4
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 March 31, 2001
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 State or Other
Jurisdiction of (Jurisdiction of
Incorporation or Organization) Incorporation or Organization)
75-1917432 75-2724264
(I.R.S. Employer (I.R.S. Employer
Identification Number) Identification Number)
407 North Big Spring, Suite 300
Midland, Texas 79701
(Address of Principal Executive Offices) (Zip Code)
Registrants' Telephone Number, Including Area Code: (915) 686-9927
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 March 31, 2001 for
Southwest Royalties, Inc 100
Number of shares of common stock outstanding as of March 31, 2001 for
Southwest Royalties Holdings, Inc. 1,075,534
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 March 31, 2001 (unaudited)
and December 31, 2000 3
Consolidated Statements of Operations for the three months
ended March 31, 2001 and 2000 (unaudited) 5
Consolidated Statements of Cash Flows for the three months
ended March 31, 2001 and 2000 (unaudited) 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 20
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
PART I - FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
March 31,December 31,
2001 2000
-------------------
(unaudited)
ASSETS
- ---------------------------------------------------
Current assets
Cash and cash equivalents $15,618 $17,217
Restricted cash 3,639 4,558
Accounts receivable, net of allowance of
$646 and $559, respectively 11,924 10,302
Receivables from related parties 2,158 1,941
Other current assets 2,956 3,166
------- -------
Total current assets 36,295 37,184
------- -------
Oil and gas properties, using the full cost
method of accounting
Proved 214,343 204,751
Unproved 648 625
------- -------
214,991 205,376
Less accumulated depletion, depreciation
and amortization 133,943 131,734
------- -------
Oil and gas properties, net 81,048 73,642
------- -------
Rental property, net 132,395 133,385
------- -------
Rental property - construction in progress 3,902 2,926
------- -------
Other property and equipment, net 4,560 4,612
------- -------
Other assets
Real estate investments 2,771 3,024
Deferred debt costs, net of accumulated
amortization of $6,485 and $5,698, respectively 6,253 7,043
Noncompete covenants, net of accumulated
amortization of $966 and $877, respectively 1,695 727
Other, net 1,285 1,258
------- -------
Total other assets 12,004 12,052
------- -------
Total assets $270,204 $263,801
======= =======
(continued)
The accompanying notes are an integral part of these
consolidated financial statements
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
(in thousands, except share data)
March 31,December 31,
2001 2000
-------------------
(unaudited)
LIABILITIES, REDEEMABLE COMMON STOCK
AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------
Current liabilities
Current maturities of long-term debt $58,633 $56,231
Accounts payable 5,514 7,045
Accounts payable to related parties 1,792 1,543
Accrued expenses 5,696 6,477
Accrued interest payable 7,685 4,612
------- -------
Total current liabilities 79,320 75,908
------- -------
Long-term debt 282,332 281,034
------- -------
Other long-term liabilities 1,679 1,645
------- -------
Redeemable common stock - 129,046 shares issued 8,290 8,290
------- -------
Stockholders' equity
Preferred stock - $1 par value; 5,000,000
shares authorized; none issued - -
Common stock - $.10 par value; 5,000,000 shares
authorized; 1,161,037 issued at March 31, 2001
and December 31, 2000 116 116
Additional paid-in capital 2,196 2,196
Accumulated deficit (99,816) (100,662)
Accumulated other comprehensive income:
Transition adjustment on implementation of
SFAS 133 net of accumulated amortization
of $226 and none, respectively 804 -
Note receivable from an officer and stockholder (1,607)
(1,616)
Less: treasury stock - at cost; 214,549 shares
at March 31, 2001 and December 31, 2000 (3,110)
(3,110)
------- -------
Total stockholders' deficit (101,417) (103,076)
------- -------
Total liabilities, redeemable common stock
and stockholders' equity $270,204 263,801
======= =======
The accompanying notes are an integral part of these
consolidated financial statements
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)
For the three months
ended March 31,
------------------------
2001 2000
----- -----
Operating revenues
Oil and gas $ 17,032 $ 11,319
Real estate 8,078 8,014
Other 86 96
--------- ---------
Total operating revenues 25,196 19,429
--------- ---------
Operating expenses
Oil and gas production 4,252 3,418
Real estate 4,246 4,574
General and administrative, net of related
party management and administrative fees of
$779 and $848, respectively 904 705
Depreciation, depletion and amortization 3,821 2,910
Other 77 330
--------- ---------
Total operating expenses 13,300 11,937
--------- ---------
Operating income 11,896 7,492
--------- ---------
Other income (expense)
Interest and dividend income 291 249
Interest expense (10,145) (10,570)
Other (1,166) 260
--------- ---------
(11,020) (10,061)
--------- ---------
Income (loss) before income taxes, minority interest
and extraordinary item 876 (2,569)
Income tax benefit (provision) - -
--------- ---------
Income (loss) before minority interest
and extraordinary item 876 (2,569)
Minority interest in subsidiaries, net of tax (30) 362
--------- ---------
Income (loss) before extraordinary item 846 (2,207)
Extraordinary gain from early extinguishment
of debt - 13,996
--------- ---------
Net income $ 846 $ 11,789
========= =========
Income (loss) per common share
Income (loss) per common share before
extraordinary item $ .79 $ (2.05)
Extraordinary gain per common share from early
extinguishment of debt - 13.00
--------- ---------
Income per common share $ .79 $ 10.95
========= =========
Weighted average shares outstanding 1,075,534 1,075,868
========= =========
The accompanying notes are an integral part of these
consolidated financial statements
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the three months
ended March 31,
2001 2000
----- -----
Cash flows from operating activities
Net income $ 846 $11,789
Adjustments to reconcile net income to
net cash provided by (used in)
operating activities:
Depreciation, depletion and amortization 3,821 2,910
Noncash interest expense 1,786 2,741
Noncash amortization of unrealized gain (226) -
Noncash unrealized loss on oil and gas hedges 1,332 -
Extraordinary gain from early extinguishment
of debt - (13,996)
Gain on sale of assets 104 (240)
Other noncash items - 179
Amortization of lease commissions 42 51
Bad debt expense 87 105
Minority interest in loss of subsidiary - (362)
Changes in operating assets and liabilities-
Accounts receivable (1,926) (925)
Other current assets 358 (83)
Accounts payable and accrued expenses (2,063) (3,962)
Change in restricted cash 218 (3,595)
Accrued interest payable 3,073 2,308
-------- -------
Net cash provided by (used in) operating
activities 7,452 (3,080)
-------- -------
Cash flows from investing activities
Proceeds from sale of oil and gas properties 10 154
Purchase of oil and gas properties (9,625) (987)
Purchase of other property and equipment and
rental property (455) (81)
Increase in construction in progress (976) (1,058)
Purchase of other assets (821) (22)
Proceeds from sale of other assets 19 17
Proceeds from sale of real estate investments 145 643
Proceeds from sale of other property and
equipment 5 1
Change in restricted cash 701 (271)
Other 9 8
-------- -------
Net cash used in investing activities (10,988) (1,596)
-------- -------
(continued)
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued)
(in thousands)
(unaudited)
For the three months
ended March 31,
2001 2000
----- -----
Cash flows from financing activities
Proceeds from borrowings 2,234 16,914
Payments on debt (324) (23,285)
Change in other long-term liabilities 34 (24)
Deferred debt cost (7) (5)
Dividends paid to minority interest owners - (30)
-------- -------
Net cash (used in) provided by financing
activities 1,937 (6,430)
-------- -------
Net decrease in unrestricted cash
and cash equivalents (1,599) (11,106)
Unrestricted cash and cash equivalents -
beginning of period 17,217 16,983
-------- -------
Unrestricted cash and cash equivalents -
end of period $15,618 $ 5,877
======== =======
Non-cash investing and financing activities
Unrealized gain on oil and gas commodity
hedges-taken to other comprehensive income $ 1,030 $ -
Note payable issued to fund non-compete
agreement $ 800 $ -
Supplemental disclosures of cash flow information
Interest paid $ 5,286 $ 5,521
The accompanying notes are an integral part of these
consolidated financial statements
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"), Midland Red Oak Realty, Inc. ("Red Oak") (collectively,
the "Company") and an equity investment in Basic Energy Service, Inc.
("Basic") (formerly Sierra Well Services, Inc.). 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.
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 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 the oil and gas commodity
prices. Red Oak is principally involved in real estate investment and
development.
Principles of Consolidation
The consolidated financial statements include the accounts of SRH and
its subsidiaries. As of March 31, 2001, the Company owned 100% of Southwest
and 81% of Red Oak. As of March 31, 2001, Southwest has only one
subsidiary, Blue Heel Company ("Blue Heel"). Effective August 2000,
Midland Southwest Software ("MSS"), a former subsidiary of Southwest, was
merged into Southwest. Blue Heel holds a nominal interest in certain oil
and gas properties owned by Southwest.
As of March 31, 2001 Red Oak has 4 wholly-owned subsidiaries, MRO
Management, Inc. ("MRO Management"), MRO Commercial, Inc. ("MRO
Commercial"), MRO N Cross, Inc. ("Northcross"), and MRO Southwest, Inc.
("MRO Southwest"). MRO Commercial, Northcross and MRO Southwest each hold
titles to certain real estate properties and are the borrowers under the
credit agreements related to such properties. These credit agreements are
non-recourse to Red Oak. MRO Management performs real estate management
services for Red Oak, MRO Commercial, Northcross, MRO Southwest and for
third party clients.
The consolidated financial statements include the Company's
proportionate share of the assets, liabilities, income and expenses of the
oil and gas limited partnerships for which Southwest serves as managing
general partner. Southwest accounts for its investments in Southwest
Partners II and III using the equity method, as they exercise 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.
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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.
Restricted Cash
Restricted cash represents amounts required to be reserved in separate
accounts by financial lenders. Restricted cash accounts have been
established for the following purposes (in thousands):
March 31, December 31,
2001 2000
---- ----
Certificate of Deposits - Red Oak $ 122 $ 118
Tenant security deposits - Red Oak 531 536
Capital expenditures account - Red Oak 123 824
Tax and insurance reserve - Red Oak 1,602 2,034
Lockbox - Red Oak 419 160
Customer service reserve - Red Oak 9 12
Interest reserves - Red Oak 71 115
Escrow fund - Southwest 762 759
------ ------
$ 3,639 $ 4,558
====== ======
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. Tenant
reimbursements are accrued and billed to the tenants monthly based on prior
experience or certain identifiable costs.
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.
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.
Through December 31, 2000, premiums paid for commodity option contracts
which qualified as hedges under Statement of Accounting Standards ("SFAS")
No. 80 "Accounting for Futures Contracts", were 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. Effective
January 1, 2001, derivative financial instruments are accounted for in
accordance with SFAS 133 as amended by SFAS 138.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
SFAS No.133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS No. 133, as amended by SFAS No. 138, establishes
accounting and reporting standards for derivative instruments, including
certain derivative instruments embedded in other contracts, (collectively
referred to as derivatives) and for hedging activities. It requires an
entity to recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a
hedge of the exposure to changes in the fair value of the exposure to
variable cash flows of a forecasted transaction, or (c) a hedge of the
foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign
currency denominated forecasted transaction. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the Company's statement of operations. The
adoption of SFAS No. 133 on January 1, 2001 did not have a material impact
on the Company's financial position or results of operations. The Company
recorded a net transition adjustment gain of $1,030,000 in accumulated
other comprehensive income on January 1, 2001. The transition adjustment is
being amortized to oil and gas sales over the term of the agreements.
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.
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
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.
Management and service fees received for contractual arrangements, if
any, are treated as reimbursement of costs, offsetting the costs incurred
to provide those services, with any excess of fees over costs credited to
the full cost pool and recognized through lower cost amortization only as
production occurs.
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 15 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. There were no interest costs capitalized for the three
months ended March 31, 2001 or 2000.
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.
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 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. 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. Effective January 1, 2001 Red Oak has
become eligible to be included in the consolidated U.S. federal income tax
return.
Reclassifications
Certain reclassifications have been made to the 2000 amounts to conform
to the 2001 presentation.
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 2001 and 2000,
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.
Interim Financial Statements
In the opinion of management, the unaudited consolidated financial
statements of the Company as of March 31, 2001 and 2000 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 2000 Form 10-K of the Company.
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
2. Liquidity
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and
the satisfaction of liabilities in the normal course of business. The
consolidated financial statements do not include any adjustments relating
to the recoverability and classification of liabilities that might be
necessary should the Company be unable to continue as a going concern.
SRH has a highly leveraged capital structure with, approximately, $32.6
million of cash interest and $58.6 million of principal (net of a related
party note of $809,000 between Southwest and Red Oak) due within the next
twelve months. The majority, $14.1 million of cash interest and $58.5
million of principal (which includes the $809,000 related party note
between Southwest and Red Oak) due within the next twelve months, pertains
to Red Oak. Management is currently in the process of renegotiating the
terms of SRH's various obligations with its debt holders and/or attempting
to seek new lenders or equity investors. Additionally, management would
consider disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's debt restructuring efforts in
connection with their real estate subsidiary will be successful or that the
debt 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 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.
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.
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.
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
4. 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, computer service and the holding Company. Effective August
2000, Midland Southwest Software ("MSS") a 100% wholly owned software
subsidiary was merged into Southwest.
For the Three Months
Ended March 31,
2001 2000
----- -----
(in thousands)
(unaudited)
Operating Revenue
Oil and gas $17,041 $11,329
Real estate 8,078 8,014
Other and eliminations 77 86
------ ------
$25,196 $19,429
====== ======
Operating profit (loss)
Oil and gas $ 9,964 $ 5,837
Real estate 1,971 1,886
Other and eliminations (39) (231)
------ ------
$11,896 $ 7,492
====== ======
Interest Expense
Oil and gas $ 5,030 $ 5,583
Real Estate 5,125 4,997
Other and eliminations (10) (10)
------ ------
$10,145 $10,570
====== ======
Depreciation, depletion and amortization
Oil and gas $ 2,328 $ 1,731
Real Estate 1,467 1,139
Other and eliminations 26 40
------ ------
$ 3,821 $ 2,910
====== ======
Capital expenditures
Oil and gas properties $ 9,625 $ 987
Oil and gas, other 94 19
Real estate 1,337 1,059
Other - 61
------- -------
$11,056 $ 2,126
======= =======
Identifiable assets
Oil and gas $126,038 $107,102
Real estate 149,655 148,500
Other and eliminations (5,489) (3,992)
------- -------
$270,204 $251,610
======= =======
SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued)
5. Comprehensive Income
Comprehensive income consists of net income, as reflected on the
consolidated statement of operations, and other gains and losses affecting
stockholders' equity that are excluded from net income. The Company
recorded other comprehensive income for the first quarter of 2001. Total
comprehensive income for the three months ended March 31, 2001 is as
follows (in thousand):
Net income $ 846
Other comprehensive income, net of tax:
Transition adjustment on implementation of
SFAS 133 - January 1, 2001 1,030
Amortization of transition adjustment (226)
-----
Other comprehensive income 804
-----
Comprehensive income $ 1,650
=====
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.,
Midland Red Oak Realty, Inc. and an equity investment in Basic Energy
Services, 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 owns and manages real estate properties through its
subsidiary, Red Oak.
Results of Operations
Three Months Ended March 31, 2001 compared to Three Months Ended March 31,
2000
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
March 31, Percentage Revenue
------------- Increase Increase
2001 2000 (Decrease)(Decrease)
----- ----- -------------------
Production volumes:
Oil and condensate (MBbls) 307 306 0% $ 25,000
Natural gas (MMcf) 1,210 1,195 1% $ 100,000
Average sales prices:
Oil and condensate (per Bbl) $28.52 $26.01 10% $ 767,000
Natural gas (per Mcf) $6.70 $ 2.75 144% $4,721,000
Revenues. Revenues for the Company increased 30% to $25.2 million for
the three months ended March 31, 2001 from $19.4 million for the same
period in 2000.
Oil and gas revenue increased 50% to $17.0 million for the three months
ended March 31, 2001 from $11.3 million for the same period in 2000. The
increase in oil and gas revenue is due primarily to increases in oil and
gas prices. Increases in oil and gas prices resulted in increased oil and
gas revenues of approximately $5.5 million. Increases in production
resulted in increased oil and gas revenues of approximately $125,000.
Increased oil and gas partnership distributions added approximately
$104,000 to increased oil and gas revenues.
Real estate revenues increased 1% to $8.1 million for the three months
ended March 31, 2001 from $8.0 million for the same period in 2000.
Operating Expenses. Operating expenses, before general and
administrative expense, depreciation, depletion and amortization, increased
3% to $8.6 million for the three months ended March 31, 2001 from $8.3
million for the same period in 2000.
Oil and gas operating expense increased approximately 24% to $4.3
million for the three months ended March 31, 2001 from $3.4 million for the
same period in 2000. The increase is due primarily to bringing higher
lifting cost wells back on line and to workover expense and repairs
associated with bringing these wells back on line. The average operating
expense increased 24% to $8.37 per BOE for the three months ended March
31,2001 from $6.77 per BOE during the same period in 2000.
Real estate operating expense decreased approximately 7% to $4.2
million for the three months ended March 31, 2001 from $4.6 million in
2000. The decrease is due to a concerted
effort by management to reduce operating costs through outsourcing of
janitorial, landscaping and other maintenance services.
General and Administrative ("G&A") Expense. G&A expense for the
Company increased 28% to $904,000 for the three months ended March 31, 2001
from $705,000 for the same period in 2000. Oil and gas G&A expense
increased 45% to $497,000 for the three months ended March 31, 2001 from
$343,000 for the same period in 2000. Oil and gas G&A expense averaged $.98
per BOE for the three months ended March 31, 2001, a 44% increase compared
to $.68 per BOE for the same period in 2000. The increase in oil and gas
G&A is the result of increased personnel costs. Real estate G&A expense
decreased 5% to $394,000 for the three months ended March 31, 2001 from
$415,000 for the same period in 2000.
Depreciation, Depletion and Amortization ("DD&A") Expense. DD&A
expense for the Company increased 31% to $3.8 million for the three months
ended March 31, 2001 from $2.9 million for the same period in 2000. Oil
and gas DD&A expense increased 34% to $2.3 million for the three months
ended March 31, 2001 from $1.7 million for the same period in 2000. Oil
and gas depletion expense on a BOE basis, increased 36% to $4.35 per BOE
for the three months ended March 31, 2001 from $3.20 per BOE for the same
period in 2000. Real estate DD&A expense increased 29% to $1.5 million for
the three months ended March 31, 2001 from $1.1 million for the same period
in 2000 due to the impact of Capitalized improvements.
Interest Expense. Interest expense for the Company decreased 4% to
$10.1 million for the three months ended March 31, 2001 from $10.6 million
for the same period in 2000. Oil and gas interest expense decreased 10% to
$5.0 million for the three months ended March 31, 2001 from $5.6 million
for the same period in 2000. The decrease is due to recent reductions in
the Prime Rate which is tied to the Company's variable rate debt. Real
estate interest expense increased 3% to $5.1 million for the three months
ended March 31, 2001 from $5.0 million for the same period in 2000.
Net Income (Loss). Due to the factors described above, net income for
the Company decreased 93% to $846,000 million for the three months ended
March 31, 2001 from $11.8 million for the same period in 2000. Oil and gas
net income was approximately $2.6 million for the three months ended March
31, 2001 as compared to $14.6 million for the same period in 2000. Included
in both the net income of the Company and the oil and gas net income for
the three months ended March 31, 2000 is an extraordinary gain associated
with the repurchase of approximately 19% of the original issue, $200
million face 10.5% senior notes issued in October of 1997, of approximately
$14.0 million. Real estate net losses increased 5% to $2.9 million for the
three months ended March 31, 2001 from $2.8 million for the same period in
2000.
Liquidity and Capital Resources
Funding for the Company's business activities has historically been
provided by operating cash flows, bank borrowings and debt issuance,
reserve-based financing and sales of equity. Any future capital
expenditures, other than those with previously arranged and set-aside lines
of financing, will most likely require additional equity or financing and
will be dependent upon financing arrangements available at the time. The
significant decrease in oil and gas prices experienced during the last
quarter of 1997 and extending through the first half of 1999, severely
limited cash flow from operations, depleted working capital and rendered
most other financing sources unavailable, or if available, on very
unattractive terms to Southwest. With the upturn in commodity prices,
Southwest's management believes that additional capital sources and
financing opportunities may be available in the market. Because of higher
commodity pricing, Southwest's operating cash flows have improved allowing
for the investment of capital expenditures that would, if successful,
increase company production and its reserve base.
SRH has a highly leveraged capital structure with, approximately, $32.6
million of cash interest and $58.6 million of principal (net of a related
party note of $809,000 between Southwest and Red Oak) due within the next
twelve months. The majority, $14.1 million of cash interest and $58.5
million of principal (which includes the $809,000 related party note
between Southwest and Red Oak) due within the next twelve months, pertains
to Red Oak. Management is currently in the process of renegotiating the
terms of SRH's various obligations with its debt holders and/or attempting
to seek new lenders or equity investors. Additionally, management would
consider disposing of certain assets in order to meet its obligations.
There can be no assurance that SRH's debt restructuring efforts in
connection with their real estate subsidiary will be successful or that the
debt 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 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.
SRH, Red Oak and Southwest regularly pursue and evaluate
recapitalization strategies and acquisition opportunities (including
opportunities to engage in mergers, consolidations or other business
combinations) and at any given time may be in various stages of evaluating
such opportunities.
Net Cash Provided by Operating Activities
Cash flows provided by operating activities for the Company were $7.5
million for the three months ended March 31, 2001 compared to cash flows
used in operations of $3.1 million for the same period in 2000.
Net cash flows provided by operating activities, for oil and gas
operations, for the three months ended March 31, 2001, were approximately
$9.1 million compared to net cash flows used in operations of $1.4 million
for the same period in 2000. The increase is due primarily to increased oil
and gas commodity prices which provided approximately $5.6 million in
additional operating cash flows and the elimination of the restricted cash
requirements which used approximately $3.6 million from operations in the
three months ended March 31, 2000 to satisfy interest sinking fund
requirements.
Net cash flows used in operating activities, for real estate operations,
for the three months ended March 31, 2001, were approximately $1.6 million
compared to $1.7 million for the same period in 2000. Red Oak's ability to
generate cash flow from operations is severely restricted due to its highly
leveraged capital structure.
Net Cash Used in Investing Activities
Cash flows used in investing activities by the Company were $11.0
million for the three months ended March 31, 2001 and $1.6 million for the
comparable period in 2000.
Net cash flows used in investing activities, for oil and gas operations,
for the three months ended March 31, 2001, were approximately $10.2 million
compared to $830,000 for the same period in 2000. Acquisitions of oil and
gas properties and other plant, property and equipment were the primary
uses of funds for both periods.
Net cash flows used in investing activities, for real estate operations,
for the three months ended March 31, 2001, were approximately $760,000
compared to $679,000 for the same period in 2000. Capital improvements and
the acquisition of a property management company where the primary uses of
funds.
Net Cash Provided by Financing Activities.
Net cash flows provided by the Company's financing activities were
approximately $1.9 million for the three months ended March 31, 2001,
compared to net cash flows used in financing activities of $6.4 million for
the comparable period in 2000.
Cash provided by financing activities, from oil and gas operations, for
the three months ended March 31, 2001, were approximately $26,000 compared
to cash used in financing activities of approximately 8.1 million for the
same period in 2000. For the three months ended March 31, 2000, proceeds
from borrowings were $15.0 million and were used to partially fund the buy
back of a portion of the 10.5% Senior Notes due 2004. Payments on debt and
other long-term liabilities of approximately $23.1 million were the primary
uses of funds in 2000.
Cash provided by financing activities for real estate operations for the
three months ended March 31, 2001 were approximately $1.9 million compared
to 1.6 million for the same period in 2000. Proceeds from borrowings were
$2.2 million and were used to finance capital improvements and working
capital. Payments on debt of $304,000 and dividends of $34,000 were the
primary uses of funds.
Other Issues
Derivative Instruments and Hedging Activities.
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No.133, "Accounting
for Derivative Instruments and Hedging Activities." SFAS No. 133, as
amended by SFAS No. 138, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts, (collectively referred to as derivatives) and for
hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to changes in the
fair value of the exposure to variable cash flows of a forecasted
transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign currency denominated forecasted
transaction. Special accounting for qualifying hedges allows a
derivative's gains and losses to offset related results on the hedged item
in the Company's statement of operations. The adoption of SFAS No. 133 on
January 1, 2001 did not have a material impact on the Company's financial
position or results of operations. The Company recorded a net transition
adjustment gain of $1.0 million in accumulated other comprehensive income
on January 1, 2001. The transition adjustment is being amortized to oil and
gas sales over the term of the agreements. The Company recorded a loss of
$1.3 million to adjust the carrying value of its oil and gas derivatives to
fair market value of $1.7 million as of March 31, 2001.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The information included in "Quantitative and Qualitative Disclosures
About Market Risk" in Item 7A of SRH's 2000 Form 10-K is incorporated
herein by reference. Such information includes a description of SHR's
potential exposure to market risks, including commodity price risk and
SHR's interest rate risk. As of March 31, 2001, there have been no
material changes in SRH's market risk exposure from that disclosed in the
2000 Form 10-K.
PART II - OTHER INFORMATION
Item 6.
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
--------------
None
SIGNATURES
SOUTHWEST ROYALTIES, INC.
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereto duly authorized.
SOUTHWEST ROYALTIES, INC.
By: /s/ H. H. Wommack, III
----------------------------------------
H.H. Wommack, III, Chairman, President,
and Chief Executive Officer
Date: May 15, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ------ -----
/s/ H.H. Wommack, III
---------------------- Chairman/President/ May 15, 2001
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
---------------------- Vice President/
Bill E. Coggin Chief Financial Officer May 15, 2001
/s/ H. Allen Corey
----------------------
H. Allen Corey Director/Secretary May 15, 2001
SIGNATURES
SOUTHWEST ROYALTIES HOLDINGS, INC.
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be
signed on its behalf by the undersigned, thereto duly authorized.
SOUTHWEST ROYALTIES HOLDINGS, INC.
By: /s/ H. H. Wommack, III
--------------------------------------
H.H. Wommack, III, Chairman, President,
and Chief Executive Officer
Date: May 15, 2001
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
--------- ------ -----
/s/ H.H. Wommack, III
---------------------- Chairman/President/ May 15, 2001
H. H. Wommack, III Chief Executive Officer
/s/ Bill E. Coggin
---------------------- Vice President/
Bill E. Coggin Chief Financial Officer May 15, 2001
/s/ H. Allen Corey
----------------------
H. Allen Corey Director/Secretary May 15, 2001