1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2000
or
? Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________ to __________
Commission file number: 000-23701
SOUTHWEST ROYALTIES, INC. SOUTHWEST ROYALTIES
(Exact Name of Registrant as HOLDINGS, INC.
Specified in Its Charter) (Exact Name of Registrant
as
Specified in Its Charter)
Delaware Delaware
(State or Other Jurisdiction of (State or Other
Jurisdiction of
Incorporation or Organization) Incorporation or
Organization)
75-1917432 75-2724264
(I.R.S. Employer (I.R.S. Employer
Identification Number) Identification Number)
407 North Big Spring, Suite 300
Midland, Texas 79701
(Address of Principal Executive Offices) (Zip Code)
(915) 686-9927
Registrants' Telephone Number, Including Area Code:
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No ___
Number of shares of common stock outstanding as of September 30, 2000 for
Southwest Royalties, Inc 100.
Number of shares of common and redeemable common stock outstanding as of
September 30, 2000 for Southwest Royalties Holdings, Inc 1,075,534.
<PAGE>
SOUTHWEST ROYALTIES, INC.
SOUTHWEST ROYALTIES HOLDINGS, INC.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION Page
Item 1. Consolidated Financial Statements
Consolidated Balance Sheets as of September 30, 2000
(unaudited) and December 31, 1999 3
Consolidated Statements of Operations for the
three and nine months ended September 30, 2000
and 1999 (unaudited) 5
Consolidated Statements of Cash Flows for the three
and nine months ended September 30, 2000
and 1999 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 26
PART II - OTHER INFORMATION
Item 6. Reports on Form 8-K and Exhibits 28
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share data)
September 30,December 31,
2000 1999
-----------------------
(unaudited)
ASSETS
---------------------------------------------------------
Current assets
Cash and cash equivalents $ 17,630 $ 16,983
Restricted cash 5,943 10,003
Accounts receivable, net of allowance of $558 and
$440, respectively 10,716 7,134
Receivables from related parties 1,664 836
Other current assets 2,355 1,179
------- -------
Total current assets 38,308 36,135
------- -------
Oil and gas properties, using the full cost
method of accounting
Proved 200,036 193,319
Unproved 1,588 2,059
------- -------
201,624 195,378
Less accumulated depletion, depreciation and
amortization 130,554 126,742
------- -------
Oil and gas properties, net 71,070 68,636
------- -------
Rental property, net 130,001 128,685
------- -------
Rental property - construction in progress 5,391 3,984
------- -------
Other property and equipment, net 4,692 4,841
------- -------
Other assets
Real estate investments 3,024 3,644
Deferred debt costs, net of accumulated
amortization of $4,908 and $2,005, respectively 7,762
13,816
Noncompete covenants, net of accumulated
amortization of $784 and $563, respectively 820 1,041
Other, net 1,315 1,385
------- -------
Total other assets 12,921 19,886
------- -------
Total assets $262,383 $ 262,167
======= =======
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except per share data)
September 30,December 31,
2000 1999
--------- -----------
(unaudited)
LIABILITIES, MINORITY INTEREST, REDEEMABLE
COMMON STOCK AND STOCKHOLDERS' DEFICIT
---------------------------------------------------------
Current liabilities
Current maturities of long-term debt $ 23,174 $ 40,277
Accounts payable 5,713 6,011
Accounts payable to related parties 884 867
Accrued expenses 6,462 5,896
Accrued interest payable 7,772 4,774
------- -------
Total current liabilities 44,005 57,825
------- -------
Long-term debt 312,098 306,806
------- -------
Other long-term liabilities 1,671 1,220
------- -------
Minority interest - 8
------- -------
Redeemable common stock of subsidiary - 1,228
------- -------
Redeemable common stock - 129,046 shares issued 8,290
8,290
------- -------
Stockholders' deficit
Preferred stock - $1 par value; 5,000,000
shares authorized; none issued - -
Common stock - $.10 par value; 5,000,000 shares
authorized; 1,161,037 issued at September 30, 2000
and December 31, 1999 116 116
Additional paid-in capital 2,196 2,196
Accumulated deficit (101,259) (110,784)
Note receivable from an officer and
stockholder (1,624) (1,648)
Less: treasury stock - at cost; 214,549 shares at
September 30, 2000 and 214,215 at December 31, 1999 (3,110)
(3,090)
------- -------
Total stockholders' deficit (103,681) (113,210)
------- -------
Total liabilities, minority interest, redeemable
common stock and stockholders' deficit $262,383 $ 262,167
======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
------ ------ ------ ------
Operating revenues
Oil and gas $14,955 $ 8,115 $39,297 $21,169
Real estate 7,933 7,985 23,391 23,936
Other 118 599 291 1,107
------ ------ ------ ------
Total operating revenues 23,006 16,699 62,979 46,212
------ ------ ------ ------
Operating expenses
Oil and gas production 3,969 2,871 11,152 8,502
Real estate 4,558 4,741 13,714 13,493
General and administrative, net of
related party management and
administrative fees of $798, $934,
$2,467 and $2,625, respectively 1,242 651 3,243
2,132
Depreciation, depletion and
amortization 2,644 1,837 7,825 7,123
Other 165 120 754 579
------ ------ ------ ------
Total operating expenses 12,578 10,220 36,688 31,829
------ ------ ------ ------
Operating income 10,428 6,479 26,291 14,383
------ ------ ------ ------
Other income (expense)
Interest and dividend income 327 269 841 681
Interest expense (10,922) (10,277) (32,398) (31,340)
Other 405 286 1,030 431
------ ------ ------ ------
(10,190) (9,722) (30,527) (30,228)
------ ------ ------ ------
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
(in thousands, except per share data)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
2000 1999 2000 1999
------ ----- ----- -----
Income (Loss) before income taxes,
minority interest, equity
loss and extraordinary item $ 238 $ (3,243) $ (4,236) $(15,845)
Income tax benefit (provision) - - -
-
--------- --------- --------- ---------
Income (Loss) before minority interest,
equity loss and extraordinary item 238 (3,243) (4,236)
(15,845)
Minority interest in subsidiaries,
net of tax (33) (67) 1,139 -
Equity in loss in subsidiary
and partnerships, net of tax - - -
(931)
--------- --------- --------- ---------
Income (Loss) before extraordinary
item 205 (3,310) (3,097) (16,776)
Extraordinary gain (loss) from
early extinguishment of debt (1,374) (5) 12,622
(1,598)
--------- --------- --------- ---------
Net income (loss) $ (1,169) $ (3,315) $ 9,525 $(18,374)
========= ========= ========= =========
Income (Loss) per common share before
extraordinary item $ .19 $ (3.08) $ (2.88) $
(15.60)
Extraordinary gain (loss) from
early extinguishment of debt (1.27) (.01) 11.74
(1.49)
--------- --------- --------- ---------
Income (loss) per common share $ (1.08) $ (3.09) $ 8.86 $ (17.09)
========= ========= ========= =========
Weighted average shares outstanding 1,075,868 1,075,868 1,075,868
1,075,868
========= ========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
2000 1999 2000 1999
------ ----- ----- -----
Cash flows from operating activities
Net income (loss) $(1,169) $(3,315) $ 9,525 $(18,374)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation, depletion and
amortization 2,644 1,837 7,825 7,123
Noncash interest expense 2,314 1,708 7,492 4,218
Extraordinary (gain) loss from early
extinguishment of debt 1,374 5 (12,622) 1,598
Gain on sale of assets (208) (194) (456) (196)
Equity (income) loss of subsidiary
and partnerships - - - 187
Impairment of equity investment - - -
744
Other noncash items 153 77 492 839
Amortization of lease commissions 41 - 145
-
Bad debt expense 100 127 240 226
Minority interest (income) loss
of subsidiary 33 67 (1,139) -
Changes in operating assets
and liabilities -
Accounts receivable (2,178) (498) (4,664) (1,432)
Other current assets (736) 197 (1,205) (123)
Accounts payable and accrued
expenses 2,153 1,374 (195) 703
Changes in restricted cash 2,744 - 4,956 -
Accrued interest payable 3,202 5,386 2,998 5,133
------ ------ ------ ------
Net cash provided by operating
activities 10,467 6,771 13,392 646
------ ------ ------ ------
Cash flows from investing activities
Proceeds from sale of oil and
gas properties 162 328 498 5,533
Purchase of oil and gas properties (2,934) (1,670) (6,744)
(2,454)
Purchase of other property and
equipment and rental property (2,120) (1,940) (6,419)
(4,413)
Purchase of other assets (586) (106) (622) (563)
Proceeds from sale of real estate
investments 410 17 1,053 631
Proceeds from sale of other assets 27 24 46
366
Proceeds from sale of other property
equipment and rental property 7 2,268 87
3,336
Purchase of real estate investments - - -
(30)
(continued)
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(in thousands)
(unaudited)
Three months ended Nine months ended
September 30, September 30,
----------------- -----------------
2000 1999 2000 1999
------ ----- ----- -----
Change in restricted cash $ (61) $ (500) $ (896) $ 408
Other 8 7 24 23
------ ------ ------ ------
Net cash provided by (used in)
investing activities (5,087) (1,572) (12,973) 2,837
------ ------ ------ ------
Cash flows from financing activities
Proceeds from borrowings 54,403 2,576 75,922 105,816
Payments on debt (51,893) (2,315) (75,655) (98,393)
Increase (decrease) in other
long-term liabilities (2) 4 (47) (28)
Deferred debt cost (1,264) (5) (1,395) (4,078)
Refund of debt issue costs 1,500 - 1,500 -
Dividends paid to minority interest
owners (30) (30) (90) (91)
Prepayment penalty on early
extinguishment of debt - - - (875)
Purchase of minority interest of
subsidiary (8) - (8) -
Other - (1) 1 3
------ ------ ------ ------
Net cash provided by
financing activities 2,706 229 228 2,354
------ ------ ------ ------
Net increase in
unrestricted cash and cash
equivalents 8,086 5,428 647 5,837
Unrestricted cash and cash equivalents -
beginning of period 9,544 14,210 16,983 13,801
------ ------ ------ ------
Unrestricted cash and cash equivalents -
end of period $17,630 $19,638 $17,630 $19,638
====== ====== ====== ======
Non-cash investing and financing activities
Deferred debt cost incurred $ 1,000 $ - $ 1,000 $ -
Increase in other long-term
liabilities associated with
deferred debt costs $ 500 $ - $ 500 $ -
Increase in accrued expenses
associated with deferred debt costs $ 500 $ - $ 500
$ -
Supplemental disclosures of cash flow
information
Interest paid $ 5,693 $ 3,185 $21,908 $21,989
The accompanying notes are an integral part of these
consolidated financial statements
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies
Business
Southwest Royalties Holdings, Inc. ("SRH"), a Delaware corporation was
formed in June 1997 to serve as a holding company for Southwest Royalties
Inc. ("Southwest"), Basic Energy Service, Inc. ("Basic") and Midland Red
Oak Realty, Inc. ("Red Oak") (collectively, the "Company"). Each
shareholder of Southwest was issued one share in SRH for each share of
Southwest stock held. Prior to the formation of SRH, Red Oak and Basic
were subsidiaries of Southwest. Southwest paid a dividend of the shares it
owned in Red Oak and Basic to SRH. After the formation of SRH, Southwest
and Red Oak became subsidiaries of SRH and, as of July 1, 1997, Basic was
deconsolidated. In May 2000, Basic changed its name from Sierra Well
Services, Inc.
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 Basic. Southwest sells its oil and gas
production to a variety of purchasers, with the prices it receives being
dependent upon oil and gas commodity prices. Red Oak is principally
involved in real estate investment and development. Basic is principally
involved in the business of oil and gas well services.
Principles of Consolidation
The consolidated financial statements include the accounts of SRH and
its subsidiaries. As of September 30, 2000, the Company owned approximately
100% of Southwest, 81% of Red Oak and 100% of Blue Heel. Blue Heel is a
subsidiary of Southwest. Effective July 1, 1997, Basic was deconsolidated
and is accounted for using the equity method. Effective November 1999, TPI
was liquidated. Effective August 2000, Midland Southwest Software ("MSS")
a software subsidiary was merged into Southwest. The consolidated
financial statements include the Company's proportionate share of the
assets, liabilities, income and expenses of oil and gas limited
partnerships for which it serves as managing general partner. The Company
accounts for its investments in Southwest Partners II and III using the
equity method, as the Company exercises significant influence over the
operations of these partnerships. All significant intercompany
transactions have been eliminated.
Estimates and Uncertainties
Preparation of the accompanying consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly liquid debt instruments purchased with
a maturity of three months or less to be cash equivalents. In addition,
the Company maintains its excess cash in several interest bearing accounts
in various financial institutions.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Restricted Cash
Restricted cash represents amounts required to be reserved in separate
accounts by financial lenders. The interest sinking fund is cash set aside
to pay interest on 10.5% Senior Notes. Effective August 17, 2000, with the
refinancing of the Revolving Line of Credit, the interest sinking fund is
no longer required to be maintained.
Restricted cash accounts have been established for the following
purposes (in thousands):
September 30,December 31,
2000 1999
---- ----
Cash bonds - Red Oak $ - $ 35
Certificate of Deposits - Red Oak 118 112
Tenant security deposits - Red Oak 528 512
Capital expenditures account - Red Oak 1,448 552
Tax and insurance reserve - Red Oak 2,533 2,465
Lockbox - Red Oak 278 439
Customer service reserve - Red Oak 8 10
Interest reserve - Red Oak 281 -
Escrow fund - Southwest 749 627
Interest sinking - Southwest - 5,251
----- ------
$ 5,943 $ 10,003
===== ======
Real Estate Revenue Recognition
The Company leases offices and retail shopping centers under
noncancelable operating leases. The Company reports base rental revenue
for financial statement purposes straight-line over the terms of the
respective leases. Accrued straight-line rents represent the amount that
straight-line rental revenue exceeds rents collected in accordance with the
lease agreements. Management, considering current information and events
regarding the tenants' ability to fulfill their lease obligations,
considers accrued straight-line rents to be impaired if it is probable that
the Company will be unable to collect all rents due according to the
contractual lease terms. If accrued straight-line rents associated with a
tenant are considered to be impaired, the amount of the impairment is
measured based on the present value of expected future cash flows.
Impairment losses, if any, are recorded through a loss on the write-off of
assets. Cash receipts on impaired accrued straight-line rents are applied
to reduce the remaining outstanding balance and as rental revenue,
thereafter.
Some leases provide for percentage rents based on the tenant's revenue.
Percentage rents are accrued monthly based on prior experience or current
tenant financial information. Some leases require tenants to reimburse the
Company for certain expenses of operating the property.
Concentrations of Credit Risk
The Company is subject to credit risk through oil and gas trade
receivables and real estate lease receivables. Although a substantial
portion of its customers' ability to pay is dependent upon conditions in
the oil and gas industry as well as general economic conditions, credit
risk is reduced due to a large customer base.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Commodity Hedging and Derivative Financial Instruments
The Company has only limited involvement with derivative financial
instruments and generally does not use them for trading purposes. They are
used to manage commodity price risks. The Company is exposed to credit
losses in the event of nonperformance by the counter-parties to its
commodity hedges. The Company anticipates, however, that such counter-
parties will be able to fully satisfy their obligations under the
contracts. The Company does not obtain collateral or other security to
support financial instruments subject to credit risk but monitors the
credit standing of the counter-parties.
The derivative financial instruments that the Company accounts for as
hedging contracts must meet the following criteria: the underlying asset
must expose the Company to price risk that is not offset in another asset
or liability, the hedging contract must reduce that price risk, and the
instrument must be designated as a hedge at the inception of the contract
and throughout the contract period. In order to qualify as a hedge, there
must be clear correlation between changes in the fair value of the
financial instrument and the fair value of the underlying asset such that
changes in the market value of the financial instrument will be offset by
the effect of price changes on the exposed items.
Premiums paid for commodity option contracts which qualify as hedges are
amortized to oil and gas sales over the term of the agreements.
Unamortized premiums are included in other assets in the consolidated
balance sheet. Amounts receivable or payable under the commodity option
contracts are accrued as an increase or decrease in oil and gas sales for
the applicable periods.
Oil and Gas Properties
All of the Company's oil and gas properties are located in the United
States and are accounted for at cost under the full cost method. Under
this method, all productive and nonproductive costs incurred in connection
with the acquisition, exploration and development of oil and gas reserves
are capitalized. No gain or loss is recognized on the sale of oil and gas
properties unless nonrecognition would significantly alter the relationship
between capitalized costs and remaining proved reserves for the affected
amortization base. When gain or loss is not recognized, the amortization
base is reduced by the amount of sales proceeds.
Net capitalized costs of oil and gas properties, including the estimated
future costs to develop proved reserves, are amortized using the units of
revenue method, whereby the provision is computed on the basis of current
gross revenues from production in relation to future gross revenues, based
on current prices, from estimated production of proved oil and gas
reserves. Should the net capitalized costs net of related deferred income
taxes exceed the estimated present value of oil and gas reserves discounted
at 10% and adjusted for related income taxes, such excess costs would be
charged to expense in the Consolidated Statements of Operations. As of
September 30, 2000, no write down of the capitalized costs of oil and gas
properties was deemed necessary.
It is reasonably possible that the estimates of anticipated future gross
revenues, the remaining estimated economic life of the product, or both
could change significantly in the near term due to the fluctuation of oil
and gas prices or production. Depletion estimates would also be affected
by such changes.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Property and Equipment
Rental property and other property and equipment is stated at cost.
Repairs and maintenance are charged to expense as incurred, with additions
and improvements being capitalized. Upon sale or other retirement of
depreciable property, the cost and accumulated depreciation are removed
from the related accounts and any gain or loss is reflected in the
Consolidated Statements of Operations.
Depreciation is provided on the straight-line method based on the
estimated useful lives of the depreciable assets as follows:
Building and improvements 20 to 30 years
Rental property and improvements 5 to 30 years
Leasehold improvements 2 to 10 years
Machinery and equipment 3 to 5 years
Furniture and fixtures 3 to 5 years
Equipment under capital lease 3 to 5 years
Rental Property - Construction in Progress
All costs associated with construction in progress are capitalized and
subject to depreciation when each project is completed. Interest is
capitalized for construction in progress. The capitalized interest is
recorded as part of the asset to which it relates and is amortized over the
assets useful life. In 2000 and 1999, no interest costs were capitalized.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
In accordance with the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, the Company reviews its long-lived assets, excluding oil and gas
properties accounted for using the full cost method of accounting, and
certain identifiable intangibles for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. In this circumstance, the Company recognizes an impairment
loss for the amount by which the carrying amount of the asset exceeds the
estimated fair value of the asset.
Deferred Debt Costs
The Company capitalizes certain costs incurred in connection with
issuing debt. These costs are being amortized to interest expense on the
straight-line method over the term of the related debt.
Gas Balancing
The Company utilizes the sales method of accounting for over or under
deliveries of natural gas. Under this method, the Company recognizes sales
revenue on all natural gas sold.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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 basis. 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. Basic (through June 30, 1997) and Red Oak are
consolidated for financial reporting purposes, but beginning January 1,
1996, were not eligible to be included in the consolidated U.S. federal
income tax return. Separate provisions for income taxes have been
determined for these entities.
Reclassifications
Certain reclassifications have been made to the 1999 amounts to conform
to the 2000 presentation.
Derivative Instruments and Hedging Activities
In June 1998, the FASB issued Statement of Financial Accounting
Standards No. 133 "Accounting for Derivative Instruments and Hedging
Activities" ("SFAS 133") which established standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the statement
of financial position and measure those instruments at fair value. It
establishes conditions under which a derivative may be designated as a
hedge, and establishes standards for reporting changes in the fair value of
a derivative. SFAS 133, as amended by SFAS 137, is required to be
implemented for all fiscal quarters of all fiscal years beginning after
June 15, 2000. Early adoption is permitted. Management has initiated the
evaluation of the possible effects of SFAS 133 on the Company and continues
to study the implications.
Income (loss) per share
Basic net income (loss) per share is computed by dividing income
available to common stockholders by the weighted average number of common
shares outstanding for the period. The computation of diluted net income
(loss) per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock
that would then share in the earnings of the entity. For 2000 and 1999,
the computation of diluted net income (loss) per share was antidilutive;
therefore, the amounts reported for basic and diluted net income (loss) per
share were the same.
Noncompete covenants
Noncompete covenants are carried at cost less accumulated amortization.
The covenants are being amortized over their contractual lives, generally
three to five years.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Interim Financial Statements
In the opinion of management, the unaudited consolidated financial
statements of the Company as of September 30, 2000 and 1999 include all
adjustments and accruals, consisting only of normal recurring accrual
adjustments, which are necessary for a fair presentation of the results for
the interim periods. These interim results are not necessarily indicative
of results for a full year.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted in this Report
pursuant to the rules and regulations of the Securities and Exchange
Commission. These consolidated financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the 1999 Form 10-K of the Company.
2. Liquidity
The accompanying consolidated financial statements have been prepared on
a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The
consolidated financial statements do not include any adjustments relating
to the recoverability and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
SRH has a highly leveraged capital structure with, approximately, $34.1
million of cash interest and $23.2 million of principal due within the next
twelve months. Management is currently in the process of renegotiating the
terms of SRH's various obligations with its note holders and/or attempting
to seek new lenders or equity investors. Additionally, management would
consider disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's continuing debt restructuring
efforts will be successful or that the note holders will agree to a course
of action consistent with SRH's requirements in restructuring the
obligations. Even if such agreement is reached, it may require approval of
additional note holders, or possibly, agreements of other creditors of SRH,
none of which is assured. Furthermore, there can be no assurance that the
sales of assets can be successfully accomplished on terms acceptable to
SRH. Under current circumstances, SRH's ability to continue as a going
concern depends upon its ability to (1) successfully restructure its 10.5%
Senior Notes and other obligations or obtain additional financing as may be
required, (2) maintain compliance with all debt covenants, (3) generate
sufficient cash flow to meet its obligations on a timely basis, and (4)
achieve satisfactory levels of future earnings. If SRH is unsuccessful in
its efforts, it may be unable to meet its debt obligations, making it
necessary to undertake such other actions as may be appropriate to preserve
asset values.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
3. Commitments and Contingencies
The Company is subject to extensive federal, state and local
environmental laws and regulations. These laws, which are constantly
changing, regulate the discharge of materials into the environment and may
require the Company to remove or mitigate the environmental effects of the
disposal or release of petroleum or chemical substances at various sites.
Environmental expenditures are expensed or capitalized depending on their
future economic benefit. Expenditures that relate to an existing condition
caused by past operations and that have no future economic benefits are
expensed. Liabilities for expenditures of a noncapital nature are expensed
when environmental assessment and/or remediation is probable and the costs
can be reasonably estimated.
Management recognizes a financial exposure that may require future
expenditures presently existing for oil and gas properties and other
operations. Other long-term liabilities at September 30, 2000 include
approximately $663,000 for estimated future remedial actions and cleanup
costs. As of September 30, 2000, 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
flows or financial position.
4. Commodity Hedging and Derivative Financial Instruments
The Company, from time to time, uses option contracts to mitigate the
volatility of price changes on commodities the Company produces and sells,
as well as, to lock in prices to protect the economics related to certain
capital projects.
On December 30, 1999, Southwest entered into a basket revenue protection
agreement, which provides the Company with an oil and gas revenue floor.
The contract is for the period January 1, 2000 through December 31, 2000.
The agreement is to be calculated on a calendar year quarter as disclosed
in the following table based on NYMEX Natural Gas and NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas Boe Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.88 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues. The carrying value of the floor is approximately
$150,000 at September 30, 2000. The market value was approximately
$160,000 at September 30, 2000.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
On September 6, 2000, Southwest entered into a floor option, which
provides the Company with a crude oil price floor. The contract is for the
period January 1, 2001 through December 31, 2001. The option is for a
notional amount of 1,100 BBls of oil a day at a floor price of $25, based
on NYMEX Light Sweet Crude. The agreement is to be calculated on a monthly
basis, with payments to be made no later than five business days, after
calculating period. The cost of the floor was approximately $466,000.
Carrying value approximates market value at September 30, 2000.
5. Long-term Debt
Long-term debt consists of the following (in thousands):
September 30,December 31,
2000 1999
----- -----
10.5% Senior Notes, interest payable semi-annually due
October 15, 2004, net of discount of $995 and $1,487,
respectively $122,690 $160,598
Revolving Loan Facility with variable rate interest,
due August 2003. Collateralized by oil and gas
properties. 50,000 35,000
Variable Rate Notes Payables:
Notes payable due July 2001, accrued interest due and
payable monthly at 7.1%, per annum with additional
1% payable in cash or additional notes.
Net of discount of $444 and $944, respectively 17,518
15,883
Notes payable due December 2001, accrued interest due
and payable monthly at 7.1%, per annum with additional
1.5% payable in cash or additional notes.
Net of discount of $1,556 and $2,556, respectively 30,482
25,298
Notes payable due July 2002, interest at 8.5% minimum
per annum, accrued interest due and payable monthly.
Net of discount of $2,906 and $4,229, respectively 104,841
101,835
Other 9,741 8,469
------- -------
335,272 347,083
Less current maturities 23,174 40,277
------- -------
$312,098 $306,806
======= =======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
10.5% Senior Notes
In October 1997, the Company issued $200 million aggregate principal
amount of 10.5% Senior Notes due October 15, 2004 (the "Notes"). The Notes
were sold at a discount and interest is payable April 15 and October 15 of
each year, commencing April 15, 1998. The Notes are general unsecured
senior obligations of the Company and rank equally in right of payment with
all other senior indebtedness of the Company and senior in right of payment
of all existing future subordinated indebtedness of the issuer. Net
proceeds from the issuance of the Notes were used primarily to repay
existing debt of approximately $84 million, purchase oil and gas properties
for approximately $72 million, purchase additional stock in Red Oak for
approximately $10 million, invest $1.7 million in an affiliate, with the
remaining balance used for working capital.
The Indenture imposes certain limitations on the ability of the Company
and its restricted subsidiaries to, among other things, incur additional
indebtedness or issue disqualified capital stock, make payments in respect
to capital stock, enter into transactions with affiliates, incur liens,
sell assets, change the nature of its business, merge or consolidate with
any other person and sell, lease, transfer or otherwise dispose of
substantially all of its properties or assets. The indenture requires the
issuer to repurchase notes under certain circumstances with the excess cash
of certain asset sales. The limitations are subject to a number of
important qualifications and exceptions. The issuer must report to the
Trustee on compliance with such limitations on a quarterly basis.
Revolving Loan Facility
In December 1999, Southwest entered into a Revolving Loan Facility with
Bank One Texas, N.A., which provided a borrowing base of $50 million with a
maturity date of December 29, 2000. Funds from the Revolving Loan Facility
may be used for working capital and other general corporate purposes,
including the repurchase of a portion of Southwest's outstanding 10.5%
Senior Notes due 2004. Advances on the Revolving Loan Facility bear
interest at the option of Southwest, based on the prime rate of Bank One
Texas, N.A. (8.5% at December 31, 1999) plus one fourth of one percent
(.25%), when the borrowing base usage is equal to or greater than 80% or
zero percent (0%) when the borrowing base usage is less than 80% or, a
Eurodollar rate (substantially equal to the London InterBank Offered Rate
("LIBOR")) plus 1.25% up to 2.0% based on the borrowing base usage
percentage. The Revolving Loan Facility is secured by no less than 85% of
Southwest's oil and gas properties. As of December 31, 1999 Southwest had
drawn $35.0 million. The remaining $15.0 million was drawn in January
2000.
The Revolving Loan Facility imposes certain limitations on the ability
of Southwest to, among other things, incur additional indebtedness or issue
disqualified capital stock, make payments in respect to capital stock,
enter into transactions with affiliates, incur liens, sell assets, change
the nature of its business, merge or consolidate with any other person and
sell, lease, transfer or otherwise dispose of substantially all of its
properties or assets. The Revolving Loan Facility required Southwest to
establish a sinking fund account with an initial deposit of $3.5 million.
Southwest is to transfer monthly one-twelfth of the annual interest
payments on the 10.5% Senior Notes beginning December 31, 1999 into this
sinking fund account for the purpose of making interest payments on the
10.5% Senior Notes. Effective August 17, 2000, this Revolving Loan Facility
was refinanced with a new lender under the Amended and Restated Loan and
Security Agreement. The new lender continues to impose limitations on
Southwest business operations, however, the sinking fund requirement was
eliminated.
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
Southwest Royalties, Inc., a wholly owned subsidiary of Southwest
Royalties Holdings, Inc. successfully completed a refinancing of their
Revolving Loan Facility in the amount of $50.0 million on August 17, 2000
with a new lender. The Amended and Restated Loan and Security Agreement
allows for a prime rate of interest (based on the new lenders prime rates)
plus one and one-half percent (1.5%). Southwest was able to extend the due
date from December 29, 2000 to August 17, 2003. Southwest, in recording
the refinancing of the Revolving Loan Facility, recorded an extraordinary
loss from early extinquishment of debt in the amount of approximately $1.4
million.
Variable Rate Notes Payable
In June 1998, MRO N Cross, Inc., a wholly owned subsidiary of Red Oak
negotiated two notes payable in the amount of $13.5 million, net of a $2
million discount, and $2.5 million. The $13.5 million note was used for the
acquisition of rental property in the amount of $12.9 million with the
remaining $600,000 to be used for capital improvements to the rental
property purchased. The $2.5 million note is reserved for capital
improvements to the rental property purchased of which $2.4 million has
been utilized as of September 30, 2000. The notes are collateralized by
the property purchased.
In December 1998, MRO Commercial, Inc., a wholly owned subsidiary of Red
Oak negotiated two notes payable in the amount of $21.7 million, net of a
$4 million discount, and $9.7 million. The $21.7 million note was used for
the acquisition of a retail shopping center and the funding of various
escrow balances. The $9.7 million note is for capital improvements to the
rental property purchased of which $5.8 million has been utilized as of
September 30, 2000. The notes are collateralized by the property purchased.
In June 1999, MRO Southwest, Inc., a wholly owned subsidiary of Red Oak
negotiated two notes payable in the amount of $97.5 million and $8.0
million, net of discounts of $5.3 million. Borrowings for both notes accrue
interest in arrears at a rate per annum equal to the greater of 8.6% or
LIBOR plus 360 basis points. The interest rate includes a servicing fee of
.10%. Approximately $91.4 million of the $97.5 million note was used to
retire existing debt on properties contributed to MRO Southwest by Red Oak,
$1.5 million was deposited into various restricted cash accounts and the
remaining proceeds were used for general corporate purposes. The $8.0
million note is for capital improvements to rental property and $5.0
million has been utilized as of September 30, 2000. The notes are
collateralized by the properties owned by MRO Southwest. The notes impose
certain restrictive covenants including restrictions on the incurrence of
additional indebtedness, dissolution, termination or liquidation of all or
substantially all of the assets, changes in the legal structure of the
assets, making any loans or advances to any third party and commingling its
assets with the assets of any of its affiliates or of any other person or
entity.
Extinguishment of Debt
In June 1999, MRO Southwest repaid certain notes payable with proceeds
from the aforementioned Variable Note Payable issued in June of 1999.
Prepayment penalties and the remaining unamortized deferred debt costs
associated with these notes resulted in an extraordinary charge of $1,598
million or $(1.49) per share. Since there is no recorded income tax
benefits on continuing operations there is no income tax benefits recorded
on the extraordinary loss.
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
In December of 1999, Southwest purchased approximately 19%, or
approximately $37.9 million original face amount, of its 10.5% Senior Notes
with the proceeds from the aforementioned Revolving Loan facility.
Southwest paid approximately $22.0 million, including all fees, to purchase
the 10.5% Senior Notes and wrote off approximately $980,000 of deferred
loan issue costs and approximately $349,000 of the original issue discount
to recognize a $14.5 million extraordinary gain on the purchase of the
Notes. Southwest has not recorded any income tax benefits on continuing
operations and therefore there is no income tax expense recognized on the
extraordinary gain. The extraordinary gain per share is approximately
$13.48.
In January of 2000, Southwest purchased approximately 19%, or
approximately $38.4 million original face amount, of its 10.5% Senior Notes
with the proceeds from the aforementioned Revolving Loan facility.
Southwest paid approximately $23.0 million, including all fees, to purchase
the 10.5% Senior Notes and wrote off approximately $980,000 of deferred
loan issue costs and approximately $349,000 of the original issue discount
to recognize a $14.1 million extraordinary gain on the purchase of the
Notes. Southwest has not recorded any income tax provisions on continuing
operations and therefore there is no income tax expense recognized on the
extraordinary gain. The extraordinary gain per share is approximately
$13.01.
On August 17, 2000, Southwest refinanced their Revolving Loan Facility
and recorded an extraordinary loss from early extinguishment of debt in the
amount of approximately $1.4 million. Southwest has not recorded any
income tax provisions on continuing operations and therefore, there is no
income tax benefit recognized on the extraordinary loss. The extraordinary
loss per share is approximately $(1.27).
Aggregate maturities of all long-term debt as of December 31, 1999 are
as follows (in thousands):
2000 $ 40,277
2001 41,412
2002 101,926
2003 391
2004 160,680
Thereafter 2,397
-------
$347,083
=======
Aggregate maturities of all long-term debt as of September 30, 2000 are
as follows (in thousands):
For the twelve
months ended
--------------
September 30, 2001 $ 23,174
September 30, 2002 135,802
September 30, 2003 52,282
September 30, 2004 45
September 30, 2005 123,098
Thereafter 871
-------
$335,272
=======
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
6. Lines of Business
The Company operates in two 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) and Real Estate Investment and Management (owns and manages
retail shopping centers and office buildings). Other items include
eliminations, manufacturing, computer service and the holding Company.
Three months ended Nine months ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
----- ----- ----- -----
(in thousands) (in thousands)
(unaudited) (unaudited)
Operating Revenue
Oil and gas $ 14,965 $ 8,644 $39,326 $21,726
Real estate 7,933 7,985 23,391 23,936
Other and eliminations 108 70 262 550
------- ------ ------ ------
$ 23,006 $16,699 $62,979 $46,212
======= ====== ====== ======
Operating profit (loss)
Oil and gas $ 9,074 $ 4,752 $22,351 $ 8,425
Real estate 1,785 1,699 4,918 5,918
Other and eliminations (431) 28 (978) 40
------- ------ ------ ------
$ 10,428 $ 6,479 $26,291 $14,383
======= ====== ====== ======
Interest Expense
Oil and gas $ 5,528 $ 5,629 $16,837 $16,757
Real Estate 5,404 4,663 15,592 14,702
Other and eliminations (10) (15) (31) (119)
------- ------ ------ ------
$ 10,922 $10,277 $32,398 $31,340
======= ====== ====== ======
Depreciation, depletion and
amortization
Oil and gas $ 1,394 $ 697 $ 4,161 $ 3,676
Real Estate 1,222 1,127 3,555 3,349
Other and eliminations 28 13 109 98
------- ------ ------ ------
$ 2,644 $ 1,837 $ 7,825 $ 7,123
======= ====== ====== ======
Capital expenditures
Oil and gas properties $ 2,934 $ 1,670 $ 6,744 $ 2,454
Oil and gas, other 162 73 294 229
Real Estate 1,957 1,793 6,046 3,927
Other and eliminations 1 74 79 257
------- ------ ------ ------
$ 5,054 $ 3,610 $13,163 $ 6,867
======= ====== ====== ======
<PAGE>
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
September 30, December 31,
2000 1999
---------- ----------
Identifiable assets
Oil and gas $ 111,481 $ 115,520
Real estate 151,667 150,269
Other and eliminations (765) (3,622)
------- -------
$ 262,383 $ 262,167
======= =======
7. Related Party Transactions
Southwest is the managing general partner for several public and
private oil and gas limited partnerships, with an officer of Southwest also
serving as a general partner for certain of the limited partnerships. As
is usual in the oil and gas industry, the operator is paid an amount for
administrative overhead attributable to operating such properties and
management fees attributable to serving as managing general partner. As
provided for in the partnership agreements, such amounts paid by the
partnerships to Southwest approximated $798,000 and $934,000 for the three
months ended September 30, 2000 and 1999 respectively and $2,467,000 and
$2,625,000 for the nine months ended September 30, 2000 and 1999. In
addition, Southwest and certain officers and employees may have an interest
in some of the partnership properties.
An affiliate of the company performs various oilfield services for
limited partnerships managed by Southwest. Such services aggregated
$57,000 and $105,000 for the three months ended September 30, 2000 and 1999
and $241,000 and $245,000 for the nine months ended September 30, 2000 and
1999. The same affiliate performed services for Southwest that aggregated
approximately $62,000 and $76,000, for the three months ended September 30,
2000 and 1999 and $210,000 and $210,000 for the nine months ended September
30, 2000 and 1999. In August 2000, Southwest made a prepayment to the
affiliate in the amount of $975,000 for oil and gas services to be provided
in the future.
On August 11, 2000, Southwest invested $100,000 in a Web-based company
through a Private Placement Offering. Southwest holds 200,000 shares of
Series A Preferred Stock. The President of the Web-based company is the
brother of H.H. Wommack, III, President of Southwest.
8. Subsequent Events
On October 11, 2000, Southwest entered into a floor option, which
provides the Company with a crude oil price floor. The contract is for the
period January 1, 2001 through December 31, 2001. The option is for a
notional amount of 500 BBls of oil a day at a floor price of $27, based on
NYMEX Light Sweet Crude. The cost of the floor was approximately $224,000.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
Southwest Royalties Holdings, Inc., a Delaware corporation, was formed
in 1997 to serve as a holding company for Southwest Royalties, Inc., Basic
Energy Services, Inc. and Midland Red Oak Realty, Inc. SRH is an
independent oil and gas company engaged in the acquisition, development and
production of oil and gas properties, primarily in the Permian Basin of
West Texas and southeastern New Mexico, through its wholly-owned
subsidiary, Southwest. Since 1983, Southwest has grown primarily through
selective acquisitions of producing oil and gas properties, both directly
and through the oil and gas partnerships it manages. SRH also participates
in the well servicing industry through its affiliate, Basic, and owns and
manages real estate properties through its subsidiary, Red Oak. In May
2000, Basic changed its name from Sierra Well Service, Inc.
Results of Operations
Three months and nine months ended September 30, 2000 compared to three
months and nine months September 30, 1999
The following table summarizes production volumes, average sales prices
and period to period comparisons for the Company's oil and gas operations,
including the effect on revenues, for the periods indicated:
Three months ended Nine months ended
September 30, September 30,
------------------- -------------------
2000 1999 2000 1999
----- ----- ----- -----
(in thousands) (in thousands)
(unaudited) (unaudited)
Production volumes:
Oil and condensate (MBbls) 312 325 928
1,013
Natural gas (MMcf) 1,213 1,056 3,605 3,195
Average sales prices:
Oil and condensate (per Bbl) 30.36 $ 17.42 $ 27.85
$ 14.47
Natural gas (per Mcf) 4.37 $ 2.27 $ 3.64 $ 2.01
Revenues. Revenues for the Company increased 38% to $23.0 million for
the three months ended September 30, 2000 and 36% to $63.0 million for the
nine months ended September 30, 2000, as compared to $16.7 million and
$46.2 million for the same periods in 1999.
Oil and gas revenues increased 84% to $15.0 million for the three months
ended September 30, 2000 and 86% to $39.3 million for the nine months ended
September 30, 2000, as compared to $8.1 million and $21.2 million for the
same periods in 1999. The increase in oil and gas revenue is due primarily
to increases in oil and gas prices.
Oil and gas production increased 2%, to 5,590 BOEPD for the three months
ended September 30, 2000 and decreased 1%, or approximately 82 BOEPD, to
5,580 BOEPD for the nine months ended September 30, 2000 as compared to the
same periods in 1999. In an ongoing effort to increase the Company's cash
position and/or reduce the number of high operating expense properties in
its oil and gas portfolio, management has sold oil and gas properties for
approximately $498,000 and $5.5 million in the nine months ended September
30, 2000 and 1999, respectively. The increase in production for the three
months ended September 30, 2000 represented an increase of approximately 7%
net of a decline from oil and gas property sales of approximately 5% or 280
BOEPD. The decrease in production for the nine months ended September 30,
2000 is primarily due to oil and gas property sales which resulted in
production declines of approximately 359 BOEPD, or approximately 6% and is
partially offset by increased production of approximately 5% or 277 BOEPD
on the remaining oil and gas properties.
<PAGE>
Real estate revenues decreased 1% to $7.9 million for the three months
ended September 30, 2000 and 2% to $23.4 million for the nine months ended
September 30, 2000, as compared to $8.0 million and $23.9 million for the
same periods in 1999.
Operating Expenses. Operating expenses, before general and
administrative expense, impairment of oil and gas properties and
depreciation, depletion and amortization, increased 12% to $8.7 million for
the three months ended September 30, 2000 and 13% to $25.6 million for the
nine months ended September 30, 2000, as compared to $7.7 million and $22.6
million for the same periods in 1999.
Oil and gas operating expense increased approximately 38% to $4.0
million for the three months ended September 30, 2000 and approximately 31%
to $11.2 million for the nine months ended September 30, 2000, as compared
to $2.9 million and $8.5 million for the same periods in 1999. The
increase in oil and gas operating expenses for the three and nine months
periods ended September 30, 2000 is due primarily to increased production
taxes, associated with the 84% and 86% increase in oil and gas revenue as
discussed above, and increased workover expense and repairs associated with
bringing wells back on line, which were deemed uneconomical due to
depressed oil and gas prices experienced during a portion of the nine
months ended September 30, 1999. The average operating expense increased
34% to $7.72 per BOE for the three months ended September 30, 2000 and 32%
to $7.29 per BOE for the nine months ended September 30, 2000 from $5.73
and $5.50 per BOE for the same periods in 1999.
Real estate operating expense decreased 4% to $4.6 million for the three
months ended September 30, 2000 and increased 1% to $13.7 million for the
nine months ended September 30, 2000, as compared to $4.7 million and $13.5
million for the same periods in 1999.
General and Administrative ("G&A") Expense. G&A expense for the Company
increased 91% to $1.2 million for the three months ended September 30, 2000
and approximately 52% to $3.2 million for the nine months ended September
30, 2000, as compared to $651,000 and $2.1 million for the same periods in
1999.
Oil and gas G&A expense increased 63% to $528,000 for the three months
ended September 30, 2000 and 48% to $1.7 million for the nine months ended
September 30, 2000, as compared to $324,000 and $1.1 million for the same
periods in 1999. Oil and gas G&A expense per BOE increased 58% to $1.03
for the three months ended September 30, 2000 and 45% to $1.09 per BOE for
the nine months ended September 30, 2000, as compared to $.65 per BOE and
$.73 per BOE for the same periods in 1999. The increase in oil and gas G&A
expense for the three months ended September 30, 2000 is due primarily to
salary increases, bonuses, and certain health insurance claims pertaining
to the Company's partially self insured insurance structure as well as
legal and professional fees associated with managements evaluation of
corporate strategies and options for dealing with its highly leverage
structure. Increases in oil and gas G&A expense for the nine months ended
September 30, 2000 are primarily due to salary increases, bonuses, and
certain health insurance claims pertaining to the Company's partially self
insured insurance structure.
Real estate G&A expense decreased 5% to $368,000 for the three months
ended September 30, 2000 and increased 6% to $1.2 million for the nine
months ended September 30, 2000, as compared to $388,000 and $1.1 million
for the same periods in 1999.
Depreciation, Depletion and Amortization ("DD&A") Expense. DD&A expense
for the Company increased 44% to $2.6 million for the three months ended
September 30, 2000 and 10% to $7.8 million for the nine months ended
September 30, 2000, as compared to $1.8 million and $7.1 million for the
same periods in 1999.
<PAGE>
Oil and gas DD&A increased 100% to $1.4 million for the three months
ended September 30, 2000 and 13% to $4.2 million for the nine months ended
September 30, 2000, as compared to $697,000 and $3.7 million for the same
periods in 1999. Oil and gas depletion expense on a BOE basis, increased
112% to $2.47 per BOE for the three months ended September 30, 2000 and 16%
to $2.49 per BOE for the nine months ended September 30, 2000, as compared
to $1.16 per BOE and $2.14 per BOE for the same periods in 1999. The
increase is due to higher and more stable commodity prices experienced
during the three and nine months ended September 30, 2000 as compared to
the same periods in 1999 and an increase in the Company's oil and gas
property basis due to acquisitions and developmental drilling performed in
late 1999 and throughout 2000.
Real estate DD&A expense increased 8% to $1.2 million for the three
months ended September 30, 2000 and increased 6% to $3.6 million for the
nine months ended September 30, 2000, as compared to $1.1 million and $3.3
million for the same periods in 1999. The increase in DD&A expense for the
three and nine months ended September 30, 2000 is due to the impact of
capitalized improvements.
Interest Expense. Interest expense for the Company increased 6% to 10.9
million for the three months ended September 30, 2000 and 3% to and $32.4
million for the nine months ended September 30, 2000, as compared to $10.3
million and $31.3 million for the same periods in 1999.
Oil and gas interest expense decreased 2% to $5.5 million for the three
months ended September 30, 2000 and remained unchanged at $16.8 million for
the nine months ended September 30, 2000, as compared to $5.6 million and
$16.8 million for the same periods in 1999.
Real estate interest expense increased 16% to $5.4 million for the three
months ended September 30, 2000 and 6% to $15.6 million for the nine months
ended September 30, 2000, as compared to $4.7 million and $14.7 million for
the same periods in 1999. The increase in interest expense for the three
and nine months ended September 30, 2000 is due to increased borrowings to
fund capital improvements and working capital.
Equity Loss in Partnership. The Company's direct and indirect investment
in Basic upon recording its portion of Basic's losses for the three months
ended March 31, 1999 was reduced to zero. Therefore, according to General
Accepted Accounting Principles, the equity method was suspended. The
Company did not record their ownership percentage of Basic's losses for the
nine months ended September 30, 2000. If Basic subsequently begins to
report net income, the Company will resume applying the equity method only
after its share of net income equals the share of net losses not recognized
during the period the equity method is suspended.
Net Income (Loss). Due to the factors described above, net (loss) for
the Company decreased 65% to $1.2 million for the three months ended
September 30, 2000 and 152% to net income of $9.5 million for the nine
months ended September 30, 2000, as compared to a net loss of $3.3 million
and $18.4 million for the same periods in 1999. Oil and gas net income
increased 558% to $2.5 million for the three months ended September 30,
2000 and 336% to $19.0 million for the nine months ended September 30,
2000, as compared to a net loss of $538,000 and $8.0 million for the same
periods in 1999. Included in the oil and gas net income for the three
months ended September 30, 2000, is an extraordinary loss of $1.4 million
from early extinguishment of debt. Included in oil and gas net income for
the nine months ended September 30, 2000 is an extraordinary gain of
approximately $12.7 million. The extraordinary gain is comprised of a gain
associated with the repurchase of approximately 19% of the original issue,
$200 million face 10.5% Senior Notes issued in October 1997, of
approximately $14.1 million and a loss of approximately $1.4 million
associated with the early extinguishment of debt upon the refinancing of
the Company's Revolving Loan Facility in the amount of $50.0 million on
August 17, 2000 with a new lender. Real estate net losses increased 24% to
$3.2 million for the three months ended September 30, 2000 and decreased 1%
to $9.5 million for the nine months ended September 30, 2000 as compared
$2.5 million and $9.6 million for the same periods in 1999.
<PAGE>
Liquidity and Capital Resources
Management is constantly monitoring the Company's cash position and its
ability to meet its financial obligations as they become due, and in this
effort, is exploring various strategies for addressing its current and
future liquidity needs. During 1999 and 1998, for instance, Southwest sold
$5.6 million and $5.7 million, respectively, of oil and gas properties in
an ongoing effort to decrease its production costs and improve its cash
position. In December 31, 1999 the Company also negotiated a $50 million
Revolving Line Facility with BankOne Texas, N.A. the proceeds of which were
used to purchase in December 1999 and January 2000, approximately $76.3
million of the 10.5% Senior Notes due 2004. On August 17, 2000, the
Company refinanced the Revolving Loan Facility with a new lender and
extended the maturity date out until August 17, 2003. As of September 30,
2000, the Company's consolidated cash balance was approximately $23.6
million, of which $17.6 million was unrestricted.
SRH financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. The consolidated financial
statements do not include any adjustments relating to the recoverability
and classification of liabilities that might be necessary should SRH be
unable to continue as a going concern.
SRH has a highly leveraged capital structure with, approximately, $34.1
million of cash interest and $23.2 million of principal due within the next
twelve months. Management is currently in the process of renegotiating the
terms of SRH's various obligations with its note holders and/or attempting
to seek new lenders or equity investors. Additionally, management would
consider disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's continuing debt restructuring
efforts will be successful or that the note holders will agree to a course
of action consistent with SRH's requirements in restructuring the
obligations. Even if such agreement is reached, it may require approval of
additional note holders, or possibly, agreements of other creditors of SRH,
none of which is assured. Furthermore, there can be no assurance that the
sales of assets can be successfully accomplished on terms acceptable to
SRH. Under current circumstances, SRH's ability to continue as a going
concern depends upon its ability to (1) successfully restructure its 10.5%
Senior Notes and other obligations or obtain additional financing as may be
required, (2) maintain compliance with all debt covenants, (3) generate
sufficient cash flow to meet its obligations on a timely basis, and (4)
achieve satisfactory levels of future earnings. If SRH is unsuccessful in
its efforts, it may be unable to meet its debt obligations, making it
necessary to undertake such other actions as may be appropriate to preserve
asset values.
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $10.5 million and $13.4
million for the three and nine months ended September 30, 2000,
respectively, as compared to net cash provided by operating activities of
$6.8 million and $646,000 for the same periods in 1999. The increase in
cash provided by operating activities, is primarily attributable to
increased oil and gas commodity prices.
Net Cash Provided by (Used in) Investing Activities
Net cash provided by (used in) investing activities by the Company were
$(5.1) million and $(13.0) million for the three and nine months ended
September 30, 2000, as compared to net cash provided by (used in) investing
activities of $(1.6) million and $2.8 million for the comparable periods in
1999. Purchase of oil and gas properties as well as capital improvements
to Real Estate holdings were the primary uses of funds in 2000. Oil and
gas property sales were the primary source of funds in 1999 while Real
Estate investment sales were the primary source of funds in 2000.
<PAGE>
SRH has tentatively budgeted $3.0 million, for the remainder of 2000, in
capital expenditures at Southwest for oil and gas development projects.
This budget is subject to change based on financial strategies currently
being developed, including hedging strategies, divestitures and debt
restructuring, as well as the level of oil and gas prices in the future.
Net Cash Provided by Financing Activities.
Net cash provided by the Company's financing activities was $2.7 million
and $228,000 for the three and nine months ended September 30, 2000 and
$229,000 and $2.4 million for the same periods in 1999, respectively. For
the three months ended September 30, 2000, proceeds from borrowings were
$54.4 million and were primarily used to refinance Southwest's Revolving
Loan Facility and fund capital improvements and working capital at Red Oak.
For the nine months ended September 30, 2000, proceeds from borrowings were
$75.9 million and were primarily used to fund the buy back of a portion of
the 10.5% Senior notes due 2004, as well as refinance Southwest's Revolving
Loan Facility and fund capital improvements and working capital at Red Oak.
Other Issues
The information included in "Other Issues" in Item 7 of SHR's 1999 Form
10-K regarding Information Systems for the year 2000 is incorporated herein
by reference. As of September 30, 2000, there have been no material
changes in SRH's Year 2000 disclosure.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The following quantitative and qualitative information is provided
about financial instruments to which the Company is a party as of September
30, 2000, and from which the Company may incur future earnings gains or
losses from changes in market interest rates or commodity prices.
Quantitative Disclosures
Interest rate sensitivity. The following table provides information
about the Company's debt obligations, which are sensitive to changes in
interest rates. The table presents cash maturities by expected maturity
dates together with the weighted average interest rates expected to be paid
on the debt, given current contractual terms and market conditions. For
fixed rate debt, the weighted average interest rate represents the
contractual fixed rates that the Company is obligated to periodically pay
on the debt; for variable rate debt, the average interest rate represents
the average rates being paid on the debt at September 30, 2000.
As of September 30, 2000
2001 2002 2003 2004 2005Thereafter Total
Fair Value
---- ---- ---- ---- -------------- -----
----------
Total Debt
maturities $23,174 $ 135,802 $ 52,282 $45 $123,098 $
871 $ 335,272 $ 314,004
Fixed rate debt $4,044 $ 428 $ 698 $19 $122,707 $ 871 $ 128,767
$ 107,499
Weighted average
interest rate 10.48% 10.48% 10.48% 10.48% 10.48%
8.04%
Variable rate debt $19,130 $ 135,374 $ 51,584 $26 $ 391 $ -
$ 206,505 $206,505
Average interest rate 10.43% 10.43% 10.97% 10.50% 10.50%
-%
Commodity price sensitivity. See Notes 1 and 4 of Notes to
Consolidated Financial Statements included in "Item 1. Consolidated
Financial Statements" for a description of the accounting procedures
followed by SRH relative to hedge derivative financial instruments and for
specific information regarding the terms of the Company's derivative
financial instrument which is sensitive to changes in natural gas and crude
oil commodity prices.
<PAGE>
On December 30, 1999, Southwest entered into a basket revenue protection
agreement, which provides the Company with an oil and gas revenue floor.
The contract is for the period January 1, 2000 through December 31, 2000.
The agreement is to be calculated on a calendar year quarter as disclosed
in the following table based on NYMEX Natural Gas and NYMEX Crude Oil:
Notional Volumes Strike Prices
------------------------- -----------------------------
Crude Natural Crude Natural Minimum
Oil (bbl) Gas (MMBtu) Oil Gas Boe Revenue
---------- ----------- ----- ------- ---- --------
Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096
Quarter 2 263,058 910,325 $ 18.88 $ 1.92 $ 26.56 $6,714,359
Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432
Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932
Payments shall be made no later than five business days, after each
quarterly floating price is determinable by NYMEX. The cost of the floor
was approximately $638,000 and is amortized monthly as a reduction of oil
and gas revenues. The carrying value of the floor is approximately
$150,000 at September 30, 2000.
On September 6, 2000, Southwest entered into a floor option, which
provides the Company with a crude oil revenue floor. The contract period
begins on January 1, 2001 ending on December 31, 2001. The option is for a
notional amount of 1,100 BBls of oil a day at a floor price of $25. The
agreement is to be calculated on a monthly basis, with payments to be made
no later than five business days, after calculating period. The cost of
the floor was approximately $466,000.
Qualitative Disclosures
Non-derivative financial instruments. The Company is a borrower under
fixed rate and variable rate debt instruments that give rise to interest
rate risk. The Company's objective in borrowing under fixed or variable
rate debt is to satisfy capital requirements while minimizing the Company's
costs of capital. To realize its objectives, the Company borrows under
fixed and variable rate debt instruments, based on the availability of
capital and market conditions. See Note 5 of Notes to Consolidated
Financial Statement included in "Item 1. Consolidated Financial Statements"
for a discussion relative to the Company's debt instruments.
Derivative financial instruments. Revenues from the Company's
operations are highly dependent on the price of oil and gas. The markets
for oil and natural gas are volatile and prices for oil and gas are subject
to wide fluctuations in response to relatively minor changes in the supply
of and demand for oil and gas and a variety of additional factors that are
beyond SRH's control. These factors include the level of consumer demand,
weather conditions, domestic and foreign governmental regulations, market
uncertainty, the price and availability of alternative fuels, political
conditions in the Middle East, foreign imports and overall economic
conditions. It is impossible for SRH to predict future oil and gas prices
with any certainty. In order to reduce the Company's exposure to oil and
gas price risks, from time to time the Company enters into commodity price
derivative contracts to hedge commodity price risks.
As of September 30, 2000, the Company's primary risk exposures
associated with financial instruments to which it is a party include
natural gas and crude oil price volatility and interest rate volatility.
The Company's primary risk exposures associated with financial instruments
have not changed significantly since December 31, 1999.
<PAGE>
PART II - OTHER INFORMATION
ITEM 6. REPORTS ON FORM 8K AND EXHIBITS
Reports on Form 8-K
None.
Exhibits
The following instruments and documents are included as Exhibits to this
Report. Exhibits incorporated by reference are so indicated by
parenthetical information.
Exhibit Number Description
-------------- ------------
27* Financial Data Schedule.
* Filed herewith.
<PAGE>
SIGNATURES
SOUTHWEST ROYALTIES, INC.
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereto duly authorized.
SOUTHWEST ROYALTIES, INC.
By: /s/ H. H. Wommack, III
---------------------------------------
H.H. Wommack, III, Chairman, President,
Chief Executive Officer, and Director
Date: November 14, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- ----
/s/ H.H. Wommack, III
---------------------------
H. H. Wommack, III Chairman/President/
Chief Executive Officer November 14, 2000
/s/ Bill E. Coggin
---------------------------
Bill E. Coggin Vice President/Chief
Financial Officer November 14, 2000
/s/ H. Allen Corey
---------------------------
H. Allen Corey Director/Secretary November 14, 2000
<PAGE>
SIGNATURES
SOUTHWEST ROYALTIES HOLDINGS, INC.
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereto duly authorized.
SOUTHWEST ROYALTIES HOLDINGS, INC.
By: /s/ H. H. Wommack, III
---------------------------------------
H.H. Wommack, III, Chairman, President,
Chief Executive Officer, and Director
Date: November 14, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ----- -----
/s/ H.H. Wommack, III
---------------------------
H. H. Wommack, III Chairman/President/
Chief Executive Officer November 14, 2000
/s/ Bill E. Coggin
---------------------------
Bill E. Coggin Vice President/Chief
Financial Officer November 14, 2000
/s/ H. Allen Corey
---------------------------
H. Allen Corey Director/Secretary November 14, 2000
<PAGE>
