facilities for SRH and its
Restricted Subsidiaries does not exceed $50,000,000 less the amount of Net
Cash Proceeds from any Asset Sale applied pursuant to the covenant "Limitation
on Asset Sales" to repay or prepay such Indebtedness that results in a
permanent reduction relating thereto; (d) Swap
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Obligations of SRH or its Restricted Subsidiaries; (e) Indebtedness
outstanding on the Issue Date (and not repaid with the proceeds of the
Offering); (f) other Indebtedness owed by SRH or its Restricted Subsidiaries
in an aggregate principal amount outstanding not to exceed $1,000,000 at any
one time; and (g) Permitted Refinancing Indebtedness.
"Permitted Investment" means, when used with reference to SRH or any
Restricted Subsidiary, (i) trade credit extended to Persons in the ordinary
course of business; (ii) purchases of Cash Equivalents; (iii) Investments by
SRH or its Restricted Subsidiaries in Persons which are wholly-owned
Restricted Subsidiaries and are engaged in the oil and gas exploration and
production business; (iv) Swap Obligations; (v) advances to officers and
employees of the Company or any Restricted Subsidiary in connection with the
performance of their duties in the ordinary course of business in an amount
not to exceed $500,000 in the aggregate outstanding at any time; (vi) margin
deposits in connection with Permitted Hedging Transactions; (vii) any
Investments outstanding on the Issue Date and Investments in Red Oak by SRH on
the Issue Date in an amount not to exceed $10 million; (viii) Investments and
expenditures made in the ordinary course of business by SRH or its Restricted
Subsidiaries, and of a nature that is or shall have become customary in, the
oil and gas business as a means of actively exploiting, exploring for,
acquiring, developing, processing, gathering, marketing or transporting oil or
gas through agreements, transactions, interests or arrangements which permit a
Person to share risks or costs, comply with regulatory requirements regarding
local ownership or satisfy other objectives customarily achieved through the
conduct of the oil and gas business jointly with third parties, including,
without limitation, (a) ownership interests in oil and gas properties or
gathering systems and (b) Investments and expenditures in the form of or
pursuant to operating agreements, processing agreements, farm-in agreements,
farm-out agreements, development agreements, area of mutual interest
agreements, unitization agreements, pooling arrangements, joint bidding
agreements, service contracts, joint venture agreements, partnership
agreements (whether general or limited), subscription agreements, stock
purchase agreements and other similar agreements with third parties; provided
that in the case of any joint venture engaged in processing, gathering,
marketing or transporting oil or gas (i) all Indebtedness of such joint
venture (other than a joint venture that is an Unrestricted Subsidiary) that
would not otherwise constitute Indebtedness of SRH or a Restricted Subsidiary
shall be deemed Indebtedness of such Person in proportion to its direct or
indirect ownership interest in such joint venture and (ii) such joint venture
shall be reasonably calculated to enhance the value of the reserves of such
Person or marketability of production from such reserves; (ix) other
Investments not in excess of $2 million at any time outstanding; (x) loans
made to officers, directors and employees of SRH or any of its Restricted
Subsidiaries approved by the applicable Board of Directors (or by an
authorized officer), the proceeds of which are used solely to purchase stock
or to exercise stock options received pursuant to an employee stock option
plan or other incentive plan, in a principal amount not to exceed the purchase
price of such stock or the exercise price of such stock options, as
applicable; and (xi) the repayment of Indebtedness not to exceed $500,000 in
conjunction with the acquisition of all the Capital Stock of Love Petroleum
Company.
"Permitted Liens" with respect to any Person means (a) Liens imposed by
governmental authorities for taxes, assessments, or other charges not yet due
or which are being contested in good faith and by appropriate proceedings, if
adequate reserves with respect thereto are maintained on the books of any of
such Person in accordance with GAAP; (b) statutory Liens of landlords,
carriers, warehousemen, mechanics, materialmen, repairmen, mineral interest
owners, or other like Liens arising by operation of law in the ordinary course
of business provided that (i) the underlying obligations are not overdue for a
period of more than 60 days, or (ii) such Liens are being contested in good
faith and by appropriate proceedings and adequate reserves with respect
thereto are maintained on the books of any of such Person in accordance with
GAAP; (c) deposits of cash or Cash Equivalents to secure the performance of
bids, trade contracts (other than borrowed money), leases, statutory
obligations, surety bonds, performance bonds, and other obligations of a like
nature incurred in the ordinary course of business (or to secure reimbursement
obligations or letters of credit issued to secure such performance or other
obligations); (d) easements, rights-of-way, zoning, similar restrictions and
other similar encumbrances or title defects incurred in the ordinary course of
business which, in the aggregate, are not material in amount and which do not,
in any case, materially detract from the value of the property subject thereto
or materially interfere with the ordinary conduct of the business of such
Person; (e) Liens securing Parent
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Guarantee, the Notes, any Subsidiary Guarantee or Permitted Bank Credit
Facilities; (f) pledges or deposits made in the ordinary course of business in
connection with worker's compensation, unemployment insurance, other types of
social security legislation, property insurance and liability insurance; (g)
Liens on the assets of any Person existing at the time such assets are
acquired by such Person, whether by merger, consolidation, purchase of assets
or otherwise so long as such Liens (A) are not created, incurred or assumed in
contemplation of such assets being acquired by such Person and (B) do not
extend to any other assets of such Person; (h) leases or subleases granted to
others that do not materially interfere with the ordinary course of business
of any of such Person, and (i) any extension, renewal or replacement of the
Liens created pursuant to any of clauses (a) through (h); provided that such
Liens would have otherwise been permitted under such clauses, and provided
further that the Liens permitted by this clause (i) do not secure any
additional Indebtedness or encumber any additional property.
"Permitted Refinancing Indebtedness" means any Indebtedness of a Person
issued in exchange for, or the net proceeds of which are used to extend,
refinance, renew, replace, defease or refund other Indebtedness of such
Person; provided that: (i) the principal amount (or accredited value, if
applicable) of such Permitted Refinancing Indebtedness does not exceed the
principal amount (or accredited value, if applicable) of the Indebtedness so
extended, refinanced, renewed, replaced, defeased or refunded (plus the amount
of reasonable expenses incurred in connection therewith); (ii) such Permitted
Refinancing Indebtedness (other than Indebtedness under Permitted Bank Credit
Facilities) has a final maturity date later than the final maturity date of,
and has a weighted average life equal to or greater than the weighted average
life of, the Indebtedness being extended, refinanced, renewed, replaced,
defeased or refunded; (iii) if the Indebtedness being extended, refinanced,
renewed, replaced, defeased or refunded is subordinated in right of payment to
the Notes, such Permitted Refinancing Indebtedness has a final maturity date
later than the final maturity date of, and is subordinated in right of payment
to, the Notes on terms at least as favorable to the Holders of Notes as those
contained in the documentation governing the Indebtedness being extended,
refinanced, renewed, replaced, defeased or refunded; and (iv) with respect to
any such Indebtedness of SRH being extended, refinanced, renewed, replaced,
defeased or refunded, such Permitted Refinancing Indebtedness shall not be
incurred by any Restricted Subsidiary.
"Person" means any corporation, individual, joint stock company, joint
venture, partnership, unincorporated association, governmental regulatory
entity, country, state, or political subdivision thereof, trust, municipality,
or other entity.
"Pledge Agreement" means that certain Pledge Agreement by SRH in favor of
the Trustee pursuant to which the Capital Stock in Sierra and Red Oak owned by
SRH have been pledged to the Trustee, for the ratable benefit of the Holders
of the Notes.
"Preferred Stock" means, with respect to any Person, any class or classes
(however designated) of Capital Stock of such Person that is preferred as to
the payment of dividends, or as to the distribution of assets upon any
voluntary or involuntary liquidation or dissolution of such Person over shares
of Capital Stock of any other class of such Person.
"Production Payment" means any volumetric or dollar-denominated production
payment or other similar burden on the property of SRH or any of its
Restricted Subsidiaries.
"Public Equity Offering" means an underwritten public offering by a
nationally recognized member of the National Association of Securities Dealers
of Qualified Capital Stock of the Issuer or SRH pursuant to an effective
registration statement filed with the SEC pursuant to the Securities Act.
"Qualified Capital Stock" means any Capital Stock that is not Disqualified
Capital Stock.
"Red Oak" means Midland Red Oak Realty, Inc.
"Reference Period" with regard to any Person means the four full fiscal
quarters of such Person ended on or immediately preceding any date upon which
any determination is to be made pursuant to the terms of the Notes or the
Indenture.
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"Reserve Report" means a report prepared by independent petroleum engineers
with respect to Hydrocarbon reserves in accordance with guidelines published
by the SEC.
"Restricted Investment" means (i) the designation of a Subsidiary as an
Unrestricted Subsidiary in the manner described in the definition of
Unrestricted Subsidiary and (ii) any Investment other than a Permitted
Investment.
"Restricted Subsidiary" means any Subsidiary of SRH (including the Issuer)
which is not an Unrestricted Subsidiary.
"Sale and Leaseback Transaction" means an arrangement relating to property
owned on the Issue Date or thereafter acquired whereby a Person or a
Subsidiary of such Person transfers such property to another Person and leases
it back from such other Person.
"SEC" means the Securities and Exchange Commission.
"Securities Act" means the Securities Act of 1933, as amended, and the rules
and regulations of the SEC promulgated thereunder.
"Security Documents" means the Pledge Agreement and each other agreement
evidencing the pledge of assets to secure the Parent Guarantee that may be
entered into on or after the Issue Date pursuant to the terms of the
Indenture.
"Sierra" means Sierra Well Service, Inc.
"Significant Subsidiary" means (a) any Restricted Subsidiary having (i) for
the most recent fiscal year of such Subsidiary, consolidated revenues greater
than $10 million or (ii) as at the end of such fiscal year of such Subsidiary,
assets or liabilities greater than $10 million and (b) any group of Restricted
Subsidiaries that, taken together, would constitute a Significant Subsidiary;
provided however, that "Significant Subsidiary" shall not include a joint
venture if and so long as an Investment therein would constitute a Permitted
Investment under clause (viii) of the definition thereof.
"Southwest Software" means Midland Southwest Software, Inc.
"Stated Maturity Date" means October 15, 2004.
"Subordinated Indebtedness" means Indebtedness of the Issuer, SRH or a
Subsidiary Guarantor that (i) requires no payment of principal prior to or on
the Stated Maturity Date and (ii) is expressly subordinate and junior in right
of payment to the Notes, the Parent Guarantee or the Subsidiary Guarantees, as
the case may be.
"Subsidiary" with respect to any Person means (i) a corporation with respect
to which such Person or its Subsidiaries own, directly or indirectly, at least
50% of such corporation's Voting Stock, or (ii) a partnership in which such
Person or a Subsidiary of such Person is, at the time, a general partner of
such partnership and has more than 50% of the total voting power of
partnership interests, or (iii) any other Person (other than a corporation or
a partnership) in which such Person, one or more Subsidiaries of such Person,
or such Person and one or more Subsidiaries of such Person, directly or
indirectly, at the date of determination thereof has (x) at least a 50%
ownership interest or (y) the power to elect or direct the election of the
directors or other governing body of such other Person.
"Subsidiary Guarantee" means any guarantee of the Notes by any Subsidiary
Guarantor.
"Subsidiary Guarantor" means each Subsidiary that becomes a Subsidiary
Guarantor of the Notes in compliance with the provisions of the Indenture.
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"Swap Obligation" of any Person means any Interest Rate or Currency
Agreement entered into with one or more financial institutions or one or more
futures exchanges in the ordinary course of business and not for purposes of
speculation that is designed to protect such Person against fluctuations in
(x) interest rates with respect to Indebtedness Incurred and which shall have
a notional amount no greater than 100% of the principal amount of the
Indebtedness being hedged thereby or (y) currency exchange rate fluctuations.
"Tax Sharing Agreement" means the Tax Sharing Agreement, dated as of
September 1, 1997, among SRH and other Subsidiaries, as in effect on the Issue
Date and as amended from time to time, provided that any such amendment is not
materially adverse to the Holders of the Notes.
"TPI" means Threading Products International, LLC.
"Unrestricted Non-Recourse Indebtedness" of any Unrestricted Subsidiary
means (i) Indebtedness of such Person that is secured solely (other than with
respect to clause (ii) below) by a Lien upon the stock of an Unrestricted
Subsidiary of such Person and as to which there is no recourse (other than
with respect to clause (ii) below) against such Person or any of its assets
other than against such stock (and the dollar amount of any Indebtedness of
such Person as described in this clause (i) shall be deemed to be zero for
purposes of all other provisions of the Indenture) and (ii) guarantees of the
Indebtedness of Unrestricted Subsidiaries of such Person.
"Unrestricted Subsidiary" means, in respect of SRH, Red Oak; and in respect
of any Person, any other Person ("Other Person") that would, but for this
definition of "Unrestricted Subsidiary" be a Subsidiary of such Person
organized or acquired after the Issue Date as to which all of the following
conditions apply: (i) neither such Person nor any of its other Subsidiaries
provides credit support of any Indebtedness of such Other Person (including
any undertaking, agreement or instrument evidencing such Indebtedness); (ii)
such Other Person is not liable, directly or indirectly, with respect to any
Indebtedness other than Unrestricted Subsidiary Indebtedness; (iii) neither
such Person nor any of its Subsidiaries has made an Investment in such Other
Person unless such Investment was permitted by the provisions described under
"--Covenants--Limitation on Restricted Payments;" and (iv) the Board of
Directors of such Person, as provided below, shall have designated such Other
Person to be an Unrestricted Subsidiary on or prior to the date of
organization or acquisition of such Other Person. Any such designation by the
Board of Directors of such Person shall be evidenced to the Trustee by
delivering to the Trustee a resolution thereof giving effect to such
designation and an officers' certificate certifying that such designation
complies with the foregoing conditions.
"Unrestricted Subsidiary Indebtedness" means, as to any Unrestricted
Subsidiary of any Person, Indebtedness of such Unrestricted Subsidiary (i) as
to which neither such Person nor any Subsidiary of such Person is directly or
indirectly liable (by virtue of such Person or any such Subsidiary being the
primary obligor on, guarantor of, or otherwise liable in any respect to, such
Indebtedness), unless such liability constitutes Unrestricted Non-Recourse
Indebtedness and (ii) which, upon the occurrence of a default with respect
thereto, does not result in, or permit any holder (other than SRH or any
Subsidiary of SRH) of any Indebtedness of such Person or any Subsidiary of
such Person to declare a default on such Indebtedness of such Person or any
Subsidiary of such Person or cause the payment thereof to be accelerated or
payable prior to its Stated Maturity Date, unless, in the case of this clause
(ii), such Indebtedness constitutes Unrestricted Non-Recourse Indebtedness.
"Voting Stock" means Capital Stock of a Person having generally the right to
vote in the election to directors of such Person.
BOOK ENTRY; DELIVERY AND FORM
Except as described in the next paragraph, the Notes are represented by a
single, permanent global certificate in definitive, fully registered form (the
"Global Note"). The Global Note was deposited on October 14, with, or on
behalf of, The Depository Trust Company ("DTC") and registered in the name of
a nominee of DTC. The Global Note is subject to certain restrictions on
transfer set forth therein and bears the legend regarding such restrictions
set forth under "Notice to Investors."
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Notes (i) originally purchased by or transferred to "foreign purchasers" or
Accredited Investors who are not Qualified Institutional Buyers or (ii) held
by Qualified Institutional Buyers who elect to take physical delivery of their
certificates instead of holding their interest through the Global Note (and
which are thus ineligible to trade through DTC) (collectively referred to
herein as the "Non-Global Purchasers") will be issued in registered
certificated form ("Certificated Securities"). Upon the transfer to a
Qualified Institutional Buyer of any Certificated Security initially issued to
a Non-Global Purchaser, such Certificated Security will, unless the transferee
requests otherwise or the Global Note has previously been exchanged in whole
for Certificated Securities, be exchanged for an interest in the Global Note.
For a description of the restrictions on the transfer of Certificated
Securities and any interest in the Global Note, see "Notice to Investors."
Pursuant to procedures established by DTC (i) upon the issuance of the
Global Note, DTC or its custodian credited, on its internal system, the
principal amount of Notes of the individual beneficial interests represented
by such Global Note to the respective accounts for persons who have accounts
with DTC and (ii) ownership of beneficial interests in the Global Note is
shown on, and the transfer of such ownership will be effected only through,
records maintained by DTC or its nominee (with respect to interests of
participants) and the records of participants (with respect to interests of
persons other than participants). Such accounts initially were designated by
or on behalf of the Initial Purchasers and ownership of beneficial interests
in the Global Note is limited to persons who have accounts with DTC
("participants") or persons who own interests through participants. Qualified
Institutional Buyers will hold their interests in the Global Note directly
through DTC, if they are participants in such system, or indirectly through
organizations which are participants in such system.
So long as DTC or its nominee is the registered owner or holder of the
Notes, DTC or such nominee, as the case may be, will be considered the sole
owner or holder of the Notes represented by such Global Note for all purposes
under the Indenture. No beneficial owner of an interest in any Global Note
will be able to transfer that interest except in accordance with DTC's
procedures in additional to those provided for under the Indenture.
Payments of the principal of, premium, if any, and interest (including
Additional Interest) on, the Global Note will be made to DTC or its nominee,
as the case may be, as the registered owner thereof. None of the Issuer, the
Trustee or any paying agent of the Issuer will have any responsibility or
liability for any aspect of the records relating to or payments made on
account of beneficial ownership interests in the Global Note or for
maintaining, supervising or reviewing any records relating to such beneficial
ownership interests.
The Issuer expects that DTC or its nominee, upon receipt of any payment of
principal, premium, if any, or interest (including Additional Interest) in
respect of the Global Note, will credit participants' accounts with payments
in amounts proportionate to their respective beneficial interests in the
principal amount of the Global Note as shown on the records of DTC or its
nominee. The Issuer also expects that payments by participants to owners of
beneficial interests in the Global Note held through such participants will be
governed by standing instructions and customary practice, as is now the case
with securities held for the accounts of customers registered in the names of
nominees for such customers. Such payments will be the responsibility of such
participants.
Transfers between participants in DTC will be effected in the ordinary way
in accordance with DTC rules and will be settled in same day funds. If a
holder requires physical delivery of a Certified Security for any reason,
including to sell Notes to persons in states which require physical delivery
of the Certificated same day Securities, or to pledge such securities, such
holder must transfer its interest in the Global Note in accordance with the
normal procedures of DTC and with the procedures set forth in the Indenture.
DTC has advised the Issuer that it will take any action permitted to be
taken by a holder of Notes (including the presentation of Notes for exchange
as described under "Exchange and Registration Rights Agreement") only at the
direction of one or more participants to whose account the interests in the
Global Note are credited and only in respect of such portion of the aggregate
principal amount of Notes as to which such participant or participants have
given such direction. However, if there is an Event of Default under the
Indenture, DTC will exchange the Global Note for Certificated Securities,
which it will distribute to its participants.
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DTC has advised the Issuer as follows: DTC is a limited purpose trust
company organized under laws of the State of New York, a member of the Federal
Reserve System, a "clearing corporation" within the meaning of the Uniform
Commercial Code and a "clearing agency" registered pursuant to the provisions
of Section 17A of the Exchange Act. DTC was created to hold securities for its
participants and facilitate the clearance and settlement of securities
transactions between participants through electronic book entry changes in
accounts of its participants, thereby eliminating the need for physical
movement of certificates. Participants include securities brokers and dealers,
banks, trust companies and clearing corporations and certain other
organizations. Indirect access to the DTC system is available to others such
as banks, brokers, dealers and trust companies that clear through or maintain
a custodial relationship with a participant, either directly or indirectly.
Although DTC has agreed to the foregoing procedures in order to facilitate
transfers of interests in the Global Note among participants of DTC, it is
under no obligation to perform such procedures, and such procedures may be
discontinued at any time. None of the Issuer, the Initial Purchasers or the
Trustee will have any responsibility for the performance by DTC or its
participants or indirect participants of their respective obligations under
the rules and procedures governing their operations.
If DTC is at any time unwilling or unable to continue as a depositary for
the Global Note and a successor depositary is not appointed by the Issuer
within 90 days, or at SRH's election at any time, Certificated Securities will
be issued in exchange for the Global Note.
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EXCHANGE AND REGISTRATION RIGHTS AGREEMENT
Pursuant to the Registration Rights Agreement, SRH and the Issuer agreed to
file with the Commission the Exchange Offer Registration Statement on the
appropriate form under the Securities Act with respect to an offer to exchange
the Old Notes for the Exchange Notes. Upon the effectiveness of the Exchange
Offer Registration Statement, the Issuer will offer to the holders of Notes
who are able to make certain representations the opportunity to exchange their
Old Notes for Exchange Notes.
If (i) SRH and the Issuer are not permitted to file the Exchange Offer
Registration Statement or to consummate the Exchange Offer because the
Exchange Offer is not permitted by applicable law or Commission policy or (ii)
any holder of Notes notifies the Issuer within the specified time period that
(A) due to a change in law or policy it is not entitled to participate in the
Exchange Offer, (B) due to a change in law or policy it may not resell the
Exchange Notes acquired by it in the Exchange Offer to the public without
delivering a prospectus and the prospectus contained in the Exchange Offer
Registration Statement is not appropriate or available for such resales by
holder or (C) it is a broker-dealer and owns Old Notes acquired directly from
the Issuer or an affiliate of SRH or the Issuer, SRH and the Issuer will file
with the Commission the Shelf Registration Statement to cover resales of the
Transfer Restricted Notes (as defined) by the holders thereof. SRH and the
Issuer will use their best efforts to cause the applicable registration
statement to be declared effective within specified periods by the Commission.
For purposes of the foregoing, "Transfer Restricted Notes" means each Old Note
until (i) the date on which such Old Note has been exchanged by a person other
than a broker-dealer for an Exchange Note in the Exchange Offer, (ii)
following the exchange by a broker-dealer in the Exchange Offer of an Old Note
for an Exchange Note, the date on which such Exchange Note is sold to a
purchaser who receives from such broker-dealer on or prior to the date of such
sale a copy of the prospectus contained in the Exchange Offer Registration
Statement, (iii) the date on which such Old Note has been effectively
registered under the Securities Act and disposed of in accordance with the
Shelf Registration Statement or (iv) the date on which such Old Note is
distributed to the public pursuant to Rule 144 under the Securities Act.
Under existing Commission interpretations, the Transfer Restricted Notes
would, in general, be freely transferable after the Exchange Offer without
further registration under the Securities Act; provided, however, that in the
case of broker-dealers participating in the Exchange Offer, a prospectus
meeting the requirements of the Securities Act will be delivered upon resale
by such broker-dealer in connection with resales of the Exchange Notes. SRH
and the Issuer have agreed, for a period of 180 days after consummation of the
Exchange Offer, to make available a prospectus meeting the requirements of the
Securities Act to any such broker-dealer for use in connection with any resale
of any Exchange Notes acquired in the Exchange Offer. A broker-dealer which
delivers such a prospectus to purchasers in connection with such resales will
be subject to certain of the civil liability provisions under the Securities
Act and will be bound by the provisions of the Registration Rights Agreement
(including certain indemnification rights and obligations).
Each holder of the Old Notes who wishes to exchange such Old Notes for
Exchange Notes in the Exchange Offer will be required to make certain
representations, including representations that (i) any Exchange Notes to be
received by it will be acquired in the ordinary course of its business, (ii)
it is not participating in, and it has no arrangement with any person to
participate in the distribution (within the meaning of the Securities Act) of
the Exchange Notes and (iii) it is neither an "affiliate" of SRH or the
Issuer, as defined in Rule 405 of the Securities Act, nor a broker-dealer
tendering Old Notes acquired directly from the Issuer for its own account. If
the holder is a broker-dealer that will receive Exchange Notes for its own
account in exchange for Old Notes that were acquired as a result of market-
making activities or other trading activities, it will be required to
acknowledge that it will deliver a prospectus in connection with any resale of
such Exchange Notes.
The Registration Rights Agreement provides that: (i) unless the Exchange
Offer would not be permitted by applicable law or Commission policy, SRH and
the Issuer will file an Exchange Offer Registration Statement with the
Commission on or prior to 60 days after the date of original issuance of the
Notes (the "Closing Date"), (ii) unless the Exchange Offer would not be
permitted by applicable law or Commission policy, SRH and the Issuer will use
their best efforts to have the Exchange Offer Registration Statement declared
effective by the
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Commission on or prior to 120 days after the Closing Date, (iii) unless the
Exchange Offer would not be permitted by applicable law or Commission policy,
the Issuer will commence the Exchange Offer and use commercially reasonable
best efforts to issue, on or prior to 30 business days after the date on which
the Exchange Offer Registration Statement was declared effective by the
Commission, Exchange Notes in exchange for all Notes tendered prior thereto in
the Exchange Offer and (iv) if obligated to file the Shelf Registration
Statement, SRH and the Issuer will file on or prior to the later of (x) 90
days after the Closing Date or (y) 30 days after such filing obligation arises
and use their best efforts to cause the Shelf Registration Statement to be
declared effective by the Commission on or prior to 90 days after such
obligation arises; provided that if the Issuer has not consummated the
Exchange Offer within 180 days of the Closing Date, then SRH and the Issuer
will file the Shelf Registration Statement with the Commission on or prior to
the 181st day after the Closing Date and use its best efforts to cause the
Shelf Registration Statement to be declared effective within 60 days after
such filing. SRH and the Issuer will be required to use their best efforts to
keep such Shelf Registration Statement continuously effective, supplemented
and amended until the second anniversary of the Closing Date or such shorter
period that will terminate when all the Transfer Restricted Notes covered by
the Shelf Registration Statement have been sold pursuant thereto.
If (i) SRH and the Issuer fail to file any of the registration statements
required by the Registration Rights Agreement on or before the date specified
for such filing, (ii) any of such registration statements is not declared
effective by the Commission or prior to the date specified for such
effectiveness (the "Effectiveness Target Date"), (iii) the Issuer fails to
consummate the Exchange Offer within 30 business days of the Effectiveness
Target Date with respect to the Exchange Offer Registration Statement, or (iv)
the Shelf Registration Statement or the Exchange Offer Registration Statement
is declared effective but thereafter, subject to certain exceptions, ceases to
be effective or usable in connection with the Exchange Offer or resales of
Transfer Restricted Notes, as the case may be, during the periods specified in
the Registration Rights Agreement (each such event referred to in clauses (i)
through (iv) above, a "Registration Default"), then the interest rate on
Transfer Restricted Notes will increase ("Additional Interest"), with respect
to the first 90-day period immediately following the occurrence of such
Registration Default by 0.50% per annum and will increase by an additional
0.50% per annum with respect to each subsequent 90-day period until all
Registration Defaults have been cured, up to a maximum amount of 2% per annum
with respect to all Registration Defaults. Following the cure of all
Registration Defaults, the accrual of Additional Interest will cease and the
interest rate will revert to the original rate.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSIDERATIONS
The following is a general discussion of certain U.S. federal income tax
considerations relevant to holders of the Notes. This discussion is based upon
the Internal Revenue Code of 1986, as amended (the "Code"), Treasury
Regulations, Internal Revenue Service ("IRS") rulings and judicial decisions
now in effect, all of which are subject to change (possible with retroactive
effect) or different interpretations. This discussion does not purport to deal
with all aspects of federal income taxation that may be relevant to a
particular investor's decision to purchase the Notes, and it is not intended
to be wholly applicable to all categories of investors, some of which, such as
dealers in securities, banks, insurance companies and tax-exempt
organizations, may be subject to special rules. In addition, this discussion
is limited to persons that will hold the Notes represented thereby as a
"capital asset" within the meaning of section 1221 of the Code.
INTEREST INCOME
Interest on the Notes will be includable in the income of a holder under the
holder's regular method of accounting. The Notes will not be treated as having
been issued with original issue discount.
MARKET DISCOUNT
Investors acquiring Notes pursuant to this Prospectus should note that the
resale of the Notes may be adversely affected by the market discount
provisions of sections 1276 through 1278 of the Code. Under the market
discount rules, if a holder of a Note (other than a holder who purchased the
Note upon original issuance) purchases it at a market discount (i.e., at a
price below its stated redemption price at maturity) in excess of a
statutorily-defined de minimis amount and thereafter recognizes gain upon a
disposition or retirement of the Note, then the lesser of the gain recognized
or the portion of the market discount that accrued on a ratable basis (or, if
elected, on a constant interest rate basis) generally will be treated as
ordinary income at the time of the disposition. Moreover, any market discount
in a Note may be taxable to an investor to the extent of appreciation at the
time of certain otherwise non-taxable transactions (e.g., gifts). Absent an
election to include market discount in income as it accrues, a holder of a
market discount debt instrument may be required to defer a portion of any
interest expense that otherwise may be deductible on any indebtedness incurred
or maintained to purchase or carry such debt instrument until the holder
disposes of the debt instrument in a taxable transaction.
SALE, EXCHANGE OR RETIREMENT OF THE NOTES
Each holder of Notes generally will recognize gain or loss upon the sale,
exchange, repurchase, redemption, retirement or other disposition of those
Notes measured by the difference (if any) between (i) the amount of cash and
the fair market value of any property received (except to the extent that such
cash or other property is attributable to the payment of accrued interest not
previously included in income, which amount will be taxable as ordinary
income) and (ii) the holder's adjusted tax basis in those Notes (including any
market discount previously included in income by the holder). Any such gain or
loss recognized on the sale, exchange, repurchase, redemption, retirement or
other disposition of a Note should be capital gain or loss (except as
discussed under "Market Discount" above), and would be long-term capital gain
or loss if the Note had been held for more than one year at the time of the
sale or exchange. If the Notes had been held by a noncorporate holder for more
than 12 months but not more than 18 months, such capital gains generally shall
be subject to tax at a maximum 28% rate. If the Notes had been held for more
than 18 months, however, such capital gain generally will be subject to tax at
a maximum 20% rate. An investor's initial basis in a Note will be the cash
price it paid therefor.
BACKUP WITHHOLDING
A holder of Notes may be subject to "backup withholding" at a rate of 31%
with respect to certain "reportable payments," including interest payments
and, under certain circumstances, principal payments on the Notes. These
backup withholding rules apply if the holder, among other things, (i) fails to
furnish a social security number or other taxpayer identification number
("TIN") certified under penalties of perjury within a
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reasonable time after the request therefor, (ii) furnishes an incorrect TIN,
(iii) fails to report properly interest, or (iv) under certain circumstances,
fails to provide a certified statement, signed under penalties of perjury,
that the TIN furnished is the correct number and that such holder is not
subject to backup withholding. A holder who does not provide the Issuer with
its correct TIN also may be subject to penalties imposed by the IRS. Any
amount withheld from a payment to a holder under the backup withholding rules
is creditable against the holder's federal income tax liability, provided that
the required information is furnished to the IRS. Backup withholding will not
apply, however, with respect to payments made to certain holders, including
corporations, tax-exempt organizations and certain foreign persons ("exempt
recipients"), provided their exemptions from backup withholding are properly
established.
The amount of any "reportable payments" including interest made to the
holders of Notes (other than to holders which are exempt recipients) and the
amount of tax withheld, if any, with respect to such payments will be reported
to such holders and to the IRS for each calendar year.
FOREIGN HOLDERS
The following discussion is a summary of certain U.S. federal income tax
consequences to a Foreign Person that holds a Note. The term "Foreign Person"
means a nonresident alien individual or foreign corporation, but only if the
income or gain on the Note is not "effectively connected with the conduct of a
trade or business within the U.S." If the income or gain on the Note is
"effectively connected with the conduct of a trade or business within the
U.S.," then the nonresident alien individual or foreign corporation will be
subject to tax on such income or gain in essentially the manner as a U.S.
citizen or resident or a domestic corporation, as discussed above, and in the
case of a foreign corporation, may also be subject to the branch profits tax.
Under the portfolio interest exception to the general rules for the
withholding of tax on interest paid to a Foreign Person, a Foreign Person will
not be subject to U.S. federal income tax (or to withholding) on interest
payments on a Note, provided that (i) the Foreign Person does not actually or
constructively own 10% or more of the total combined voting power of all
classes of stock of the Issuer entitled to vote and is not a controlled
foreign corporation with respect to the U.S. that is related to the Issuer
through stock ownership and (ii) the Issuer, its paying agent or the person
who would otherwise be required to withhold tax received either (A) a
statement (an "Owner's Statement") signed under penalties of perjury by the
beneficial owner of the Note in which the owner certifies that the owner is
not a U.S. person, or in the case of an individual, that he is neither a
citizen nor a resident of the United States, and which provides the owner's
name and address, or (B) a statement signed under penalties of perjury by the
Financial Institution holding the Note on behalf of the beneficial owner,
together with a copy of the Owner's Statement. The term "Financial
Institution" means a securities clearing organization, bank or other financial
institution that holds customers' securities in the ordinary course of its
trade or business and that holds a Note on behalf of the owner of the Note. A
Foreign Person who does not qualify for the "portfolio interest" exception,
would, under current law, generally be subject to U.S. federal withholding tax
at a flat rate of 30% (or lower applicable treaty rate) on interest payments.
In general, gain recognized by a Foreign Person upon the redemption, sale or
exchange of a Note (including any gain representing accrued market discount)
will not be subject to U.S. federal income tax. However, a Foreign Person may
be subject to U.S. federal income tax at a flat rate of 30% (unless exempt by
an applicable treaty) on any such gain if the Foreign Person is an individual
present in the U.S. for 183 days or more during the taxable year in which the
Note is redeemed, sold or exchanged, and certain other requirements are met.
EXCHANGE OFFER
The exchange of the Exchange Notes for the Notes pursuant to this Offer will
not be treated as an "exchange" for U.S. federal income tax purposes because
the Exchange Notes will not be considered to differ materially in kind or
extent from the Old Notes. Rather, the Exchange Notes received by a holder
will be treated as a continuation of the Old Notes in the hands of such
holder. As a result, there will be no U.S. federal income tax consequences to
holders exchanging the Old Notes for the Exchange Notes pursuant to this
Offer. The holder must continue to include stated interest in income as if the
exchange had not occurred. Similarly, there would be no U.S. federal income
tax consequences to a holder of Old Notes that does not participate in the
Exchange Offer.
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PLAN OF DISTRIBUTION
Prior to the Initial Offering, there was no market for the Notes. The Notes
are not listed on a national securities exchange or authorized for trading on
the National Association of Securities Dealers Automated Quotation System. The
Old Notes sold to QIBs are eligible for trading in the PORTAL market. The
Issuer has been advised by the Initial Purchasers that the Initial Purchasers
currently intend to make a market in the Exchange Notes; however, they are not
obligated to do so and any market making may be discontinued by the Initial
Purchasers at any time. Therefore, there can be no assurance that an active
market for the Old Notes or the Exchange Notes will develop.
The Initial Purchasers may have engaged in transactions that stabilize,
maintain or otherwise affect the price of the Notes. Specifically, the Initial
Purchasers may have overalloted in connection with the Private Placement,
creating a short position in the Old Notes for its own account. In addition,
to cover over-allotments or to stabilize the price of the Old Notes, the
Initial Purchasers may bid for, and purchase, Old Notes in the open market.
Any of these activities may stabilize or maintain the market price of the Old
Notes above independent market levels. The Initial Purchasers were not
required to engage in these activities, and may end any of these activities at
any time.
If a trading market develops for the Old Notes or the Exchange Notes, future
trading prices of such securities will depend on many factors, including,
among other things, prevailing interest rates, the Company's results of
operations and the market for similar securities. Depending on such factors,
such securities may trade at a discount from their offering price.
Certain of the Initial Purchasers and their respective affiliates provide or
have provided banking, advisory and other financial services for the Company
in the ordinary course of business. Banc One Capital Corporation is an
affiliate of Bank One, Texas, N.A. ("Bank One"). Bank One is a lender under
the Southwest Credit Facility and received its proportionate share (82%) of
the repayment by the Issuer of borrowings thereunder from the net proceeds of
the Private Placement. Paribas Corporation is an affiliate of Banque Paribas.
Banque Paribas is a lender under the Southwest Credit Facility and received
its proportionate share (18%) of the repayment of the Issuer of borrowings
thereunder from the net proceeds of the Private Placement.
Each broker-dealer that receives Exchange Notes for its own account pursuant
to the Exchange Offer must acknowledge that it will deliver a prospectus in
connection with any resale of such Exchange Notes. This Prospectus, as it may
be amended or supplemented from time to time, may be used by a broker-dealer
in connection with resales of Exchange Notes received in exchange for Old
Notes where such Old Notes were acquired as a result of market-making
activities or other trading activities. The Issuer and SRH have agreed that,
starting on the Expiration Date and ending on the close of business 180 days
after the Expiration Date, they will make this Prospectus, as amended or
supplemented, available to any broker-dealer for use in connection with any
such resale. A broker-dealer that delivers such a prospectus to purchasers in
connection with such resales will be subject to certain of the civil liability
provisions under the Securities Act and will be bound by the provisions of the
Registration Agreement (including certain indemnification rights and
obligations). In addition, for 180 days after the completion of the Exchange
Offer, all dealers effecting transactions in the Exchange Notes may be
required to deliver a prospectus.
Neither the Issuer nor SRH will receive any proceeds from any sale of
Exchange Notes by broker-dealers. Exchange Notes received by broker-dealers
for their own account pursuant to the Exchange Offer may be sold from time to
time in one or more transactions in the over-the-counter market, in negotiated
transactions, through the writing of options on the Exchange Notes or a
combination of such methods of resale, at market prices prevailing at the time
of resale, at prices related to such prevailing market prices or negotiated
prices. Any such resale may be made directly to purchasers or to or through
brokers or dealers who may receive compensation in the form of commissions or
concessions from any such broker-dealer and/or the purchasers of any such
Exchange Notes. Any broker-dealer that resells Exchange Notes that were
received by it for its own account pursuant to the Exchange Offer and any
broker or dealer that participates in a distribution of such Exchange Notes
may be deemed to be an "underwriter" within the meaning of the Securities Act
and any profit on any such resale of
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Exchange Notes and any commissions or concessions received by any such persons
may be deemed to be underwriting compensation under the Securities Act. The
Letter of Transmittal states that by acknowledging that it will deliver and by
delivering a prospectus, a broker-dealer will not be deemed to admit that it
is an "underwriter" within the meaning of the Securities Act.
For a period of 180 days after the Expiration Date, the Issuer will promptly
send additional copies of this Prospectus to any broker-dealer that requests
such documents in the Letter of Transmittal. The Issuer and SRH have agreed in
the Registration Rights Agreement to pay all expenses incident to the Exchange
Offer other than commissions or concessions of any brokers or dealers and to
indemnify the holders of the Old Notes (including any broker-dealers) against
certain liabilities, including liabilities under the Securities Act.
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TRANSFER RESTRICTIONS ON OLD NOTES
OFFERS AND SALES BY THE INITIAL PURCHASERS
The Old Notes have not been registered under the Securities Act and may not
be offered or sold in the United States, or to, or for the account or benefit
of, U.S. persons except in accordance with an applicable exemption from the
registration requirements thereof. Accordingly the Old Notes were being
offered and sold only to Qualified Institutional Buyers (as defined in Rule
144A under the Securities Act) ("QIBs") under Rule 144A under the Securities
Act and other Institutional Accredited Investors in a private sale exempt from
the registration requirements of the Securities Act.
INVESTOR REPRESENTATIONS AND RESTRICTIONS ON RESALE
Each purchaser of the Old Notes was deemed to have represented and agreed as
follows:
(1) it was acquiring the Old Notes for its own account or for an account
with respect to which it exercises sole investment discretion, and that it
or such account is a QIB or an Institutional Accredited Investor acquiring
the Old Notes for investment purposes and not for distribution;
(2) it acknowledged that the Old Notes had not been registered under the
Securities Act and could not be offered or sold except as permitted below;
(3) it understood and agreed (x) that such Old Notes were being offered
only in a transaction not involving any public offering within the meaning
of the Securities Act, and (y) that (A) if within two years after the date
of original issuance of the Old Notes or if within three months after it
ceases to be an affiliate (within the meaning of Rule 144 under the
Securities Act) of the Issuer, it decided to resell, pledge or otherwise
transfer the Old Notes on which the legend set forth below appears, such
Old Notes may be resold, pledged or transferred only (i) to the Issuer,
(ii) so long as such securities are eligible for resale pursuant to Rule
144A, to a person whom the seller reasonably believes is a QIB that
purchases for its own account or for the account of a QIB to whom notice is
given that the resale, pledge or transfer is being made in reliance on Rule
144A (as indicated by the box checked by the transferor on the Certificate
of Transfer on the reverse of the Old Note if such Old Note is not in book-
entry form), (iii) to an Institutional Accredited Investor (as indicated by
the box checked by the transferor on the Certificate of Transfer on the
reverse of the Old Note if such Old Note is not in book-entry form) who has
certified to the Issuer and the Trustee for the Old Notes that such
transferee is an Institutional Accredited Investor and is acquiring the Old
Notes for investment purposes and not for distribution, (iv) pursuant to an
exemption from the registration requirements of the Securities Act provided
by Rule 144 (if applicable) under the Securities Act or (v) pursuant to an
effective registration statement under the Securities Act, in each case in
accordance with any applicable securities laws of any state of the United
States, (B) the initial purchaser, and each subsequent holder is required
to, notify any purchaser of the Old Notes from it of the resale
restrictions referred to in (A) above, if then applicable, and (C) with
respect to any transfer of the Old Notes by an Institutional Accredited
Investor, such holder will deliver to the Issuer and the Trustee such
certificates and other information as they may reasonably require to
confirm that the transfer by it complies with the foregoing restrictions;
(4) it understands that the notification requirement referred to in (3)
above will be satisfied, in the case only of transfers by physical delivery
of Certificated Securities other than a Global Note by virtue of the fact
that the following legend will be placed on the Old Notes unless otherwise
agreed by the Issuer:
"THIS SECURITY HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933,
AS AMENDED (THE "SECURITIES ACT"), OR THE SECURITIES LAWS OF ANY STATE. THE
HOLDER HEREOF, BY PURCHASING THIS SECURITY, AGREES FOR THE BENEFIT OF THE
ISSUER THAT THIS SECURITY MAY NOT BE RESOLD, PLEDGED OR OTHERWISE
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TRANSFERRED (X) PRIOR TO THE SECOND ANNIVERSARY OF THE ISSUANCE HEREOF (OR
A PREDECESSOR NOTE HERETO) OR (Y) BY ANY HOLDER THAT WAS AN AFFILIATE OF
THE ISSUER AT ANY TIME DURING THE THREE MONTHS PRECEDING THE DATE OF SUCH
TRANSFER, IN EITHER CASE OTHER THAN (1) TO THE ISSUER, (2) SO LONG AS THIS
SECURITY IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES
ACT ("RULE 144A"), TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A
QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A PURCHASING
FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER
TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING
MADE IN RELIANCE ON RULE 144A (AS INDICATED BY THE BOX CHECKED BY THE
TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE OF THIS NOTE), (3)
TO AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR" AS DEFINED IN RULE
501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT (AS INDICATED BY THE
BOX CHECKED BY THE TRANSFEROR ON THE CERTIFICATE OF TRANSFER ON THE REVERSE
OF THIS NOTE) THAT IS ACQUIRING THIS SECURITY FOR INVESTMENT PURPOSES AND
NOT FOR DISTRIBUTION, AND A CERTIFICATE IN THE FORM ATTACHED TO THIS NOTE
IS DELIVERED BY THE TRANSFEREE TO THE COMPANY AND THE TRUSTEE, (4) PURSUANT
TO AN EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT PROVIDED BY RULE
144 (IF APPLICABLE) UNDER THE SECURITIES ACT OR (5) PURSUANT TO AN
EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT, IN EACH CASE IN
ACCORDANCE WITH ANY APPLICABLE SECURITIES LAWS OF ANY STATE OF THE UNITED
STATES. AN INSTITUTIONAL ACCREDITED INVESTOR HOLDING THIS SECURITY AGREES
IT WILL FURNISH TO THE ISSUER AND THE TRUSTEE SUCH CERTIFICATES AND OTHER
INFORMATION AS THEY MAY REASONABLY REQUIRE TO CONFIRM THAT ANY TRANSFER BY
IT OF THIS NOTE COMPLIES WITH THE FOREGOING RESTRICTIONS. THE HOLDER
HEREOF, BY PURCHASING THIS NOTE, REPRESENTS AND AGREES FOR THE BENEFIT OF
THE ISSUER THAT IT IS (1) A QUALIFIED INSTITUTIONAL BUYER WITHIN THE
MEANING OF RULE 144A OR (2) AN INSTITUTION THAT IS AN "ACCREDITED INVESTOR"
AS DEFINED IN RULE 5O1(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND
THAT IT IS HOLDING THIS SECURITY FOR INVESTMENT PURPOSES AND NOT FOR
DISTRIBUTION. THIS SECURITY IS SUBJECT TO A REGISTRATION RIGHTS AGREEMENT
DATED AS OF OCTOBER 14, 1997, AMONG THE COMPANY, THE ISSUER, JEFFERIES &
COMPANY, INC., BANC ONE CAPITAL CORPORATION AND PARIBAS CORPORATION, A COPY
OF WHICH IS ON FILE WITH THE SECRETARY OF THE ISSUER."
(5) it (i) has such knowledge and experience in financial and business
matters as to be capable of evaluating the merits and risks of its
prospective investment in the Old Notes and (ii) has the ability to bear
the economic risks of its prospective investment and can afford the
complete loss of such investment;
(6) it had received a copy of the Offering Circular relating to the
offering of the Old Notes and acknowledges that it has had access to such
financial and other information, and has been afforded the opportunity to
ask questions of the Issuer and receive answers thereto, as it deemed
necessary in connection with its decision to purchase the Old Notes; and
(7) it understood that the Issuer, the Initial Purchasers and others will
rely upon the truth and accuracy of the foregoing acknowledgments,
representations and agreements and agreed that if any of the
acknowledgments, representations and warranties deemed to have been made by
it by its purchase of the Old Notes are no longer accurate, it shall
promptly notify the Issuer and the Initial Purchasers. If it acquired the
Old Notes as a fiduciary or agent for one or more investor accounts, it
represented that it has sole investment discretion with respect to each
such account and it has full power to make the foregoing acknowledgments,
representations and agreements on behalf of such account.
ANY OLD NOTES NOT EXCHANGED IN THE EXCHANGE OFFER FOR EXCHANGE NOTES WILL
CONTINUE TO BE SUBJECT TO THE TRANSFER RESTRICTIONS DESCRIBED ABOVE.
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LEGAL MATTERS
The validity of the Exchange Notes offered hereby has been passed upon for
the Company by Baker, Donelson, Bearman & Caldwell, P.C., Memphis, Tennessee.
H. Allen Corey, an officer and director of the Issuer and SRH, is also of
counsel to Baker, Donelson, Bearman & Caldwell, P.C.
EXPERTS
ACCOUNTANTS
The consolidated financial statements of the Company as of December 31,
1996, and for the period ended December 31, 1996, included in this Prospectus
have been audited by KPMG Peat Marwick LLP, independent public accountants, as
stated in their report appearing herein. The consolidated financial statements
of the Company as of December 31, 1995, and for the two years in the period
ended December 31, 1995, included in this Prospectus have been audited by
Joseph Decosimo and Company, LLP, independent accountants, as stated in their
report appearing herein.
The historical statement of revenues and direct operating expenses of the
Oil and Gas Properties Acquisition for the years ended December 31, 1994, 1995
and 1996, included in this Prospectus has been so included in reliance on the
report of Price Waterhouse LLP, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
The statements of revenues and certain expenses of Bear Canyon Shopping
Center, Bears Path Center and Madera Village Shopping Center for the nine
months ended September 30, 1996, and of 50 Penn Place, Colonnade at Polo Park
Venture, Independence Plaza, Ltd., Plaza Palomino and Crossroads Mall for the
year ended December 31, 1996, have been included in this Prospectus in
reliance upon the reports of KPMG Peat Marwick LLP, independent certified
public accountants, appearing elsewhere herein, and upon the authority of said
firm as experts in accounting and auditing.
CHANGE IN ACCOUNTANTS
The Board of Directors of Southwest and SRH decided to engage KPMG Peat
Marwick LLP as independent accountants. KPMG Peat Marwick was so engaged on
June 9, 1997, replacing Joseph Decosimo and Company LLP on that date.
Joseph Decosimo and Company, LLP had been engaged to audit the Company's
financial statements for the two years ended December 31, 1994 and 1995.
Joseph Decosimo and Company's reports on the Company's financial statements
for those years do not contain an adverse opinion or a disclaimer of opinion,
and such reports are not qualified or modified as to uncertainty, audit scope
or accounting principals. During the time Joseph Decosimo and Company served
as the Company's accountant, the Company and Joseph Decosimo and Company had
no disagreements on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which, if not
resolved to the satisfaction of Joseph Decosimo and Company, would have caused
it to make reference thereto in such reports nor were there any reportable
events required to be disclosed. In accordance with the rules of the
Commission, Joseph Decosimo and Company has reviewed and concurred with the
above discussion. A copy of Joseph Decosimo and Company's letter is filed as
an exhibit to the registration statement of which this Prospectus is a part.
RESERVE ENGINEERS
Information relating to the estimated proved reserves of oil and natural gas
and the related estimates of future net revenues and present values thereof as
of June 30, 1997 included in this Prospectus and in the notes to the financial
statements of the Company have been prepared by Ryder Scott Company Petroleum
Engineers for properties representing 89% of the Company's PV-10 Value at such
date. Information relating to the estimated proved reserves of oil and natural
gas and the related estimates of future net revenues and present values
thereof for the Oil and Gas Properties Acquisition as of June 30, 1997
included in this Prospectus have been prepared by Ryder Scott Company
Petroleum Engineers. Information relating to the estimated proved reserves of
oil and natural gas and the related estimates of future net revenues and
present values thereof as of December 31, 1996 and for prior periods included
in this Prospectus and in the notes to the financial statements of the Company
have been prepared by independent petroleum engineer, Donald R. Creamer.
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GLOSSARY OF TERMS
The definitions set forth below shall apply to the indicated terms as used
in this Prospectus. All volumes of natural gas referred to herein are stated
at the legal pressure base to the state or area where the reserves exit and at
60 degrees Fahrenheit and in most instances are rounded to the nearest major
multiple.
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume.
Bcf. Billion cubic feet.
Boe. Barrel of oil equivalent, determined using the ratio of one Bbl of
crude oil, condensate or natural gas liquids to six Mcf of natural gas.
Bopd. Barrels of oil per day.
Completion. The installation of permanent equipment for the production of
oil and natural gas, or in the case of a dry hole, the reporting of
abandonment to the appropriate agency.
Development well. A well drilled within the proved area of an oil or natural
gas reservoir to the depth of a stratigraphic horizon known to be productive.
Dry hole or well. A well found to be incapable of producing hydrocarbons in
sufficient quantities such that proceeds from the sale of such production
exceed production expenses and taxes.
Exploratory well. A well drilled to find and produce oil or natural gas
reserves not classified as proved, to find a new reservoir in a field
previously found to be productive of oil or natural gas in another reservoir
or to extend a known reservoir.
Field. An area consisting of a single reservoir or multiple reservoirs all
grouped on or related to the same individual geological structural feature
and/or stratigraphic condition.
Gross acres or gross wells. The total acres or wells, as the case may be, in
which a working interest is owned.
Horizontal drilling. A drilling technique that permits the operator to
contact and intersect a larger portion of the producing horizon than
conventional vertical drilling techniques and can result in both increased
production rates and greater ultimate recoveries of hydrocarbons.
MBbls. One thousand barrels.
MBoe. One thousand barrels of oil equivalent, determined using the ratio of
one Bbl of crude oil, condensate or natural gas liquids to six Mcf of natural
gas.
Mcf. One thousand cubic feet.
Mcfd. One thousand cubic feet per day.
Mcfe. One thousand cubic feet equivalent, determined using the ratio of six
Mcf of natural gas to one Bbl of crude oil, condensate or natural gas liquids.
MMBbls. One million barrels of crude oil or other liquid hydrocarbons.
MMBoe. One million barrels of oil equivalent, determined using the ratio of
one Bbl of crude oil, condensate or natural gas liquids to six Mcf of natural
gas.
MMcf. One million cubic feet.
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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 gross revenue to be generated from the
production of proved reserves, net of estimated production and future
development costs, 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.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Unaudited Pro Forma Combined Financial Statements of Southwest
Royalties, Inc......................................................... F-1
Unaudited Pro Forma Combined Balance Sheet as of September 30, 1997..... F-2
Unaudited Pro Forma Combined Statement of Operations for the year ended
December 31, 1996...................................................... F-4
Unaudited Pro Forma Combined Statement of Operations for the nine months
ended September 30, 1997............................................... F-5
Notes to Unaudited Pro Forma Combined Financial Statements.............. F-6
Consolidated Financial Statements of Southwest Royalties Holdings, Inc.
and Subsidiaries:
Independent Auditors' Reports........................................... F-12
Consolidated Balance Sheets as of December 31, 1995 and 1996, and
September 30, 1997 (unaudited)......................................... F-14
Consolidated Statements of Operations for the years ended December 31,
1994, 1995 and 1996, and the nine months ended September 30, 1996 and
1997 (unaudited)....................................................... F-16
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1994, 1995 and 1996, and the nine months ended September
30, 1997 (unaudited)................................................... F-17
Consolidated Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996, and the nine months ended September 30, 1996 and
1997 (unaudited)....................................................... F-18
Notes to Consolidated Financial Statements.............................. F-20
Historical Statement of the Oil and Gas Properties Acquisition:
Report of Independent Accountants....................................... F-37
Historical Statement of Revenues and Direct Operating Expenses for the
years ended December 31, 1994, 1995 and 1996 and the nine months ended
September 30, 1997 (unaudited)......................................... F-38
Notes to Historical Statement of Revenues and Direct Operating Expenses. F-39
Financial Statements of 50 Penn Place:
Independent Auditors' Report............................................ F-42
Statements of Revenue and Certain Expenses for the year ended December
31, 1996 and the nine months ended September 30, 1997 (unaudited)...... F-43
Notes to Statements of Revenue and Certain Expenses..................... F-44
Financial Statements of Bear Canyon Shopping Center:
Independent Auditors' Report............................................ F-46
Statement of Revenue and Certain Expenses for the nine months ended
September 30, 1996..................................................... F-47
Notes to Statement of Revenue and Certain Expenses...................... F-48
Financial Statements of Bears Path Center:
Independent Auditors' Report............................................ F-50
Statement of Revenue and Certain Expenses for the nine months ended
September 30, 1996..................................................... F-51
Notes to Statement of Revenue and Certain Expenses...................... F-52
Financial Statements of Colonnade at Polo Park Venture:
Independent Auditors' Report............................................ F-54
Statements of Revenue and Certain Expenses for the year ended December
31, 1996 and the nine months ended September 30, 1997 (unaudited)...... F-55
Notes to Statements of Revenue and Certain Expenses..................... F-56
Financial Statements of Independence Plaza, Ltd.:
Independent Auditors' Report............................................ F-58
Statements of Revenue and Certain Expenses for the year ended December
31, 1996 and the nine months ended September 30, 1997 (unaudited)...... F-59
Notes to Statements of Revenue and Certain Expenses..................... F-60
</TABLE>
I-1
<PAGE>
<TABLE>
<S> <C>
Financial Statements of Madera Village Shopping Center:
Independent Auditors' Report............................................ F-62
Statement of Revenue and Certain Expenses for the nine months ended
September 30, 1996..................................................... F-63
Notes to Statement of Revenue and Certain Expenses...................... F-64
Financial Statements of Plaza Palomino:
Independent Auditors' Report............................................ F-66
Statements of Revenue and Certain Expenses for the year ended December
31, 1996 and the three months ended March 31, 1997 (unaudited)......... F-67
Notes to Statements of Revenue and Certain Expenses..................... F-68
Financial Statements of Crossroads Mall:
Independent Auditors' Report............................................ F-69
Statements of Revenue and Certain Expenses for the nine months ended
December 31, 1996 and the nine months ended September 30, 1997
(unaudited)............................................................ F-70
Notes to Statements of Revenue and Certain Expenses..................... F-71
</TABLE>
I-2
<PAGE>
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SOUTHWEST ROYALTIES HOLDINGS, INC.
The unaudited pro forma combined financial statements have been prepared to
give effect to the issuance of the Old Notes, as issued on October 14, 1997,
and the application of net proceeds therefrom, the Transactions, certain
completed and pending acquisitions of Southwest and Red Oak (to the extent not
already reflected in the consolidated financial statements of the Company) and
the exchange of the Old Notes for New Notes (having no significant effects on
the unaudited pro forma combined financial statements) as if such transactions
had taken place on September 30, 1997 with respect to the unaudited pro forma
combined balance sheet, and as of January 1, 1996 with respect to the
unaudited pro forma combined statements of operations.
The unaudited pro forma combined financial statements included herein are
not necessarily indicative of the results that might have occurred had the
transactions taken place at the date specified and are not intended to be a
projection of future results. In addition, future results may vary
significantly from the results reflected in the accompanying unaudited pro
forma combined financial statements because of normal production declines,
changes in product prices, future acquisitions and divestitures, changes in
the real estate market, and other factors.
The following unaudited pro forma combined financial statements should be
read in conjunction with the consolidated financial statements and the related
notes of the Company.
F-1
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
PRO FORMA PRO
THE ACQUISITION FORMA
COMPANY ADJUSTMENTS COMBINED
------- ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
ASSETS
------
Current assets
Cash and cash equivalents................ $ 11,152 $189,982 (a) $47,026
(82,630)(b)
(67,688)(c)
(1,699)(d)
(2,091)(e)
Accounts receivable...................... 11,182 11,182
Other.................................... 1,224 1,224
-------- --------
Total current assets................... 23,558 59,432
-------- --------
Oil and gas properties, using the full cost
method
Proved .................................. 112,394 67,688 (c) 180,082
Unproved................................. 4,193 4,193
Accumulated depreciation and depletion... (35,982) (35,982)
-------- --------
Oil and gas properties, net............ 80,605 148,293
Rental property, net....................... 55,785 25,705 (e) 81,490
Other property and equipment............... 5,060 5,060
Other assets:
Investment in subsidiary................. 2,778 1,699 (d) 4,477
Real estate investments.................. 4,237 4,237
Deferred debt costs, net................. 3,466 7,600 (a) 9,181
67 (e)
(1,952)(f)
Other, net............................... 5,336 5,336
-------- --------
Total other assets..................... 15,817 23,231
-------- --------
Total assets............................... $180,825 $317,506
======== ========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-2
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
AS OF SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
PRO FORMA PRO
THE ACQUISITION FORMA
COMPANY ADJUSTMENTS COMBINED
------- ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
LIABILITIES, REDEEMABLE COMMON STOCK AND
STOCKHOLDERS' EQUITY
----------------------------------------
Current liabilities
Current portion of long-term debt.......... $ 3,408 $ 3,408
Accounts payable and accrued expenses...... 19,779 (242)(b) 19,537
Other current liabilities.................. 5 5
-------- --------
Total current liabilities.............. 23,192 22,950
-------- --------
Long-term debt, less current maturities..... 138,805 197,582 (a) 282,374
(77,694)(b)
23,681 (e)
Other long-term liabilities................. 4,588 (2,878)(b) 1,710
Deferred income taxes....................... 4,809 (636)(b) 3,490
(683)(f)
Minority interest........................... 1,937 1,937
Redeemable common stock of subsidiary....... 2,630 2,630
Redeemable common stock..................... 8,291 8,291
Stockholders' equity
Preferred stock............................ -- --
Common stock............................... 116 116
Additional paid-in capital................. 2,196 2,196
Retained earnings (deficit)................ (935) (1,180)(b) (3,384)
(1,269)(f)
Note receivable from an officer and
stockholder............................... (1,714) (1,714)
Treasury stock, at cost.................... (3,090) (3,090)
-------- --------
Total stockholders' equity (deficit)... (3,427) (5,876)
-------- --------
Total liabilities and stockholders' equity.. $180,825 $317,506
======== ========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-3
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS
----------------------------- PRO
THE OIL AND GAS RED OAK ACQUISITION DECONSOLIDATION FORMA
COMPANY ACQUISITIONS ACQUISITIONS ADJUSTMENTS OF SIERRA(M) COMBINED
-------- ------------ ------------ ----------- --------------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Operating revenues
Oil and gas............ $ 35,296 $18,587 $ -- $ (867)(g) $ 53,016
Well servicing......... 8,013 -- -- $(8,013) --
Real estate............ 4,487 -- 13,223 17,710
Other ................. 622 -- -- (260) 362
-------- ------- ------- --------
Total operating
revenues............ 48,418 18,587 13,223 71,088
-------- ------- ------- --------
Operating expenses
Oil and gas............ 14,846 9,525 -- (3,478)(g) 20,893
Well servicing......... 6,145 -- -- (6,145) --
Real estate............ 1,887 -- 6,571 -- 8,458
General and
administrative........ 6,953 -- 1,108 (1,771) 6,290
Depreciation,
depletion and
amortization.......... 8,430 -- -- 4,562 (h) (863) 13,513
1,384 (i)
Other.................. 554 -- -- 554
-------- ------- ------- --------
Total operating
expenses............ 38,815 9,525 7,679 49,708
-------- ------- ------- --------
Operating income........ 9,603 9,062 5,544 21,380
-------- ------- ------- --------
Other income (expense)
Interest expense....... (10,016) -- -- (14,415)(j) 82 (31,862)
(7,513)(k)
Interest income........ 441 -- -- (11) 430
Other.................. 561 -- -- 31 592
-------- ------- ------- --------
Income (loss) before
income taxes and
minority interest...... 589 9,062 5,544 (9,460)
Income tax benefit
(provision)............ (365) -- -- 4,007 (l) (160) 3,482
Minority interest in
subsidiaries........... 181 -- -- (184) (3)
Equity in earnings of
subsidiary............. -- -- -- (448) (448)
-------- ------- ------- --------
Income (loss) from
continuing operations.. $ 405 $ 9,062 $ 5,544 $ (6,429)
======== ======= ======= ========
Income (loss) from
continuing operations
per share.............. $ 0.42 $ (6.67)
======== ========
Weighted average common
shares................. 964,009 964,009
======== ========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-4
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS
-----------------------------
THE OIL AND GAS RED OAK ACQUISITION DECONSOLIDATION PRO FORMA
COMPANY ACQUISITIONS ACQUISITIONS ADJUSTMENTS OF SIERRA(M) COMBINED
--------- ------------ ------------ ----------- --------------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Operating revenues
Oil and gas ........... $ 26,068 $13,145 $ -- $(1,340)(g) $ 37,873
Well servicing ........ 7,789 -- -- $(7,789) --
Real estate............ 5,029 -- 8,848 13,877
Other.................. 948 -- -- (44) 904
--------- ------- ------ ---------
Total operating
revenues............ 39,834 13,145 8,848 52,654
--------- ------- ------ ---------
Operating expenses
Oil and gas............ 12,166 6,980 -- (2,737)(g) 16,409
Well servicing......... 5,600 -- -- (5,600) --
Real estate............ 1,907 -- 4,259 6,166
General and
administrative........ 5,059 -- 894 (1,302) 4,651
Depreciation,
depletion and
amortization.......... 8,093 -- -- 3,785 (h) (747) 11,968
837 (i)
Other.................. 1,003 -- -- 1,003
--------- ------- ------ ---------
Total operating
expenses.............. 33,828 6,980 5,153 40,197
--------- ------- ------ ---------
Operating income........ 6,006 6,165 3,695 12,457
--------- ------- ------ ---------
Other income (expense)
Interest expense....... (10,950) -- -- (9,913)(j) 184 (24,617)
(3,938)(k)
Interest income........ 545 -- -- (9) 536
Other.................. (66) -- -- 14 (52)
--------- ------- ------ ---------
Income (loss) before
income taxes and
minority interest...... (4,465) 6,165 3,695 (11,676)
Income tax benefit
(provision)............ 1,526 -- -- 2,561 (l) 1 4,088
Minority interest in
subsidiaries........... 322 -- -- (l) 321
Equity in earnings of
subsidiary............. -- -- -- -- (4) (4)
--------- ------- ------ ---------
Income (loss) before
extraordinary loss..... $ (2,617) $ 6,165 $3,695 $ (7,271)
========= ======= ====== =========
Income (loss) before
extraordinary loss per
share.................. $ (2.42) $ (6.74)
========= =========
Weighted average common
shares................. 1,078,454 1,078,454
========= =========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-5
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
1. BASIS OF PRESENTATION
The unaudited pro forma combined financial statements have been prepared to
give effect to the Offering and the application of net proceeds therefrom to
repay a portion of the Company's debt (the "Exising Debt"), the Transactions
and certain completed and pending acquisitions of Southwest Royalties, Inc.
("Southwest"), and Midland Red Oak Realty, Inc. ("Red Oak") (to the extent not
already reflected in the consolidated financial statements of the Company), as
if such transactions had taken place on September 30, 1997 with respect to the
unaudited pro forma combined balance sheet, and as of January 1, 1996 with
respect to the unaudited pro forma combined statements of operations. Each of
the acquisitions is recorded using the purchase method of accounting.
Following is a description of the individual columns included in the
unaudited pro forma combined balance sheet:
THE COMPANY--Represents the consolidated balance sheet of Southwest
Royalties Holdings, Inc. ("SRH") as of September 30, 1997.
Following is a description of the individual columns included in the
unaudited pro forma combined statements of operations:
THE COMPANY--Represents the consolidated statements of operations
(exclusive of extraordinary items) of SRH for the year ended December 31,
1996 and the nine months ended September 30, 1997.
OIL AND GAS ACQUISITIONS--Represents the revenues and direct operating
expenses of the oil and gas properties acquired for the period from January
1, 1996 to the earlier of the closing date of each acquisition or September
30, 1997. On December 26, 1996, Southwest acquired certain oil and gas
properties from Hondo Drilling, in January 1997, Southwest acquired an
interest in the Flying M Field, and on October 14, 1997, Southwest
completed the acquisition of certain oil and gas properties ("Oil and Gas
Properties Acquisition") for a total purchase price of $72.3 million. See
Note 3 for summarized information for these acquisitions.
RED OAK ACQUISITIONS--Represents the revenue and certain expenses of the
real estate properties acquired for the period from January 1, 1996 to the
earlier of the closing date of each acquisition or September 30, 1997. On
October 15, 1996, Red Oak completed the acquisition of Bear Canyon, Bears
Path and Madera Village, on April 7, 1997, Red Oak closed the Plaza
Palomino acquisition, on September 2, 1997 Red Oak closed the River Oaks
Village acquisition, on September 30, 1997, Red Oak closed the acquisition
of 50 Penn Place, on October 21, 1997, Red Oak closed the Colonnade,
Independence Plaza, and San Miguel acquisitions, and on October 23, 1997,
Red Oak closed the Crossroads acquisitions. See Note 4 for summarized
information for these acquisitions.
2. PRO FORMA ENTRIES
(a) To record the issuance of $200.0 million of 10 1/2% Senior Notes due
2004, including net proceeds of approximately $190.0 million, debt issuance
costs of approximately $7.6 million and discount of $2.4 million.
(b) To record the repayment of existing Southwest debt of approximately
$77.7 million and related accrued interest of approximately $3.1 million and
prepayment penalties of approximately $1.8 million. The loss on the
extinguishment of debt will be reported as an extraordinary item, net of
related tax effect.
(c) To record the Oil and Gas Properties Acquisition using the purchase
method of accounting. The allocation of the purchase price to the acquired
assets and liabilities is preliminary and, therefore, subject to change.
F-6
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
(d) To record the Company's additional investment of $1,699,000 in a
partnership of which Southwest serves as general partner. The partnership's
primary asset is its investment in Sierra.
(e) To record the Red Oak Acquisitions using the purchase method of
accounting and to record incremental borrowings under the MROP Facility and
additional mortgage facilities. The allocation of each purchase price to the
acquired assets and liabilities is preliminary and, therefore, subject to
change.
(f) To record the write-off of deferred debt costs related to the Existing
Debt. This write-off will be treated as a loss or extinguishment of debt and
reported as an extraordinary item, net of related tax effects.
(g) To eliminate the oil and gas revenues and production costs associated
with the tertiary recovery (CO2) project on the Oil and Gas Properties
Acquisition. The Company's acquisition of the Oil and Gas Properties
Acquisition did not include the business of the tertiary recovery project. The
seller of the Oil and Gas Properties Acquisition was involved in a CO2 project
which the Company explicitly did not acquire. The principle tangible assets
and liabilities of the CO2 project were pipeline imbalances which the Company
did not acquire.
(h) To record estimated incremental depletion expense on the Oil and Gas
acquisitions.
(i) To record estimated incremental depreciation expense on the Red Oak
acquisitions.
(j) To record incremental interest expense associated with the Senior Notes
including incremental interest associated with the Oil and Gas acquisitions,
amortization of the estimated debt issue costs of $7 million over the life of
the Senior Notes and the reversal of interest recognized on the debt of
Southwest to be retired with the proceeds of the Senior Notes. A 1/8% change
in interest rate on such notes would result in a $225,000 change in annual
interest expense.
(k) To record incremental interest associated with borrowings used to
finance the Red Oak Acquisitions. The associated notes are generally for 20
years with interest ranging from 9.25% to 13.00% and loan origination costs
from 1% to 3% of the respective note amounts.
(l) To adjust pro forma income tax expense.
(m) To reflect the deconsolidation of Sierra. On July 1, 1997, additional
common stock of Sierra was sold to a partnership. As a consequence, the
Company no longer has majority voting control of Sierra. Southwest is the
general partner of the partnership.
F-7
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
3. OIL AND GAS ACQUISITIONS
The following tables summarize the revenues and direct operating expenses for
the Oil and Gas Acquisitions for periods prior to their acquisition. The
audited statements of revenues and direct operating expenses for the Oil and
Gas Properties Acquisition are included elsewhere herein. Such audited
financial statements for Flying M and Hondo are not presented as they are not
required.
OIL AND GAS ACQUISITIONS
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
OIL AND GAS
PROPERTIES OIL AND GAS
FLYING M HONDO ACQUISITION ACQUISITIONS
-------- ----- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Oil and gas revenues.............. $1,660 $797 $16,130 $18,587
Oil and gas operating expenses.... 668 391 8,466 9,525
------ ---- ------- -------
Operating income................ $ 992 $406 $ 7,664 $ 9,062
====== ==== ======= =======
</TABLE>
STATEMENTS OF REVENUES AND DIRECT OPERATING EXPENSES
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
OIL AND GAS
PROPERTIES OIL AND GAS
FLYING M ACQUISITION ACQUISITIONS
-------- ----------- ------------
(IN THOUSANDS)
<S> <C> <C> <C>
Oil and gas revenues.................... $495 $12,650 $13,145
Oil and gas operating expenses.......... 218 6,762 6,980
---- ------- -------
Operating income...................... $277 $ 5,888 $ 6,165
==== ======= =======
</TABLE>
F-8
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
4. RED OAK ACQUISITIONS
The following tables summarize the revenue and certain expenses for the Red
Oak Acquisitions for periods prior to their acquisition. The audited
statements of revenues and certain expenses for each of the acquisitions
(other than River Oaks Village and San Miguel) are presented elsewhere herein.
The audited financial statements of River Oaks Village and San Miguel are not
presented as they are not required.
RED OAK ACQUISITIONS
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
YEAR ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
BEARS BEAR MADERA RIVER OAKS PLAZA INDEPENDENCE 50 PENN SAN RED OAK
PATH CANYON VILLAGE VILLAGE PALOMINO COLONNADE PLAZA PLACE CROSSROADS MIGUEL ACQUISITIONS
----- ------ ------- ---------- -------- --------- ------------ ------- ---------- ------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Real estate
revenues.......... $151 $243 $814 $627 $1,157 $675 $1,079 $3,525 $4,572 $380 $13,223
Operating expenses
Property
management....... 96 98 250 202 478 254 551 1,530 2,938 174 6,571
General and
administrative... 7 9 26 100 99 37 125 508 159 38 1,108
---- ---- ---- ---- ------ ---- ------ ------ ------ ---- -------
Total operating
expenses....... 103 107 276 302 577 291 676 2,038 3,097 212 7,679
---- ---- ---- ---- ------ ---- ------ ------ ------ ---- -------
Operating income... $ 48 $136 $538 $325 $ 580 $384 $ 403 $1,487 $1,475 $168 $ 5,544
==== ==== ==== ==== ====== ==== ====== ====== ====== ==== =======
</TABLE>
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
RIVER OAKS PLAZA INDEPENDENCE 50 PENN SAN RED OAK
VILLAGE PALOMINO COLONNADE PLAZA PLACE CROSSROADS MIGUEL ACQUISITIONS
---------- -------- --------- ------------ ------- ---------- ------ ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Real Estate Revenues.... $454 $343 $623 $877 $2,725 $3,514 $312 $8,848
Operating expenses
Property management.... 96 121 196 490 1,049 2,171 136 4,259
General and
administrative........ 98 26 23 107 295 301 44 894
---- ---- ---- ---- ------ ------ ---- ------
Total operating
expenses............ 194 147 219 597 1,344 2,472 180 5,153
---- ---- ---- ---- ------ ------ ---- ------
Operating income........ $260 $196 $404 $280 $1,381 $1,042 $132 $3,695
==== ==== ==== ==== ====== ====== ==== ======
</TABLE>
F-9
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
5. OIL AND GAS RESERVE DATA
The following unaudited pro forma supplemental information regarding the oil
and gas activities of Southwest is presented pursuant to the disclosure
requirements promulgated by the Commission and Statement of Financial
Accounting Standards No. 69, "Disclosures About Oil and Gas Producing
Activities". The pro forma combined reserve information is presented as if the
acquisition of the oil and gas interests described above had occurred on
January 1, 1996.
Management emphasizes that reserve estimates are inherently imprecise and
subject to revision and that estimates of new discoveries are more imprecise
than those of producing oil and gas properties. Accordingly, the estimates are
expected to change as future information becomes available. Such changes could
be significant.
Quantities of oil and gas reserves
<TABLE>
<CAPTION>
OIL AND NATURAL BARRELS OF
CONDENSATE GAS OIL EQUIVALENT
(MBBLS) (MMCF) (MBOE)
---------- ------- --------------
<S> <C> <C> <C>
Total Proved Reserves:
Balance, January 1, 1996.................... 36,888 84,212 50,923
Sales of minerals-in-place................. (989) (466) (1,067)
Revisions of previous estimates............ 2,291 6,143 3,315
Production................................. (1,812) (5,888) (2,793)
------ ------ ------
Balance, December 31, 1996................... 36,378 84,001 50,378
====== ====== ======
</TABLE>
F-10
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND SEPTEMBER 30, 1997
Standardized measure of discounted future net cash flows
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
(IN
THOUSANDS)
<S> <C>
Future cash inflows................................................ $1,183,721
Future production and development costs............................ (400,659)
----------
Future net cash flows before income taxes.......................... 783,062
Future income tax expense.......................................... (234,919)
----------
Future net cash flows.............................................. 548,143
10% annual discount for estimated timing of cash flows............. (245,568)
----------
Standardized measure of discounted future net cash flows........... $ 302,575
==========
</TABLE>
Changes relating to the standardized measure of discounted future net cash
flows
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
(IN
THOUSANDS)
<S> <C>
Sales of oil and gas produced, net of production costs............ $(32,641)
Net change in sales prices net of production costs................ 182,229
Extensions and discoveries, net of future production and
development costs................................................ --
Revisions to estimated future development costs................... 1,854
Revisions of previous quantity estimates.......................... 28,439
Accretion of discount............................................. 17,430
Net change in income taxes........................................ (54,974)
Sale of minerals-in-place......................................... (2,439)
Changes in production rates, timing and other..................... (11,626)
--------
128,272
Discounted future net cash flows--
Beginning of period............................................. 174,303
--------
End of period................................................... $302,575
========
</TABLE>
F-11
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Southwest Royalties Holdings, Inc.:
We have audited the accompanying consolidated balance sheet of Southwest
Royalties Holdings, Inc. and subsidiaries as of December 31, 1996, and the
related consolidated statement of operations, stockholders' equity and cash
flows for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the 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 audit provides 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, 1996, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Midland, Texas
August 11, 1997 (except as to Note 16,
which is as of September 18, 1997)
F-12
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Board of Directors and Stockholders
SOUTHWEST ROYALTIES, INC.
Midland, Texas
We have audited the accompanying consolidated balance sheet of SOUTHWEST
ROYALTIES, INC. and subsidiaries as of December 31, 1995, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years ended December 31 ,1995 and 1994. These consolidated financial
statements are the responsibility of the company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our 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 consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial 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, INC. and subsidiaries as of December 31, 1995, and the results of
their operations and their cash flows for the years ended December 31, 1995
and 1994, in conformity with generally accepted accounting principles.
Joseph Decosimo and Company, LLP
Chattanooga, Tennessee
March 27, 1996, except for
note 14, as to which the date
is August 11, 1997
F-13
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- SEPTEMBER 30,
ASSETS 1995 1996 1997
------ ------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Current assets
Cash and cash equivalents..................... $ 3,364 $ 8,284 $ 11,152
Accounts receivables net of allowance of $30,
$173 and $123,respectively................... 6,504 7,728 10,366
Receivables from related parties.............. 1,116 792 816
Federal income tax receivable................. 270 -- --
Subscription receivable....................... -- 2,807 --
Deferred income taxes......................... 191 -- --
Other current assets.......................... 822 1,074 1,224
------- -------- --------
Total current assets........................ 12,267 20,685 23,558
------- -------- --------
Oil and gas properties, using the full cost
method of accounting...........................
Proved........................................ 73,788 89,453 112,394
Unproved...................................... 2,076 1,866 4,193
------- -------- --------
75,864 91,319 116,587
Less accumulated depletion, depreciation and
amortization................................. 23,387 29,821 35,982
------- -------- --------
Oil and gas properties, net................. 52,477 61,498 80,605
------- -------- --------
Well servicing property and equipment, net...... 2,010 4,628 --
------- -------- --------
Rental property, net............................ 18,789 29,177 55,785
------- -------- --------
Other property and equipment, net............... 4,955 4,873 5,060
------- -------- --------
Other assets....................................
Equity investment in subsidiary............... -- -- 2,778
Real estate investments....................... 1,973 4,510 4,237
Deferred debt costs, net of accumulated
amortization of $683, $1,041 and $1,501,
respectively................................. 1,776 2,892 3,466
Other, net.................................... 1,187 2,021 5,336
------- -------- --------
Total other assets.......................... 4,936 9,423 15,817
------- -------- --------
Total assets.................................... $95,434 $130,284 $180,825
======= ======== ========
</TABLE>
See accompanying notes to unaudited pro forma combined financial statements
F-14
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
LIABILITIES, REDEEMABLE COMMON STOCK AND ----------------- SEPTEMBER 30,
STOCKHOLDERS' EQUITY 1995 1996 1997
---------------------------------------- ------- -------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Current liabilities
Current maturities of long-term debt........ $ 4,661 $ 10,216 $ 3,408
Accounts payable............................ 8,036 6,893 10,937
Accounts payable to related parties......... 1,340 1,179 1,442
Accrued expenses............................ 2,051 3,038 7,400
Federal income taxes payable................ -- 30 5
Deferred income taxes....................... -- 425 --
------- -------- --------
Total current liabilities................. 16,088 21,781 23,192
------- -------- --------
Long-term debt................................ 68,825 83,589 138,805
------- -------- --------
Other long-term liabilities................... 1,522 3,134 4,588
------- -------- --------
Deferred income taxes......................... 5,699 5,830 4,809
------- -------- --------
Minority interest............................. 1,240 4,931 1,937
------- -------- --------
Redeemable common stock in subsidiary......... 2,501 2,520 2,630
------- -------- --------
Redeemable common stock....................... -- 8,258 8,291
------- -------- --------
Stockholders' equity
Preferred stock--$1 par value; 5,000,000
shares authorized; none issued............. -- -- --
Common stock - $.10 par value; 5,000,000
shares authorized; 1,160,537 issued at
December 31, 1995 and 1996 and 1,161,537
issued at September 30, 1997............... 116 116 116
Additional paid-in capital.................. 1,305 2,196 2,196
Retained earnings (accumulated deficit)..... 1,767 2,172 (935)
Note receivable from an officer and
stockholder................................ (1,760) (1,735) (1,714)
Less: Treasury stock-- at cost; 194,575 and
204,575 shares at December 31, 1995 and
1996, respectively and 214,215 at September
30, 1997................................... (1,869) (2,508) (3,090)
------- -------- --------
Total stockholders' equity (deficit)........ (441) 241 (3,427)
------- -------- --------
Total liabilities and stockholders' equity.... $95,434 $130,284 $180,825
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-15
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE NINE
FOR THE YEARS ENDED MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
---------------------------- -------------------
1994 1995 1996 1996 1997
-------- -------- -------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Operating revenues
Oil and gas, including re-
lated party
management fees of $1,318,
$1,506, $1,509, $1,140 and
$1,156, respectively...... $ 16,321 $ 22,717 $ 35,296 $ 24,638 $ 26,068
Well servicing, including
related party revenues of
$292, $166, $112, $87 and
$8, respectively......... 2,377 4,218 8,013 6,163 7,789
Real estate............... 605 3,213 4,487 3,092 5,029
Other..................... 325 352 622 424 948
-------- -------- -------- -------- ---------
Total operating
revenues............... 19,628 30,500 48,418 34,317 39,834
-------- -------- -------- -------- ---------
Operating expenses
Oil and gas............... 7,879 11,511 14,846 10,833 12,166
Well servicing............ 2,136 3,315 6,145 4,519 5,600
Real estate............... 195 1,414 1,887 1,295 1,907
General and
administrative, net of
related party
administrative costs of
$1,805, $2,039, $2,139,
$1,610 and $1,607,
respectively.............. 4,292 5,018 6,953 4,580 5,059
Depreciation, depletion
and amortization......... 4,437 6,719 8,430 6,249 8,093
Other..................... 105 228 554 407 1,003
-------- -------- -------- -------- ---------
Total operating
expenses............... 19,044 28,205 38,815 27,883 33,828
-------- -------- -------- -------- ---------
Operating income............ 584 2,295 9,603 6,434 6,006
-------- -------- -------- -------- ---------
Other income (expense)
Interest and dividend
income................... 229 269 441 275 545
Interest expense.......... (1,975) (5,635) (10,016) (7,180) (10,950)
Other..................... 1,687 (78) 561 438 (66)
-------- -------- -------- -------- ---------
(59) (5,444) (9,014) (6,467) (10,471)
-------- -------- -------- -------- ---------
Income (loss) before income
taxes, minority interest
and extraordinary item... 525 (3,149) 589 (33) (4,465)
Income tax benefit
(provision).............. (171) 1,044 (365) (54) 1,526
-------- -------- -------- -------- ---------
Income (loss) before
minority interest and
extraordinary item....... 354 (2,105) 224 (87) (2,939)
Minority interest in
subsidiaries............. (1) (15) 181 71 322
-------- -------- -------- -------- ---------
Income (loss) before
extraordinary item......... 353 (2,120) 405 (16) (2,617)
Extraordinary item, net of
tax...................... -- -- -- -- (490)
-------- -------- -------- -------- ---------
Net income (loss)........... $ 353 $ (2,120) $ 405 $ (16) $ (3,107)
======== ======== ======== ======== =========
Earnings (loss) per common
share
Earnings (loss) per common
share before
extraordinary item....... $ 0.37 $ (2.19) $ 0.42 $ (0.02) $ (2.42)
Extraordinary item, net of
tax...................... -- -- -- -- (0.45)
-------- -------- -------- -------- ---------
Earnings (loss) per common
share...................... $ 0.37 $ (2.19) $ 0.42 $ (0.02) $ (2.88)
======== ======== ======== ======== =========
Weighted average shares
outstanding................ 955,340 965,962 964,009 959,520 1,078,454
======== ======== ======== ======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-16
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK
---------------- PAID-IN NOTE RECEIVABLE --------------
SHARES AMOUNT CAPITAL EARNINGS FROM STOCKHOLDER SHARES AMOUNT
--------- ------ ------- -------- ---------------- ------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance--January 1,
1994................... 1,156,537 $115 $1,250 $3,534 $ -- 194,575 $1,869
Issuance of stock
options as
compensation........... -- -- 56 -- -- -- --
Note receivable issued
to stockholder......... -- -- -- -- 1,736 -- --
Net income.............. -- -- -- 353 -- -- --
--------- ---- ------ ------ ------ ------- ------
Balance--December 31,
1994................... 1,156,537 115 1,306 3,887 1,736 194,575 1,869
Stock option exercised.. 4,000 1 (1) -- -- -- --
Accrued interest on note
receivable............. -- -- -- -- 24 -- --
Net loss................ -- -- -- (2,120) -- -- --
--------- ---- ------ ------ ------ ------- ------
Balance--December 31,
1995................... 1,160,537 116 1,305 1,767 1,760 194,575 1,869
Payments received on
note receivable........ -- -- -- -- (25) -- --
Issuance of common stock
warrants............... -- -- 857 -- -- -- --
Issuance of stock
options as additional
compensation........... -- -- 34 -- -- -- --
Purchase of treasury
stock.................. -- -- -- -- -- 10,000 639
Net income.............. -- -- -- 405 -- -- --
--------- ---- ------ ------ ------ ------- ------
Balance--December 31,
1996................... 1,160,537 116 2,196 2,172 1,735 204,575 2,508
Stock option exercised
(unaudited)............ 500 -- -- -- -- -- --
Payments received on
notes receivable
(unaudited)............ -- -- -- -- (21) -- --
Purchase of treasury
stock (unaudited)...... -- -- -- -- -- 9,640 582
Net loss (unaudited).... -- -- -- (3,107) -- -- --
--------- ---- ------ ------ ------ ------- ------
Balance--September 30,
1997 (unaudited)....... 1,161,037 $116 $2,196 $ (935) $1,714 214,215 $3,090
========= ==== ====== ====== ====== ======= ======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-17
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE NINE MONTHS
DECEMBER 31, ENDED SEPTEMBER 30,
--------------------------- --------------------
1994 1995 1996 1996 1997
------- -------- -------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating
activities
Net income (loss)........... $ 353 $ (2,120) $ 405 $ (16) $ (3,107)
Adjustments to reconcile
net income (loss) to net
cash provided by
operating activities:
Depreciation, depletion
and amortization......... 4,437 6,719 8,430 6,249 8,093
Noncash interest expense.. 21 47 1,902 1,495 1,534
Write-off deferred debt
costs, net of tax........ -- -- -- -- 490
(Gain) loss on sale of
assets................... (1,687) 78 226 141 119
Other noncash items....... 70 -- 257 -- (168)
Bad debt expense.......... 83 315 168 -- --
Provision for deferred
income taxes............. 28 (869) 747 (49) (1,494)
Minority interest in
income (loss) of
subsidiary............... 1 15 (181) (71) (323)
Changes in operating
assets and liabilities--
Accounts receivable...... (62) (2,078) (1,128) (2,217) (6,048)
Income tax receivable.... -- (270) 270 -- --
Other current assets..... 157 (297) (379) (392) (613)
Accounts payable and
accrued expenses........ 1,793 4,161 (467) (305) 10,953
Income taxes payable..... 28 (67) 30 -- (25)
------- -------- -------- --------- ---------
Net cash provided by
operating activities....... 5,222 5,634 10,280 4,835 9,411
------- -------- -------- --------- ---------
Cash flows from investing
activities
Proceeds from sale of oil
and gas properties....... 2,563 2,082 1,081 1,206 1,146
Purchase of oil and gas
properties............... (9,583) (17,897) (16,740) (9,808) (26,522)
Purchase of Espero Energy
Corporation.............. -- (13,000) -- -- --
Purchase of other property
and equipment............ (5,615) (14,737) (14,443) (3,286) (34,944)
Purchase of other assets.. (2,142) (979) (1,095) (506) (2,659)
Proceeds from sale of
other assets............. 2,345 320 196 71 182
Proceeds from sale of
other property and
equipment................ 2,949 287 274 204 (21)
Purchase of real estate
investments.............. (158) (608) (2,569) (424) (57)
Other..................... -- -- 71 64 144
------- -------- -------- --------- ---------
Net cash used by investing
activities................. (9,641) (44,532) (33,225) (12,479) (62,731)
------- -------- -------- --------- ---------
Cash flows from financing
activities
Proceeds from borrowings.. 11,446 46,514 29,094 10,314 87,119
Payments on debt.......... (7,619) (7,486) (9,379) (2,187) (31,987)
Payments on other long-
term liabilities......... (43) (105) (512) (300) (101)
Increase in other long-
term liabilities......... 55 80 46 25 724
Cash received on
subscriptions receivable. -- -- -- -- 2,807
Purchase of treasury
stock.................... -- -- (250) (250) (582)
Deferred debt costs....... (129) (1,931) (1,333) (240) (1,464)
Issuance of stock
warrants................. -- -- 857 -- --
Issuance of redeemable
common stock, net of
issue costs.............. -- -- 5,451 -- 33
Net proceeds from sale of
minority interest........ 1,344 2,094 4,158 1,966 904
Dividends paid to minority
interest owners.......... -- -- (139) (93) (91)
Purchase of treasury stock
by subsidiary............ -- -- (128) (128) (1,174)
------- -------- -------- --------- ---------
Net cash provided by
financing activities....... 5,054 39,166 27,865 9,107 56,188
------- -------- -------- --------- ---------
Net increase in cash and
cash equivalents........... 635 268 4,920 1,463 2,868
Cash and cash
equivalents--beginning of
period................... 2,461 3,096 3,364 3,364 8,284
------- -------- -------- --------- ---------
Cash and cash equivalents--
end of period.............. $ 3,096 $ 3,364 $ 8,284 $ 4,827 $ 11,152
======= ======== ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-18
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE
FOR THE YEARS ENDED MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
-------------------- -------------
1994 1995 1996 1996 1997
------ ------ ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Supplemental disclosures of cash flow
information
Interest paid........................... $1,467 $4,964 $7,780 $6,180 $8,704
Income taxes paid (received)............ $ 114 $ 141 $ (559) $ 73 $ (74)
Supplemental schedule of noncash investing
and financing activities--
Increase in accrued expenses from
general partner
contribution to partnership............ $ -- $ -- $ -- $ -- $1,699
Long-term debt and liabilities assumed
in acquisition of real estate.......... $ -- $ -- $ 150 $ -- $ --
Increase in other long-term liabilities
from general partner contribution to
partnership............................ $ -- $ 188 $ 198 $ 198 $ --
Debt issued for other property and
equipment.............................. $ -- $ 662 $ 604 $ 262 $ --
Deferred taxes relating to acquisition
of oil and gas properties.............. $ -- $3,315 $ -- $ -- $ --
Increase in other long-term liabilities
from purchase of treasury stock........ $ -- $ -- $ 389 $ 389 $ --
Transfer oil and gas properties as debt
issue costs............................ $ -- $ -- $ 204 $ 204 $ --
Increase in accounts receivable from
sale of minority interest in subsidiary. $ 120 $ -- $ -- $ -- $ --
Increase in subscription receivable from
sale of redeemable common stock......... $ -- $ -- $2,807 $ -- $ --
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-19
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. 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 the exact same amount of shares in SRH as they had held in
Southwest so that the ownership in SRH was the same as it was in Southwest
before and after the formation of SRH. Southwest then dividended 100% of the
shares it owned in Red Oak and Sierra up to SRH. Prior to the formation of
SRH, Red Oak and Sierra were subsidiaries of Southwest. After the formation of
SRH, Southwest and Red Oak became subsidiaries of SRH, and as of July 1, 1997,
Sierra was deconsolidated. See Note 3.
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, which include plugging and workovers for wells.
Principles of Consolidation
The consolidated financial statements include the accounts of SRH and its
subsidiaries, each of which are wholly owned, except Red Oak, Sierra and
Threading Products International, LLC ("TPI" (a subsidiary of Southwest)). As
of December 31, 1995 and 1996, the Company owned approximately 78% and 76% of
Red Oak, 99% and 54% of Sierra and 95% of TPI. Effective July 1997, Southwest
Partners III purchased additional shares of Sierra stock thus decreasing the
Company's total direct and indirect ownership percentage to 45%. Therefore,
effective July 1, 1997, Sierra was deconsolidated and is reported upon using
the equity method (see Note 3). The consolidated financial statements include
the Company's proportionate share of the assets, liabilities, income and
expenses of oil and gas limited partnerships for which it serves as managing
general partner. 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.
Concentrations of Credit Risk
The Company is subject to credit risk through trade receivables. Although a
substantial portion of its debtors' ability to pay is dependent upon the oil
and gas industry, credit risk is minimized due to a large customer base.
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
F-20
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
It is reasonably possible that the estimates of anticipated future gross
revenues, the remaining estimated economic life of the product, or both could
change significantly in the near term due to the potential fluctuation of oil
and gas prices or production. Depletion estimates would also be affected by
such changes.
Property and Equipment
Oil and gas well servicing equipment, rental property and other property and
equipment is stated at cost. Repairs and maintenance are charged to expense as
incurred, with additions and improvements being capitalized. Upon sale or
other retirement of depreciable property, the cost and accumulated
depreciation are removed from the related accounts and any gain or loss is
reflected in the Consolidated Statements of Operations.
Depreciation is provided on the straight-line method based on the estimated
useful lives of the depreciable assets as listed below:
<TABLE>
<S> <C>
Building and improvements.................................. 20 to 30 years
Rental property and improvement............................ 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
</TABLE>
Real Estate Investments
The Company is a limited partner in various limited partnerships, which are
carried at cost. No earnings have been distributed to the Company from these
partnerships.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
on January 1, 1996. This Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Adoption of this Statement did not have an impact on the
Company's financial position, results of operations, or liquidity.
Deferred Debt Costs
The Company capitalizes certain cost incurred in connection with obtaining
debt. These costs are being amortized to interest expense on the straight-line
method over the term of the related debt.
F-21
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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, 1995 and December 31,
1996, the Company was underproduced by approximately 990 and 693 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 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 1994 and 1995 amounts to
conform to the 1996 presentation.
Earnings (Loss) Per Share
Net earnings (loss) per share is computed using the weighted average number
of shares of common stock and redeemable common stock outstanding. Common
equivalent shares from warrants are excluded from the computation as their
exercise price is equivalent to the fair market value of the common stock and
there would be no dilution under the treasury stock method.
Interim Financial Statements
The interim financial information as of September 30, 1997, and for the nine
months ended September 30, 1996 and 1997, is unaudited. However, in the
opinion of management, these interim financial statements include all the
necessary adjustments to fairly present the results of the interim periods,
and all such adjustments are of a normal recurring nature. The interim
financial statements should be read in conjunction with the audited financial
statements for the years ended December 31, 1994, 1995 and 1996.
2. SUBSIDIARIES, ACQUISITIONS AND DISPOSITIONS
During 1994, Red Oak sold 62,384 shares of redeemable common stock for
approximately $1,560,000 through a private placement offering. During 1995,
Red Oak sold an additional 39,616 shares of redeemable common stock for
approximately $990,000 and 34,611 shares of its Series A cumulative
convertible preferred stock for approximately $1,731,000. The redeemable
common stock is redeemable at the stockholder's option at a price equal to the
purchase price plus a 6% annual return computed on a cumulative, but not
compounded, basis between December 1, 1996 and December 1, 1999. Redemptions
are to be paid out of future earnings of Red Oak. If there are no future
earnings, redemptions will be paid out of additional paid-in capital.
F-22
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On August 2, 1995, SW Espero, Inc., a wholly owned subsidiary of Southwest,
acquired all of the stock of Espero Energy Corporation for approximately
$13,000,000, which was funded through a credit agreement with an asset
management company. SW Espero, Inc. and Espero Energy Corporation were
immediately merged, with Espero Energy Corporation being the surviving
corporation. The acquisition was accounted for as a purchase and the total
purchase price was allocated to the assets and liabilities acquired based upon
their estimated respective fair market values. The results of operations of
Espero Energy Corporation are included in the Consolidated Statements of
Operations beginning August 2, 1995.
On September 26, 1996, Red Oak formed a subsidiary with an unrelated third
party. On October 15, 1996, the subsidiary acquired three shopping centers for
a total purchase price of $12.5 million. The transaction was funded through a
$2.3 million contribution from Red Oak and a $1.2 million contribution from
the unrelated third party. The subsidiary funded the remaining $9 million of
the purchase price through a note payable due June 1, 1998. (See Note 6). The
transaction was accounted for using the purchase method. The results of
operations of the properties acquired are included in the Consolidated
Statements of Operations beginning September 26, 1996.
Pro Forma Results of Operations--(unaudited)
The following table reflects the pro forma results of operations as though
the acquisitions had occurred on January 1, 1995. The pro forma amounts are
not necessarily indicative of the results that may be reported in the future.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
----------------
1995 1996
------- -------
<S> <C> <C>
Revenues................................................ $35,942 $49,626
Net loss................................................ (3,940) (29)
Net loss per share...................................... (4.09) (0.03)
</TABLE>
3. INVESTMENT
The investment in subsidiary held by the Company consists of a 45% ownership
interest in Sierra Well Service, Inc. The investment is accounted for on the
equity method. Effective July 1997, Southwest Partners III purchased
additional shares of Sierra stock thus decreasing Southwest's total direct and
indirect ownership percentage. Therefore, with the change of Southwest's
ownership percentage from a majority to a minority interest, Sierra was
deconsolidated. The deconsolidation of Sierra required an adjustment to the
investment account to reflect the change in accounting from the consolidation
method to the equity method.
Pertinent financial information for Sierra Well Service, Inc. as of
September 30, 1997 and for the quarter ended September 30, 1997 is as follows:
<TABLE>
<S> <C>
Balance sheet
Assets......................................................... $28,472
=======
Liabilities.................................................... $11,358
Equity......................................................... 17,114
-------
$28,472
=======
Income statement
Revenues....................................................... $ 7,117
Expenses....................................................... 7,058
-------
59
x45%
-------
Company's share of net income.................................... $ 26
=======
</TABLE>
F-23
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. PROPERTY AND EQUIPMENT
Property and equipment, including oil and gas well servicing, rental
property and other, consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1995 1996
------- -------
<S> <C> <C>
Land..................................................... $ 2,157 $ 2,157
Building and improvements................................ 1,310 1,326
Machinery and equipment.................................. 4,017 7,365
Furniture and fixtures................................... 1,564 1,714
Equipment under capital lease............................ 766 1,000
Rental property.......................................... 19,441 30,287
------- -------
29,255 43,849
Less accumulated depreciation............................ 3,501 5,171
------- -------
$25,754 $38,678
======= =======
</TABLE>
5. FUTURE LEASE RECEIVABLES
Red Oak leases office and retail shopping centers under noncancelable
operating leases that expire at various dates through 2028. The following is a
summary of minimum future rentals expected to be received under noncancelable
operating leases (in thousands):
<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,
------------------------
<S> <C>
1997............................................................ $ 2,684
1998............................................................ 9,349
1999............................................................ 7,711
2000............................................................ 5,962
2001............................................................ 4,462
2002............................................................ 2,410
Thereafter...................................................... 9,672
-------
$42,250
=======
</TABLE>
The preceding future minimum rentals do not include percentage rents.
F-24
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------- SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
(UNAUDITED)
<S> <C> <C> <C>
Revolving line of credit with variable-rate
interest, due February 1999. Monthly payments,
beginning July 1, 1997, of $550 plus interest.
Collateralized by oil and gas properties (see
Note 17)....................................... $32,100 $28,125 $ 44,900
9% Notes payable, with variable quarterly
payments including interest, due December 2003.
Collateralized by oil and gas properties (see
Note 17)....................................... 22,557 27,649 26,338
10% Note payable, interest payable monthly, due
June 1998. Collateralized by oil and gas
properties..................................... -- 9,000 --
12% Note payable, interest payable semi-annually
due November 2001. Collateralized by oil and
gas properties (see Note 17)................... -- 7,143 7,229
15% Subordinated note payable................... 2,500 -- --
Capital lease obligations....................... 555 692 225
Note payable at 3-year U.S. Treasury plus
3.875%, monthly payments of $41 including
interest, due February 2002. Collateralized by
real estate.................................... 4,516 4,428 --
Note payable at prime plus 1.5%................. 798 -- --
Note payable at 3-year U.S. Treasury plus 3.5%,
monthly payments of $46 including interest, due
November 2002. Collateralized by real estate... 4,764 4,954 --
Note payable at prime plus 1.125%............... 4,000 -- --
8.05% Note payable, annual payments of $87
including interest, due January 2026.
Collateralized by real estate.................. -- 968 968
Note payable, at prime plus 1.5%, monthly
payments of $68 including interest, due
September 2003. Collateralized by real estate.. -- 7,106 --
13% Notes payable, due May 2000. Cash interest
of 10% payable monthly with additional interest
payable based on excess cash flow or through
the issuance of additional notes.
Collateralized by real estate.................. -- -- 55,357
Other........................................... 1,696 3,740 7,196
------- ------- --------
73,486 93,805 142,213
Less current maturities....................... 4,661 10,216 3,408
------- ------- --------
$68,825 $83,589 $138,805
======= ======= ========
</TABLE>
Revolving Line of Credit
The revolving credit line allows Southwest to borrow the lesser of $75
million or the borrowing base which is renegotiated periodically. As of
December 31, 1996, the borrowing base was $28,125,000, and as of September 30,
1997, the borrowing base was $44,900,000. The revolving line of credit
agreement provides for the revolver to become due and payable on February 28,
1999. Fees on the unused portion of the revolving line of credit are three-
eighths of one percent ( 3/8%) per annum on the daily average of the
unadvanced amount of the borrowing base.
Southwest has the option to elect an interest rate based on LIBOR plus the
applicable Eurodollar Margin or Prime plus a base rate margin. Both margins
are based on the percentage of the revolving commitment
F-25
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
outstanding. The Eurodollar Margin ranges from a minimum of 1.75% to a maximum
of 2.50% and the Prime base rate margin ranges from a minimum of .25% to a
maximum of 1.00%. At December 31, 1996 the Company had chosen the LIBOR rate
election for approximately $28 million of its then outstanding balance on the
revolving line of credit. The LIBOR elections ranged from 7.50% to 8.44%.
Certain covenants of the revolving line of credit require a tangible net
worth of not less than $2 million, a current ratio of 1.0 to 1, a minimum
fixed coverage ratio of 1.1 to 1, restrictions on cash dividends, additional
indebtedness and purchases of investments. Substantially all of Southwest's
assets are collateralized in connection with this debt. Southwest was in
violation of several covenants as of December 31, 1996 and September 30, 1997,
and obtained waivers of the covenants from the lender for the December 31,
1996 violations. Effective June 30, 1997, the lender amended the current ratio
to 0.84 to 1, until September 30, 1997, at which time the ratio becomes 1.0 to
1, and amended the minimum fixed charge ratio to 1.0 to 1, until July 1, 1998,
at which time the ratio becomes 1.1 to 1. Management believes that it is
likely the Company will comply with these covenants as amended.
9% Notes Payable
In August 1995, a subsidiary of Southwest entered into a note agreement
which provided for $30,305,000 in five senior secured amortizing term notes,
having a stated interest of 9%, with quarterly payments which include
interest. These quarterly payments consist of all excess cash balances over
$500,000, less any funds advanced under the notes and unused for the
development of oil and gas properties. The notes are due December 31, 2003,
and are collateralized by certain oil and gas properties.
The covenants of the note agreement include: (1) a working capital base that
is never less than $100,000 at any time after December 31, 1995, $250,000 at
any time after March 31, 1996, and $500,000 at and after June 27, 1996; and
(2) an interest coverage ratio that is never less than 150% at any time after
December 31, 1995. The covenants are based on the subsidiary's financial
statements.
One of the terms of the note agreement provides for an initial 7% gross
overriding royalty interest conveyance in all oil and gas properties of the
subsidiary which shall be adjusted upward to a maximum of 9.95% or downward to
a minimum of 4% on January 1, 1998 in order for a 15.75% internal rate of
return to be achieved on December 31, 2003.
10% Note Payable
In October 1996, Red Oak, through a subsidiary, negotiated a term note of
$9,000,000 to finance the purchase of real estate. This note was repaid with a
portion of the proceeds from the 13% note payable discussed below.
12% Note Payable
In November 1996, Southwest entered into a senior subordinated note
agreement which provided for $8,000,000 to be used for developmental drilling.
The note bears interest at a stated rate of 12%, payable semi-annually,
matures November 1, 2001, and is collateralized by oil and gas properties. The
note agreement contains certain restrictive covenants that include: (1) a
leverage ratio of combined adjusted net tangible assets to combined
indebtedness that is never less than 150% at any time after November, 1996;
and (2) investments in the form of loans and advances to various subsidiaries
are less than $1,200,000 in the aggregate and not outstanding for more than 90
days. Certain covenants also place restrictions on cash dividends, additional
indebtedness and investments, and compensation to certain key employees.
F-26
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As part of the above noted agreement, Southwest issued common stock warrants
which are exercisable in whole or in part any time prior to November 5, 2001.
These warrants had an estimated fair value of approximately $857,000. At
December 31, 1996, the lender was entitled to 45,413 warrants at an exercise
price of $68 per share.
13% Notes Payable
In April 1997, MRO Properties, Inc. ("MROP"), a wholly-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 six mortgage loans, originally incurred to
complete the acquisition of certain Red Oak properties and to finance the
acquisition of an additional real estate property. Borrowings under the
facility bear interest at a rate of 13% with 10% payable in cash and the
remaining 3% payable in cash or additional notes at MROP's option. 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.
The deferred debt costs associated with refinancing of the mortgage loans
were charged to expense as an extraordinary item. The amount relating to the
early extinguishment of debt approximated $490,000 which consisted of $742,000
in deferred debt charges with a related income tax benefit of $252,000.
Aggregate maturities of all long-term debt as of December 31, 1996,
including capital leases, are as follows and reflect the changes negotiated
subsequent to year end (in thousands):
<TABLE>
<S> <C>
1997.............................................................. $10,216
1998.............................................................. 11,433
1999.............................................................. 22,022
2000.............................................................. 30,267
2001.............................................................. 11,507
Thereafter........................................................ 8,360
</TABLE>
Aggregate maturities of all long-term debt as of September 30, 1997,
including capital leases, are as follows and reflect the changes negotiated
subsequent to the period end (in thousands):
<TABLE>
<CAPTION>
FOR THE TWELVE MONTHS ENDED
---------------------------
<S> <C>
September 30, 1998............................................... $ 3,408
September 30, 1999............................................... 241
September 30, 2000............................................... 55,532
September 30, 2001............................................... 343
September 30, 2002............................................... 115
Thereafter....................................................... 82,574
</TABLE>
F-27
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. INCOME TAXES
The U.S. Federal tax provision (benefit) attributable to income (loss)
before income taxes, minority interest and extraordinary item consists of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995 1996
---- ------- -----
<S> <C> <C> <C>
Current............................................. $143 $ (175) $(382)
Benefit of net operating loss carryforward.......... -- (1,765) (913)
Deferred............................................ 28 896 1,660
---- ------- -----
$171 $(1,044) $ 365
==== ======= =====
</TABLE>
Reconciliations between the amount determined by applying the U.S. federal
statutory rate to income (loss) before income taxes, minority interest and
extraordinary item with the income tax provision (benefit) is as follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995 1996
---- ------- ----
<S> <C> <C> <C>
Computed "expected" tax expense using the U.S. federal
statutory rate........................................... $179 $(1,071) $206
Reduction in available net operating loss carryforwards
resulting from certain subsidiaries which became
ineligible for inclusion in the consolidated return...... -- -- 143
Meals and entertainment................................... 11 16 32
Other..................................................... (19) 11 (16)
---- ------- ----
Provision (benefit) for income taxes...................... $171 $(1,044) $365
==== ======= ====
</TABLE>
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):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------- -------
<S> <C> <C>
Deferred tax assets:
Net operating loss carry forwards............................ $ 1,582 $ 2,485
Alternative minimum tax credit carryforwards................. 262 170
Receivables.................................................. 530 469
Note receivable.............................................. -- 55
Other long term assets....................................... 573 247
Other long term liabilities.................................. 326 397
Other........................................................ 152 --
------- -------
Total gross deferred tax assets............................ 3,425 3,823
------- -------
Deferred tax liabilities:
Oil and gas properties, principally due to differences in the
tax and book basis and depletion methods and the deduction
of intangible drilling costs for tax purpose................ (7,178) (8,406)
Other property and equipment................................. (473) (600)
Accounts payable and accrued expenses........................ (1,282) (1,026)
Other........................................................ -- (46)
------- -------
Total gross deferred tax liabilities....................... (8,933) (10,078)
------- -------
Net deferred tax liability................................. $(5,508) $(6,255)
======= =======
</TABLE>
F-28
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A valuation allowance is provided when it is more likely than not that some
portion of the deferred tax assets will not be realized. Based on expectations
for the future and the availability of certain tax planning strategies that
would generate taxable income to realize the net tax benefits, if implemented,
management has determined that taxable income of the Company will more likely
than not be sufficient to fully utilize available carryforwards prior to their
ultimate expiration.
As of December 31, 1996, the Company had net operating loss carryforwards
for U.S. federal income tax purposes of approximately $7,309,000, which are
available to offset future regular taxable income, if any. The net operating
loss carryforwards expire in 2010 and 2011. The Company has alternative
minimum tax credit carryforwards totaling $170,000 to offset regular income
tax, which have no scheduled expiration date.
8. LEASES
The Company rents office space on a month to month basis in a building that
it also manages. Rent expense totaled approximately $241,000, $295,000 and
$243,000 for the years ended December 31, 1994, 1995 and 1996, respectively.
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 $9,240 for the years ended December 31, 1994 and 1995 and
$9,500 for the year ended December 31, 1996. For the years ended December 31,
1994, 1995 and 1996, the Company matched 20% of the employees' contributions.
For the year ended December 31, 1997, 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, 1994, 1995 and 1996, the Company contributed approximately
$45,000, $54,000 and $60,000, respectively, to the plan.
10. STOCKHOLDERS' EQUITY
In August 1996, the Company issued 129,046 shares of redeemable common stock
through a private placement offering for $68 per share. The stock is
redeemable at the stockholder's option at any time beginning five years from
the issuance of the stock (December 31, 2001) at a purchase price determined
as follows:
(i) The Company shall review no less than five and no more than ten
publicly traded oil and gas companies each with a market capitalization
between $50 million and $150 million ("Public Company"). The Company shall
determine the ratio of each Public Company's market capitalization to
EBITDA for the most recent fiscal year. The Company shall then average such
multiples and take this averaged multiple and apply it to the Company's
EBITDA for the most recent fiscal year, to estimate a value for the
Company's common stock.
(ii) The Company will determine the multiple of the market capitalization
of each Public Company relating to the present value of such Public
Company's oil and gas reserves. Present value will be determined by
discounting the expected net cash flow from the oil and gas reserves by
10%. The Company will then take the average multiple based on this
methodology and apply it to the present value of the Company's oil and gas
reserves discounted by 10% to determine a value for the expected net cash
flow from the Company's common stock.
F-29
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company will then take the average of (i) and (ii) to determine the
value of the Company's common stock.
The redemption right terminates on the effective date of any registration
statement filed with the Securities and Exchange Commission relative to the
offer and sale of the Company's common stock to the public.
During 1994, the Company issued a 6% note to a stockholder. The note
requires semi-monthly payments of $5,500 and is collateralized by the
Company's common stock held by the stockholder.
11. 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 the other nine partnership agreements,
Southwest's obligation to repurchase units in any one year is limited to 10%
of the capital contributed by all of the respective limited partners. The
repurchase price is based on the discounted future revenues from oil and gas
reserves of the respective partnership and the value of other partnership
assets. Such amounts required for repurchase in connection with the acceptance
by a portion of the limited partners is approximately $4,833,000 at December
31, 1996. The total amount of limited partner unit repurchases for the years
ended December 31, 1995 and 1996 was approximately $176,000 and $378,000,
respectively.
The Company is subject to extensive federal, state and local environmental
laws and regulations. These laws, which are constantly changing, regulate the
discharge of materials into the environment and may require the Company to
remove or mitigate the environmental effects of the disposal or release of
petroleum or chemical substances at various sites. Environmental expenditures
are expensed or capitalized depending on their future economic benefit.
Expenditures that relate to an existing condition caused by past operations
and that have no future economic benefits are expensed. Liabilities for
expenditures of a noncapital nature are expensed when environmental assessment
and/or remediation is probable and the costs can be reasonably estimated.
Management recognizes a financial exposure that may require future
expenditures presently existing for oil and gas properties and other
operations. Other long-term liabilities at December 31, 1996 include $504,000
for estimated future remedial actions and cleanup costs. As of December 31,
1996, 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.
F-30
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
12. 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. As provided for in the
partnership agreements, such amounts paid by the partnerships to Southwest as
operator approximated $1,805,000, $2,039,000, and $2,139,000 for the years
ended December 31, 1994, 1995 and 1996, respectively. In addition, Southwest
and certain officers and employees may have an interest in some of the
partnership properties.
Sierra performs various oilfield services for limited partnerships managed
by Southwest. Such services aggregated $292,000, $166,000 and $112,000 for the
years ended December 31, 1994, 1995 and 1996, respectively. Southwest also
receives management fees as well as reimbursement of administrative costs
attributable to serving as managing general partner of certain of the limited
partnerships, with such fees aggregating $1,318,000, $1,506,000 and $1,509,000
for the years ended December 31, 1994, 1995 and 1996, respectively.
13. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses, other current assets and other current
liabilities approximates fair value because of the short maturity of these
instruments.
Based on the borrowing rates currently estimated to be available to the
Company for loans with similar terms, the fair value of long-term debt
approximates the carrying amount as of December 31, 1995 and 1996.
14. LINES OF BUSINESS
The Company operates in three major segments: Oil and Gas Activities (oil
and gas acquisition, development, exploration and production, as well as
organizing and serving as managing general partner for various public and
private limited partnerships engaged in oil and gas development and
production), Oil and Gas Well Servicing (provides well completion,
recompletion and production equipment, transportation services, tank supply
rental services and other support and well maintenance services to operating
oil and gas companies) and Real Estate Investment and Management (owns and
manages retail shopping centers and office buildings). Other items include
eliminations, manufacturing, computer service and broker/dealer.
<TABLE>
<CAPTION>
1994 1995 1996
------ ------ -------
<S> <C> <C> <C>
Operating profit (loss)
Oil and gas.................................... $ 855 $2,151 $ 9,676
Well service................................... (146) (177) (506)
Real estate.................................... (36) 933 1,288
Other and eliminations......................... (89) (612) (855)
------ ------ -------
$ 584 $2,295 $ 9,603
====== ====== =======
Interest expense
Oil and gas.................................... $1,830 $4,296 $ 7,966
Well service................................... 23 70 82
Real estate.................................... 122 1,272 1,904
Other and eliminations......................... -- (3) 64
------ ------ -------
$1,975 $5,635 $10,016
====== ====== =======
Depreciation, depletion and amortization
Oil and gas.................................... $3,990 $5,643 $ 6,734
Well service................................... 154 448 863
Real estate.................................... 82 446 660
Other.......................................... 211 182 173
------ ------ -------
$4,437 $6,719 $ 8,430
====== ====== =======
</TABLE>
F-31
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
<TABLE>
<CAPTION>
1995 1996
------- --------
<S> <C> <C> <C>
Identifiable assets
Oil and gas........... $76,170 $ 95,042
Well service.......... 2,993 6,585
Real estate........... 21,666 35,365
Other and
eliminations......... (5,395) (6,708)
------- --------
$95,434 $130,284
Capital Expenditures
Oil and gas........... $32,077 $ 16,740
Well service.......... 1,598 3,826
Real estate........... 13,239 13,947
------- --------
$46,914 $ 34,513
======= ========
</TABLE>
15. RESTATEMENT
The Company has restated its previously issued financial statements for the
year ended December 31, 1995, to adjust for understatement of previously
reported assets, liabilities and net income, resulting in the following
changes:
<TABLE>
<CAPTION>
NET
OIL AND GAS INCOME
RECEIVABLES LIABILITIES (LOSS)
----------- ----------- -------
<S> <C> <C> <C>
As previously reported........................ $2,295 $95,602 $(2,374)
Understatement of oil and gas accrual net of
lease operating expense and production....... 527 179 348
Understatement of redeemable common stock due
to redemption feature........................ -- 94 (94)
------ ------- -------
As adjusted................................. $2,822 $95,875 $(2,120)
====== ======= =======
</TABLE>
16. CONDENSED ISSUER FINANCIAL DATA (UNAUDITED)
Summarized consolidated financial information for Southwest is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- SEPTEMBER 30,
1995 1996 1997
------- ------- -------------
<S> <C> <C> <C>
Consolidated Balance Sheet Data:
Current assets................................ $11,198 $18,439 $ 17,741
Net property and equipment.................... 57,422 66,348 85,665
Other assets, net............................. 2,439 3,991 12,208
------- ------- --------
$71,059 $88,778 $115,614
======= ======= ========
Current liabilities........................... $14,548 $19,127 $ 19,211
Long-term debt................................ 53,641 55,234 79,684
Other liabilities............................. 1,404 2,968 4,303
Deferred income taxes......................... 5,620 6,025 4,809
Minority interest............................. 140 158 174
Redeemable common stock....................... -- 8,258 8,291
Stockholders equity........................... (4,294) (2,992) (858)
------- ------- --------
$71,059 $88,778 $115,614
======= ======= ========
</TABLE>
F-32
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Consolidated Statement of Operations Data:
<TABLE>
<CAPTION>
SOUTHWEST SIERRA RED OAK ELIMINATIONS CONSOLIDATED
--------- ------ ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
For the year ended December
31, 1994:
Operating revenues....... $16,597 $2,652 $ 656 $(277) $19,628
Depreciation, depletion
and amortization........ 4,201 154 82 -- 4,437
Operating income (loss).. 765 (146) (35) -- 584
Interest expense......... 1,830 23 122 -- 1,975
Income (loss) before
taxes................... 849 (172) (152) -- 525
Net income (loss)........ 552 (96) (103) -- 353
For the year ended December
31, 1995:
Operating revenues....... $23,087 $4,437 $3,213 $(237) $30,500
Depreciation, depletion
and amortization........ 5,825 448 446 -- 6,719
Operating income (loss).. 1,539 (177) 933 -- 2,295
Interest expense......... 4,359 70 1,272 (66) 5,635
Loss before taxes........ (2,579) (248) (322) -- (3,149)
Net loss................. (1,688) (168) (221) (43) (2,120)
For the year ended December
31, 1996:
Operating revenues....... $36,109 $8,273 $4,487 $(451) $48,418
Depreciation, depletion
and amortization........ 6,907 863 660 -- 8,430
Operating income (loss).. 8,824 (506) 1,285 -- 9,603
Interest expense......... 8,030 82 1,904 -- 10,016
Income (loss) before
taxes................... 1,823 (608) (607) (19) 589
Net income (loss)........ 1,152 (448) (441) 142 405
For the period ending
September 30, 1996:
Operating revenues....... $25,201 $6,372 $3,092 $(348) $34,317
Depreciation, depletion
and amortization........ 5,166 632 451 -- 6,249
Operating income......... 5,473 111 850 -- 6,434
Interest expense......... 5,986 52 1,142 -- 7,180
Income (loss) before
taxes................... 185 76 (282) (12) (33)
Net income (loss)........ 71 52 (198) 59 (16)
For the period ending
September 30, 1997:
Operating revenues....... $27,135 $7,833 $5,029 $(163) $39,834
Depreciation, depletion
and amortization........ 6,520 747 826 -- 8,093
Operating income......... 3,991 184 1,831 -- 6,006
Interest expense......... 6,889 184 3,880 (3) 10,950
Loss before taxes........ (2,346) (5) (2,101) (13) (4,465)
Net income (loss)........ (1,489) (4) (1,937) 323 (3,107)
</TABLE>
17. SUBSEQUENT EVENTS
Southwest
In October 1997, Southwest Royalties Inc., a wholly owned subsidiary of
Southwest Royalties Holdings, Inc. issued $200,000,000 of 10 1/2% Senior Notes
due 2004. The proceeds from the sale of the notes were used to purchase
certain oil and gas properties and related assets and to cancel certain debt
held at September 30, 1997. The cancelled debt consisted of $44,900,000 on a
revolving line of credit, $26,338,000 on a 9% note payable and $7,229,000 on a
12% note payable. In consideration of the intent and ability to refinance
existing debt with the note offering, Southwest reclassified the above
mentioned debt at September 30, 1997 as non-current.
F-33
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In October 1997, Southwest used a portion of the proceeds from the above
note offering to purchase 250,000 shares of Red Oak's stock for a total of
$10,000,000. In connection with the purchase of the additional shares, Red Oak
became eligible to be included in the Company's consolidated U.S. federal
income tax return.
Southwest is a general partner of Southwest Partners III, L.P., which was
formed May 12, 1997. Under the terms of the partnership agreement, Southwest
is required to make capital contributions equal to 10% of the total limited
partner capital contributions. To date, the limited partners have made capital
contributions of $16.3 million, and accordingly, the Company has a liability
to the Partnership in the amount of $1,625,675.
In September 1997, Southwest entered into an agreement to acquire certain
oil and gas properties and related assets for $72,342,000, subject to closing
adjustments. The acquisition closed on October 14, 1997.
Real Estate
Subsequent to September 1997, Red Oak was committed to purchase three
shopping centers and one office building all located in Texas, for a combined
total of approximately $25,705,000. A total of $475,000 is being held in
escrow and will be applied to each respective purchase price upon closing.
18. 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):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER NINE MONTHS
31, ENDED
---------------------- SEPTEMBER 30,
1994 1995 1996 1997
------ ------- ------- -------------
<S> <C> <C> <C> <C>
Acquisition of properties.................. $7,795 $24,116 $ 3,234 $11,384
Exploration costs.......................... $ 59 $ 1,278 $ 184 $ 1,923
Development costs.......................... $2,134 $ 6,683 $13,322 $13,215
</TABLE>
Results of operations for oil and gas producing activities are as follows
(in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER NINE MONTHS
31, ENDED
----------------------- SEPTEMBER 30,
1994 1995 1996 1997
------- ------- ------- -------------
<S> <C> <C> <C> <C>
Revenues................................. $16,321 $22,717 $35,296 $26,068
Production costs......................... 7,879 11,511 14,846 12,166
Depreciation, depletion and amortization. 3,508 5,068 6,434 6,161
------- ------- ------- -------
4,934 6,138 14,016 7,741
Income tax expense....................... 1,678 2,087 4,906 2,632
------- ------- ------- -------
Results of operations from producing
activities.............................. $ 3,256 $ 4,051 $ 9,110 $ 5,109
======= ======= ======= =======
</TABLE>
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
F-34
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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, 1996 assume an average oil price of $23.89 per Bbl (reflecting
adjustments for oil quality and gathering and transportation costs) and an
average gas price of $3.67 per 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 or 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 and
of 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
<TABLE>
<CAPTION>
OIL AND NATURAL BARRELS OF
CONDENSATE GAS OIL EQUIVALENT
(MBBLS) (MMCF) (MBOE)
---------- ------- --------------
<S> <C> <C> <C>
Total Proved Reserves:
Balance, January 1, 1994.................... 7,236 27,405 11,804
Extensions and discoveries................. -- -- --
Purchase of minerals-in-place.............. 928 9,208 2,463
Sales of minerals-in-place................. (58) (840) (198)
Revisions of previous estimates............ 2,531 5,395 3,430
Production................................. (629) (3,178) (1,159)
------ ------ ------
Balance, December 31, 1994.................. 10,008 37,990 16,340
Extensions and discoveries................. -- -- --
Purchase of minerals-in-place.............. 4,760 25,156 8,953
Sales of minerals-in-place................. (1,013) (5,978) (2,009)
Revisions of previous estimates............ 3,639 18,061 6,648
Production................................. (814) (4,639) (1,587)
------ ------ ------
Balance, December 31, 1995.................. 16,580 70,590 28,345
Extensions and discoveries................. -- -- --
Purchase of minerals-in-place.............. 2,843 6,844 3,983
Sales of minerals-in-place................. (989) (466) (1,067)
Revisions of previous estimates............ 1,373 5,211 2,242
Production................................. (1,001) (5,403) (1,901)
------ ------ ------
Balance, December 31, 1996.................. 18,806 76,776 31,602
====== ====== ======
</TABLE>
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.
F-35
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1994 1995 1996
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Future cash inflows.............................. $227,864 $433,514 $735,100
Future production and development costs.......... (125,113) (213,698) (283,894)
-------- -------- --------
Future net cash flows before income taxes........ 102,751 219,816 451,206
Future income tax expense........................ (28,879) (64,064) (142,017)
-------- -------- --------
Future net cash flows............................ 73,872 155,752 309,189
10% annual discount for estimated timing of cash
flows........................................... (31,766) (71,646) (130,648)
-------- -------- --------
Standardized measure of discounted future net
cash flows...................................... $ 42,106 $ 84,106 $178,541
======== ======== ========
</TABLE>
The principal sources of change in the standardized measure of discounted
future net cash flows are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1994 1995 1996
------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Sales of oil and gas produced, net of production
costs............................................ $(8,442) $(11,206) $(20,450)
Net change in sales prices net of production
costs............................................ 11,778 13,106 92,332
Extensions and discoveries, net of future
production and development costs................. -- -- --
Revisions to estimated future development costs (9,503) (78) 1,854
Purchases of minerals-in-place.................... 9,646 42,733 38,480
Revisions of previous quantity estimates.......... 17,100 17,756 19,794
Accretion of discount............................. 3,811 5,802 11,790
Net change in income taxes........................ (7,248) (18,134) (39,268)
Sales of minerals-in-place........................ (631) (7,979) (2,439)
Changes in production rates, timing and other..... -- -- (7,658)
------- -------- --------
16,511 42,000 94,435
Discounted future net cash flows--
Beginning of period............................. 25,595 42,106 84,106
------- -------- --------
End of period................................... $42,106 $ 84,106 $178,541
======= ======== ========
</TABLE>
F-36
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors of
Southwest Royalties, Inc.
We have audited the accompanying Historical Statement of Revenues and Direct
Operating Expenses of the Oil and Gas Properties Acquisition for the years
ended December 31, 1994, 1995 and 1996. This historical statement is the
responsibility of the management of the owners of the properties. Our
responsibility is to express an opinion on this historical statement based on
our audit.
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 historical statement is free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the historical statement. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation
of the historical statement. We believe that our audits provide a reasonable
basis for our opinion.
The accompanying statement as described in Note 1 was prepared for the
purpose of complying with certain rules and regulations of the Securities and
Exchange Commission (SEC) for inclusion in a prospectus to be issued in
connection with an offering by Southwest Royalties, Inc. under Rule 144A of
the Securities Act of 1933. It is not intended to be a complete presentation
of the financial condition, operations and cash flows of the property.
In our opinion, the historical statement referred to in the first paragraph
of this report presents fairly, in all material respects, the revenue and
direct operating expenses of the property as described in Note 1 for the years
ended December 31, 1994, 1995 and 1996, in conformity with generally accepted
accounting principles.
As described in Note 2 to the historical statement, these properties have
significant transactions with related parties.
PRICE WATERHOUSE LLP
Houston, Texas
October 7, 1997
F-37
<PAGE>
OIL AND GAS PROPERTIES ACQUISITION
HISTORICAL STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND NINE MONTHS ENDED SEPTEMBER
30, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE
FOR THE YEARS ENDED NINE MONTHS
DECEMBER 31, ENDED
----------------------- SEPTEMBER 30,
1994 1995 1996 1997
------- ------- ------- -------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Revenues:
Oil and gas condensate................. $11,396 $12,294 $15,325 $12,025
Gas.................................... 452 489 805 625
------- ------- ------- -------
Total................................ 11,848 12,783 16,130 12,650
------- ------- ------- -------
Direct operating expenses:
Injection gas.......................... 2,872 3,360 3,603 2,737
Taxes other than on income............. 1,313 1,203 1,014 905
Labor.................................. 664 585 596 336
Utilities.............................. 535 548 484 330
Other operating expense................ 2,068 2,168 2,769 2,454
------- ------- ------- -------
Total................................ 7,452 7,864 8,466 6,762
------- ------- ------- -------
Revenues in excess of direct operating
expenses................................ $ 4,396 $ 4,919 $ 7,664 $ 5,888
======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of this financial statement.
F-38
<PAGE>
OIL AND GAS PROPERTIES ACQUISITION
NOTES TO HISTORICAL STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES
DECEMBER 31, 1994, 1995 AND 1996 AND UNAUDITED SEPTEMBER 30, 1997
(IN THOUSANDS)
1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
On September 10, 1997, Southwest Royalties, Inc. ("Southwest") entered into
a Purchase and Sale Agreement (the "Agreement") with a major oil company (the
"Oil Company") to acquire the interests in certain producing oil and gas
properties (the "Property") which are located in the Permian Basin of the
United States as described in Exhibit A, Schedule 1 to the Agreement.
The accompanying statement of revenues and direct operating expenses
("Statement") was prepared from the historical accounting records of the Oil
Company (accrual basis, successful efforts method of accounting for oil and
gas activities, in accordance with generally accepted accounting principles).
Complete financial statements, including a balance sheet, are not presented
as the Property was not maintained as a separate business unit and assets,
liabilities or indirect operating costs applicable to the Property were not
segregated. It is not practicable to identify all assets, liabilities or
indirect operating costs applicable to the Property.
Oil revenues and associated direct operating expenses relate to the net
revenue interest and net working interest, respectively, in the Property. With
respect to gas sales, the sales method is used for recording revenues. Under
this approach, each party recognizes revenue based on sales actually made
regardless of its proportionate share of the related production. Gas
imbalances related to production on the Property do not have a material impact
on the Statement. Direct operating expenses include labor, repairs and
maintenance, fuel consumed and supplies utilized to operate and maintain the
wells, related equipment and facilities. The Statement does not include
general and administrative expenses, interest or provisions for depreciation,
depletion, amortization and dismantlement costs, or for taxes on income.
The preparation of 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.
2. RELATED PARTY TRANSACTIONS
Substantially all of the revenues, labor and other operating expenses relate
to transactions with the Oil Company. The Oil Company purchases a significant
portion of production from these leases based on the Oil Company's posted
prices for processing at its refineries. Services performed by the Oil Company
and other Oil Company affiliates directly related to the property's operations
are shown as direct operating expenses in the Statements.
3. COMMITMENTS AND CONTINGENCIES
In the course of its business affairs and operations, the owners of the
properties are subject to possible loss contingencies arising from government
environmental, health and safety laws and regulations and third-party
litigation. There are no matters which, in the opinion of management of the
owners of the properties, will have a material adverse effect on the financial
results of the Property.
4. SUPPLEMENTARY FINANCIAL INFORMATION FOR OIL AND GAS PRODUCING ACTIVITIES
(UNAUDITED)
Estimated Quantities of Proved Oil and Gas Reserves
Reserve information presented below is based on the June 30, 1997 reserve
reports prepared by an independent petroleum engineer. Changes in reserve
estimates were derived by adjusting the June 30, 1997 quantities for
historical production and changes in prices.
F-39
<PAGE>
OIL AND GAS PROPERTIES ACQUISITION
NOTES TO HISTORICAL STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES--
(CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996 AND UNAUDITED SEPTEMBER 30, 1997
(IN THOUSANDS)
Proved reserves are estimated quantities of crude oil, natural gas and
natural gas liquids which geological and engineering data demonstrate with
reasonable certainty to be recoverable in future years from known reservoirs
under existing economic and operating conditions. Proved developed reserves
are those which are expected to be recovered through existing wells with
existing equipment and operating methods. Below are the net quantities of
proved reserves and proved developed reserves for the Property:
<TABLE>
<CAPTION>
OIL GAS
------- ------
(MBBLS) (MMCF)
<S> <C> <C>
Proved reserves at December 31, 1993........................ 14,577 4,413
Production.................................................. (748) (251)
Revision of previous estimates.............................. 1,106 452
------ -----
Proved reserves at December 31, 1994........................ 14,935 4,614
Production.................................................. (748) (244)
Revision of previous estimates.............................. 329 131
------ -----
Proved reserves at December 31, 1995........................ 14,516 4,501
Production.................................................. (760) (195)
Revision of previous estimates.............................. 483 238
------ -----
Proved reserves at December 31, 1996........................ 14,239 4,544
------ -----
Proved developed reserves at:
December 31, 1994......................................... 13,341 3,460
------ -----
December 31, 1995......................................... 12,867 3,569
------ -----
December 31, 1996......................................... 12,530 3,778
------ -----
</TABLE>
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
RELATING TO PROVED OIL AND GAS RESERVES
The "Standardized Measure of Discounted Future Net Cash Flows Relating to
the Proved Oil and Gas Reserves" (Standardized Measure) has been prepared in
accordance with Statement of Financial Accounting Standards No. 69. The
Standardized Measure does not purport to present the fair market value of the
proved oil and gas reserves. This would require consideration of expected
future economic and operating conditions, which are not taken into account in
calculating the Standardized Measure.
Under the Standardized Measure, 1996, 1995 and 1994 future cash inflows were
estimated by applying December 31, 1995, 1994 and 1993 prices, respectively,
adjusted for fixed and determinable escalations, to the estimated future
production of proved reserves. Future cash inflows for 1996, 1995 and 1994
were reduced by estimated future production and development costs based on
1996, 1995 and 1994 year-end costs, respectively, to determine pre-tax cash
inflows. Future net cash inflows were discounted using a 10% annual discount
rate to arrive at the Standardized Measure. No deduction has been made for
depletion, depreciation or any indirect costs such as general corporate
overhead or interest expense.
F-40
<PAGE>
OIL AND GAS PROPERTIES ACQUISITION
NOTES TO HISTORICAL STATEMENT OF REVENUES AND DIRECT OPERATING EXPENSES--
(CONTINUED)
DECEMBER 31, 1994, 1995 AND 1996 AND UNAUDITED SEPTEMBER 30, 1997
(IN THOUSANDS)
The following Standardized Measure and changes in the Standardized Measure
are based on the reserve estimate performed at June 30, 1997 adjusted using
appropriate year-end prices and costs.
Set forth below is the Standardized Measure (before income taxes) relating
to proved oil and gas reserves at:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Future cash inflows........................... $ 247,269 $ 269,934 $ 361,634
Future production and development costs....... (113,017) (112,347) (118,013)
--------- --------- ---------
Future net cash inflows....................... 134,252 157,587 243,621
Discounted to present value at a 10% annual
rate......................................... (62,342) (73,178) (113,129)
--------- --------- ---------
Standardized Measure (before income taxes) of
discounted future net cash flows............. $ 71,910 $ 84,409 $ 130,492
========= ========= =========
</TABLE>
The Standardized Measure of discounted future net cash flows is based on the
following oil and gas prices in dollars per barrel and dollars per Mcf,
respectively, at:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995 1996
------ ------ ------
<S> <C> <C> <C>
Oil (per Bbl)........................................... $16.00 $18.00 $24.25
Gas (per Mcf)........................................... $ 1.80 $ 1.92 $ 3.59
</TABLE>
The following is an analysis of the changes in the Standardized Measure
(before income taxes):
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------------
1994 1995 1996
------- ------- --------
<S> <C> <C> <C>
Standardized measure (before income taxes)--
beginning of year................................. $43,812 $71,910 $84,409
Increases (decreases):
Sales, net of production costs................... (4,396) (4,919) (7,664)
Net changes in prices and costs.................. 26,735 13,160 45,621
Revision of quantity estimates................... 5,658 2,015 4,665
Changes in production rates, timing and other.... (4,280) (4,948) (4,980)
Accretion of discount............................ 4,381 7,191 8,441
------- ------- --------
Standardized measure (before income taxes)--end of
year.............................................. $71,910 $84,409 $130,492
======= ======= ========
</TABLE>
F-41
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of 50 Penn Place for the year ended December 31, 1996. This statement is the
responsibility of Price Edwards & Company's management. Our responsibility is
to express an opinion on this statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of 50 Penn Place's revenue and
expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of 50 Penn Place for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Oklahoma City, Oklahoma
July 30, 1997
F-42
<PAGE>
50 PENN PLACE
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Revenue
Rent (Note 3)...................................... $2,847,189 $2,212,825
Recoveries from tenants............................ 577,782 448,549
Other, principally parking revenue................. 100,419 63,761
---------- ----------
3,525,390 2,725,135
---------- ----------
Certain expenses
Utilities.......................................... 755,864 521,418
Contracted services................................ 452,151 327,957
Salaries and related expenses...................... 285,532 154,208
Administrative expenses............................ 150,845 85,372
Repairs and maintenance............................ 97,990 57,694
Property taxes..................................... 95,955 72,971
Management fees.................................... 71,598 56,235
Insurance.......................................... 66,570 37,565
Supplies........................................... 61,513 30,525
---------- ----------
2,038,018 1,343,945
---------- ----------
Revenue in excess of certain expenses............ $1,487,372 $1,381,190
========== ==========
</TABLE>
See accompanying notes to statements of revenue and certain expenses.
F-43
<PAGE>
50 PENN PLACE
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES
YEAR ENDED DECEMBER 31, 1996
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying statements present revenue and certain expenses of 50 Penn
Place (the "Property"), an office building and retail center located in
Oklahoma City, Oklahoma whose operations are managed by Price Edward &
Company. Midland Red Oak Realty, Inc. ("Red Oak"), a subsidiary of Southwest
Royalties Holdings, Inc. ("SRH") as of September 30, 1997, and MBL Life
Assurance Corporation, owner of the Property, have executed a formal Purchase
and Sale Agreement allowing Red Oak to acquire the Property for approximately
$15 million.
The accompanying statements have been prepared using the accrual basis of
accounting for the purpose of complying with the rules and regulations of the
Securities and Exchange Commission ("SEC") for inclusion in the registration
statement on Form S-4 of SRH and are presented in accordance with Rule 3.14 of
SEC Regulation S-X, which allows audited statements to be presented for only
the most recent period if the properties were purchased from an unrelated
party and if the registrant makes certain disclosures regarding factors
considered in purchasing the Property (see the Business section of the
Prospectus).
The statements are not representative of the actual results of operations of
the Property for the year ended December 31, 1996, and the nine months ended
September 30, 1997, due to the exclusion of the following expenses, which may
not be comparable to the proposed future operations of the Property:
.Depreciation and amortization
.Corporate expenses of Property owner
.Federal and state income taxes
.Mortgage interest
.Other costs not directly related to the proposed future operations of the
Property
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statements of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3. RENT REVENUE
Office and retail space is leased to tenants under various operating leases
with terms ranging from one to fifteen years. The leases generally provide for
minimum rent and reimbursement of real estate taxes, common area maintenance,
and certain other operating expenses. Certain leases also contain provisions
for percentage rent. Percentage rent earned for the year ended December 31,
1996, approximated $69,000.
Future minimum rentals (base rent) to be received under noncancelable
operating leases in effect at December 31, 1996, are as follows:
<TABLE>
<S> <C>
1997............................. $ 2,163,023
1998............................. 1,898,156
1999............................. 1,640,568
2000............................. 1,354,578
2001............................. 1,080,401
Thereafter....................... 2,667,649
-----------
$10,804,375
===========
</TABLE>
F-44
<PAGE>
50 PENN PLACE
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
YEAR ENDED DECEMBER 31, 1996
AND NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
4. CONCENTRATION OF CREDIT RISK
At December 31, 1996, one tenant, General Services Administration, accounted
for more than 10% of total revenue. Rent revenue earned from the tenant for the
year ended December 31, 1996, approximated $494,000.
5. COMMITMENTS
At December 31, 1996, the Property had two noncancelable service agreements
which expire in March and July 1999. The future minimum payments under the
agreements at December 31, 1996, are as follows:
<TABLE>
<S> <C>
1997................................ $109,524
1998................................ 109,524
1999................................ 56,381
--------
$275,429
========
</TABLE>
F-45
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Bear Canyon Shopping Center for the nine months ended September 30, 1996.
This statement is the responsibility of Southwest Royalties Holdings, Inc.'s
management. Our responsibility is to express an opinion on this statement
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Bear Canyon Shopping Center's
revenue and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Bear Canyon Shopping Center for the nine months ended September 30, 1996,
in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
July 31, 1997
F-46
<PAGE>
BEAR CANYON SHOPPING CENTER
STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C>
Revenue
Rent (Note 3)....................................................... $165,590
Recoveries from tenants............................................. 77,713
--------
243,303
--------
Certain expenses
Property taxes...................................................... 23,001
Marketing expense................................................... 5,450
Repairs and maintenance............................................. 31,376
Utilities........................................................... 17,328
Management fees..................................................... 8,516
Sales taxes......................................................... 9,065
Security............................................................ 1,238
Insurance........................................................... 4,021
Other............................................................... 7,472
--------
107,467
--------
Revenue in excess of certain expenses............................. $135,836
========
</TABLE>
See accompanying notes to statement of revenue and certain expenses.
F-47
<PAGE>
BEAR CANYON SHOPPING CENTER
NOTES TO STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
1.BASIS OF PRESENTATION
The accompanying statement of revenue and certain expenses relates to the
operations of Bear Canyon Shopping Center (the "Property"), an office and
retail building located in Tucson, Arizona. The property, along with two other
offices and retail buildings located in Tucson, Arizona, was purchased by
Midland Red Oak Realty, Inc., a subsidiary of Southwest Royalties Holdings,
Inc. ("SRH"), for an aggregate of $12,500,000 in cash on October 15, 1996.
The accompanying statement of revenue and certain expenses has been prepared
using the accrual basis of accounting for the purpose of complying with the
rules and regulations of the Securities and Exchange Commission ("SEC") for
inclusion in the registration statement on Form S-4 of SRH and are presented
in accordance with Rule 3.14 of SEC Regulation S-X, which allows audited
statements to be presented for only the most recent period if the properties
were purchased from an unrelated party and if the registrant makes certain
disclosures regarding factors considered in purchasing the Property (see the
Business section of the Prospectus).
The statement is not representative of the actual results of operations of
the property for the nine months ended September 30, 1996 due to the exclusion
of the following expenses, which may not be comparable to the proposed future
operations of the Property:
.Depreciation and amortization
.Interest on mortgage which was not assumed by SRH
.Federal and state income taxes
.Other costs not directly related to the proposed future operations of the
property
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statement of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3.RENT REVENUE
Office and retail space is leased to tenants under various operating leases
with terms ranging from one to 30 years. The leases generally provide for
minimum rent and reimbursement of real estate taxes, common area maintenance
and certain operating expenses.
Future minimum rentals to be received in calendar years subsequent to
September 30, 1996 under noncancelable operating leases in effect at the date
of this report are as follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------
<S> <C>
1997...................................... $ 272,535
1998...................................... 245,924
1999...................................... 188,519
2000...................................... 164,270
2001...................................... 150,571
Thereafter................................ 262,072
----------
$1,283,891
==========
</TABLE>
F-48
<PAGE>
BEAR CANYON SHOPPING CENTER
NOTES TO STATEMENT OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
(4)CONCENTRATION OF CREDIT RISK
At September 30, 1996, two tenants individually accounted for more than 10%
of total revenue. Rent revenue earned, including recoveries and percentage
rents from these tenants for the nine months ended September 30, 1996, were as
follows:
<TABLE>
<S> <C>
Tenant A............................. $27,434
Tenant B............................. 24,329
</TABLE>
F-49
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Bears Path Center for the nine months ended September 30, 1996. This
statement is the responsibility of Southwest Royalties Holdings, Inc.'s
management. Our responsibility is to express an opinion on this statement
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Bears Path Center's revenue
and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Bears Path Center for the nine months ended September 30, 1996, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
July 31, 1997
F-50
<PAGE>
BEARS PATH CENTER
STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C>
Revenue
Rent (Note 3)....................................................... $107,561
Recoveries from tenants............................................. 43,513
Other............................................................... 395
--------
151,469
--------
Certain expenses
Property taxes...................................................... 36,913
Marketing expense................................................... 6,406
Repairs and maintenance............................................. 26,857
Utilities........................................................... 9,070
Management fees..................................................... 7,485
Sales taxes......................................................... 5,569
Security............................................................ 825
Insurance........................................................... 3,080
Other............................................................... 6,979
--------
103,184
--------
Revenue in excess of certain expenses............................. $ 48,285
========
</TABLE>
See accompanying notes to statement of revenue and certain expenses.
F-51
<PAGE>
BEARS PATH CENTER
NOTES TO STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
1. BASIS OF PRESENTATION
The accompanying statement of revenue and certain expenses relates to the
operations of Bears Path Center (the "Property"), an office and retail
building located in Tucson, Arizona. The property, along with two other office
and retail buildings located in Tucson, Arizona, was purchased by Midland Red
Oak Realty, Inc., a subsidiary of Southwest Royalties Holdings, Inc. ("SRH"),
for an aggregate of $12,500,000 in cash on October 15, 1996.
The accompanying statement of revenue and certain expenses has been prepared
using the accrual basis of accounting for the purpose of complying with the
rules and regulations of the Securities and Exchange Commission ("SEC") for
inclusion in the registration statement on Form S-4 of SRH and are presented
in accordance with Rule 3.14 of SEC Regulation S-X, which allows audited
statements to be presented for only the most recent period if the properties
were purchased from an unrelated party and if the registrant makes certain
disclosures regarding factors considered in purchasing the Property (see the
Business section of the Prospectus).
The statement is not representative of the actual results of operations of
the property for the nine months ended September 30, 1996 due to the exclusion
of the following expenses, which may not be comparable to the proposed future
operations of the Property:
.Depreciation and amortization
.Interest on mortgage which was not assumed by SRH
.Federal and state income taxes
.Other costs not directly related to the proposed future operations of the
property
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statement of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3.RENT REVENUE
Office and retail space is leased to tenants under various operating leases
with terms ranging from one to 15 years. The leases generally provide for
minimum rent and reimbursement of real estate taxes, common area maintenance
and certain operating expenses.
Future minimum rentals to be received in calendar years subsequent to
September 30, 1996 under noncancelable operating leases in effect at the date
of this report are as follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------
<S> <C>
1997........................................ $170,059
1998........................................ 166,026
1999........................................ 167,894
2000........................................ 132,163
2001........................................ 53,092
Thereafter.................................. 131,357
--------
$820,591
========
</TABLE>
F-52
<PAGE>
BEARS PATH CENTER
NOTES TO STATEMENT OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
4.CONCENTRATION OF CREDIT RISK
At September 30, 1996, four tenants individually accounted for more than 10%
of total revenue. Rent revenue earned, including recoveries and percentage
rents from these tenants for the nine months ended September 30, 1996, were as
follows:
<TABLE>
<S> <C>
Tenant A............................. $32,683
Tenant B............................. 28,351
Tenant C............................. 19,508
Tenant D............................. 17,414
</TABLE>
F-53
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Colonnade at Polo Park Venture for the year ended December 31, 1996. This
statement is the responsibility of Colonnade at Polo Park Venture's
management. Our responsibility is to express an opinion on this statement
based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Colonnade at Polo Park
Venture's revenue and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Colonnade at Polo Park Venture for the year ended December 31, 1996, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Midland, Texas
July 22, 1997
F-54
<PAGE>
COLONNADE AT POLO PARK VENTURE
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Revenue
Rent (Notes 3 and 4)............................... $650,522 $548,134
Recoveries from tenants............................ 25,199 21,713
Other.............................................. -- 52,769
-------- --------
675,721 622,616
-------- --------
Certain expenses
Property taxes..................................... 74,679 74,586
Repairs and maintenance............................ 72,807 31,918
Management fees.................................... 21,600 16,200
General and administrative......................... 15,016 7,201
Insurance.......................................... 34,526 26,091
Utilities.......................................... 57,848 57,281
Leasing commission................................. 4,135 --
Other.............................................. 9,947 5,290
-------- --------
290,558 218,567
-------- --------
Revenue in excess of certain expenses............ $385,163 $404,049
======== ========
</TABLE>
See accompanying notes to statements of revenue and certain expenses.
F-55
<PAGE>
COLONNADE AT POLO PARK VENTURE
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying statements of revenue and certain expenses relates to the
operations of Colonnade at Polo Park Venture (the "Property"), a shopping
center located in Midland, Texas. As of July 22, 1997, Midland Red Oak Realty,
Inc. ("Red Oak"), a subsidiary of Southwest Royalties Holdings, Inc. ("SRH")
has executed a formal Purchase and Sale Agreement to acquire the Property for
approximately $3,950,000.
The accompanying statements of revenue and certain expenses have been
prepared using the accrual basis of accounting for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission
("SEC") for inclusion in the registration statement on Form S-4 of SRH and are
presented in accordance with Rule 3.14 of SEC Regulation S-X, which allows
audited statements to be presented for only the most recent period if the
properties were purchased from an unrelated party and if the registrant makes
certain disclosures regarding factors considered in purchasing the Property
(see the Business section of the Prospectus).
The statements are not representative of the actual results of operations of
the Property for the year ended December 31, 1996 and the nine months ended
September 30, 1997, due to the exclusion of the following expenses, which may
not be comparable to the proposed future operations of the Property:
.Depreciation and amortization
.Mortgage interest which will not be assumed by SRH
.Federal income taxes
.Other costs not directly related to the proposed future operations of the
Property
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statements of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3. RENT REVENUE
Retail space is leased to tenants under various operating leases with terms
ranging from one to 10 years. The leases generally provide for minimum rent
and reimbursement of common area maintenance and certain other operating
expenses. Certain leases also contain provisions for percentage rent.
Percentage rent earned for the year ended December 31, 1996 was $14,376.
Future minimum rentals to be received under noncancelable operating leases
in effect at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997.............................. $ 596,615
1998.............................. 571,626
1999.............................. 363,214
2000.............................. 177,747
2001.............................. 165,481
Thereafter........................ 170,752
----------
$2,045,435
==========
</TABLE>
F-56
<PAGE>
COLONNADE AT POLO PARK VENTURE
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
4. CONCENTRATION OF CREDIT RISK
At December 31, 1996, two tenants individually accounted for more than 10%
of total revenue. Rent revenue earned from these tenants for the year ended
December 31, 1996 were as follows:
<TABLE>
<S> <C>
Tenant A............................ $ 92,523
Tenant B............................ 100,352
</TABLE>
F-57
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Independence Plaza, Ltd. for the year ended December 31, 1996. This
statement is the responsibility of Independence Plaza, Ltd.'s management. Our
responsibility is to express an opinion on this statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Independence Plaza, Ltd.'s
revenue and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Independence Plaza, Ltd. for the year ended December 31, 1996, in
conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Midland, Texas
July 22, 1997
F-58
<PAGE>
INDEPENDENCE PLAZA, LTD.
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Revenue
Rent (Notes 3 and 4)............................... $1,077,986 $844,301
Other.............................................. 1,145 32,427
---------- --------
1,079,131 876,728
---------- --------
Certain expenses
Property taxes..................................... 98,346 69,502
Repairs and maintenance............................ 175,054 199,428
Management fees.................................... 37,500 27,000
General and administrative......................... 87,887 80,465
Insurance.......................................... 20,964 12,935
Security service................................... 19,841 13,755
Utilities.......................................... 219,387 175,083
Other.............................................. 17,230 18,360
---------- --------
676,209 596,528
---------- --------
Revenue in excess of certain expenses............ $ 402,922 $280,200
========== ========
</TABLE>
See accompanying notes to statements of revenue and certain expenses.
F-59
<PAGE>
INDEPENDENCE PLAZA, LTD.
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying statements of revenue and certain expenses relates to the
operations of Independence Plaza, Ltd. (the "Property"), an office building
located in Midland, Texas. As of July 22, 1997, Midland Red Oak Realty, Inc.
("Red Oak"), a subsidiary of Southwest Royalties Holdings, Inc. ("SRH") has
executed a formal Purchase and Sale Agreement to acquire the Property for
approximately $4,450,000.
The accompanying statements of revenue and certain expenses have been
prepared using the accrual basis of accounting for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission
("SEC")for inclusion in the registration statement on Form S-4 of SRH and are
presented in accordance with Rule 3.14 of SEC Regulations S-X, which allows
audited statements to be presented for only the most recent period if the
properties were purchased from an unrelated party and if the registrant makes
certain disclosures ragarding factors considered in purchasing the Property
(see the Business section of the Prospectus).
The statements are not representative of the actual results of operations of
the Property for the year ended December 31, 1996 and the nine months ended
September 30, 1997, due to the exclusion of the following expenses, which may
not be comparable to the proposed future operations of the Property:
.Depreciation and amortization
.Mortgage interest which will not be assumed by SRH
.Federal income taxes
.Other costs not directly related to the proposed future operations of the
Property
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statements of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3. RENT REVENUE
Retail space is leased to tenants under various operating leases with terms
ranging from one to 25 years. The leases generally provide for minimum rent
and reimbursement of certain operating expenses.
Future minimum rentals to be received under noncancelable operating leases
in effect at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997.............................. $1,012,710
1998.............................. 958,540
1999.............................. 796,520
2000.............................. 399,350
2001.............................. 371,827
Thereafter........................ 1,376,516
----------
$4,915,463
==========
</TABLE>
F-60
<PAGE>
INDEPENDENCE PLAZA, LTD.
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
4. CONCENTRATION OF CREDIT RISK
At December 31, 1996, three tenants individually accounted for more than 10%
of total revenue. Rent revenue earned from these tenants for the year ended
December 31, 1996 were as follows:
<TABLE>
<S> <C>
Tenant A............................ $211,134
Tenant B............................ 198,060
Tenant C............................ 127,896
</TABLE>
F-61
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Madera Village Shopping Center for the nine months ended September 30,
1996. This statement is the responsibility of Southwest Royalties Holdings,
Inc.'s management. Our responsibility is to express an opinion on this
statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Madera Village Shopping
Center's revenue and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Madera Village Shopping Center for the nine months ended September 30,
1996, in conformity with generally accepted accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
July 31, 1997
F-62
<PAGE>
MADERA VILLAGE SHOPPING CENTER
STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
<TABLE>
<S> <C>
Revenue
Rent (Note 3)....................................................... $574,801
Recoveries from tenants............................................. 237,826
Other............................................................... 929
--------
813,556
--------
Certain expenses
Property taxes...................................................... 150,190
Marketing expense................................................... 5,132
Repairs and maintenance............................................. 35,811
Utilities........................................................... 13,986
Management fees..................................................... 26,152
Sales taxes......................................................... 29,866
Security............................................................ 1,237
Insurance........................................................... 3,822
Other............................................................... 9,568
--------
275,764
--------
Revenue in excess of certain expenses............................. $537,792
========
</TABLE>
See accompanying notes to statement of revenue and certain expenses.
F-63
<PAGE>
MADERA VILLAGE SHOPPING CENTER
NOTES TO STATEMENT OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
1.BASIS OF PRESENTATION
The accompanying statement of revenue and certain expenses relates to the
operations of Madera Village Shopping Center (the "Property"), an office and
retail building located in Tucson, Arizona. The property, along with two other
office and retail buildings located in Tucson, Arizona, was purchased by
Midland Red Oak Realty, Inc., a subsidiary of Southwest Royalties Holdings,
Inc. ("SRH"), for an aggregate of $12,500,000 in cash on October 15, 1996.
The accompanying statement of revenue and certain expenses has been prepared
using the accrual basis of accounting for the purpose of complying with the
rules and regulations of the Securities and Exchange Commission ("SEC") for
inclusion in the registration statement on Form S-4 of SRH and are presented
in accordance with Rule 3.14 of SEC Regulation S-X, which allows audited
statements to be presented for only the most recent period if the properties
were purchased from an unrelated party and if the registrant makes certain
disclosures regarding factors considered in purchasing the Property (see the
Business section of the Prospectus).
The statement is not representative of the actual results of operations of
the property for the nine months ended September 30, 1996 due to the exclusion
of the following expenses, which may not be comparable to the proposed future
operations of the Property:
.Depreciation and amortization
.Interest on mortgage which was not assumed by SRH
.Federal and state income taxes
.Other costs not directly related to the proposed future operations of the
property
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statement of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3.RENT REVENUE
Office and retail space is leased to tenants under various operating leases
with terms ranging from one to 40 years. The leases generally provide for
minimum rent and reimbursement of real estate taxes, common area maintenance
and certain operating expenses.
Future minimum rentals to be received in calendar years subsequent to
September 30, 1996 under noncancelable operating leases in effect at the date
of this report are as follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------
<S> <C>
1997...................................... $ 789,816
1998...................................... 752,246
1999...................................... 709,935
2000...................................... 627,072
2001...................................... 578,017
Thereafter................................ 3,569,266
----------
$7,026,352
==========
</TABLE>
F-64
<PAGE>
MADERA VILLAGE SHOPPING CENTER
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996
4.CONCENTRATION OF CREDIT RISK
At September 30, 1996, three tenants individually accounted for more than
10% of total revenue. Rent revenue earned, including recoveries and percentage
rents from these tenants for the nine months ended September 30, 1996, were as
follows:
<TABLE>
<S> <C>
Tenant A............................ $228,684
Tenant B............................ 104,505
Tenant C............................ 98,229
</TABLE>
F-65
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Plaza Palomino for the year ended December 31, 1996. This statement is the
responsibility of Southwest Royalties Holdings, Inc.'s management. Our
responsibility is to express an opinion on this statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
It is not intended to be a complete presentation of Plaza Palomino's revenue
and expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Plaza Palomino for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
July 18, 1997
F-66
<PAGE>
PLAZA PALOMINO
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE THREE MONTHS ENDED MARCH 31, 1997
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1996 1997
------------ ------------
(UNAUDITED)
<S> <C> <C>
Revenue
Rent (Note 3)....................................... $ 945,537 257,090
Recoveries from tenants............................. 198,594 75,569
Other............................................... 13,210 10,057
---------- --------
1,157,341 342,716
---------- --------
Certain expenses
Property taxes...................................... 114,906 28,726
Marketing expense................................... 113,686 32,761
Repairs and maintenance............................. 82,302 21,719
Utilities........................................... 77,367 16,762
Management fees..................................... 55,320 16,578
Administrative salaries............................. 43,695 9,495
Sales taxes......................................... 38,820 9,101
Security............................................ 14,343 1,955
Insurance........................................... 8,222 1,526
Other............................................... 28,117 7,996
---------- --------
576,778 146,619
---------- --------
Revenue in excess of certain expenses............. $ 580,563 196,097
========== ========
</TABLE>
See accompanying notes to statements of revenue and certain expenses.
F-67
<PAGE>
PLAZA PALOMINO
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE YEAR ENDED DECEMBER 31, 1996 AND
FOR THE THREE MONTHS ENDED MARCH 31, 1997
1. BASIS OF PRESENTATION
The accompanying statements of revenue and certain expenses relate to the
operations of Plaza Palomino (the "Property"), an office and retail building
located in Tucson, Arizona. The property was purchased by Midland Red Oak
Realty, Inc., a subsidiary of Southwest Royalties Holdings, Inc. ("SRH"), for
$7,025,000 in cash on April 7, 1997.
The accompanying statements of revenue and certain expenses have been
prepared using the accrual basis of accounting for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission
("SEC") for inclusion in the registration statement on Form S-4 of SRH and are
presented in accordance with Rule 3.14 of SEC Regulation S-X, which allows
audited statements to be presented for only the most recent period if the
properties were purchased from an unrelated party and if the registrant makes
certain disclosures regarding factors considered in purchasing the Property
(see the Business section of the Prospectus).
The statements are not representative of the actual results of operations of
the property for the year ended December 31, 1996 and for the three months
ended March 31, 1997 due to the exclusion of the following expenses, which may
not be comparable to the proposed future operations of the Property:
.Depreciation and amortization
.Interest on mortgage which was not assumed by SRH
.Federal and state income taxes
.Other costs not directly related to the proposed future operations of the
property
2.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statements of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3. RENT REVENUE
Office and retail space is leased to tenants under various operating leases
with terms ranging from one to 15 years. The leases generally provide for
minimum rent and reimbursement of real estate taxes, common area maintenance
and certain operating expenses.
Future minimum rentals to be received under noncancelable operating leases
subsequent to December 31, 1996, in effect at the date of this report are as
follows:
<TABLE>
<CAPTION>
YEARS ENDING DECEMBER 31,
-------------------------
<S> <C>
1997...................................... $1,023,781
1998...................................... 916,149
1999...................................... 621,427
2000...................................... 385,561
2001...................................... 181,659
Thereafter................................ 242,783
----------
$3,371,360
==========
</TABLE>
F-68
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
Southwest Royalties Holdings, Inc. and Subsidiaries:
We have audited the accompanying statement of revenue and certain expenses
of Crossroads Mall for the nine months ended December 31, 1996. This statement
is the responsibility of Crossroads Mall management. Our responsibility is to
express an opinion on this statement based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the statement of revenue and certain
expenses is free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the statement.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the statement. We believe that our audit provides a reasonable
basis for our opinion.
The accompanying statement of revenue and certain expenses, as described in
Note 1, was prepared for the purpose of complying with the rules and
regulations of the Securities and Exchange Commission for inclusion in the
registration statement on Form S-4 of Southwest Royalties Holdings, Inc. and
is not intended to be a complete presentation of Crossroads Mall revenue and
expenses.
In our opinion, the statement referred to above presents fairly, in all
material respects, the revenue and certain expenses, as described in Note 1,
of Crossroads Mall for the nine months ended December 31, 1996, in conformity
with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
San Antonio, Texas
September 17, 1997
F-69
<PAGE>
CROSSROADS MALL
STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
NINE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Revenue:
Minimum rent....................................... $2,390,188 $2,283,278
Percentage rent.................................... 336,433 94,048
Expense recoveries................................. 1,028,673 1,032,712
Other.............................................. 69,343 104,178
---------- ----------
3,824,637 3,514,216
---------- ----------
Certain expenses:
Property taxes..................................... 609,586 535,759
Repairs and maintenance............................ 958,523 939,796
Utilities.......................................... 320,407 295,836
Security........................................... 152,115 129,708
Management fees.................................... 132,367 135,000
Marketing.......................................... 247,533 166,231
Other operating expenses........................... 243,597 269,735
---------- ----------
2,664,128 2,472,065
---------- ----------
Revenue in excess of certain expenses................ $1,160,509 $1,042,151
========== ==========
</TABLE>
See accompanying notes to statements of revenue and certain expenses.
F-70
<PAGE>
CROSSROADS MALL
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES
FOR THE NINE MONTHS ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying statements of revenue and certain expenses relates to the
operations of Crossroads Mall (the "Property"), a two-level enclosed shopping
center located in San Antonio, Texas. The property was purchased by Midland
Red Oak Realty ("Red Oak"), a subsidiary of Southwest Royalties Holdings, Inc.
("SRH") for $15,000,000 on October 23, 1997.
The accompanying statements of revenue and certain expenses have been
prepared using the accrual basis of accounting for the purpose of complying
with the rules and regulations of the Securities and Exchange Commission
("SEC") for inclusion in the registration statement on Form S-4 of SRH and are
presented in accordance with Rule 3.14 of SEC Regulation S-X, which allows
audited statements to be presented for only the most recent period if the
properties were purchased from an unrelated party and if the registrant makes
certain disclosures regarding factors considered in purchasing the Property
(see the Business section of the Prospectus).
The statements are not representative of the actual results of operations of
the Property for the nine months ended December 31, 1996 and the nine months
ended September 30, 1997, due to the exclusion of the following expenses,
which may not be comparable to the proposed future operations of the Property:
. Depreciation and amortization
. Interest on mortgage which will not be assumed by SRH
. Federal income taxes
. Other costs not directly related to the proposed future operations of the
Property
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
Rent revenue is recognized on a straight-line basis over the term of the
individual leases.
Use of Estimates
Management of the Property has made a number of estimates and assumptions
relating to the reporting and disclosure of revenue and certain expenses
during the reporting period to prepare the statements of revenue and certain
expenses in conformity with generally accepted accounting principles. Actual
results could differ from those estimates.
3. RENT REVENUE
Retail space is leased to tenants under various operating leases with terms
ranging from one to 40 years. The leases generally provide for minimum rent
and reimbursement of common area maintenance and certain other operating
expenses. Certain leases also contain provisions for percentage rent.
Future minimum rentals to be received under noncancelable operating leases
in effect at December 31, 1996 are as follows:
<TABLE>
<S> <C>
1997.......................................................... $2,754,757
1998.......................................................... 2,684,056
1999.......................................................... 2,553,856
2000.......................................................... 2,291,137
2001.......................................................... 2,051,763
Thereafter.................................................... 3,276,010
-----------
$15,611,579
===========
</TABLE>
F-71
<PAGE>
CROSSROADS MALL
NOTES TO STATEMENTS OF REVENUE AND CERTAIN EXPENSES--(CONTINUED)
FOR THE NINE MONTHS ENDED DECEMBER 31, 1996 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
Certain lessees have filed Chapter 11 bankruptcy. Accordingly, collection of
future rentals under existing lease agreements is not reasonably assured;
thus, future rentals related to such lessees are not included in the above
minimum rental amounts. Management of the Property believes that all rental
revenues recognized through September 30, 1997 are collectible. They will
continuously monitor the various bankruptcy situations and recognize rental
revenues only to the extent that collection is concluded to be reasonably
assured.
4. CONCENTRATION OF CREDIT RISK
At December 31, 1996, five tenants aggregated accounted for approximately
42% of total revenue. Rent revenue earned from such tenants for the nine
months ended December 31, 1996 was as follows:
<TABLE>
<S> <C>
Tenant A (Chapter 11 bankruptcy)................................. $393,517
Tenant B......................................................... 381,143
Tenant C......................................................... 348,900
Tenant D......................................................... 265,262
Tenant E......................................................... 200,746
</TABLE>
5. MANAGEMENT AGREEMENT
The Property has a real estate management agreement with a realty service
company. This agreement can be terminated at the Property's option. A
management fee of 3 1/2 percent of gross collected revenues versus a minimum
fee of $15,000 is payable to the management company monthly. Total management
fees for the nine months ended December 31, 1996, were approximately $132,000.
F-72
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO DEALER, SALESMAN OR OTHER PERSON IS AUTHORIZED IN CONNECTION WITH ANY OF-
FERING MADE HEREBY TO GIVE INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CON-
TAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRE-
SENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR
THE INITIAL PURCHASERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL,
OR THE SOLICITATION OF AN OFFER TO BUY, ANY OF THE NOTES OFFERED HEREBY IN ANY
JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLIC-
ITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY
SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, IMPLY THAT THE INFORMATION
HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF.
---------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information..................................................... 3
Incorporation by Reference................................................ 4
Prospectus Summary........................................................ 5
Forward-Looking Statements................................................ 18
Risk Factors.............................................................. 19
The Company............................................................... 26
Private Placement......................................................... 29
Use of Proceeds........................................................... 29
Capitalization............................................................ 30
Selected Historical and Pro Forma Financial Information................... 31
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 34
Business.................................................................. 42
Management................................................................ 58
Principal Stockholders and Ownership of Management........................ 61
Certain Transactions...................................................... 61
Exchange Offer............................................................ 62
Description of Notes...................................................... 69
Exchange and Registration Rights Agreement................................ 98
Certain United States Federal Income Tax Considerations................... 100
Plan of Distribution...................................................... 102
Transfer Restrictions on Old Notes........................................ 104
Legal Matters............................................................. 106
Experts................................................................... 106
Glossary of Terms......................................................... 107
Index to Financial Statements............................................. I-1
</TABLE>
FOR 180 DAYS AFTER THE COMPLETION OF THE EXCHANGE OFFER, ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
$200,000,000
LOGO
[LOGO OF SOUTHWEST ROYALTIES, INC. APPEARS HERE]
SOUTHWEST ROYALTIES, INC.
OFFER TO EXCHANGE 10 1/2% SERIES B SENIOR NOTES DUE 2004 FOR 10 1/2% SERIES A
SENIOR NOTES DUE 2004
---------------
PROSPECTUS
---------------
February 9, 1998
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
