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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 NO. 001-11899
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THE HOUSTON EXPLORATION COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 22-2674487
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1100 LOUISIANA STREET, SUITE 2000
HOUSTON, TEXAS 77002-5219
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES AND ZIP CODE)
(713) 830-6800
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
---------------------------
Indicate by check mark 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
----- -----
As of August 13, 1999, 23,909,440 shares of Common Stock, par value $.01
per share, were outstanding.
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THE HOUSTON EXPLORATION COMPANY
TABLE OF CONTENTS
<TABLE>
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PAGE
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<S> <C>
FACTORS AFFECTING FORWARD LOOKING STATEMENTS ............................................................... 3
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets -- June 30, 1999 and December 31, 1998 ........................... 4
Consolidated Statements of Operations -- Three Month and Six Month Periods Ended
June 30, 1999 and 1998 ................................................................... 5
Consolidated Statements of Cash Flows -- Six Month Periods Ended
June 30, 1999 and 1998 ................................................................... 6
Notes to Consolidated Financial Statements ................................................... 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations .................................................................... 11
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Shareholders .............................................. 21
Item 6. Exhibits and Reports on Form 8-K ............................................................. 21
SIGNATURES ................................................................................................. 22
</TABLE>
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FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1993, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The
words "anticipate," "believe," "expect," "estimate," "project" and similar
expressions are intended to identify forward-looking statements. Without
limiting the foregoing, all statements under the caption "Item 2--Management's
Discussion and Analysis of Financial Condition and Results of Operations"
relating to Houston Exploration's anticipated capital expenditures, future cash
flows and borrowings, pursuit of potential future acquisition opportunities and
sources of funding for exploration and development are forward-looking
statements. Such statements are subject to certain risks and uncertainties, such
as the volatility of natural gas and oil prices, uncertainty of reserve
information and future net revenue estimates, reserve replacement risks,
drilling risks, operating risks of natural gas and oil operations, acquisition
risks, substantial capital requirements, government regulation, environmental
matters and competition. Should one or more of these risks or uncertainties
materialize, or should underlying assumptions prove incorrect, actual results
may vary materially from those anticipated, believed, expected, estimated or
projected. For additional discussion of such risks, uncertainties and
assumptions, see "Items 1 and 2. Business and Properties" and "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in the Company's Annual Report on Form 10-K filed for the
year ended December 31, 1998 under the Securities Act of 1934, as amended.
All statements contained in this Form 10-Q, including the
forward-looking statements discussed above, are made as of August 13, 1999,
except for those statements that are expressly made as of another date. The
Company disclaims any responsibility for the correctness of any information
contained in this Form 10-Q to the extent such information is affected or
impacted by events, circumstances, or developments occurring after August 13,
1999, or by the passage of time after such date and, except as required by
applicable securities laws, the Company does not intend to update such
information.
Unless otherwise indicated, references to "Houston Exploration" or the
"Company" refer to The Houston Exploration Company and its subsidiaries on a
combined basis.
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PART I. FINANCIAL INFORMATION
ITEMS 1. FINANCIAL STATEMENTS
THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1999 1998
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Cash and cash equivalents ........................................................... $ 1,927 $ 4,645
Accounts receivable ................................................................. 27,099 23,050
Accounts receivable-- Affiliate ..................................................... 537 137
Inventories ......................................................................... 962 915
Prepayments and other ............................................................... 912 754
------------ ------------
Total current assets ...................................................... 31,437 29,501
Natural gas and oil properties, full cost method
Unevaluated properties ............................................................ 160,295 145,317
Properties subject to amortization ................................................ 872,474 828,168
Other property and equipment ........................................................ 9,568 9,464
1,042,337 982,949
Less: Accumulated depreciation, depletion and amortization .......................... (481,466) (446,367)
------------ ------------
560,871 536,582
Other assets ........................................................................ 3,985 3,369
------------ ------------
TOTAL ASSETS .............................................................. $ 596,293 $ 569,452
============ ============
LIABILITIES:
Accounts payable and accrued expenses ............................................... $ 35,592 $ 32,743
Subordinated note -- Affiliate........................................................ 80,000 --
------------ ------------
Total current liabilities ................................................. 115,592 32,743
Long-term debt and notes ............................................................ 248,000 233,000
Subordinated note -- Affiliate ...................................................... -- 80,000
Deferred federal income taxes ....................................................... 33,936 31,027
Other deferred liabilities .......................................................... 140 152
------------ ------------
TOTAL LIABILITIES ......................................................... 397,668 376,922
COMMITMENTS AND CONTINGENCIES (SEE NOTE 3)
STOCKHOLDERS' EQUITY:
Common Stock, $.01 par value, 50,000 shares authorized and 23,905 shares issued
and outstanding at June 30, 1999 and 23,895 shares issued and outstanding at
December 31, 1998 ................................................................ 239 239
Additional paid-in capital .......................................................... 231,091 230,931
Retained earnings (deficit) ......................................................... (32,705) (38,640)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ................................................ 198,625 192,530
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 596,293 $ 569,452
============ ============
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED, SIX MONTHS ENDED,
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES:
Natural gas and oil revenues .................... $ 35,021 $ 35,141 $ 61,541 $ 68,025
Other ........................................... 116 370 461 570
---------- ---------- ---------- ----------
Total revenues .......................... 35,137 35,511 62,002 68,595
OPERATING COSTS AND EXPENSES:
Lease operating ................................. 4,333 3,563 8,295 7,432
Severance tax ................................... 1,188 1,350 2,187 2,468
Depreciation, depletion and amortization ........ 17,972 20,191 35,029 39,505
General and administrative, net ................. 919 1,707 1,949 3,282
---------- ---------- ---------- ----------
Total operating expenses ................ 24,412 26,811 47,460 52,687
Income from operations ............................ 10,725 8,700 14,542 15,908
Interest expense, net ............................. 3,192 950 6,213 1,250
---------- ---------- ---------- ----------
Net income before income taxes .................... 7,533 7,750 8,329 14,658
Provision for federal income taxes ................ 2,344 2,444 2,394 4,629
---------- ---------- ---------- ----------
NET INCOME ........................................ $ 5,189 $ 5,306 $ 5,935 $ 10,029
========== ========== ========== ==========
Net income per share .............................. $ 0.22 $ 0.22 $ 0.25 $ 0.42
========== ========== ========== ==========
Net income per share-- assuming dilution .......... $ 0.21 $ 0.22 $ 0.25 $ 0.42
========== ========== ========== ==========
Weighted average shares outstanding ............... 23,897 23,890 23,896 23,639
Weighted average shares outstanding-- assuming
dilution ...................................... 28,177 24,288 24,022 23,927
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30,
------------------------------
1999 1998
------------ ------------
(UNAUDITED)
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OPERATING ACTIVITIES:
Net income ........................................................... $ 5,935 $ 10,029
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization ........................... 35,029 39,505
Deferred income tax expense ........................................ 2,909 5,124
Changes in operating assets and liabilities:
(Increase) decrease in accounts receivable ...................... (4,449) 13,263
Increase in inventories ......................................... (47) (158)
Increase in prepayments ......................................... (158) (581)
Increase in other assets and liabilities ........................ (593) (1,672)
Increase (decrease) in accounts payable and accrued expenses .... 2,849 (11,380)
------------ ------------
Net cash provided by operating activities ............................ 41,475 54,130
INVESTING ACTIVITIES:
Investment in property and equipment (59,353) (129,949)
------------ ------------
Net cash used in investing activities (59,353) (129,949)
FINANCING ACTIVITIES:
Proceeds from long term borrowings ................................... 27,000 175,000
Repayments of long term borrowings
(12,000) (100,000)
Proceeds from issuance of common stock ............................... 160 137
------------ ------------
Net cash provided by financing activities ............................ 15,160 75,137
------------ ------------
Decrease in cash and cash equivalents ................................ (2,718) (682)
Cash and cash equivalents, beginning of period ....................... 4,645 4,745
------------ ------------
Cash and cash equivalents, end of period ............................. $ 1,927 $ 4,063
============ ============
Cash paid for interest ............................................... $ 11,483 $ 3,210
============ ============
Cash paid for taxes .................................................. $ -- $ --
============ ============
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 -- SUMMARY OF ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
Houston Exploration is an independent natural gas and oil company
engaged in the exploration, development, exploitation and acquisition of
domestic natural gas and oil properties. The Company's operations are currently
focused offshore in the Gulf of Mexico and onshore in South Texas, South
Louisiana, the Arkoma Basin, East Texas and West Virginia. Houston Exploration's
strategy is to utilize its geological and geophysical expertise to grow its
reserve base through a combination of exploratory drilling in the Gulf of Mexico
and lower risk, exploitation and development drilling onshore. At December 31,
1998, the Company had net proved reserves of 480 Bcfe, 98% of which were natural
gas and 80% of which were classified as proved developed.
Houston Exploration began exploring for natural gas and oil in December
1985 on behalf of The Brooklyn Union Gas Company ("Brooklyn Union") and in
September 1996 the Company completed an initial public offering of its common
stock. As of June 30, 1999, THEC Holdings Corp., a wholly owned subsidiary of
Brooklyn Union, owned approximately 64% of the outstanding shares of Houston
Exploration's common stock. Brooklyn Union is a wholly-owned subsidiary of
KeySpan Corporation ("KeySpan"). KeySpan is a diversified energy provider that:
(i) distributes natural gas, through its subsidiary Brooklyn Union, in the New
York City and Long Island areas; (ii) is contracted by Long Island Power
Authority ("LIPA") to manage LIPA's electricity service in the Long Island area;
and (iii) through its unregulated subsidiaries, is involved in gas retailing,
power plant management and energy management services.
Principles of Consolidation
The consolidated financial statements include the accounts of The
Houston Exploration Company and its wholly-owned subsidiary, Seneca Upshur
Petroleum Company (collectively the "Company"). All significant intercompany
balances and transactions have been eliminated.
Interim Financial Statements
The balance sheet of the Company at June 30, 1999 and the statements of
operations and cash flows for the periods indicated herein have been prepared by
the Company without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted, although the
Company believes that the disclosures contained herein are adequate to make the
information presented not misleading. The balance sheet at December 31, 1998 is
derived from the December 31, 1998 audited financial statements, but does not
include all disclosures required by generally accepted accounting principles.
The Interim Financial Statements should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included in the Company's
Annual Report on Form 10-K for the year ended December 31, 1998.
In the opinion of management, all adjustments, consisting of normal
recurring accruals, necessary to present fairly the information in the
accompanying financial statements have been included. The results of operations
for such interim periods are not necessarily indicative of the results for the
full year.
Reclassifications and Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. The Company's most significant financial estimates are based
on remaining proved natural gas and oil reserves. Because there are numerous
uncertainties inherent in the estimation process, actual
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results could differ from the estimates. Certain reclassifications for prior
years have been made to conform with current year presentation.
Net Income Per Share
Basic earnings per share ("EPS") is calculated by dividing net income
by the weighted average number of shares of common stock outstanding during the
period. No dilution for any potentially dilutive securities is included. Diluted
EPS assumes the conversion of all potentially dilutive securities and is
calculated by dividing net income by the weighted average number of shares
common stock outstanding plus all potentially dilutive securities.
<TABLE>
<CAPTION>
THREE MONTHS ENDED, SIX MONTHS ENDED,.
JUNE 30, JUNE 30,
------------------------- -------------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Numerator:
Net income ................................................. $ 5,189 $ 5,306 $ 5,935 $ 10,029
Interest expense convertible debt, net of tax .......... 689 -- -- --
---------- ---------- ---------- ----------
Net income, adjusted ....................................... $ 5,878 5,306 5,935 10,029
========== ========== ========== ==========
Denominator:
Weighted average shares outstanding ........................ 23,897 23,890 23,896 23,639
Add: dilutive securities
Convertible debt ................................. 4,092 -- -- --
Options .......................................... 188 398 126 288
---------- ---------- ---------- ----------
Total weighted average shares outstanding and dilutive
securities ............................................... 28,177 24,288 24,022 23,927
========== ========== ========== ==========
Net income per share ....................................... $ 0.22 $ 0.22 $ 0.25 $ 0.42
========== ========== ========== ==========
Net income per share-- assuming dilution ................... $ 0.21 $ 0.22 $ 0.25 $ 0.42
========== ========== ========== ==========
</TABLE>
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement broadens the definition of a
derivative instrument and establishes accounting and reporting standards
requiring that every derivative instrument, including certain derivative
instruments embedded in other contracts, be recorded in the balance sheet as
either an asset or liability measured at its fair market value. Derivatives that
are not hedges must be adjusted to fair value currently in earnings. If a
derivative is a hedge, depending on the nature of the hedge, special accounting
allows changes in fair value of the derivative to be either offset against the
change in fair value of the hedged asset or liability in the income statement or
recorded in comprehensive income until the hedged item is recognized in
earnings. The Company must formally document, designate and assess the
effectiveness of transactions that are recorded as hedges. The ineffective
portion of a hedged derivative's change in fair value will be immediately
recognized in earnings. In June of 1999, the FASB issued SFAS No. 137, which
extends the adoption requirement of SFAS No. 133 from January 1, 2000 to January
1, 2001. The Company plans to adopt SFAS No. 133 effective January 1, 2001.
Currently, the Company cannot estimate the impact of the statement on results of
future operations; however, it believes that the impact will not be material.
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NOTE 2 -- LONG-TERM DEBT AND NOTES
<TABLE>
<CAPTION>
JUNE 30,1999 DECEMBER 31,1998
------------ ----------------
(IN THOUSANDS)
<S> <C> <C>
SENIOR DEBT:
Bank credit facility, due 2003 .............. $ 148,000 $ 133,000
SUBORDINATED DEBT:
8 5/8% Senior Subordinated Notes, due 2008 .. 100,000 100,000
Subordinated Note--KeySpan, due 2000 ........ -- 80,000
---------- ----------
Total long-term debt and notes .......... $ 248,000 $ 313,000
========== ==========
</TABLE>
As of June 30, 1999, outstanding borrowings of $80 million under the
KeySpan note were classified as current liabilities, as the note matures January
1, 2000. The carrying amount of borrowings outstanding under the revolving bank
credit facility and the KeySpan note approximate fair value as interest rates
are tied to current market rates. At June 30, 1999, the quoted market value of
the 8 5/8% senior subordinated notes was 98% of the $100 million carrying value
or $98 million. Subsequent to June 30, 1999, the Company borrowed an additional
$4 million under its revolving bank credit facility, bringing outstanding
borrowings and extensions of credit under letter of credit agreements to $152.4
million as of August 13, 1999.
NOTE 3 -- COMMITMENTS AND CONTINGENCIES
The Company is involved from time to time in various claims and
lawsuits incidental to its business. In the opinion of management, the ultimate
liability thereunder, if any, will not have a material adverse effect on the
financial position or results of operations of the Company.
NOTE 4 -- RELATED PARTY TRANSACTIONS
KeySpan Joint Venture
In March 1999, the Company signed a joint exploration agreement ( the
"KeySpan Joint Venture") with a subsidiary of KeySpan, KeySpan Exploration &
Production, LLC, to explore for natural gas and oil over a term of three years
expiring December 31, 2001. The joint venture may be terminated at the option of
either party at the end of the then current calendar year. Houston Exploration
is joint venture manager and operator. Effective January 1, 1999, KeySpan agreed
to commit up to $100 million per calendar year and Houston Exploration agreed to
commit its proportionate share of the funds per calendar year necessary to fund
a joint exploration and development drilling program. Houston Exploration
contributed all of its undeveloped offshore leases as of January 1, 1999 to the
joint venture. KeySpan will receive 45% of Houston Exploration's working
interest in all prospects to be drilled under the program. Revenues will be
shared 55% Houston Exploration and 45% KeySpan. During the term of the KeySpan
Joint Venture, KeySpan pays 100% of actual intangible drilling costs up to a
maximum of $20.7 million per year. All additional intangible drilling costs
incurred during such year are paid 51.75% by KeySpan and 48.25% by Houston
Exploration. In addition, Houston Exploration receives reimbursement of a
portion of its general and administrative costs during the term of the joint
venture. During the three month and the six month periods ended June 30, 1999,
KeySpan incurred approximately $4.2 million and $8.4 million, respectively, in
drilling costs and the Company received approximately $1.1 million and $2.2
million, respectively, in general and administrative reimbursements pursuant to
KeySpan Joint Venture.
KeySpan Facility
In November 1998, the Company entered into a revolving credit facility
with KeySpan (the "KeySpan Facility"), which provides a maximum commitment of
$150 million. The KeySpan Facility ranks subordinate, in right of payment, to
the revolving bank credit facility and pari passu to the Company's 8 5/8% senior
subordinated notes. Borrowings under the KeySpan Facility are unsecured and any
principal amount outstanding at January 1, 2000 will be converted into common
stock of the Company pursuant to a stipulated formula. As of June 30, 1999,
outstanding borrowings under the KeySpan Facility totaled $80 million and were
classified as current liabilities. For the three month
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and the six month periods ended June 30, 1999, the Company incurred a total of
$1.6 million and $2.6 million, respectively, in interest and fees to KeySpan
pursuant to the KeySpan Facility.
Section 29 Tax Credits
In January 1997, the Company entered into an agreement to sell to a
subsidiary of KeySpan certain interests in onshore producing wells of the
Company that produce from formations that qualify for tax credits under Section
29 of the Internal Revenue Code ("Section 29"). Section 29 provides for a tax
credit from non-conventional fuel sources such as oil produced from shale and
tar sands and natural gas produced from geopressured brine, Devonian shale, coal
seams and tight sands formations. KeySpan acquired an economic interest in wells
that are qualified for the tax credits and, in exchange, the Company (i)
retained a volumetric production payment and a net profits interest of 100% in
the properties, (ii) received a cash down payment of $1.4 million and (iii)
receives a quarterly payment of $0.75 for every dollar of tax credit utilized.
The Company manages and administers the daily operations of the properties in
exchange for an annual management fee of $100,000. The income statement effect
representing benefits received from the Section 29 tax credits was a reduction
to income tax expense of $0.3 million for each of the three month periods ended
June 30, 1999 and 1998 and $0.5 million for each of the six month periods ended
June 30, 1999 and 1998.
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion is intended to assist in an understanding of
the Company's historical financial position and results of operations for the
three months and the six months ended June 30, 1998 and 1999. The Company's
consolidated financial statements and notes thereto included elsewhere in this
report contain detailed information that should be referred to in conjunction
with the following discussion.
GENERAL
Houston Exploration is an independent natural gas and oil company
engaged in the exploration, development, exploitation and acquisition of
domestic natural gas and oil properties. The Company's operations are currently
focused offshore in the Gulf of Mexico and onshore in South Texas, South
Louisiana, the Arkoma Basin, East Texas and West Virginia. Houston Exploration's
strategy is to utilize its geological and geophysical expertise to grow its
reserve base through a combination of exploratory drilling in the Gulf of Mexico
and lower risk, exploitation and development drilling onshore. At December 31,
1998, the Company had net proved reserves of 480 Bcfe, 98% of which were natural
gas and 80% of which were classified as proved developed.
Houston Exploration began exploring for natural gas and oil in December
1985 on behalf of The Brooklyn Union Gas Company ("Brooklyn Union") and in
September 1996 the Company completed an initial public offering its of common
stock. As of March 31, 1999, THEC Holdings Corp., a wholly owned subsidiary of
Brooklyn Union, owned approximately 64% of the outstanding shares of Houston
Exploration's common stock. Brooklyn Union is a wholly-owned subsidiary of
KeySpan ("KeySpan"). KeySpan is a diversified energy provider that: (i)
distributes natural gas, through its subsidiary Brooklyn Union, in the New York
City and Long Island areas; (ii) is contracted by Long Island Power Authority
("LIPA") to manage LIPA's electricity service in the Long Island area; and (iii)
through its unregulated subsidiaries, is involved in gas retailing, power plant
management and energy management services.
As an independent oil and gas producer, the Company's revenue,
profitability and future rate of growth are substantially dependent upon
prevailing prices for natural gas, oil and condensate, which are dependent upon
numerous factors beyond the Company's control, such as economic, political and
regulatory developments and competition from other sources of energy. The energy
markets have historically been very volatile, as evidenced by the recent
volatility of natural gas and oil prices, and there can be no assurance that
commodity prices will not be subject to wide fluctuations in the future. A
substantial or extended decline in natural gas and oil prices could have a
material adverse effect on the Company's financial position, results of
operations, cash flows, quantities of natural gas and oil reserves that may be
economically produced and access to capital.
The Company uses the full cost method of accounting for its investment
in natural gas and oil properties. Under the full cost method of accounting, all
costs of acquisition, exploration and development of natural gas and oil
reserves are capitalized into a "full cost pool" as incurred, and properties in
the pool are depleted and charged to operations using the unit-of-production
method based on the ratio of current production to total proved natural gas and
oil reserves. To the extent that such capitalized costs (net of accumulated
depreciation, depletion and amortization) less deferred taxes exceed the present
value (using a 10% discount rate) of estimated future net cash flows from proved
natural gas and oil reserves and the lower of cost or fair value of unproved
properties, such excess costs are charged to operations. If a write down is
required, it would result in a charge to earnings but would not have an impact
on cash flows from operating activities. Once incurred, a write down of oil and
gas properties is not reversible at a later date even if oil and gas prices
increase.
Year 2000. Year 2000 issues result from the inability of computer
programs or computerized equipment to accurately calculate, store or use a date
subsequent to December 31, 1999. Typically, the year 2000 could be
misinterpreted as the year 1900. This date misinterpretation could result in a
system failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions, send invoices
or engage in normal business.
To ensure year 2000 ("Y2K") compliance, the Company has implemented a
plan to review all financial and operational systems and equipment involving a
four phase process: assessment, remediation and replacement, testing and
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<PAGE> 12
implementation. The Company began the testing and implementation phase at the
beginning of the second quarter of 1999. Testing and implementation of system
updates and the replacement of computer equipment is currently approximately 95%
complete. The Company expects its Y2K project to be fully complete by September
30, 1999. During 1998, the Company incurred approximately $20,000 in costs and
expenses related to its Y2K compliance efforts and during the first six months
of 1999, the Company incurred an additional $25,000 in Y2K costs. Y2K costs are
currently being expensed as they are incurred. However, in certain instances the
Company may determine that replacing existing equipment would be more efficient
and the costs of these replacements would then be capitalized. The Company
currently expects that it will incur up to an additional $100,000 in Y2K costs
during 1999. The Company believes that total costs to become Y2K compliant will
not exceed $200,000 including costs incurred through June 30, 1999, and that
such costs will not have a material adverse effect on the Company's financial
condition, operations or liquidity.
The foregoing timetable and assessment of costs to become Y2K compliant
reflect management's current best estimates. These estimates are based on many
assumptions, including assumptions about the cost, availability and ability of
resources to locate, remediate and modify affected systems and equipment. Based
upon its activities to date, the Company does not believe that these factors
will cause results to differ significantly from those estimated. However, the
Company cannot reasonably estimate the potential impact on its financial
condition and operations if key third parties including, among others,
suppliers, contractors, joint venture partners, financial institutions,
customers, traders, and governments do not become Y2K compliant on a timely
basis. The Company is in the process of contacting many of these third parties
in an effort to determine the extent to which the Company is vulnerable to those
third parties' potential failure to remediate their own year 2000 issues. The
Company expects its survey of key third parties to be fully complete by
September 30, 1999; however, no assurance can be given that a Y2K problem will
not occur for the Company as a result of a Y2K problem of a third party.
The Company has established a contingency plan in the event it is
unable to complete all phases of its Y2K program or if it experiences a system
failure or malfunction due to Y2K issues. The Company's contingency plan will
allow it to override computer operated functions with manual operations.
In the event the Company is unable to complete the remediation or
replacement of critical computer software and equipment, establish alternative
procedures in a timely manner, or if those with whom the Company conducts
business are unsuccessful in implementing timely solutions, year 2000 issues
could result in an interruption in, or a failure of certain normal business
activities that could result in a material adverse effect on the Company's
results of operations, liquidity and financial position. The Company's
remediation efforts are intended to reduce the Company's level of uncertainty
about Y2K compliance and the possibility of interruption of normal operations.
The Company believes that the potential impact, if any, of its systems not being
year 2000 compliant should not affect the Company's ability to continue oil and
gas exploration, drilling, production and sales activities. However, there can
be no guarantee that the Company, its business partners, vendors or customers
will successfully be able to identify and remedy all potential Y2K problems and
that a resulting system failure would not have a material adverse effect on the
Company.
In a recent Securities and Exchange Commission release regarding year
2000 disclosures, the Securities and Exchange Commission stated that public
companies must disclose the most reasonably likely worst case year 2000
scenario. Analysis of the most reasonably likely worst case year 2000 scenario
that Houston Exploration may face leads to contemplation of the following
possibilities which, though unlikely in some or many cases, must be included in
any consideration of worst cases: widespread failure of electrical, gas, and
similar supplies by utilities serving the Company; widespread disruption of the
services of communications common carriers; similar disruption to means and
modes of transportation for Houston Exploration and its employees, contractors,
suppliers, and customers; significant disruption to Houston Exploration's
ability to gain access to, and remain working in, office buildings and other
facilities; the failure of substantial numbers of the Company's computer
hardware and software systems, including both internal business systems and
systems (such as those with embedded chips) controlling operational facilities
such as onshore and offshore oil and gas production facilities, gas meters and
pipelines, the effects of which would have a cumulative material adverse impact
on the Company. Among other things, the Company could face substantial claims by
customers or loss of revenues due to service interruptions, inability to fulfill
contractual obligations, inability to account for certain revenues or
obligations or to bill customers accurately and on a timely basis, and increased
expenses associated with litigation, stabilization of operations following
systems failures, and the execution of contingency plans. Houston Exploration
could also experience an inability by customers, traders, and others to pay, on
a timely basis or at all, obligations owed to the Company. Under these
circumstances, the adverse effect on the Company, and the reduction of the
Company's revenues, could be material, although not quantifiable at this time.
Further in this scenario, the cumulative effect of these failures could have a
substantial adverse effect on the economy, domestically and internationally. The
adverse effect
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<PAGE> 13
on Houston Exploration, and the reduction of the Company's revenues, from a
domestic or global recession or depression is also likely to be material,
although not quantifiable at this time.
Recent Developments. At the Company's quarterly meeting of its Board of
Directors held on July 27, 1999, the Company's Board approved a $15 million
increase to the Company's 1999 capital expenditure budget of $90 million,
bringing the 1999 capital expenditure budget to $105 million. The increase will
incorporate approximately $10 million for offshore drilling, $3 million for
onshore drilling and the balance for seismic and leasehold acquisition costs. In
addition to the increase in the capital expenditure budget, the Company's Board
of Directors appointed Mr. David G. Elkins to serve as a director of the
Company. Mr. Elkins has been a senior officer and general counsel of Sterling
Chemicals, Inc. since January 1, 1998. Previously, he was a senior partner in
the law firm of Andrews & Kurth L.L.P. where he specialized in corporate and
business law, including mergers and acquisitions and securities law matters.
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<PAGE> 14
RESULTS OF OPERATIONS
The following table sets forth the Company's historical natural gas and
oil production data during the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS ENDED, SIX MONTHS ENDED,
JUNE 30, JUNE 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
PRODUCTION:
Natural gas (MMcf) ........................... 16,675 15,861 32,810 30,996
Oil (MBbls) .................................. 85 57 140 104
Total (MMcfe) ................................ 17,185 16,203 33,650 31,620
AVERAGE SALES PRICES:
Natural gas (per Mcf) realized(1) ............ $ 2.03 $ 2.17 $ 1.82 $ 2.15
Natural gas (per Mcf) unhedged ............... 2.03 2.13 1.82 2.09
Oil (per Bbl) ................................ 14.34 13.14 12.84 13.61
EXPENSES (PER MCFE):
Lease operating .............................. $ 0.25 $ 0.22 $ 0.25 $ 0.24
Severance tax ................................ 0.07 0.08 0.06 0.08
Depreciation, depletion and amortization ..... 1.05 1.25 1.04 1.25
General and administrative, net .............. 0.05 0.11 0.06 0.10
</TABLE>
- ----------------
(1) Reflects the effects of hedging.
RECENT FINANCIAL AND OPERATING RESULTS
COMPARISON OF THREE MONTHS ENDED JUNE 30, 1998 AND 1999
Production. Houston Exploration's production increased 6% from 16,203
MMcfe for the three months ended June 30, 1998 to 17,185 MMcfe for the three
months ended June 30, 1999. The increase in production was primarily
attributable to new offshore production added from the November 1998 acquisition
of the Mustang Island A-31/32 properties combined with a full quarter of
production from the South Louisiana properties purchased at the end of April
1998 offset in part by a decline in production at the Charco Field. The
production decline at Charco reflects the Company's decision to curtail capital
spending in South Texas during in the fourth quarter of 1998 due to depressed
natural gas prices. Drilling resumed in the first quarter of 1999 with two rigs
running and during the second quarter, the Company added a third drilling rig.
Natural Gas and Oil Revenues. Natural gas and oil revenues were
comparable at $35.1 million for the three months ended June 30, 1998 and $35.0
million for the three months ended June 30, 1999. Revenues remained flat as the
production increase of 6% was offset in full by a 6% decrease in average
realized natural gas prices, from $2.17 per Mcf for the three months ended June
30, 1998 to $2.03 per Mcf for the three months ended June 30, 1999.
For the three months ended June 30, 1999, the Company's hedging
activities had no effect on natural gas revenues as the Company realized an
average gas price of $2.03 per Mcf which was equal to the average unhedged
natural gas price of $2.03 per Mcf. For the corresponding three month period of
1998, the average realized gas price was $2.17 per Mcf, which was 102% of the
unhedged average gas price of $2.13 per Mcf, resulting in an increase in natural
gas revenues of $0.7 million for the three months ended June 30, 1998.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 19% from $3.6 million for the three months ended June 30, 1998 to $4.3
million for the three months ended June 30, 1999. On an Mcfe basis, lease
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<PAGE> 15
operating expenses increased from $0.22 for the three months ended June 30, 1998
to $0.25 for the three months ended June 30, 1999. The increase in lease
operating expenses and lease operating expenses on a per unit basis for the
three months ended June 30, 1999 as compared to the corresponding period of 1998
is attributable the Company's two producing property acquisitions made in 1998:
offshore, the Mustang Island A-31/32 complex and onshore, the South Louisiana
properties. These two acquisitions significantly expanded the Company's
operations and, due to the nature of their locations, are more costly to operate
on a per unit basis. Severance tax, which is a function of volume and revenues
generated from onshore production, decreased slightly from $1.4 million for the
three months ended June 30, 1998 to $1.2 million for the three months ended June
30, 1999. On an Mcfe basis, severance tax decreased from $0.08 per Mcfe, for the
three months ended June 30, 1998 to $0.07 per Mcfe, for the corresponding three
months of 1999. The decrease in both the severance tax expense and the rate per
Mcfe is due to lower natural gas prices received during the second quarter of
1999 as compared to prices received during the second quarter of 1998.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense decreased 11% from $20.2 million for the three months ended
June 30, 1998 to $18.0 million for the three months ended June 30, 1999.
Depreciation, depletion and amortization expense per Mcfe decreased 16% from
$1.25 for the three months ended June 30, 1998 to $1.05 for the corresponding
three months in 1999. The decrease in depreciation, depletion and amortization
expense was a result of a lower depletion rate. The lower depletion rate is
primarily a result of the $130 million ($84.5 million net of tax) writedown in
natural gas and oil properties that was taken in the fourth quarter of 1998 due
to weak natural gas prices; combined with an increase in production during the
second quarter of 1999 and a lower level of capital spending during 1999 as
compared to 1998.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $0.2 million and $1.3 million for the three months ended June 30,
1998 and 1999, respectively, decreased 47% from $1.7 million for the three
months ended June 30, 1998 to $0.9 million for the three months ended June 30,
1999. Included in reimbursements received from working interest owners were
reimbursements totaling $1.0 million received from KeySpan pursuant to the
KeySpan Joint Venture (see Note --4 Related Party Transactions). The Company
capitalized general and administrative expenses directly related to oil and gas
exploration and development activities of $1.9 million and $1.3 million,
respectively, for the three months ended June 30, 1998 and 1999. The decrease in
capitalized general and administrative expenses is a result of lower aggregate
general and administrative expenses during the second quarter of 1999 as
compared to the corresponding period of 1998. Aggregate general and
administrative expenses are lower during the quarter ended June 30, 1999
primarily as a result of the Company's efforts to control and reduce expenses
where possible. On an Mcfe basis, general and administrative expenses decreased
55% from $0.11 for the three months ended June 30, 1998 to $0.05 for the three
months ended June 30, 1999. The lower rate per Mcfe during the second quarter of
1999 reflects a combination of an increase in production, a reduction in
aggregate general and administrative expenses and the effect of the KeySpan
Joint Venture reimbursements.
Interest Expense. Interest expense, net of capitalized interest,
increased from $1.0 million for the three months ended June 30, 1998 to $3.2
million for the three months ended June 30, 1999. Capitalized interest increased
from $2.5 million for the three months ended June 30, 1998 to $2.8 million for
the three months ended June 30, 1999. The increase in aggregate interest expense
was attributable to higher average debt levels during three months ended June
30, 1999 as compared to the corresponding period of 1998. With the issuance of
the $100 million of 8 5/8% senior subordinated notes in March 1998 and the
implementation of the KeySpan Facility in November 1998, the Company expects its
1999 average debt levels to exceed those in 1998 and accordingly, expects an
increase in net interest expense.
Income Tax Provision. The provision for income taxes remained flat at
an expense of $2.4 million for the three months ended June 30, 1998 compared to
an expense of $2.3 million for the three months ended June 30, 1999. The slight
4% decrease in income tax expense for the three months ended June 30, 1999
corresponds to the 4% decline in pretax income for the three months ended June
30, 1999 as compared to the corresponding three months of 1998.
Operating Income and Net Income. Flat natural gas revenues resulting
from a 6% increase in production offset by a 6% decrease in natural gas prices
combined with a decrease in operating expenses of 9% caused operating income to
increase 23% from $8.7 million for the three months ended
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<PAGE> 16
June 30, 1998 to $10.7 million for the three months ended June 30, 1999. Net
income, however, remained relatively unchanged at $5.2 million for the three
months ended June 30, 1999 compared to $5.3 million for the corresponding three
months of 1999 due to higher interest expense during the second quarter of 1999.
Comparison of Six Months Ended June 30, 1998 and 1999
Production. Houston Exploration's production increased 6% from 31,620
MMcfe for the six months ended June 30, 1998 to 33,650 MMcfe for the six months
ended June 30, 1999. The increase in production was primarily attributable to
production added from the acquisition of producing properties at Mustang Island
A-31/32 in November 1998 and the South Louisiana properties acquired in late
April 1998 offset in part by a production decline at the Company's Charco Field.
The production decline at Charco reflects the Company's decision to curtail
capital spending in South Texas during in the fourth quarter of 1998 due to
depressed natural gas prices. Developmental drilling resumed at Charco in the
first quarter of 1999 with two rigs running and during the second quarter, the
Company added a third drilling rig.
Natural Gas and Oil Revenues. Natural gas and oil revenues decreased
10% from $68.0 million for the six months ended June 30, 1998 to $61.5 million
for the six months ended June 30, 1999 as a result of a 15% decrease in average
realized natural gas prices, from $2.15 per Mcf in the six months ended June 30,
1998 to $1.82 per Mcf in the six months ended June 30, 1999 offset in part by
the 6% increase in production.
For the six months ended June 30, 1999, hedging activities had no
effect on natural gas revenues as the Company realized an average gas price of
$1.82 which was equal to the unhedged natural gas price of $1.82 per Mcf. For
the six months ended June 30, 1998, the average realized gas price was $2.15 per
Mcf, which was 103% of the unhedged average gas price of $2.09, resulting in an
increase to natural gas revenues of $1.8 million for the six month period.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 12% from $7.4 million for the six months ended June 30, 1998 to $8.3
million for the six months ended June 30, 1999. On an Mcfe basis, lease
operating expenses increased from $0.24 for the six first months of 1998 to
$0.25 for the first six months of 1999. The increase in lease operating expenses
and lease operating expenses on a per unit basis for the six months ended June
30, 1999 as compared to the corresponding period of 1998 is attributable to the
acquisition of the Mustang Island A-31/32 properties and the South Louisiana
properties both of which have significantly expanded the Company's operations
and, due to the nature of their locations, are more costly to operate on a per
unit basis. Severance tax, which is a function of volume and revenues generated
from onshore production, decreased from $2.5 million for the six months ended
June 30, 1998 to $2.2 million for the six months ended June 30, 1999. On an Mcfe
basis, severance tax decreased from $0.08 per Mcfe for the six month periods
ended June 30, 1998 to $0.06 per Mcfe for the corresponding period of 1999. The
decrease in severance tax expense and the rate per Mcfe reflects the lower
natural gas prices received during the first six months of 1999 as compared to
the first six months of 1998.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense decreased 11% from $39.5 million for the six months ended
June 30, 1998 to $35.0 million for the six months ended June 30, 1999.
Depreciation, depletion and amortization expense per Mcfe decreased 17% from
$1.25 for the six months ended June 30, 1998 to $1.04 for the six months ended
June 30, 1999. The decrease in depreciation, depletion and amortization expense
was a result of a lower depletion rate. The lower depletion rate is primarily a
result of the $130 million ($84.5 million net of tax) writedown in natural gas
and oil properties that was taken in the fourth quarter of 1998 due to weak
natural gas prices; combined with an increase in production and a lower level of
capital spending during first six months of 1999 as compared to the
corresponding period of 1998.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $0.5 million and $2.5 million, for the six months ended June 30, 1998
and 1999, respectively, decreased 42% from $3.3 million for the six months ended
June 30, 1998 to $1.9 million for the six months ended June 30, 1999. Included
in reimbursements received from working interest owners were reimbursements
totaling $2.2 million received from KeySpan pursuant to the KeySpan Joint
Venture (see Note --4 Related Party Transactions). The Company capitalized
general and administrative expenses directly related to oil and gas exploration
and development activities of $3.9 million and $2.5 million, respectively, for
the six months ended
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<PAGE> 17
June 30, 1998 and 1999. The decrease in capitalized general and administrative
expenses is a result of lower aggregate general and administrative expenses
during the first six months of 1999 as compared to the corresponding period of
1998. Aggregate general and administrative expenses are lower during the first
half of 1999 primarily as a result of the Company's efforts to control and
reduce expenses where possible. On an Mcfe basis, general and administrative
expenses decreased 40% from $0.10 for the six months ended June 30, 1998 to
$0.06 for the six months ended June 30, 1999. The lower rate per Mcfe during the
first six months of 1999 reflects a combination of an increase in production, a
reduction in aggregate general and administrative expenses and the effect of the
KeySpan Joint Venture reimbursements.
Interest Expense, Net. Interest expense, net of capitalized interest,
increased from $1.3 million for the six months ended June 30, 1998 to $6.2
million for the six ended June 30, 1999. Capitalized interest increased from
$4.5 million for six months ended June 30, 1998 to $5.6 million for the six
months ended June 30, 1999. The increase in aggregate interest expense was
attributable to higher average debt levels during the first half of 1999. With
the issuance of $100 million of 8 5/8% senior subordinated notes in March 1998
and the implementation of the KeySpan Facility in November 1998, the Company
expects its 1999 average debt levels to exceed those in 1998 and accordingly,
expects an increase in net interest expense.
Income Tax Provision. The provision for income taxes decreased 48% from
an expense of $4.6 million for the first six months of 1998 to an expense of
$2.4 million for the first six months of 1999 due to a decrease in pretax income
in 1999 primarily caused by lower natural gas prices combined with an increase
in interest expense.
Operating Income and Net Income. Despite a 10% decrease in operating
expenses weak natural gas prices caused operating income for the six months
ended June 30, 1999 to decrease by 9% from $15.9 million for the six months
ended June 30, 1998 to $14.5 million for the six months ended June 30, 1999. Net
income decreased 41% from $10.0 million for the six months ended June 30, 1998
to $5.9 million for the six months ended June 30, 1999 and reflects higher
interest expense during the first six months of 1999.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its operations, acquisitions,
capital expenditures and working capital requirements from cash flows from
operations, bank borrowings and, prior to its 1996 initial public offering of
common stock, capital contributions from KeySpan. On March 2, 1998, the Company
issued $100 million of 8 5/8% senior subordinated indebtedness. Net proceeds of
approximately $97 million were used to repay a portion of the outstanding
borrowings under the Company's revolving bank credit facility (the "Credit
Facility"). In November of 1998, the Company established a $150 million
subordinated revolving credit facility with KeySpan (the "KeySpan Facility") and
borrowed $80 million under this facility to fund a portion of the November 1998
acquisition of producing natural gas and oil properties in the Gulf of Mexico
from Chevron U.S.A. Inc.(the "Chevron Acquisition").
As of June 30, 1999, the Company had a working capital deficit of $84.2
million, which includes current maturities of $80 million outstanding under the
KeySpan Facility. As of June 30, 1999, the Company's had $51.6 million of
borrowing capacity available under the Credit Facility and $70.0 million of
borrowing capacity available under the KeySpan Facility. Net cash provided by
operating activities for the six months ended June 30, 1999 was $41.5 million
compared to $54.1 million for the six months ended June 30, 1998. The decrease
in working capital during the first six months of 1999 is primarily due to lower
revenues caused by weak natural gas prices during the first half of 1999. The
Company's cash position was increased during the first six months of 1999 by a
net increase in borrowings under the Credit Facility of $15 million. Funds used
in investing activities consisted of $59.4 million for investments in property
and equipment. As a result of these activities, cash and cash equivalents
decreased $2.7 million from $4.6 million at December 31, 1998 to $1.9 million at
June 30, 1999.
Future Capital Requirements. The Company's initial capital expenditure
budget for 1999 of $90 million was increased by $15 million in July 1999 to a
total of $105 million. The capital expenditure budget includes development costs
associated with recently acquired properties and amounts that are contingent
upon drilling success. The Company does not include property acquisition costs
in its capital expenditure budget as the size and timing of capital requirements
for acquisitions is inherently unpredictable. As of June 30, 1999, the Company
has spent a total of $59.3 million on natural gas and oil properties which
includes $2.2 million for exploration, $44.2 for development, workovers and
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<PAGE> 18
recompletions, and $12.9 for leasehold acquisition costs, which includes
capitalized interest and capitalized general and administrative expenses. The
Company will continue to evaluate its capital spending plans through the year.
No significant abandonment or dismantlement costs are anticipated through 1999.
Actual levels of capital expenditures may vary significantly due to a variety of
factors, including drilling results, natural gas prices, industry conditions and
outlook and future acquisitions of properties. The Company believes cash flows
from operations and borrowings under its Credit Facility will be sufficient to
fund these expenditures. As of June 30, 1999 the Company has not made a
significant acquisition of proved reserves; however, the Company intends to
continue to selectively seek acquisition opportunities for proved reserves with
substantial exploration and development potential both offshore and onshore;
although, there can be no assurance that the Company will be able to identify
and make acquisitions of proved reserves on terms it considers favorable. The
Company expects to fund exploration and development through a combination of
cash flow from operations, borrowings under its Credit Facility, or the issuance
of equity or debt securities.
On May 20, 1999, the Company filed a "shelf" registration with the
Securities and Exchange Commission to offer and sell in one or more offerings up
to a total offering amount of $250 million in securities which could include
shares of the Company's common stock, shares of preferred stock or unsecured
debt securities or, a combination thereof. The Company intends to use the net
proceeds received from the sale of any securities for the repayment of debt and
general corporate purposes, including acquisitions. There can be no assurance
that the Company will be able to consummate any such offering on acceptable
terms.
In March 1999, the Company signed a joint exploration agreement (the
"KeySpan Joint Venture") with a subsidiary of KeySpan, KeySpan Exploration &
Production, LLC, to explore for natural gas and oil over a term of three years
expiring December 31, 2001. The joint venture may be terminated at the option of
either party at the end of the then current calendar year. Houston Exploration
is joint venture manager and operator. Effective January 1, 1999, KeySpan agreed
to commit up to $100 million per calendar year and Houston Exploration agreed to
commit its proportionate share of the funds per calendar year necessary to fund
a joint exploration and development drilling program. Houston Exploration
contributed all of its undeveloped offshore leases as of January 1, 1999 to the
joint venture. KeySpan will receive 45% of Houston Exploration's working
interest in all prospects to be drilled under the program. Revenues will be
shared 55% Houston Exploration and 45% KeySpan. During the term of the KeySpan
Joint Venture, KeySpan pays 100% of actual intangible drilling costs up to a
maximum of $20.7 million per year. All additional intangible drilling costs
incurred during such year are paid 51.75% by KeySpan and 48.25% by Houston
Exploration. In addition, Houston Exploration receives reimbursement of a
portion of its general and administrative costs during the term of the joint
venture. The Company plans to drill approximately eight to ten offshore
exploratory wells under the terms of the KeySpan Joint Venture during 1999. As
of August 11, 1999 and pursuant to the Joint Venture, the Company has drilled
one unsuccessful exploratory well at Mustang Island 859; is in the process of
drilling one exploratory well at Galveston Island 190; and is participating in
the completion of one exploratory well at East Cameron 84.
Capital Structure. The Company has entered into a revolving bank credit
facility with a syndicate of lenders led by Chase Bank of Texas, National
Association. The Credit Facility was amended March 30, 1999 and May 4, 1999 and
provides a maximum commitment of $250 million, subject to borrowing base
limitations. At June 30, 1999, the conforming portion of the borrowing base or
threshold amount was $175 million. The Company has the option to increase the
threshold amount to a borrowing base of $200 million at an incremental interest
rate. Up to $2.0 million of the borrowing base is available for the issuance of
letters of credit to support performance guarantees. The Credit Facility matures
on March 1, 2003 and is unsecured. At June 30, 1999, $148 million was
outstanding under the Credit Facility and $0.4 million was outstanding in letter
of credit obligations. Subsequent to June 30, 1999, the Company borrowed an
additional $4.0 million under the Credit Facility, bringing outstanding
borrowings and extensions of credit to $152.4 million as of August 13, 1999.
Interest is payable on borrowings under the Credit Facility, at the
Company's option, at (i) a fluctuating rate ("Base Rate") equal to the greater
of the Federal Funds rate plus 0.5% or Chase's prime rate, or (ii) a fixed rate
("Fixed Rate") equal to a quoted LIBOR rate plus a variable margin of 0.625% to
1.50%, depending on the amount outstanding under the Credit Facility. Interest
is payable at calendar quarters for Base Rate loans and at the earlier of
maturity or three months from the date of the loan for Fixed Rate loans. In
addition, the Credit Facility requires a commitment fee of: (i) between 0.375%
and 0.500% per annum on the unused portion of the designated borrowing base, and
(ii) 33% of the fee in (i) above on the difference between the lower of the
facility amount or the borrowing base and the designated borrowing base.
The Credit Facility contains covenants of the Company, including
certain restrictions on liens and financial covenants which require the Company
to, among other things, maintain (i) an interest coverage ratio of 2.5 to 1.0 of
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<PAGE> 19
earnings before interest, taxes and depreciation ("EBITDA") to cash interest
and (ii) a total debt to capitalization ratio of less than 60%. For purposes of
the total debt to capitalization ratio, the calculation of total capitalization
excludes the effects of non-cash charges related to the $84.5 million, after
tax, writedown of oil and gas properties incurred by the Company in the fourth
quarter of 1998. In addition, the covenants restrict cash dividends and/or
purchase or redemption of the Company's stock, as well as the encumbering of the
Company's gas and oil assets or the pledging of the assets as collateral. As of
June 30, 1999, the Company was in compliance with all such covenants.
On March 2, 1998, the Company issued $100 million of 8 5/8% Senior
Subordinated Notes (the "Notes") due January 1, 2008. The Notes bear interest at
a rate of 8 5/8% per annum with interest payable semi-annually on January 1 and
July 1. The Notes are redeemable at the option of the Company, in whole or in
part, at any time on or after January 1, 2003 at a price equal to 100% of the
principal amount plus accrued and unpaid interest, if any, plus a specified
premium if the Notes are redeemed prior to January 1, 2006. Notwithstanding the
foregoing, at any time prior to January 1, 2001, the Company may redeem up to
35% of the original aggregate principal amount of the Notes with the net
proceeds of any equity offering, provided that at least 65% of the original
aggregate principal amount of the Notes remains outstanding immediately after
the occurrence of such redemption. Upon the occurrence of a change of control
(as defined), the Company will be required to offer to purchase the Notes at a
purchase price equal to 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest, if any. The Notes are general unsecured obligations
of the Company and rank subordinate in right of payment to all existing and
future senior debt, including the Credit Facility, and will rank senior or pari
passu in right of payment to all existing and future subordinated indebtedness
including the KeySpan Facility.
The KeySpan Facility established by the Company in November 1998
provides a maximum loan commitment of $150 million. The KeySpan Facility ranks,
in right of payment, subordinate to the Credit Facility and pari passu to the
Senior Subordinated Notes. Borrowings are unsecured. Any principal amount that
remains outstanding under the KeySpan Facility at January 1, 2000 will be
converted into common stock of the Company, with the number of shares to be
determined based upon the average of the closing prices of the Company's common
stock, rounded to three decimal places, as reported under "NYSE Composite
Transaction Reports" in the Wall Street Journal during the 20 consecutive
trading days ending three trading days prior to January 1, 2000. Because the
market value represents an average of the Company's common stock over twenty
consecutive trading days, ending three days prior to the maturity date of the
loan, the market price may be higher or lower than the price of the common stock
on the conversion date. Interest accrued under the KeySpan Facility is payable
monthly and borrowings bear interest at LIBOR plus 1.4%. In addition, the
Company incurs a quarterly commitment fee of 0.0125% on the unused portion of
the maximum commitment and has incurred a one time upfront fee of $50,000. As of
June 30, 1999, outstanding borrowings under the facility were $80 million, all
of which were classified as current liabilities. For the three and six month
periods ended June 30, 1999, the Company incurred a total $1.3 million and $2.6
million, respectively in interest and fees to KeySpan. Borrowings were used to
finance a portion of the November 1998 Chevron Acquisition.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Natural Gas Hedging. The Company utilizes derivative commodity
instruments to hedge future sales prices on a portion of its natural gas
production to achieve a more predictable cash flow, as well as to reduce its
exposure to adverse price fluctuations of natural gas. While the use of these
hedging arrangements limits the downside risk of adverse price movements, they
may limit future revenues from favorable price movements. The use of hedging
transactions also involves the risk that the counterparties will be unable to
meet the financial terms of such transactions. Hedging instruments used are
swaps, collars and options, and are generally placed with major financial
institutions that the Company believes are minimal credit risks. The Company
accounts for these transactions as hedging activities and, accordingly, gains or
losses are included in natural gas and oil revenues in the period the hedged
production occurs. Unrealized gains and losses on these contracts, if any, are
deferred and offset against the related settlement amounts.
As of June 30, 1999, the Company had entered into commodity price
hedging contracts with respect to its gas production as listed below. Natural
gas production during the month of June 1999 was 5,564 MMcf (5,662 MMMbtu).
-19-
<PAGE> 20
<TABLE>
<CAPTION>
FIXED PRICE SWAPS COLLARS
----------------------- ------------------------------------
NYMEX NYMEX
VOLUME CONTRACT VOLUME CONTRACT PRICE
PERIOD (MMMBTU) PRICE (MMMBTU) FLOOR CEILING
------------ -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
July 1999 -- -- 4,030 $ 2.115 $ 2.427
August 1999 -- -- 3,100 $ 2.074 $ 2.406
September 1999 -- -- 3,900 $ 2.126 $ 2.474
October 1999 -- -- 4,030 $ 2.138 $ 2.485
November 1999 -- -- 3,750 $ 2.440 $ 2.797
December 1999 -- -- 3,875 $ 2.580 $ 2.975
January 2000 -- -- 930 $ 2.500 $ 3.320
February 2000 -- -- 870 $ 2.400 $ 3.248
March 2000 -- -- 930 $ 2.300 $ 3.000
April 2000 -- -- 900 $ 2.200 $ 2.697
May 2000 -- -- 900 $ 2.200 $ 2.697
June 2000 -- -- 930 $ 2.200 $ 2.697
July 2000 -- -- 900 $ 2.200 $ 2.697
August 2000 -- -- 930 $ 2.200 $ 2.697
September 2000 -- -- 900 $ 2.200 $ 2.697
</TABLE>
As of August 13, 1999, the Company had no commodity hedging contracts
extending beyond September 2000 and had not entered into any basis swaps during
the remainder of 1999 or extending into 2000.
These hedging transactions are settled based upon the average of the
reported settlement prices on the New York Mercantile Exchange (the "NYMEX") for
the last three trading days of a particular contract month (the "settlement
price"). With respect to any particular swap transaction, the counterparty is
required to make a payment to the Company in the event that the settlement price
for any settlement period is less than the swap price for such transaction, and
the Company is required to make payment to the counterparty in the event that
the settlement price for any settlement period is greater than the swap price
for such transaction. For any particular collar transaction, the counterparty is
required to make a payment to the Company if the settlement price for any
settlement period is below the floor price for such transaction, and the Company
is required to make payment to the counterparty if the settlement price for any
settlement period is above the ceiling price for such transaction. For any
particular floor transaction, the counterparty is required to make a payment to
the Company if the settlement price for any settlement period is below the floor
price for such transaction. The Company is not required to make any payment in
connection with a floor transaction. For option contracts, the Company has the
option, but not the obligation, to buy contracts at the strike price up to the
day before the last trading day for that NYMEX contract.
The Company periodically enters into basis swaps (either as part of a
particular hedging transaction or separately) tied to a particular NYMEX-based
transaction to eliminate basis risk. Because substantially all of the Company's
natural gas production is sold under spot contracts that have historically
correlated with the NYMEX price, the Company believes that it has no material
basis risk.
-20-
<PAGE> 21
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
On April 27, 1999, the Company held its annual meeting of shareholders.
All matters brought for a vote before the shareholders as listed in the
Company's proxy statement were approved as follows:
1. The election of the following seven Directors of the Company
to serve until the Company's next annual meeting:
<TABLE>
<CAPTION>
DIRECTOR VOTES FOR VOTES WITHHELD
--------------- ---------- --------------
<S> <C> <C>
James G. Floyd 23,061,705 32,750
Robert B. Catell 23,061,505 32,950
Gordon F. Ahalt 23,086,905 7,550
Russell D. Gordy 23,087,305 7,150
Craig G. Matthews 23,061,505 32,950
James Q. Riordan 23,061,705 32,750
Donald C. Vaughn 23,087,305 7,150
</TABLE>
2. The issuance of up to $150 million of common stock of the
Company to KeySpan Corporation upon conversion of the
principal amount outstanding under the KeySpan Credit Facility
on January 1, 2000.
VOTES FOR VOTES AGAINST ABSTAINED
--------- ------------- ---------
22,049,560 200,275 1,400
3. The appointment of Arthur Andersen LLP as the Company's
independent public accountants for the fiscal year ending
December 31, 1999.
VOTES FOR VOTES AGAINST ABSTAINED
--------- ------------- ---------
23,090,330 1,525 2,600
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a)Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
* 10.1 -- First Amendment and Supplement to Amended and
Restated Credit Agreement dated May 4, 1999 by and
among The Houston Exploration Company and Chase Bank
of Texas, National Association, as agent.
* 27.1 -- Financial Data Schedule.
</TABLE>
- ------------------
* Filed herewith.
(b)Reports on Form 8-K:
None
-21-
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE HOUSTON EXPLORATION COMPANY
By: /s/ James G. Floyd
-------------------------------------------
James G. Floyd
Date: August 13, 1999 President and Chief Executive Officer
By: /s/ James F. Westmoreland
-------------------------------------------
James F. Westmoreland
Date: August 13, 1999 Vice President, Chief Accounting Officer,
Comptroller and Secretary
-22-
<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<S> <C>
* 10.1 -- First Amendment and Supplement to Amended and
Restated Credit Agreement dated May 4, 1999 by and
among The Houston Exploration Company and Chase Bank
of Texas, National Association, as agent.
* 27.1 -- Financial Data Schedule.
</TABLE>
- ------------------
* Filed herewith.
<PAGE> 1
EXHIBIT 10.1
FIRST AMENDMENT TO AMENDED AND
RESTATED CREDIT AGREEMENT
This FIRST AMENDMENT AND SUPPLEMENT TO AMENDED AND RESTATED CREDIT
AGREEMENT (this "First Amendment") executed effective as of the 4th day of May,
1999 (the "Effective Date"), is by and among THE HOUSTON EXPLORATION COMPANY, a
Delaware corporation ("Company"); CHASE BANK OF TEXAS, NATIONAL ASSOCIATION (in
its individual capacity, "Chase"), as agent (in such capacity, "Agent") for each
of the lenders that is a signatory hereto or which becomes a signatory hereto
and to the hereinafter described Credit Agreement as provided in Section 12.06
of the Credit Agreement (individually, together with its successors and assigns,
"Lender" and collectively, "Lenders").
R E C I T A L S
A. The Company, the Agent and the Lenders are parties to that
certain Amended and Restated Credit Agreement dated as of March 30, 1999 (the
"Credit Agreement"), pursuant to which the Lenders agreed to make loans and
issue Letters of Credit to and for the account of the Company.
B. Natexis Banque and The Bank of New York each desire to become
a Lender under the Credit Agreement.
C. In view of the foregoing, the Company, the Agent and the
Lenders hereby agree to amend the Credit Agreement in the particulars
hereinafter provided.
NOW, THEREFORE, in consideration of the premises and other good and
valuable consideration and the mutual benefits, covenants and agreements herein
expressed, the parties hereto now agree as follows:
1. All capitalized terms used in this Amendment and not otherwise
defined herein shall have the meanings ascribed to such terms in the Credit
Agreement.
2. The following terms defined in Section 1.02 of the Credit
Agreement are hereby amended as follows:
a. The term "Agreement" is hereby amended in its entirety to read
as follows:
"Agreement" shall mean this Credit Agreement, as
amended by the First Amendment, and as the same may be further
amended or supplemented from time to time.
b. The term "Commitment" is hereby amended in its entirety to
read as follows:
"Commitment" shall mean, as to each Lender, the
obligation of such Lender to make Loans to the Company or of
the Agent to
<PAGE> 2
issue, reissue, renew or extend Letters of Credit on behalf of
such Lender for the account of the Company, in an aggregate
amount at any one time outstanding equal to the amount set
forth opposite such Lender's name on Schedule I attached to
the First Amendment (as the same may be reduced or increased
from time to time pursuant to Section 2.03 hereof); provided,
however, the total Commitments of all Lenders shall be subject
to the Borrowing Base pursuant to the terms of this Agreement
including, without limitation, Sections 2.01(a) and (b).
3. Section 1.02 of the Credit Agreement is hereby supplemented,
where alphabetically appropriate, with the addition of the following definition:
"First Amendment" shall mean that certain First Amendment to
Amended and Restated Credit Agreement dated effective as of May 4,
1999, between the Company, the Agent and the Lenders.
4. In addition to any and all other applicable conditions
precedent contained in Article VI of the Credit Agreement, this Amendment shall
become binding upon receipt by the Agent of the following documents, each of
which shall be satisfactory to the Agent in form and substance:
a. Counterparts of this Amendment duly executed by the
Company.
b. A Note, duly completed and executed by the Company
and payable to the order of Natexis Banque.
c. A Note, duly completed and executed by the Company
and payable to the order of The Bank of New York.
d. Such other documents as the Agent or its counsel may
reasonably request.
5. The parties hereto hereby acknowledge and agree that, except
as specifically supplemented and amended, changed or modified hereby, the Credit
Agreement shall remain in full force and effect in accordance with its terms.
6. The Company hereby reaffirms that as of the date of this
Amendment, the representations and warranties made by the Company in Article VII
of the Credit Agreement are true and correct on the date hereof as though made
on and as of the date of this Amendment.
7. This Amendment shall be governed by, and construed in
accordance with, the laws of the State of Texas.
8. This Amendment may be executed in two or more counterparts,
and it shall not be necessary that the signatures of all parties hereto be
contained on any one counterpart hereof; each
-2-
<PAGE> 3
counterpart shall be deemed an original, but all of which together shall
constitute one and the same instrument.
9. THE CREDIT AGREEMENT, THIS AMENDMENT, THE NOTE AND THE
SECURITY INSTRUMENTS REPRESENT THE FINAL AGREEMENT BETWEEN THE PARTIES AND MAY
NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR SUBSEQUENT ORAL
AGREEMENTS OF THE PARTIES. THERE ARE NO UNWRITTEN OR ORAL AGREEMENTS BETWEEN THE
PARTIES.
-3-
<PAGE> 4
IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be
duly executed effective as of the date first above written.
COMPANY:
THE HOUSTON EXPLORATION COMPANY
By: /s/ Thomas W. Powers
--------------------
Name: Thomas W. Powers
Title: Senior Vice President
Business Development
Finance and Treasurer
Address: 1100 Louisiana
Suite 2000
Houston, Texas 77002
Telecopier No.: 713/830-6885
Telephone No.: 713/652-2847
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 1]
<PAGE> 5
ADMINISTRATIVE AGENT:
CHASE BANK OF TEXAS, NATIONAL
ASSOCIATION, as Administrative Agent
By: /s/ Russell Johnson
-------------------
Name: Russell Johnson
Title: Vice President
Applicable Lending Office for Base Rate Loans:
Address: 712 Main Street
Houston, Texas 77002
Applicable Lending Office for Fixed Rate Loans:
Address: 712 Main Street
Houston, Texas 77002
Telecopier: 713/216-4117
Telephone: 713/216-5617
Address for Notices:
Loan and Agency Services
The Chase Manhattan Bank
1 Chase Manhattan Plaza, 8th Floor
New York, New York 10081
Telecopier No.: 212/552-7490
Telephone No.: 212/552-7943
Attention: Muniram Appanna
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 2]
<PAGE> 6
BONY:
THE BANK OF NEW YORK
By: /s/ Steven Kalachman
--------------------
Name: Steven Kalachman
Title: Vice President
Applicable Lending Office for Base Rate Loans:
Address: One Wall Street
Energy Division, 19th Floor
New York, New York 10286
Telecopier No.: 212/635-7924
Telephone No.: 212/635-7550
Attention: Kathy D'Elena
Applicable Lending Office for Fixed Rate Loans:
Address: One Wall Street
Energy Division, 19th Floor
New York, New York 10286
Telecopier No.: 212/635-7924
Telephone No.: 212/635-7550
Attention: Kathy D'Elena
Address for Notices:
The Bank of New York
One Wall Street
Energy Division, 19th Floor
New York, NY 10286
Telecopier No.: 212/635-7924
Telephone No.: 212/635-7550
Attention: Kathy D'Elena
with a copy to:
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 3]
<PAGE> 7
Address:
The Bank of New York
One Wall Street
Energy Division, 19th Floor
New York, NY 10286
Telecopier No.: 212/635-7924
Telephone No.: 212/635-7861
Attention: Peter Keller
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 4]
<PAGE> 8
NATEXIS:
NATEXIS BANQUE
By: /s/ John H. Thieroff
---------------------
Name: John H. Thieroff
Title: Vice President
By: /s/ N. Eric Ditges
-------------------
Name: N. Eric Ditges
Title: Assistant Vice President
Applicable Lending Office for Base Rate Loans:
Address: 645 5th Avenue, 20th Floor
New York, New York 10022
Telecopier No.: 212/872-5045
Applicable Lending Office for Fixed Rate Loans:
Address: 645 5th Avenue, 20th Floor
New York, New York 10022
Telecopier No.:212/872-5045
Address for Notices:
Natexis Banque, Southwest
Representative Office
333 Clay Street, Suite 4340
Houston, Texas 77002
Telecopier No.: 713/759-9908
Telephone No.: 713/759-9401
Attention: Tanya McAllister
with a copy to:
Address:
Natexis Banque, New York Branch
645 5th Avenue, 20th Floor
New York, New York 10022
Telecopier No.: 212/872-5045
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 5]
<PAGE> 9
Attention: Joan Rankine
and
Natexis Banque, Southwest
Representative Office
333 Clay Street, Suite 4340
Houston, Texas 77002
Telecopier No.: 713/759-9908
Telephone No.: 713/759-9401
Attention: John H. Thieroff
[First Amendment to Amended and
Restated Credit Agreement
Signature Page 6]
<PAGE> 10
SCHEDULE I
COMMITMENTS
<TABLE>
<CAPTION>
LENDER COMMITMENT
------ ----------
<S> <C>
Chase Bank of Texas, National Association $ 50,000,000
The Bank of Nova Scotia $ 40,000,000
First Union National Bank $ 35,000,000
PNC Bank National Association $ 35,000,000
Comerica Bank - Texas $ 25,000,000
The Bank of New York $ 25,000,000
Natexis Banque $ 25,000,000
------------
TOTAL $235,000,000
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF THE HOUSTON EXPLORATION COMPANY SET FORTH IN THE
COMPANY'S FORM 10-Q FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,927
<SECURITIES> 0
<RECEIVABLES> 27,636
<ALLOWANCES> 0
<INVENTORY> 962
<CURRENT-ASSETS> 31,437
<PP&E> 1,042,337
<DEPRECIATION> 481,466
<TOTAL-ASSETS> 596,293
<CURRENT-LIABILITIES> 115,592
<BONDS> 248,000
0
0
<COMMON> 239
<OTHER-SE> 198,386
<TOTAL-LIABILITY-AND-EQUITY> 596,293
<SALES> 61,541
<TOTAL-REVENUES> 62,002
<CGS> 0
<TOTAL-COSTS> 47,460
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,213
<INCOME-PRETAX> 8,329
<INCOME-TAX> 2,394
<INCOME-CONTINUING> 5,935
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,935
<EPS-BASIC> .25
<EPS-DILUTED> .25
</TABLE>
