-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MFYaGV4y3PwadLDUcq/Eng4KVXr6VgJiV+yIPRDkvry/N3HpnQKvDbb+JzdT1yRQ SBytfvMKWtg2V8s2zDl9FQ== 0000821699-00-000005.txt : 20000510 0000821699-00-000005.hdr.sgml : 20000510 ACCESSION NUMBER: 0000821699-00-000005 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHWEST ROYALTIES INC CENTRAL INDEX KEY: 0000821699 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 751917432 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-23701 FILM NUMBER: 623584 BUSINESS ADDRESS: STREET 1: 407 N BIG SPRING STREET SUITE 300 CITY: MIDLAND STATE: TX ZIP: 79701 BUSINESS PHONE: 9156869927 MAIL ADDRESS: STREET 1: 407 N BIG SPRING STREET SUITE 300 CITY: MIDLAND STATE: TX ZIP: 79701 10-K/A 1 8 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K/A (Mark One) X Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Fiscal year ended December 31, 1999 or ? Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __________ to _______________ Commission file number: 000-23701 SOUTHWEST ROYALTIES, INC. SOUTHWEST ROYALTIES (Exact Name of Registrant as HOLDINGS, INC. Specified in Its Charter) (Exact Name of Registrant as Specified in Its Charter) Delaware Delaware (State or Other Jurisdiction of (State or Other Jurisdiction of Incorporation or Organization) Incorporation or Organization) 75-1917432 75-2724264 (I.R.S. Employer Identification (I.R.S. Employer Identification Number) Number) 407 North Big Spring, Suite 300 Midland, Texas 79701 (Address of Principal Executive (Zip Code) Offices) Registrants' Telephone Number, Including Area Code: (915) 686-9927 Securities to be registered pursuant to Section 12(b) of the Act: None Securities to be registered pursuant to Section 12(g) of the Act: 10.5% Senior Notes due 2004 (Title of Class) Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent files pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. X As of December 31, 1999, Southwest Royalties, Inc. had outstanding 100 shares of common stock, $.10 par value, which is its only class of stock. As of December 31, 1999, Southwest Royalties Holdings, Inc. had outstanding 1,075,868 shares of common stock, $.10 par value, which is its only class of stock. The common stock of Southwest Royalties Holdings, Inc. is not traded on any exchange and, therefore, its aggregate market value and the value of shares held by nonaffiliates cannot be determined. All of the outstanding shares of Southwest Royalties, Inc. are held by Southwest Royalties Holdings, Inc. EXPLANATION FOR THIS AMENDMENT: Southwest Royalties Holdings, Inc. and Southwest Royalties, Inc. file this Amendment No. 1 to the Annual Report, Form 10-K, for the fiscal year ended December 31, 1999 in order to correct a date disclosed in Item 8, Independent Auditor's Report. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Index to Consolidated Financial Statements Page ----- Consolidated Financial Statements of Southwest Royalties Holdings, Inc. and Subsidiaries Independent Auditors' Report 42 Consolidated Balance Sheets as of December 31, 1999 and 1998 43 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997 45 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 47 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997 48 Notes to Consolidated Financial Statements 50 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Southwest Royalties Holdings, Inc.: We have audited the accompanying consolidated balance sheets of Southwest Royalties Holdings, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Southwest Royalties Holdings, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company is experiencing difficulty in generating sufficient cash flow to meet its obligations and sustain its operations which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. KPMG LLP Midland, Texas March 15, 2000 SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands) December 31, ------------------------ ASSETS 1999 1998 - ---------------------------------------------------------- ----- ----- Current assets Cash and cash equivalents $ 16,983 $ 13,801 Restricted cash 10,003 5,050 Accounts receivable, net of allowance of $440 and $342, respectively 7,134 5,248 Receivables from related parties 836 1,594 Other current assets 1,179 1,624 ------- ------- Total current assets 36,135 27,317 ------- ------- Oil and gas properties, using the full cost method of accounting Proved 193,319 194,096 Unproved 2,059 3,230 ------- ------- 195,378 197,326 Less accumulated depletion, depreciation and amortization 126,742 121,841 ------- ------- Oil and gas properties, net 68,636 75,485 ------- ------- Rental property, net 128,685 132,120 ------- ------- Rental property - construction in progress 3,984 - ------- ------- Other property and equipment, net 4,841 5,888 ------- ------- Other assets Equity investment in subsidiary and partnerships - 931 Real estate investments 3,644 4,019 Deferred debt costs, net of accumulated amortization of $5,681 and $3,136, respectively 13,816 8,725 Noncompete covenants, net of accumulated amortization of $563 and $269, respectively 1,041 1,335 Other, net 1,385 1,730 ------- ------- Total other assets 19,886 16,740 ------- ------- Total assets $262,167 $257,550 ======= ======= (continued) The accompanying notes are an integral part of these consolidated financial statements. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - (continued) (in thousands, except per share data) December 31, LIABILITIES, MINORITY INTEREST, REDEEMABLE ------------------------ COMMON STOCK AND STOCKHOLDERS' EQUITY 1999 1998 - ---------------------------------------------------------- ----- ----- Current liabilities Current maturities of long-term debt $ 40,277 $ 12,716 Accounts payable 6,011 7,116 Accounts payable to related parties 867 173 Accrued expenses 10,670 9,737 ------- ------- Total current liabilities 57,825 29,742 ------- ------- Long-term debt 306,806 322,368 ------- ------- Other long-term liabilities 1,220 1,797 ------- ------- Minority interest 8 206 ------- ------- Redeemable common stock of subsidiary 1,228 2,979 ------- ------- Redeemable common stock 8,290 8,290 ------- ------- Stockholders' equity Preferred stock - $1 par value; 5,000,000 shares authorized; none issued - - Common stock - $.10 par value; 5,000,000 shares authorized; 1,161,037 issued at December 31, 1999 and 1998 116 116 Additional paid-in capital 2,196 2,196 Accumulated deficit (110,784) (105,375) Note receivable from an officer and stockholder (1,648) (1,679) Less: treasury stock - at cost; 214,215 shares at December 31, 1999 and 1998 (3,090) (3,090) ------- ------- Total stockholders' deficit (113,210) (107,832) ------- ------- Total liabilities, minority interest, redeemable common stock and stockholders' equity $262,167 $257,550 ======= ======= The accompanying notes are an integral part of these consolidated financial statements. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) For the years ended December 31, ---------------------------------- 1999 1998 1997 ----- ----- ----- Operating revenues Oil and gas $ 31,425 $ 32,467 $ 38,500 Well servicing, including related party revenues of $0, $0 and $8, respectively - - 7,789 Real estate 31,301 25,650 9,338 Other 1,206 1,392 1,227 --------- --------- --------- Total operating revenues 63,932 59,509 56,854 --------- --------- --------- Operating expenses Oil and gas production 10,833 18,395 18,500 Well servicing - - 5,600 Real estate 18,374 13,242 4,138 General and administrative, net of related party management and administrative fees of $3,515, $3,789 and $3,538, respectively 3,109 4,450 5,745 Depreciation, depletion and amortization 9,987 19,240 15,034 Impairment of oil and gas properties - 64,000 - - Other 798 1,235 1,342 --------- --------- --------- Total operating expenses 43,101 120,562 50,359 --------- --------- --------- Operating income (loss) 20,831 (61,053) 6,495 --------- --------- --------- Other income (expense) Interest and dividend income 954 1,478 1,002 Interest expense (41,910) (36,490) (18,894) Other 952 370 145 --------- --------- --------- (40,004) (34,642) (17,747) --------- --------- --------- (continued) SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - (continued) (in thousands, except per share data) For the years ended December 31, ---------------------------------- 1999 1998 1997 ----- ----- ----- Loss before income taxes, minority interest, equity loss and extraordinary item (19,173) (95,695) (11,252) Income tax benefit - 2,348 2,641 --------- --------- --------- Loss before minority interest, equity loss and extraordinary item (19,173) (93,347) (8,611) Minority interest in subsidiaries, net of tax 1,820 913 430 Equity loss in subsidiary and partnerships, net of tax (931) (3,620) (203) --------- --------- --------- Loss before extraordinary item (18,284) (96,054) (8,384) Extraordinary gain (loss) from early extinguishment of debt, net of tax 12,875 - (3,109) --------- --------- --------- Net Loss $(5,409) $(96,054) $(11,493) ========= ========= ========= Loss per common share Loss per common share before extraordinary item $ (17.00) $ (89.28) $ (7.78) Extraordinary gain (loss) from early extinguishment of debt, net of tax 11.97 - (2.88) --------- --------- --------- Loss per common share $ (5.03) $ (89.28) $ (10.66) ========= ========= ========= Weighted average shares outstanding 1,075,868 1,075,868 1,077,808 ========= ========= ========= The accompanying notes are an integral part of these consolidated financial statements SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the years ended December 31, 1999, 1998 and 1997 (in thousands, except share data) Note Common StockAdditional ReceivableTreasury Stock --------------Paid-InAccumulated from --------------- Shares AmountCapital DeficitStockholderShares Amount ------- ------------- --------------------------------- - - Balance - January 1, 19971,160,537 $116 $2,196 $ 2,172 $(1,735)204,575 $(2,508) Stock option exercised 500 - - - - - - Payments received on note receivable - - - - 28 - - Purchase of treasury stock - - - - - 9,640 (582) Net loss - - - (11,493) - - - --------- ---- ----- ------- ------ ------- ------ Balance - December 31, 19971,161,037 116 2,196 (9,321) (1,707) 214,215 (3,090) Payments received on note receivable - - - - 28 - - Net loss - - - (96,054) - - - --------- ---- ----- ------- ------ ------- ------ Balance - December 31, 19981,161,037 116 2,196 (105,375) (1,679) 214,215 (3,090) Payments received on note receivable - - - - 31 - - Net loss - - - (5,409) - - - --------- ---- ----- ------- ------ ------- ------ Balance - December 31, 19991,161,037 $ 116 $ 2,196 $ (110,784) $ (1,648) 214,215 $ (3,090) ========= ==== ===== ======= ====== ======= ====== The accompanying notes are an integral part of these consolidated financial statements. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) For the years ended December 31, ---------------------------------- 1999 1998 1997 ----- ----- ----- Cash flows from operating activities Net loss $ (5,409) $(96,054) $(11,493) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation, depletion and amortization 9,987 19,240 15,034 Impairment of oil and gas properties - 64,000 - - Noncash interest expense 6,344 2,963 1,311 Extraordinary (gain) loss from early extinguishment of debt (12,875) - 1,411 Gain (Loss) on sale of assets (167) (275) 84 Equity in loss of subsidiary and partnerships 187 3,620 203 Impairment of equity investment 744 - - Other noncash items 329 3 (176) Amortization of lease commissions 525 184 - Bad debt expense 438 501 241 Deferred income taxes - (2,348) (2,606) Minority interest in loss of subsidiary (1,820) (913) (430) Changes in operating assets and liabilities- Accounts receivable (1,704) 3,709 (6,029) Other current assets 60 (226) (594) Deferred lease costs (398) (773) (402) Accounts payable and accrued expenses (512) 166 6,612 Accrued interest payable (853) 227 2,898 Income taxes payable - - (30) Change in restricted cash (5,284) - - ------- ------- ------- Net cash provided by (used in) operating activities (10,408) (5,976) 6,034 ------- ------- ------- Cash flows from investing activities Proceeds from sale of oil and gas properties 5,575 5,706 1,538 Purchase of oil and gas properties (3,688) (10,046) (103,205) Purchase of other property and equipment and rental property (3,277) (54,462) (61,645) Purchase of other assets (733) (712) (3,121) Purchase of noncompete covenants - (1,604) - Increase in construction in progress (3,984) - - - Proceeds from sale of other assets 515 1,317 219 Proceeds from sale of other property, equipment and rental property 3,446 50 209 Purchase of real estate investments - (333) (91) Proceeds from sale of real estate investment 660 765 - - Change in restricted cash 331 3,014 (8,064) Other 31 22 258 ------- ------- ------- Net cash used in investing activities (1,124) (56,283) (173,902) ------- ------- ------- (continued) SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - (continued) (in thousands) For the years ended December 31, ---------------------------------- 1999 1998 1997 ----- ----- ----- Cash flows from financing activities Proceeds from borrowings 144,740 54,589 309,870 Payments on debt (120,388) (3,877) (113,381) Decrease in other long-term liabilities (52) (12) (1,325) Cash received on subscriptions receivable - - 2,807 Purchase of treasury stock - - (582) Deferred debt costs (8,546) (1,576) (9,842) Issuance of redeemable common stock, net of issue costs - - 32 Net proceeds from sale of subsidiaries common stock - - 1,007 Prepayment penalty on early extinguishment of debt (887) - (341) Dividends paid to minority interest owners (121) (120) (122) Purchase of minority interest in subsidiary - (309) - - Purchase of treasury stock by subsidiary (32) - (1,174) ------- ------- ------- Net cash provided by financing activities 14,714 48,695 186,949 ------- ------- ------- Net increase (decrease) in unrestricted cash and cash equivalents 3,182 (13,564) 19,081 Unrestricted cash and cash equivalents - beginning of period 13,801 27,365 8,284 ------- ------- ------- Unrestricted cash and cash equivalents - end of period $ 16,983 $ 13,801 $27,365 ======= ======= ======= Supplemental disclosures of cash flow information Interest paid $ 36,419 $ 31,695 $14,802 The accompanying notes are and integral part of these consolidated financial statements. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Organization and Summary of Significant Accounting Policies Business Southwest Royalties Holdings, Inc. ("SRH"), a Delaware corporation was formed in June 1997 to serve as a holding company for Southwest Royalties Inc. ("Southwest"), Sierra Well Service Inc. ("Sierra") and Midland Red Oak Realty, Inc. ("Red Oak") (collectively, the "Company"). Each shareholder of Southwest was issued one share in SRH for each share of Southwest stock held. Prior to the formation of SRH, Red Oak and Sierra were subsidiaries of Southwest. Southwest paid a dividend of the shares it owned in Red Oak and Sierra to SRH. After the formation of SRH, Southwest and Red Oak became subsidiaries of SRH and, as of July 1, 1997, Sierra was deconsolidated. Southwest is principally involved in the business of oil and gas development and production, as well as organizing and serving as managing general partner for various public and private limited partnerships engaged in oil and gas acquisitions, exploration, development and production. Southwest is also the general partner of Southwest Partners II and III, which own common stock in Sierra. Southwest sells its oil and gas production to a variety of purchasers, with the prices it receives being dependent upon the oil and gas commodity prices. Red Oak is principally involved in real estate investment and development. Sierra is principally involved in the business of oil and gas well services. Principles of Consolidation The consolidated financial statements include the accounts of SRH and its subsidiaries. As of December 31, 1999 and 1998, the Company owned approximately 81% of Red Oak, 39% of Sierra, 100% of Blue Heel, 99% of MSS and 100% and 98%, respectively, of TPI. Blue Heel, MSS and TPI are subsidiaries of Southwest. Effective July 1, 1997, Sierra was deconsolidated and is accounted for using the equity method (see Note 4). Effective November 1999, TPI was liquidated. The consolidated financial statements include the Company's proportionate share of the assets, liabilities, income and expenses of oil and gas limited partnerships for which it serves as managing general partner. The Company accounts for its investments in Southwest Partners II and III using the equity method, as the Company exercises significant influence over the operations of these partnerships. All significant intercompany transactions have been eliminated. Estimates and Uncertainties Preparation of the accompanying consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. In addition, the Company maintains its excess cash in several interest bearing accounts in various financial institutions. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Restricted Cash Restricted cash represents amounts required to be reserved in separate accounts by financial lenders. The interest sinking fund is cash set aside to pay interest on the 10.5% Senior Notes. Restricted cash accounts have been established for the following purposes (in thousands): 1999 1998 ---- ---- Cash bonds $ 35 - Certificate of Deposits 112 105 Tenant security deposits 512 412 Interest reserves - 707 Capital expenditures account 552 1,229 Tax and insurance reserve 2,465 1,009 Tenant bankruptcy reserve - 767 Lockbox 439 217 Customer service reserve 10 10 Escrow fund 627 594 Interest sinking fund 5,251 - ------ ----- $10,003 5,050 ====== ===== Real Estate Revenue Recognition The Company leases offices and retail shopping centers under noncancelable operating leases. The Company reports base rental revenue for financial statement purposes straight-line over the terms of the respective leases. Accrued straight-line rents represent the amount that straight-line rental revenue exceeds rents collected in accordance with the lease agreements. Management, considering current information and events regarding the tenants' ability to fulfill their lease obligations, considers accrued straight-line rents to be impaired if it is probable that the Company will be unable to collect all rents due according to the contractual lease terms. If accrued straight-line rents associated with a tenant are considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows. Impairment losses, if any, are recorded through a loss on the write-off of assets. Cash receipts on impaired accrued straight-line rents are applied to reduce the remaining outstanding balance and as rental revenue, thereafter. Some leases provide for percentage rents based on the tenant's revenue. Percentage rents are accrued monthly based on prior experience or current tenant financial information. Some leases require tenants to reimburse the Company for certain expenses of operating the property. Concentrations of Credit Risk The Company is subject to credit risk through oil and gas trade receivables and real estate lease receivables. Although a substantial portion of its customers' ability to pay is dependent upon conditions in the oil and gas industry as well as general economic conditions, credit risk is reduced due to a large customer base. Commodity Hedging and Derivative Financial Instruments The Company has only limited involvement with derivative financial instruments and generally does not use them for trading purposes. They are used to manage commodity price risks. The Company is exposed to credit losses in the event of nonperformance by the counter-parties to its commodity hedges. The Company anticipates, however, that such counter- parties will be able to fully satisfy their obligations under the contracts. The Company does not obtain collateral or other security to support financial instruments subject to credit risk but monitors the credit standing of the counter-parties. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The derivative financial instruments that the Company accounts for as hedging contracts must meet the following criteria: the underlying asset must expose the Company to price risk that is not offset in another asset or liability, the hedging contract must reduce that price risk, and the instrument must be designated as a hedge at the inception of the contract and throughout the contract period. In order to qualify as a hedge, there must be clear correlation between changes in the fair value of the financial instrument and the fair value of the underlying asset such that changes in the market value of the financial instrument will be offset by the effect of price changes on the exposed items. Premiums paid for commodity option contracts which qualify as hedges are amortized to oil and gas sales over the term of the agreements. Unamortized premiums are included in other assets in the consolidated balance sheet. Amounts receivable or payable under the commodity option contracts are accrued as an increase or decrease in oil and gas sales for the applicable periods. Oil and Gas Properties All of the Company's oil and gas properties are located in the United States and are accounted for at cost under the full cost method. Under this method, all productive and nonproductive costs incurred in connection with the acquisition, exploration and development of oil and gas reserves are capitalized. No gain or loss is recognized on the sale of oil and gas properties unless nonrecognition would significantly alter the relationship between capitalized costs and remaining proved reserves for the affected amortization base. When gain or loss is not recognized, the amortization base is reduced by the amount of sales proceeds. Net capitalized costs of oil and gas properties, including the estimated future costs to develop proved reserves, are amortized using the units of revenue method, whereby the provision is computed on the basis of current gross revenues from production in relation to future gross revenues, based on current prices, from estimated production of proved oil and gas reserves. Should the net capitalized costs net of related deferred income taxes exceed the estimated present value of oil and gas reserves discounted at 10% and adjusted for related income taxes, such excess costs would be charged to expense in the Consolidated Statements of Operations. As of December 31, 1999, no write down of the capitalized costs of oil and gas properties was deemed necessary. As of December 31, 1998, the net capitalized cost exceeded the estimated present value of oil and gas reserves resulting in a noncash charge of $64.0 million. Once incurred, a writedown of oil and gas properties is not reversible at a later date, even if oil or natural gas prices increase. It is reasonably possible that the estimates of anticipated future gross revenues, the remaining estimated economic life of the product, or both could change significantly in the near term due to the fluctuation of oil and gas prices or production. Depletion estimates would also be affected by such changes. Property and Equipment Rental property and other property and equipment is stated at cost. Repairs and maintenance are charged to expense as incurred, with additions and improvements being capitalized. Upon sale or other retirement of depreciable property, the cost and accumulated depreciation are removed from the related accounts and any gain or loss is reflected in the Consolidated Statements of Operations. Depreciation is provided on the straight-line method based on the estimated useful lives of the depreciable assets as follows: Building and improvements 20 to 30 years Rental property and improvements 5 to 30 years Leasehold improvements 2 to 10 years Machinery and equipment 3 to 5 years Furniture and fixtures 3 to 5 years Equipment under capital lease 3 to 5 years SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Rental Property - Construction in Progress All costs associated with construction in progress are capitalized and subject to depreciation when each project is completed. Interest is capitalized for construction in progress. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the assets useful life. In 1999 and 1998, no interest costs were capitalized. Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of In accordance with the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, the Company reviews its long-lived assets, excluding oil and gas properties accounted for using the full cost method of accounting, and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In this circumstance, the Company recognizes an impairment loss for the amount by which the carrying amount of the asset exceeds the estimated fair value of the asset. Deferred Debt Costs The Company capitalizes certain costs incurred in connection with issuing debt. These costs are being amortized to interest expense on the straight-line method over the term of the related debt. Gas Balancing The Company utilizes the sales method of accounting for over or under deliveries of natural gas. Under this method, the Company recognizes sales revenue on all natural gas sold. As of December 31, 1999, 1998 and 1997, the Company was underproduced by approximately 587 MMcf, 620 MMcf and 697 MMcf, respectively. Income Taxes Deferred tax assets and liabilities are recognized for the estimated future tax effects attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rate is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced, if necessary, by a valuation allowance for the amount of tax benefits that may not be realized. SRH and its eligible subsidiaries file a consolidated U.S. federal income tax return. Sierra (through June 30, 1997) and Red Oak are consolidated for financial reporting purposes, but beginning January 1, 1996, were not eligible to be included in the consolidated U.S. federal income tax return. Separate provisions for income taxes have been determined for these entities. Reclassifications Certain reclassifications have been made to the 1998 and 1997 amounts to conform to the 1999 presentation. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Derivative Instruments and Hedging Activities In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133") which established standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. It establishes conditions under which a derivative may be designated as a hedge, and establishes standards for reporting changes in the fair value of a derivative. SFAS 133, as amended by SFAS 137, is required to be implemented for all fiscal quarters of all fiscal years beginning after June 15, 2000. Early adoption is permitted. Income (loss) per share Basic net income (loss) per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. The computation of diluted net income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the earnings of the entity. For 1999, 1998 and 1997, the computation of diluted net loss per share was antidilutive; therefore, the amounts reported for basic and diluted net income (loss) per share were the same. Noncompete covenants Noncompete covenants are carried at cost less accumulated amortization. The covenants are being amortized over their contractual lives, generally three to five years. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 2. Liquidity The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. SRH has a highly leveraged capital structure with, approximately, $30.8 million of cash interest and $40.3 million of principal due at December 31, 1999. Subsequent to year end, SRH drew down the remaining $15.0 million on the Revolving Loan Facility. As a result, $32.1 million of cash interest payments and $55.3 million of principal will be due in 2000 (See Note 18). Due to severely depressed commodity prices experienced throughout 1998 and into the first half of 1999, and lagging rental property utilization, SRH is experiencing difficulty in generating sufficient cash flow to meet its obligations and sustain its operations. Management is currently in the process of renegotiating the terms of SRH's various obligations with its note holders and/or attempting to seek new lenders or equity investors. Additionally, management would consider disposing of certain assets in order to meet its obligations. There can be no assurance that SRH's debt restructuring efforts will be successful or that the note holders will agree to a course of action consistent with SRH's requirements in restructuring the obligations. Even if such agreement is reached, it may require approval of additional note holders, or possibly, agreements of other creditors of SRH, none of which is assured. Furthermore, there can be no assurance that the sales of assets can be successfully accomplished on terms acceptable to SRH. Under current circumstances, SRH's ability to continue as a going concern depends upon its ability to (1) successfully restructure its Revolving Loan Facility, the 10.5% Senior Notes and other obligations or obtain additional financing as may be required, (2) maintain compliance with all debt covenants, (3) generate sufficient cash flow to meet its obligations on a timely basis, and (4) achieve satisfactory levels of future earnings. If SRH is unsuccessful in its efforts, it may be unable to meet its obligations on the Revolving Loan Facility, the 10.5% Senior Notes, as well as other obligations, making it necessary to undertake such other actions as may be appropriate to preserve asset values. 3. Subsidiaries, Acquisitions and Dispositions During 1994, Red Oak sold 62,384 shares of redeemable common stock for approximately $1,560,000 million through a private placement offering. During 1995, Red Oak sold an additional 39,616 shares of redeemable common stock for approximately $990,000 and 34,611 shares of its Series A cumulative convertible preferred stock, for approximately $1,731,000. The redeemable common stock is redeemable at the stockholder's option at a price equal to the purchase price plus a 6% annual return computed on a cumulative, but not compounded basis. Redemptions are to be paid out of future earnings of Red Oak. If there are no future earnings, redemptions will be paid out of additional paid-in capital. The redemption rights expired on 58,384 of the redeemable common shares on December 1, 1999. The remaining shares' redemption rights will expire in March through June of 2000. On September 26, 1996, Red Oak formed a subsidiary with an unrelated third party. On October 15, 1996, the subsidiary acquired three shopping centers for a total purchase price of $12.5 million. The transaction was funded through a $2.3 million contribution from Red Oak and a $1.2 million contribution from the unrelated third party. In April 1997 Red Oak purchased the interest of the unrelated third party and merged the subsidiary into Red Oak. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) On October 14, 1997, Southwest acquired various working interests in 431 producing oil and gas wells, located in seven oil and gas fields in the Permian Basin of West Texas and southeastern New Mexico for $72.3 million. Southwest operates 133 of these wells. Southwest funded this acquisition through the issuance of 10.5% Senior Notes (see Note 7). The results of operations of the properties acquired are included in the Consolidated Statement of Operations beginning October 14, 1997. In 1997, Red Oak acquired five shopping centers and two office buildings in Texas, Oklahoma and Arizona for a total cost of $50.9 million. The transactions were accounted for using the purchase method. The results of operations of the properties acquired are included in the Consolidated Statements of Operations as of the close of each acquisition. In June 1998, Red Oak acquired a retail shopping center in Texas for $13.5 million. The acquisition was financed by the variable note payable due July 2001 described in Note 7. The operations of the retail shopping center from the date of acquisition through December 31, 1998 have been included in the Consolidated Statement of Operations for the year ended December 31, 1998. In December 1998, Red Oak acquired a retail shopping center in Texas for $21.0 million. The acquisition was financed by the variable note payable due December 2001 described in Note 7. The operations of the retail shopping center from the date of acquisition through December 31, 1998 have been included in the Consolidated Statement of Operations for the year ended December 31, 1998. 4. Equity Investment in Subsidiary and Partnerships As of December 31, 1999, the investment in subsidiary held by the Company consists of a 28% direct ownership interest in Sierra as well as an additional 11% indirect interest the Company obtained through limited partnerships, Southwest Partners II and Southwest Partners III, for which Southwest serves as the managing general partner. The investment is accounted for using the equity method. A Financial Institution owns preferred stock in Sierra, which can be converted to common stock at the Financial Institutions option. If the Financial Institution elects to convert its preferred stock to common stock, the Companys direct ownership would decrease to 20% and its indirect ownership would decrease to 7%. Effective July 1, 1997, Southwest Partner III purchased additional shares of Sierra stock, decreasing Southwest's total direct and indirect ownership percentage below 50%. Therefore, with the change of Southwest's ownership percentage from a majority to a minority interest, Sierra was deconsolidated. The deconsolidation of Sierra required an adjustment to the investment account to reflect the change in accounting from the consolidation method to the equity method. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Pertinent financial information for Sierra Well Service, Inc. as of December 31, 1999 and 1998 and for the years ended December 31, 1999 and 1998 and for the six months ended December 31, 1997 is as follows (in thousands): December 31, December 31, 1999 1998 ---- ---- Balance Sheets Assets $ 53,327 $ 46,861 ====== ====== Liabilities $ 58,263 $ 59,891 Stockholders' deficit (4,936) (13,030) ------ ------ Total liabilities and stockholders' deficit $ 53,327 $ 46,861 ====== ====== For the year For the year Six months ended ended ended December 31, December 31, December 31, 1999 1998 1997 ---- ---- ---- Statements of Operations Revenues $ 37,331 $ 45,319 $ 18,370 Expenses 50,732 50,944 19,163 Impairment of long lived assets - 22,671 - - ------ ------ ------ Net Income/(Loss) (13,401) (28,296) (793) ====== ====== ====== Company's share of net loss $ (931) $ (3,620) $ (203) ====== ====== ====== SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 5. Property and Equipment Property and equipment, including rental property and other, consists of the following (in thousands): Years Ended December 31, ------------------------ 1999 1998 ----- ----- Land $ 2,352 $ 2,287 Building and improvements 1,051 1,419 Machinery and equipment 2,896 3,048 Furniture and fixtures 1,536 2,367 Equipment under capital lease 56 93 Rental property 137,535 137,059 ------- ------ 145,426 146,273 Less accumulated depreciation 11,900 8,265 ------- ------ $133,526 $138,008 ======= ====== 6. Future Lease Receivables Red Oak leases office and retail shopping centers under noncancelable operating leases that expire at various dates through 2035. The following is a summary of minimum future rentals expected to be received under noncancelable operating leases as of December 31, 1999 (in thousands): 2000 $ 19,407 2001 15,279 2002 12,145 2003 9,207 2004 6,886 Thereafter 24,262 ------ $ 87,186 ====== The preceding future minimum rentals do not include percentage rents or reimbursements. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 7. Long-term Debt Long-term debt consists of the following (in thousands): December 31, ------------------- 1999 1998 ----- ----- 10.5% Senior Notes, interest payable semi-annually due October 15, 2004, net of discount of $1,487 and $2,116, respectively $160,598 $197,884 13.5% Notes payable, due April 2000. Cash interest of 10.5% payable monthly with additional interest payable based on excess cash flow or through the issuance of additional notes. Collateralized by real estate. - 72,273 Revolving Loan Facility with variable rate interest, due December 2000. Collateralized by oil and gas properties. 35,000 - Variable Rate Notes Payables: Notes payable due July 2001, accrued interest due and payable monthly at 7.1%, per annum with additional 1% payable in cash or additional notes. Net of discount of $944 and $1,611, respectively 15,883 13,891 Notes payable due December 2001, accrued interest due and payable monthly at 7.1%, per annum with additional 1.5% payable in cash or additional notes. Net of discount of $2,556 and $3,889, respectively 25,298 21,806 Notes payable due July 2002, interest at 8.5% minimum per annum, accrued interest due and payable monthly. Net of discount of $4,229, respectively 101,835 - Other 8,469 29,230 ------- ------- 347,083 335,084 Less current maturities 40,277 12,716 ------- ------- $306,806 $322,368 ======= ======= 10.5% Senior Notes In October 1997, the Company issued $200 million aggregate principal amount of 10.5% Senior Notes due October 15, 2004 (the "Notes"). The Notes were sold at a discount and interest is payable April 15 and October 15 of each year, commencing April 15, 1998. The Notes are general unsecured senior obligations of the Company and rank equally in right of payment with all other senior indebtedness of the Company and senior in right of payment of all existing future subordinated indebtedness of the issuer. Net proceeds from the issuance of the Notes were used primarily to repay existing debt of approximately $84 million, purchase oil and gas properties for approximately $72 million, purchase additional stock in Red Oak for approximately $10 million, invest $1.7 million in an affiliate, with the remaining balance used for working capital. The Indenture imposes certain limitations on the ability of the Company and its restricted subsidiaries to, among other things, incur additional indebtedness or issue disqualified capital stock, make payments in respect to capital stock, enter into transactions with affiliates, incur liens, sell assets, change the nature of its business, merge or consolidate with any other person and sell, lease, transfer or otherwise dispose of substantially all of its properties or assets. The indenture requires the issuer to repurchase notes under certain circumstances with the excess cash of certain asset sales. The limitations are subject to a number of important qualifications and exceptions. The issuer must report to the Trustee on compliance with such limitations on a quarterly basis. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 13.5% Note Payable In April 1997 MRO Properties Inc. ("MROP"), a 100% owned subsidiary of Red Oak entered into a $42 million credit facility maturing in April 2000 with an institutional lender (the "MROP Facility"). The MROP Facility was executed in order to consolidate nine mortgage loans, originally incurred to complete the acquisition of certain Red Oak properties and to finance the acquisition of an additional real estate property. Borrowings under the facility bear interest at a rate of 13%, with 10% payable in cash and the remaining 3% payable in cash or additional notes. The facility contains a number of covenants that, among other things, restrict the ability of MROP to incur additional indebtedness and dispose of assets. The facility is secured by a first lien on substantially all of MROP's properties. In September 1997, the Company negotiated an additional $30.5 million in loan proceeds which was used to acquire a retail shopping center and office building in Oklahoma City, Oklahoma and a retail shopping center in San Antonio, Texas. The loan is collateralized by the properties purchased, and by properties contributed by Red Oak. This note was repaid with a portion of the proceeds from the June 1999 Variable Rate Note Payable. Revolving Loan Facility In December 1999, Southwest entered into a Revolving Loan Facility with Bank One Texas, N.A., which provided a borrowing base of $50 million with a maturity date of December 29, 2000. Funds from the Revolving Loan Facility may be used for working capital and other general corporate purposes, including the repurchase of a portion of Southwest's outstanding 10.5% Senior Notes due 2004. Advances on the Revolving Loan Facility bear interest at the option of Southwest, based on the prime rate of Bank One Texas, N.A. (8.5% at December 31, 1999) plus one fourth of one percent (.25%), when the borrowing base usage is equal to or greater than 80% or zero percent (0%) when the borrowing base usage is less than 80% or, a Eurodollar rate (substantially equal to the London InterBank Offered Rate ("LIBOR")) plus 1.25% up to 2.0% based on the borrowing base usage percentage. The Revolving Loan Facility is secured by no less than 85% of Southwest's oil and gas properties. As of December 31, 1999, the company has drawn $35.0 million. The remaining $15.0 million was drawn in January 2000(See Note 18). The Revolving Loan Facility imposes certain limitations on the ability of Southwest to, among other things, incur additional indebtedness or issue disqualified capital stock, make payments in respect to capital stock, enter into transactions with affiliates, incur liens, sell assets, change the nature of its business, merge or consolidate with any other person and sell, lease, transfer or otherwise dispose of substantially all of its properties or assets. The Revolving Loan Facility required Southwest to establish a sinking fund account with an initial deposit of $3.5 million. Southwest is to transfer monthly one-twelfth of the annual interest payments on the 10.5% Senior Notes beginning December 31, 1999 into this sinking fund account for the purpose of making interest payments on the 10.5% Senior Notes. Variable Rate Notes Payable In June 1998, MRO N Cross, Inc., a wholly owned subsidiary of Red Oak negotiated two notes payable in the amount of $13.5 million, net of a $2 million discount, and $2.5 million. The $13.5 million note was used for the acquisition of rental property in the amount of $12.9 million with the remaining $600,000 to be used for capital improvements to the rental property purchased. The $2.5 million note is reserved for capital improvements to the rental property purchased of which $1.3 million has been utilized as of December 31, 1999. The notes are collateralized by the property purchased. In December 1998, MRO Commercial, Inc., a wholly owned subsidiary of Red Oak negotiated two notes payable in the amount of $21.7 million, net of a $4 million discount, and $9.7 million. The $21.7 million note was used for the acquisition of a retail shopping center and the funding of various escrow balances. The $9.7 million note is for capital improvements to the rental property purchased of which $1.9 million has been utilized as of December 31, 1999. The notes are collateralized by the property purchased. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) In June 1999, MRO Southwest, Inc., a wholly owned subsidiary of Red Oak negotiated two notes payable in the amount of $97.5 million and $8.0 million, net of discounts of $5.3 million. Borrowings for both notes accrue interest in arrears at a rate per annum equal to the greater of 8.6% or LIBOR plus 360 basis points. The interest rate includes a servicing fee of .10%. Approximately $91.4 million of the $97.5 million note was used to retire existing debt on properties contributed to MRO Southwest by Red Oak, $1.5 million was deposited into various restricted cash accounts and the remaining proceeds were used for general corporate purposes. The $8.0 million note is for capital improvements to rental property and $3.4 million has been utilized as of December 31, 1999. The notes are collateralized by the properties owned by MRO Southwest. The notes impose certain restrictive covenants including restrictions on the incurrence of additional indebtedness, dissolution, termination or liquidation of all or substantially all of the assets, changes in the legal structure of the assets, making any loans or advances to any third party and commingling its assets with the assets of any of its affiliates or of any other person or entity. Extinguishment of Debt In 1997, the Company repaid certain notes payable with proceeds from the 10.5% Senior Notes. The remaining unamortized deferred debt costs associated with these notes resulted in an extraordinary charge of $3,109,000, net of $1,241,000 of tax benefit, or $2.88 per share. In June 1999, MRO Southwest repaid certain notes payable with proceeds from the aforementioned Variable Note Payable issued in June of 1999. Prepayment penalties and the remaining unamortized deferred debt costs associated with these notes resulted in an extraordinary charge of, approximately, $1,598,000 or $(1.49) per share. Since there is no recorded income tax benefits on continuing operations there is no income tax benefits recorded on the extraordinary loss. In December of 1999, Southwest purchased approximately 19%, or approximately $37.9 million original face amount, of its 10.5% Senior Notes with the proceeds from the aforementioned Revolving Loan facility. Southwest paid approximately $22.0 million, including all fees, to purchase the 10.5% Senior Notes and wrote off approximately $349,000 of deferred loan issue costs and approximately $980,000 of the original issue discount to recognize a $14.5 million extraordinary gain on the purchase of the Notes. Southwest has not recorded any income tax benefits on continuing operations and therefore there is no income tax expense recognized on the extraordinary gain. The extraordinary gain per share is approximately $13.48. Southwest purchased an additional 19% or approximately $38.4 million original face amount of its 10.5% Senior Notes in January of 2000 (See Note 18). Aggregate maturities of all long-term debt as of December 31, 1999 are as follows (in thousands): 2000 $ 40,277 2001 41,412 2002 101,926 2003 391 2004 160,680 Thereafter 2,397 ------- $347,083 ======= SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 8. Income Taxes Income tax provision (benefit) and amounts separately allocated were as follows (in thousands): December 31, ---------------------------- 1999 1998 1997 ----- ----- ----- Loss before minority interest, equity loss and extraordinary item $ - $(2,348) $ (2,641) Equity loss in subsidiary - - (106) Extraordinary loss from early extinguishment - - (1,241) ------ ------ ----- $ - $(2,348) $ (3,988) ====== ====== ===== The U.S. Federal tax provision (benefit) attributable to loss before income taxes, minority interest and extraordinary item consists of the following (in thousands): December 31, ---------------------------- 1999 1998 1997 ----- ----- ----- Current $ - $ - $ (35) Benefit of net operating loss carryforward (11,307) (14,165) (7,340) Deferred 9,266 (20,237) 3,341 Valuation allowance 2,041 32,054 1,393 ------ ------ ----- $ - $(2,348) $(2,641) ====== ====== ===== Reconciliation's between the amount determined by applying the U.S. federal statutory rate to loss before income taxes, minority interest and extraordinary item with the income tax provision (benefit) is as follows (in thousands): December 31, ---------------------------- 1999 1998 1997 ----- ----- ----- Computed "expected" tax expense using the U.S. federal statutory rate $(6,488) $(34,510) $ (3,826) Reduction in available net operating loss carryforwards 4,944 - - Meals and entertainment 16 16 16 Change in valuation allowance 2,041 32,054 1,156 Other (513) 92 13 ------ ------ ----- Provision (benefit) for income taxes $ - $(2,348) $(2,641) ====== ====== ===== SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities were as follows (in thousands): December 31, ------------------- 1999 1998 Deferred tax assets: ----- ----- Net operating loss carry forwards $ 28,226 21,862 Alternative minimum tax credit carryforwards 170 170 Receivables 278 152 Oil and gas properties, principally due to differences in the tax and book basis and depletion methods and the deduction of intangible drilling costs for tax purposes 2,356 7,833 Equity investment in subsidiary 1,081 1,103 Other long term assets 2,192 1,817 Other long term liabilities 286 463 Covenant not to complete 64 57 Other 243 29 ------ ------- Total gross deferred tax assets 34,896 33,486 ------ ------- Less valuation allowance (34,727) (32,686) ------ ------- Total gross deferred tax assets 169 800 ------ ------- Deferred tax liabilities: Other property and equipment (158) (663) Real estate investments - (21) Accounts payable and accrued expenses (11) (7) Other - (109) ------ ------- Total gross deferred tax liabilities (169) (800) ------ ------- Net deferred tax asset (liability) $ - $ - ====== ======= A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. Based on expectations for the future, management has determined that taxable income of Southwest will likely not be sufficient to fully utilize available carryforwards prior to their ultimate expiration. As such, Southwest has recorded a valuation allowance of $27,598,000 to reflect the realizability of its net deferred tax assets. The amount of the valuation allowance could be reduced if estimates of future taxable income during the carryforward period are increased. As of December 31, 1999, Southwest had net operating loss carryforwards for U.S. federal income tax purposes of approximately $65,180,000, which are available to offset future regular taxable income, if any. The net operating loss carryforwards expire in various periods from 2012 through 2017. Southwest has alternative minimum tax credit carryforwards totaling $170,000 to offset regular income tax, which have no scheduled expiration date. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Red Oak files an independent return exclusive of Southwest and has net operating loss carryforwards of $17,836,000 expiring in various periods through 2017. Based on expectations for the future, management has determined that taxable income of Southwest will likely not be sufficient to fully utilize available carryforwards prior to their ultimate expiration. Approximately $7,129,000 of the valuation allowance relates primarily to the uncertainty of the realizability of Red Oak's carryforwards, the amount of the valuation allowance could be reduced if estimates of future taxable income during the carryforward period are increased. 9. Profit Sharing Plan On January 1, 1991, the Company adopted an employee profit sharing plan that is intended to provide participating employees with additional income upon retirement. Employees may contribute between 1% and 15% of their base salary up to a maximum of $10,000 for the years ended December 31, 1999 and 1998 and $9,500 for the year ended December 31, 1997. For the years ended December 31, 1999, 1998 and 1997, the Company matched 20% of the employees' contributions. For the year ended December 31, 2000, the Company will match 20% of the employees' contributions. For subsequent years, the Company will make contributions to the plan on a discretionary basis. Employee contributions are fully vested at all times. Employer contributions are fully vested upon retirement or after five years of service. For the years ended December 31, 1999, 1998 and 1997, the Company contributed approximately $72,000, $61,000 and $66,000, respectively, to the plan. 10. Redeemable Common Stock In August 1996, the Company issued 129,046 shares of redeemable common stock through a private placement offering for $68 per share. The stock is redeemable at the stockholder's option at any time beginning five years from the issuance of the stock (December 31, 2001) at a purchase price determined as follows: (i) The Company shall review no less than five and no more than ten publicly traded oil and gas companies each with a market capitalization between $50 million and $150 million ("Public Company"). The Company shall determine the ratio of each Public Company's market capitalization to EBITDA for the most recent fiscal year. The Company shall then average such multiples and take this averaged multiple and apply it to the Company's EBITDA for the most recent fiscal year, to estimate a value for the Company's common stock. (ii) The Company will determine the multiple of the market capitalization of each Public Company relating to the present value of such Public Company's oil and gas reserves. Present value will be determined by discounting the expected net cash flow from the oil and gas reserves by 10%. The Company will then take the average multiple based on this methodology and apply it to the present value of the Company's oil and gas reserves discounted by 10% to determine a value for the expected net cash flow from the Company's common stock. The Company will then take the average of (i) and (ii) to determine the value of the Company's common stock. The redemption right terminates on the effective date of any registration statement filed with the Securities and Exchange Commission relative to the offer and sale of the Company's common stock to the public. 11. Stockholders' Equity During 1994, the Company issued a 6% note to a stockholder. The note requires semi-monthly payments of $5,500 and is collateralized by the Company's common stock held by the stockholder. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 12. Commitments and Contingencies The partnership agreements relating to certain limited partnerships for which Southwest serves as managing general partner provide for Southwest to offer to repurchase such limited partner units. Under the terms of three of the partnership agreements, Southwest is obligated to repurchase a maximum of $100,000 annually of the units of limited partnerships' interests originally outstanding. Under the terms of nine other partnership agreements, Southwest's obligation to repurchase units in any one year is limited to 10% of the capital contributed by all of the respective limited partners. The repurchase price is based on the discounted future revenues from oil and gas reserves of the respective partnership and the value of other partnership assets. Such amounts required for repurchase in connection with the acceptance by a portion of the limited partners is approximately $2,447,000 at December 31, 1999. The total amount of limited partner unit repurchases for the years ended December 31, 1999 and 1998 was approximately $71,000 and $287,000, respectively. The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which are constantly changing, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites. Environmental expenditures are expensed or capitalized depending on their future economic benefit. Expenditures that relate to an existing condition caused by past operations and that have no future economic benefits are expensed. Liabilities for expenditures of a noncapital nature are expensed when environmental assessment and/or remediation is probable and the costs can be reasonably estimated. Management recognizes a financial exposure that may require future expenditures presently existing for oil and gas properties and other operations. Other long-term liabilities at December 31, 1999 includes $663,000 for estimated future remedial actions and cleanup costs. As of December 31, 1999, the Company has not been fined, cited or notified of any environmental violations which would have a material adverse effect upon capital expenditures, earnings or the competitive position in the oil and gas industry. However, management does recognize that by the very nature of its business, significant costs could be incurred to bring the Company into total compliance. The amount of such future expenditures is not readily determinable due to several factors, including the unknown magnitude of possible contaminations, the unknown timing and extent of the corrective actions which may be required, the determination of the Company's liability in proportion to other responsible parties and the extent to which such expenditures are recoverable from insurance or indemnifications from prior owners of the Company's properties. It is reasonably possible this estimate could change materially in the near term. In the normal course of its business, the Company is subject to pending or threatened legal actions; in the opinion of management, any such matters will be resolved without material effect on the Company's operations, cash flow or financial position. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 13. Commodity Hedging and Derivative Financial Instruments The Company, from time to time, uses option contracts to mitigate the volatility of price changes on commodities the Company produces and sells as well as to lock in prices to protect the economics related to certain capital projects. On July 9, 1999, Southwest entered into a commodity swap agreement to hedge a portion of its crude oil sales. The agreement is for a notional amount of 1,000 BBls of oil a day with a strike price of $20.22, based on West Texas Intermediate - NYMEX. The contract is for the period August 1, 1999 through October 31, 1999. At the option of the counter-party the contract has been extended to January 31, 2000. On December 30, 1999, Southwest entered into a basket revenue protection agreement, which provides the Company with an oil and gas revenue floor. The contract is for the period January 1, 2000 through December 31, 2000. The agreement is to be calculated on a calendar year quarter as disclosed in the following table based on NYMEX Natural Gas and NYMEX Crude Oil: Notional Volumes Strike Prices ------------------------- ----------------------------- Crude Natural Crude Natural Minimum Oil (bbl) Gas (MMBtu) Oil Gas Boe Revenue ---------- ----------- ----- ------- ---- -------- Quarter 1 269,254 976,676 $ 21.12 $ 1.91 $ 28.76 $7,552,096 Quarter 2 263,058 910,325 $ 18.80 $ 1.92 $ 26.56 $6,714,359 Quarter 3 257,206 857,728 $ 18.00 $ 1.97 $ 25.88 $6,319,432 Quarter 4 251,914 813,400 $ 18.00 $ 2.20 $ 26.80 $6,323,932 Payments shall be made no later than five business days, after each quarterly floating price is determinable by NYMEX. The cost of the floor was approximately $638,000 and is amortized monthly as a reduction of oil and gas revenues. 14. Related Party Transactions Southwest is the managing general partner for several public and private oil and gas limited partnerships, with an officer of Southwest also serving as a general partner for certain of the limited partnerships. As is usual in the oil and gas industry, the operator is paid an amount for administrative overhead attributable to operating such properties and management fees attributable to serving as managing general partner. As provided for in the partnership agreements, such amounts paid by the partnerships to Southwest approximated $3,515,000, $3,789,000 and $3,538,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Included in these amounts, an affiliate of Southwest paid management fees of approximately $136,000 and $147,000, for the years ended December 31, 1999 and 1998, and approximately $54,000, for the six months ended December 31, 1997. In addition, Southwest and certain officers and employees may have an interest in some of the partnership properties. An affiliate of the company performs various oilfield services for limited partnerships managed by Southwest. Such services aggregated $365,000, $115,000 and $155,000 for the years ended December 31, 1999, 1998 and 1997. The same affiliate performed services for Southwest that aggregated approximately $313,000 and $131,000, for the years ended December 31, 1999 and 1998 and approximately $47,000, for the six months ended December 31, 1997. 15. Disclosures About Fair Value of Financial Instruments The carrying amount of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, other current assets and other current liabilities approximates fair value because of the short maturity of these instruments. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The fair value of the Company's 10.5% Senior Notes is estimated based on the quoted market price for the notes. 1999 1998 ----- ----- Carrying Fair Carrying Fair Amount Value Amount Value ------- ------ ------- ------ 10.5% Senior notes, net discount of $1,487 and 2,116, respectively $160,598 $89,935 $197,884 $79,154 The fair value of all other long-term debt approximates the carrying amount as of December 31, 1999 and 1998, based on the borrowing rates currently estimated to be available to the Company for loans with similar terms. The Company purchased the Basket Revenue Protection Agreement on December 31, 1999, and therefore deems the carrying value of $638,000 to equate to fair market value at December 31, 1999. The carrying amount of investment in subsidiary at December 31, 1999 is recorded at zero because the investor's proportionate share of the investee's net loss exceeded the original investment. The fair value of SRH's investment in Sierra is undeterminable at December 31, 1999, as Sierra is highly leveraged and is not publicly traded. If Sierra subsequently begins to report net income, Southwest will resume applying the equity method only after its share of net income equals the share of net losses not recognized during the period the equity method is suspended. 16. Lines of Business The Company operates in three major segments: Oil and Gas Activities (oil and gas acquisition, development, exploration and production, as well as organizing and serving as managing general partner for various public and private limited partnerships engaged in oil and gas development and production), Oil and Gas Well Servicing (provides well completion, recompletion and production equipment, transportation services, tank supply rental services and other support and well maintenance services to operating oil and gas companies) and Real Estate Investment and Management (owns and manages retail shopping centers and office buildings). Other items include eliminations, manufacturing, computer service and the holding Company. Effective July 1, 1997, Sierra, the oil and gas well servicing business, was deconsolidated, therefore only six months of income statement information is displayed in the tables and no balance sheet information is displayed as of December 31, 1998 (see Note 4.) 1999 1998 1997 ----- ----- ----- (in thousands) Operating Revenue Oil and gas $31,998 $ 32,599 $38,662 Well service - - 7,833 Real estate 31,301 25,650 9,338 Other and eliminations 633 1,260 1,021 ------ ------ ------ $63,932 $ 59,509 $56,854 ====== ====== ====== Operating profit (loss) Oil and gas $14,146 $(68,633) $ 3,654 Well service - - 184 Real estate 6,812 7,605 3,074 Other and eliminations (127) (25) (417) ------ ------ ------ $20,831 $(61,053) $ 6,495 ====== ====== ====== SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 1999 1998 1997 ----- ----- ----- (in thousands) Interest Expense Oil and gas $22,381 $ 22,536 $12,329 Well Service - - 184 Real Estate 19,664 13,969 6,320 Other and eliminations (135) (15) 61 ------ ------- ------- $41,910 $ 36,490 $18,894 ====== ======= ======= Depreciation, depletion and amortization Oil and gas $ 5,392 $ 16,118 $12,803 Well Service - - 747 Real Estate 4,485 2,935 1,313 Other and eliminations 110 187 171 ------- ------- ------- $ 9,987 $ 19,240 $15,034 ======= ======= ======= Identifiable assets Oil and gas $115,520 $ 111,876 $ 205,054 Well service - - - Real estate 150,269 148,340 98,890 Other and eliminations (3,622) (2,666) 1,499 ------- ------- ------- $262,167 $ 257,550 $ 305,443 ======= ======= ======= Capital expenditures Oil and gas properties $ 3,688 $ 10,046 $103,205 Oil and gas, other 233 618 1,135 Real estate 6,723 53,411 53,626 Other 306 433 236 ------- ------- ------- $10,950 $ 64,508 $158,202 ======= ======= ======= 17. Condensed Issuer Financial Data Summarized consolidated financial information for Southwest is as follows (in thousands): December 31, --------------------------------- 1999 1998 1997 ----- ----- ----- Consolidated Balance Sheet Data: Current assets $28,276 $ 20,486 $35,545 Net property and equipment 73,477 81,373 156,302 Other assets, net 10,814 8,417 11,789 ------- ------- ------- $112,567 $ 110,276 $ 203,636 ======= ======= ======= Current liabilities $46,597 $ 12,299 $14,614 Long-term debt 161,553 199,058 198,938 Other liabilities 841 1,361 1,412 Deferred income taxes - - 2,522 Minority interest 8 7 202 Stockholders deficit (96,432) (102,449) (14,052) ------- ------- ------- $112,567 $ 110,276 $ 203,636 ======= ======= ======= SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) December 31, --------------------------------- 1999 1998 1997 ----- ----- ----- Consolidated Cash Flow Data: Net cash provided by (used in) operating activities $ (8,412) $(5,309) $ 4,920 Net cash provided by (used in) investing activities 3,022 (5,803) (104,912) Net cash provided by (used in) financing activities 8,543 (770) 116,680 ------- ------- ------- Net increase (decrease) in unrestricted cash and cash equivalents $ 3,153 $(11,882) $16,688 ======= ======= ======= Consolidated Statement of Operations Data (in thousands): SRH SouthwestSierraRed Oak ElimConsolidated ---- --------------------------------------- For the year ended December 31, 1999: Operating revenues $ - $32,637 $ - $31,301 $ (6) $ 63,932 Depreciation, depletion and amortization - 5,502 - 4,485 - 9,987 Operating income (loss) (55) 14,074 - 6,812 - 20,831 Interest expense - 22,382 - 19,664 (136) 41,910 Loss before taxes, minority interest, equity loss and extraordinary item (39) (7,623) - (11,419) (92) (19,173) Net income (loss) (39) 5,986 - (13,017) 1,661 (5,409) For the year ended December 31, 1998: Operating revenues $ - $33,879 $ - $25,650 $ 20 $ 59,509 Depreciation, depletion and amortization - 16,305 - 2,935 - 19,240 Impairment of properties - 64,000 - - - 64,000 Operating income (loss) (44) (68,614) - 7,605 - (61,053) Interest expense - 22,544 - 13,969 23 36,490 Loss before taxes, minority interest, equity loss and extraordinary item (28) (89,769) - (5,806) 92 (95,695) Net loss (2,645) (88,425) - (5,858) (874) (96,054) For the year ending December 31, 1997: Operating revenues $ - $39,727 $7,833 $9,338 $ (44) $ 56,854 Depreciation, depletion and amortization - 12,974 747 1,313 - 15,034 Operating income - 3,237 184 3,074 - 6,495 Interest expense - 12,372 184 6,320 18 18,894 Income (loss) before taxes, minority interest, equity loss and extraordinary item 15,249 (8,097) (5) (3,125) (15,274) (11,252) Net income (loss) 15,046 (7,733) (4) (3,987) (14,815) (11,493) 18. Subsequent Events In January of 2000, Southwest drew down the remaining $15.0 million on the Revolving Loan Facility and applied the proceeds towards the purchase of an additional 19% or approximately $38.4 million original face amount of its 10.5% Senior Notes. Southwest paid approximately $23.0 million, including all fees, to purchase the 10.5% Senior Notes and wrote off an additional $349,000 of deferred loan issue costs and an additional $980,000 of the original issue discount to recognize an additional $14.0 million extraordinary gain on the purchase of the notes. Southwest has not recorded any income tax benefits on the continuing operations and therefore there is no income tax expense recognized on the extraordinary gain. SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) 19. Supplemental Financial Data - Oil and Gas Producing Activities (unaudited): The following information is presented in accordance with Statement of Financial Accounting Standards No. 69, "Disclosure about Oil and Gas Producing Activities," (SFAS No. 69), except as noted. Costs incurred in connection with oil and gas producing activities are as follows (in thousands): Years ended December 31, -------------------------------- 1999 1998 1997 ----- ----- ----- Acquisition of properties $ 417 $ 1,315 $ 80,797 Exploration costs 76 834 2,769 Development costs 3,195 7,897 19,639 ------ ------ ------- Total costs incurred $ 3,688 $ 10,046 $103,205 ====== ====== ======= Results of operations for oil and gas producing activities are as follows (in thousands): Years ended December 31, -------------------------------- 1999 1998 1997 ----- ----- ----- Revenues $ 31,425 $ 32,467 $ 38,500 ------ ------- ------ Production costs 10,833 18,395 18,500 Depletion 4,901 15,601 12,419 Impairment of oil and gas properties - 64,000 - ------ ------- ------ 15,691 (65,529) 7,581 Income tax provision 5,335 - 2,578 ------- ------- ------ Results of operations from oil and gas producing activities (excluding corporate overhead) $ 10,356 $ (65,529) $ 5,003 ======= ======= ====== SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Reserve Quantity Information The estimates of the Company's proved oil and gas reserves, which are located in the United States, are based on evaluations reviewed by independent petroleum engineers. Reserves were estimated in accordance with guidelines established by the U. S. Securities and Exchange Commission and the Financial Accounting Standards Board, which require that reserve estimates be prepared under existing economic and operating conditions with no provision for price and cost escalations except by contractual arrangements. The reserve estimates at December 31, 1999 assume an average oil price of $23.90/Bbl (reflecting adjustments for oil quality and gathering and transportation costs) and an average gas price of $2.06/Mcf (reflecting adjustments for BTU content, gathering and transportation costs and gas processing and shrinkage). Oil and gas reserve quantity estimates are subject to numerous uncertainties inherent in the estimation of quantities of proved reserves and the projection of future rates of production and the timing of development expenditures. The accuracy of such estimates is a function of the quality of available data, engineering and geological interpretation and judgement. Results of subsequent drilling, testing and production may cause either upward or downward revision of previous estimates. Further, the volumes considered to be commercially recoverable fluctuate with the changes in prices and operating costs. The Company emphasizes that reserve estimates are inherently imprecise and that estimates of new discoveries are more imprecise than those of currently producing oil and gas properties. Accordingly, these estimates are expected to change, as additional information becomes available in the future. Oil and Natural Barrels of Condensate Gas Oil Equivalent (MBbls) (MMcf) (Mboe) ------ ------ ------- Total Proved Reserves: Balance, January 1, 1997 18,806 76,776 31,602 Extensions and discoveries 474 1,230 679 Purchase of minerals-in-place 16,419 7,274 17,631 Sales of minerals-in-place (83) (91) (98) Revisions of previous estimates (4,642) (14,825) (7,113) Production (1,308) (5,639) (2,248) ------ ------ ------ Balance, December 31, 1997 29,666 64,725 40,453 Extensions and discoveries 27 1,526 282 Purchase of minerals-in-place 288 895 437 Sales of minerals-in-place (1,024) (6,132) (2,046) Revisions of previous estimates (6,324) 2,815 (5,855) Production (1,689) (5,556) (2,615) ------ ------ ------ Balance, December 31, 1998 20,944 58,273 30,656 Purchase of minerals-in-place 261 1,329 483 Sales of minerals-in-place (1,704) (2,751) (2,163) Revisions of previous estimates 6,633 12,855 8,776 Production (1,306) (4,627) (2,077) ------ ------ ------ Balance, December 31, 1999 24,828 65,079 35,675 ====== ====== ====== Total proved developed reserves January 1, 1997 10,302 58,961 20,129 December 31, 1997 18,472 46,585 26,236 December 31, 1998 12,006 37,481 18,253 December 31, 1999 16,618 43,023 23,789 SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) Standardized Measure of Discounted Future Net Cash Flows The standardized measure of discounted future net cash flows is computed by applying year-end prices of oil and gas (with consideration of price changes only to the extent provided by contractual arrangements) to the estimated future production of proved oil and gas reserves less estimated future expenditures (based on year-end costs) to be incurred in developing and producing the proved reserves, discounted using a rate of 10% per year to reflect the estimated timing of the future cash flows. Future income taxes are calculated by comparing discounted future cash flows to the tax basis of oil and gas properties plus available carryforwards and credits and applying the current tax rates to the difference. Discounted future cash flow estimates like those shown below are not intended to represent estimates of the fair value of oil and gas properties. Estimates of fair value should also consider probable reserves, anticipated future oil and gas prices, interest rates, changes in development and production costs and risks associated with future production. Because of these and other considerations, any estimate of fair value is necessarily subjective and imprecise. During most of 1996 and 1997, the Company benefited from higher oil and gas prices as compared to previous years. However, during the fourth quarter of 1997 and the year 1998, oil prices began a downward trend that has continued throughout 1998 and the first half of 1999. A continuation of the oil price environment experienced throughout 1998 and the first half of 1999 will have an adverse affect on the Company's revenues and operating cash flow, and may result in a downward adjustment to the Company's current 2000 capital budget. December 31, --------------------------------------- 1999 1998 1997 ----- ----- ----- (in thousands) Future cash inflows $ 727,615 $315,709 $ 620,418 Future production and development costs (284,354) (181,627) (303,406) -------- -------- -------- Future net cash flows before income taxes 443,261 134,082 317,012 Future income tax expense (103,067) - (59,764) -------- -------- -------- Future net cash flows 340,194 134,082 257,248 10% annual discount for estimated timing of cash flows (164,634) (62,182) (117,427) -------- -------- -------- Standardized measure of discounted future net cash flows $ 175,560 $ 71,900 $ 139,821 ======== ======== ======== SOUTHWEST ROYALTIES HOLDINGS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (continued) The principal sources of change in the standardized measure of discounted future net cash flows are as follows: December 31, --------------------------------------- 1999 1998 1997 ----- ----- ----- (in thousands) Sales of oil and gas produced, net of production costs $(20,592) $(14,072) $(20,000) Net change in sales prices net of production costs 116,644 (76,234) (119,553) Extensions and discoveries, net of future production and development costs - 1,195 3,540 Revisions to estimated future development costs (4,059) 3,103 (4,833) Purchases of minerals-in-place 1,866 1,334 80,690 Revisions of previous quantity estimates 60,317 (18,054) (37,403) Accretion of discount 7,190 17,230 25,217 Net change in income taxes (53,188) 32,483 46,887 Sales of minerals-in-place (5,685) (5,899) (384) Changes in production rates, timing and other 1,167 (9,007) (12,881) ------- ------- ------- 103,660 (67,921) (38,720) Discounted future net cash flows - Beginning of period 71,900 139,821 178,541 ------- ------- ------- End of period $ 175,560 $ 71,900 $ 139,821 ======= ======= ======= 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 9, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ----- /s/ H. H. Wommack, III ------------------------ Chairman/President/ May 9, 2000 H. H. Wommack, III Chief Executive Officer /s/ J Steven Person -------------------------Vice President of J Steven Person Marketing/Chief May 9, 2000 Financial Officer /s/ H. Allen Corey ------------------------- H. Allen Corey Director/Secretary May 9, 2000 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 9, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE --------- ----- ----- /s/ H. H. Wommack, III ------------------------ Chairman/President/ May 9, 2000 H. H. Wommack, III Chief Executive Officer /s/ J Steven Person -------------------------Vice President of J Steven Person Marketing/Chief May 9, 2000 Financial Officer /s/ H. Allen Corey ------------------------ H. Allen Corey Director/Secretary May 9, 2000 -----END PRIVACY-ENHANCED MESSAGE-----